Nichols Company, which manufactures a single product, is operating at full capac

Question

Nichols Company, which manufactures a single product, is operating at full capacity of 20,000 units per month. The follow unit costs relate to the manufacture of this product:

Manufacturing:

     Direct materials                           $2.00

     Direct labor                                    4.00

     Variable overhead                      1.00

     Fixed overhead                           1.80

Selling and administrative:

     Variable                                          3.00

     Fixed                                                1.20

The company has 100 units left over from last year which have small defects and which will have to be sold at a reduced price as scrap. This would have no effect on the company's other sales. The variable selling and administrative costs would have to be incurred to sell the defective units. What cost is relevant as a guide for setting a minimum price on these defective units?

Explanation / Answer

$3 is the relevant cost in this case.

____________

Explanation:

$3 is the amount of variable selling and administrative expense that the company will have to incur in order to sell defective units. Since, these units have already been produced and cannot be sold without incurring additional selling and administrative expenses, we need not consider the costs of direct material, direct labor, variable overhead and fixed overheads in the determination of relevant costs (all of these are sunk costs and have no relevance in relation to defective units as they cannot be avoided even if the units are not sold).

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