Accounting
What the Numbers Mean 10e
Demonstration Problem
Chapter 16 – Exercise 11
Accept Special Sales Order?
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
Direct labor
Variable overhead
Fixed overhead
$
6.00 per unit
6.00 per unit
8.00 per unit
$ 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.
Problem Solution
Cost per unit
Direct material
Problem Solution
Cost per unit
Direct material
$ 6.00
Given
Problem Solution
Cost per unit
Direct material
Direct labor
$ 6.00
Problem Solution
Cost per unit
Direct material
Direct labor
$ 6.00
6.00
Given
Problem Solution
Cost per unit
Direct material
Direct labor
Variable overhead
$ 6.00
6.00
Problem Solution
Cost per unit
Direct material
Direct labor
Variable overhead
$ 6.00
6.00
8.00
Given
Problem Solution
Cost per unit
Direct material
Direct labor
Variable overhead
Fixed overhead
$ 6.00
6.00
8.00
Problem Solution
Cost per unit
Direct material
Direct labor
Variable overhead
Fixed overhead
$ 6.00
6.00
8.00
4.00
Fixed overhead per unit =
Total fixed overhead / Current units produced =
$480,000 / 120,000 units
Problem Solution
Cost per unit
Direct material
Direct labor
Variable overhead
Fixed overhead
Cost per unit
$ 6.00
6.00
8.00
4.00
Problem Solution
Cost per unit
Direct material
Direct labor
Variable overhead
Fixed overhead
Cost per unit
$ 6.00
6.00
8.00
4.00
$24.00
Problem Solution
Cost per unit
Direct material
Direct labor
Variable overhead
Fixed overhead
Cost per unit
$ 6.00
6.00
8.00
4.00
$24.00
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.
Problem Solution
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:
The relevant costs of accepting this
special offer are the incremental
costs incurred by producing the
additional 20,000 units.
Problem Solution
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
Direct labor
Variable overhead
Contribution margin per unit
6.00
6.00
8.00
$ 4.00
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 10e
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.
David H. Marshall
Wayne W. McManus
Daniel F. Viele