Demonstration Problem Chapter 16 – Exercise 5 Accept Special Sales Order? Accounting What the Numbers Mean 9e

Problem Definition Circuit Masters, Inc., (CMI) is presently operating at 80% of capacity and manufacturing 120,000 units of a patented electronic component. The cost structure of the component is as follows: Raw materials $ 6.00 per unit Direct labor 6.00 per unit Variable overhead 8.00 per unit Fixed overhead $ 480,000 per year

Problem Definition An Italian firm has offered to purchase 20,000 of the components at a price of $24 per unit, FOB CMI’s plant. The normal selling price is $32 per component. This special order will not affect any of CMI’s “normal” business. Management calculated that the cost per component is $24, so it is reluctant to accept this special order.

Problem Requirements a.Show how management came up with a cost of $24 per unit for this component. b.Evaluate this cost calculation. Explain why it is or is not appropriate. c.Should the offer from the Italian firm be accepted? Why or why not?

Problem Solution a.Show how management came up with a cost of $24 per unit for this component. Calculate the cost per unit of manufacturing 120,000 component parts in the current year.

Cost per unit Direct material Problem Solution

Cost per unit Direct material$ 6.00 Problem Solution Given

Cost per unit Direct material$ 6.00 Direct labor Problem Solution

Cost per unit Direct material$ 6.00 Direct labor 6.00 Problem Solution Given

Cost per unit Direct material$ 6.00 Direct labor 6.00 Variable overhead Problem Solution

Cost per unit Direct material$ 6.00 Direct labor 6.00 Variable overhead 8.00 Problem Solution Given

Cost per unit Direct material$ 6.00 Direct labor 6.00 Variable overhead 8.00 Fixed overhead Problem Solution

Cost per unit Direct material$ 6.00 Direct labor 6.00 Variable overhead 8.00 Fixed overhead 4.00 Problem Solution Fixed overhead per unit = Total fixed overhead / Current units produced = $480,000 / 120,000 units

Cost per unit Direct material$ 6.00 Direct labor 6.00 Variable overhead 8.00 Fixed overhead 4.00 Cost per unit Problem Solution

Cost per unit Direct material$ 6.00 Direct labor 6.00 Variable overhead 8.00 Fixed overhead 4.00 Cost per unit $24.00 Problem Solution

Cost per unit Direct material$ 6.00 Direct labor 6.00 Variable overhead 8.00 Fixed overhead 4.00 Cost per unit $24.00 Problem Solution Solution: Cost per unit = $24.00

Problem Requirements a.Show how management came up with a cost of $24 per unit for this component. b.Evaluate this cost calculation. Explain why it is or is not appropriate. c.Should the offer from the Italian firm be accepted? Why or why not?

Problem Solution The calculation includes an inappropriate unitization of fixed costs for decision making purposes. Unless the additional production of 20,000 units results in a movement to a new relevant range, total fixed expenses will not change.

Problem Requirements a.Show how management came up with a cost of $24 per unit for this component. b.Evaluate this cost calculation. Explain why it is or is not appropriate. c.Should the offer from the Italian firm be accepted? Why or why not?

Problem Solution c.Should the offer from the Italian firm be accepted? Why or why not? Analyze the relevant costs associated with producing an additional 20,000 units by accepting the special offer of $24 per unit.

Relevant Cost Analysis Selling price Problem Solution

Relevant Cost Analysis Selling price $24.00 Problem Solution

Relevant Cost Analysis Selling price $24.00 Less relevant costs: Problem Solution

Relevant Cost Analysis Selling price $24.00 Less relevant costs: Problem Solution The relevant costs of accepting this special offer are the incremental costs incurred by producing the additional 20,000 units.

Relevant Cost Analysis Selling price $24.00 Less relevant costs: Direct material Problem Solution

Relevant Cost Analysis Selling price $24.00 Less relevant costs: Direct material 6.00 Problem Solution

Relevant Cost Analysis Selling price $24.00 Less relevant costs: Direct material 6.00 Direct labor Problem Solution

Relevant Cost Analysis Selling price $24.00 Less relevant costs: Direct material 6.00 Direct labor 6.00 Problem Solution

Relevant Cost Analysis Selling price $24.00 Less relevant costs: Direct material 6.00 Direct labor 6.00 Variable overhead Problem Solution

Relevant Cost Analysis Selling price $24.00 Less relevant costs: Direct material 6.00 Direct labor 6.00 Variable overhead 8.00 Problem Solution

Relevant Cost Analysis Selling price $24.00 Less relevant costs: Direct material 6.00 Direct labor 6.00 Variable overhead 8.00 Contribution margin per unit Problem Solution

Relevant Cost Analysis Selling price $24.00 Less relevant costs: Direct material 6.00 Direct labor 6.00 Variable overhead 8.00 Contribution margin per unit$ 4.00 Problem Solution

Relevant Cost Analysis Selling price $24.00 Less relevant costs: Direct material 6.00 Direct labor 6.00 Variable overhead 8.00 Contribution margin per unit$ 4.00 Problem Solution Note: Fixed costs are not relevant to this decision!

Problem Solution The offer should be accepted because it would generate contribution of $4 per unit or $80,000 total contribution. Since CMI was operating with idle capacity, and unless a more profitable opportunity were available for the use of the idle capacity, accepting the offer would increase profits by $80,000.

Accounting What the Numbers Mean 9e David H. Marshall Wayne W. McManus Daniel F. Viele You should now have a better understanding of special pricing decisions. Remember that there is a demonstration problem for each chapter that is here for your learning benefit.