3) Jeff\'s Widget Corporation produces and sells a part used in the production o

Question

3) Jeff's Widget Corporation produces and sells a part used in the production of bicycles. The unit costs associated with this part are as follows:

Direct materials $ 0.14

Direct labor 0.30

Variable manufacturing overhead 0.20

Fixed manufacturing overhead 0.05

Total cost $0.69

Saturn Company has approached Jeff's Widget Corporation with an offer to purchase 20,000 units of this part at a price of $.80. Accepting this special sales order will put idle manufacturing capacity to use and will not affect regular sales. Total fixed costs will not change.

Determine whether or not the special order should be accepted. Justify your conclusion.

Explanation / Answer

Fixed costs are sunk costs till they are within capacity limits. A special order will not affect the fixed costs and will be taken up only if the variable costs are covered in the price being offered

Variable costs of production

= Direct materials + Direct labor + Variable manufacturing overhead

= $0.14 + $0.30 + $0.20

= $0.64 per unit

Contribution per unit from special order

= Selling price – Variable costs

= $0.80 - $0.64

= $0.16 per unit

Total contribution

= Number of units x Contribution per unit

= 20,000 x $0.16

= $3,200

The special order should be accepted as this will increase net income by $3,200 as the fixed costs will remain the same

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