Relevant-cost approach to short-run pricing decisions Alexon SL is an electronics business with eight product lines. Profit data for one of the products (XT-107) for the month just ended (June 2018) are as follows: Sales, 200 000 units at average price of €100 Variable costs Direct materials at €35 per unit Direct manufacturing labor at €10 per unit €7 000 000 2 000 000 €20 000 000 Variable manufacturing overhead at €5 per unit 1 000 000 Sales commissions at 15% of sales 3 000 000 Other variable costs at €5 per unit Total variable costs 1 000 000 14 000 000 Contribution margin 6 000 000 Fixed costs Operating profit 5 000 000 €1 000 000 Xuclà Mecàniques Fluvià SA, an instruments company, has a problem with its preferred supplier of XT-107 component products. This supplier has had a three-week strike and will not be able to supply Xuclà 3000 units next month. Xuclà approaches the sales representative of Alexon SL, Angela Zamora, about providing 3000 units of XT-107 at a price of €80 per unit. Zamora informs the XT-107 product manager, Francisco García-Salve, that she would accept a flat commission of €6000 rather than the usual 15% if this special order were accepted. Alexon has the capacity to produce 300,000 units of XT-107 each month, but demand has not exceeded 200 000 units in any month in the last year.
Cost-Volume-Profit Analysis
Cost Volume Profit (CVP) analysis is a cost accounting method that analyses the effect of fluctuating cost and volume on the operating profit. Also known as break-even analysis, CVP determines the break-even point for varying volumes of sales and cost structures. This information helps the managers make economic decisions on a short-term basis. CVP analysis is based on many assumptions. Sales price, variable costs, and fixed costs per unit are assumed to be constant. The analysis also assumes that all units produced are sold and costs get impacted due to changes in activities. All costs incurred by the company like administrative, manufacturing, and selling costs are identified as either fixed or variable.
Marginal Costing
Marginal cost is defined as the change in the total cost which takes place when one additional unit of a product is manufactured. The marginal cost is influenced only by the variations which generally occur in the variable costs because the fixed costs remain the same irrespective of the output produced. The concept of marginal cost is used for product pricing when the customers want the lowest possible price for a certain number of orders. There is no accounting entry for marginal cost and it is only used by the management for taking effective decisions.
Relevant-cost approach to short-run pricing decisions
Alexon SL is an
month just ended (June 2018) are as follows:
Sales, 200 000 units at average price of €100
Variable costs
Direct materials at €35 per unit
Direct manufacturing labor at €10 per unit
€7 000 000
2 000 000
€20 000 000
Variable manufacturing
Sales commissions at 15% of sales 3 000 000
Other variable costs at €5 per unit
Total variable costs 1 000 000 14 000 000
Contribution margin 6 000 000
Fixed costs
Operating profit
5 000 000
€1 000 000
Xuclà Mecàniques Fluvià SA, an instruments company, has a problem with its preferred supplier
of XT-107 component products. This supplier has had a three-week strike and will not be able to
supply Xuclà 3000 units next month. Xuclà approaches the sales representative of Alexon SL,
Angela Zamora, about providing 3000 units of XT-107 at a price of €80 per unit. Zamora
informs the XT-107 product manager, Francisco García-Salve, that she would accept a flat
commission of €6000 rather than the usual 15% if this special order were accepted. Alexon has
the capacity to produce 300,000 units of XT-107 each month, but demand has not exceeded 200
000 units in any month in the last year.
Required
1 If the 3000-unit order from Xuclà is accepted, what will be the e ect on monthly operating
profit? (Assume the same cost structure as occurred in June 2018.)
2 Francisco ponders whether to accept the 3000-unit special order. He is afraid of the precedent
that might be set by cutting the price. He says, ‘The price is below our full cost of €95 per unit.
I think we should quote a full price, or Xuclà will expect favoured treatment again and again
if we continue to do business with them.’ Do you agree with Francisco? Explain.
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