The Ellis Machine Tool company is considering production for a special order for

Question

The Ellis Machine Tool company is considering production for a special order for 10,000 pieces at $0.65 a piece, which is below the regular price. The current operating level, which is below full capacity of 70,000 pieces, shows the operating results as contained in the following report. The regular production during the year was 50,000 pieces. Factory overhead costs will continue regardless of the decision. Required: What are the relevant costs for that special order? What are the incremental costs for this decision? Prepare a schedule showing the incremental cost. Which costs represent sunk costs? What would be the opportunity cost, if any, associated with the special order?

Explanation / Answer

a) The costs relevant for this special order are the variable costs - Direct Material and Direct Labor as they will change with the level of activity

b) The incremental costs are the variable costs which are direct labor and direct material Incremental Cost Sheet Cost at 50000 pieces Incrmental Cost for additional Total Cost at 60000 units 10000 units A B = A /50000 * 10000 C = A + B Direct Material 20000 4000 24000 Direct Labor 10000 2000 12000 Total 30000 6000 36000 c) The factory overhead costs represent sunk cost , because these costs will continue regardless of the decision d) Selling Price of 10000 units = 0.65 Total Revenue= 10000 * 0.65 = 6500 Cost for 10000 units   = 6000 Hence , contribution = 6500 - 6000 = 500 In the given situation , the oppurtunity cost = $ 500 , because that is contribution which will be foregone if the decision to manufacture and sell additional 10000 units is not taken

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