Chapter 11, Problem 5F15

Cane Company manufactures two products called A1pia d Beta that sell for $120 and $80, respectively. Each product uses only one type of raw material that costs $6 per pound. The company has the capacity produce 100,000 units of each product. Its average cost per unit for each product at this level of activity are given below:

The company considers its traceable fixed manufacturing overhead to be avoidable, whereas its common fixed expenses are unavoidable and have been allocated to products based on sales dollars.
Required:
(Answer each question independently unless instructed otherwise.)
Assume that Cane expects to produce and sell 95,000 Alphas dining the current vex. One of Cane’s sales representatives has found a new customer who is willing to buy 10,000 additional Alphas for a price of $80 per emit; however pursuing this opportunity will decrease Alpha sales to regular customers by 5,000 units. What is the financial advantage (disadvantage) of accepting the new customer’s order?

To determine

Concept Introduction:

Financial advantage (disadvantage): Financial advantage (disadvantage) refers to the incremental profit or loss, a company will earn in situations like acceptance of a special order, dropping of a business line, etc.

It is calculated by only considering the relevant costs. The incremental revenues and incremental costs are taken together to calculate financial advantage or disadvantage. Financial advantage refers to incremental net operating income and financial disadvantage refers to incremental net operating loss.

To calculate:

Financial advantage (disadvantage) of accepting the new customer’s order for Alpha

Answer to Problem 5F15

Solution:

The financial disadvantage of accepting the new customer’s order for Alpha is $ 145,000.

Explanation of Solution

The incremental net operating profit (loss) is the difference between incremental revenues and costs.

Alpha - Incremental Net operating profit (Loss) (in $)
Incremental Revenue ( $ 80/ unit X 10,000 additional units)		800,000
Less:
Incremental costs -
Direct material ( $ 30/ units X 10,000 additional units)	300,000
Direct labor ( $ 20/ unit X 10,000 additional units)	200,000
Variable manufacturing overhead ( $ 7/ unit X 10,000 additional units)	70,000
Variable selling expenses ( $ 12/ unit X 10,000 additional units)	120,000
Total incremental costs		(690,000)
Less: Foregone Sales revenue due to acceptance of order ( $ 120 per unit X 5,000 units )		(600,000)
Add: Decrease in costs related to the sales forgone		345,000
Alpha - Incremental net operating income (Loss)		(145,000)

Given, the information for the product Alpha −

• Additional sales units = 10,000 units
• Selling price per unit = $ 80 per unit
• Direct Material per unit = $ 30 per unit
• Direct Labor per unit = $ 20 per unit
• Variable manufacturing overhead per unit = $ 7 per unit
• Variable selling expenses per unit = $ 12 per unit
• Foregone number of units due to acceptance of offer = 5,000 units
• Sales price per unit for regular sales = $ 120 per unit

Calculations:

1. Incremental revenue

  $\begin{array}{l}Incrementalrevenue=\$\text{ 80 }perunitX\text{ 10},000units\hfill \\ Incrementalrevenue=\$\text{ 800},000\hfill \end{array}$

2. Incremental costs

  $\begin{array}{l}Directmaterial=\$\text{ 30 }perunitX\text{ 10},000units\hfill \\ Directmaterial=\$\text{ 30}0,000\hfill \end{array}$

  $\begin{array}{l}Directlabor=\$\text{ 20 }perunitX10,000units\hfill \\ Directlabor=\$\text{ 200},000\hfill \end{array}$

  $\begin{array}{l}Variablemanufacturingoverheadperunit=\$\text{ 7 }perunitX\text{ 10},000units\hfill \\ Variablemanufacturingoverheadperunit=\$\text{ 70},000\hfill \end{array}$

  $\begin{array}{l}Variablesellingexpensesperunit=\$\text{ 12 }perunitX\text{ 10},000units\hfill \\ Variablesellingexpensesperunit=\$\text{ 12}0,000\hfill \end{array}$

  $\begin{array}{l}Totalincrementalcosts=Directmaterial+Directlabor+Variablemanufacturingoverhead\\ +Variablesellingexpenses\end{array}$

  $\begin{array}{l}Totalincrementalcosts=\$\text{ 300},000+\$\text{ 200,000 }+\$\text{ 70},000+\$\text{ 120},000\hfill \\ Totalincrementalcosts=\$\text{ 690},000\hfill \end{array}$

3. Foregone Sales revenue due to acceptance of offer

  $\begin{array}{l}ForegoneSalesrevenueduetoacceptanceofoffer=\$120perunitX5,000units\hfill \\ ForegoneSalesrevenueduetoacceptanceofoffer=\$600,000\hfill \end{array}$

4. Decrease in cost due to sales forgone −

  $\begin{array}{l}\begin{array}{l}Decreaseincostduetosalesforgone=\left(\begin{array}{l}Directmaterialperunit+DirectLaborperunit\\ +Variablemanufacturing+Variablesellingexpenses\end{array}\right)\\ XSalesforgoneUnits\end{array}\hfill \\ Decreaseincostduetosalesforgone=\left(\$30+\$20+\$7+\$12\right)X5,000units\hfill \\ Decreaseincostduetosalesforgone=\$345,0000\hfill \end{array}$

5. Incremental Net operating income (Loss)

  $\begin{array}{l}\begin{array}{l}IncrementalNetoperatingincome(Loss)=Incrementalrevenue-Incrementalcosts\\ -ForegoneSalesrevenueduetoacceptanceofoffer\\ +Decreasein\cos tduetosalesforgone\end{array}\hfill \\ IncrementalNetoperatingincome(Loss)=\$\text{ 800},000-\$\text{ 690},000-\$600,000+\$345,000\hfill \\ IncrementalNetoperatingincome(Loss)=\text{ (\$ 145,000)}\hfill \end{array}$

Conclusion

Thus, the financial disadvantage of accepting the new customer’s order for Alpha = $ 145,000.