EXERCISE 6-9. Problems Associated with Cost Allocation [lo 2] Custom Metal Works

Question

EXERCISE 6-9. Problems Associated with Cost Allocation [lo 2] Custom Metal Works received an offer from a big-box retail company to purchase 3,000 metal outdoor tables for $220 each. Custom Metal Works accountants determine that the following costs apply to the tables:

Of the $70 of overhead, $14 is variable and $56 relates to fixed costs. The $56 of fixed overhead is allocated as $1.12 per direct labor dollar.

a. What will be the real effect on profit if the order is accepted?

b. Explain why managers who focus on reported cost per unit may be inclined to turn down the order.

Please show all steps. Thank you.

Explanation / Answer

Metal Outdoor Tables Direct Material 125.00 Direct Labor 50.00 MOH: Variable 14.00 Fixed 56.00 (50*1.12) Total Cost 245.00 A Relevant Cost for the Order: Metal Outdoor Tables Direct Material 125.00 Direct Labor 50.00 MOH: Variable 14.00 Total Cost 189.00 Offer Price 220.00 Benefit PU 31.00 Order Qty 3,000 Total Benefit 93,000 Profits will increase by 93000 if we accept the order.(Real impact) Note: Fixed Cost is a Sunk Cost, it will continue to occur if we accept the order or not. B Managers who focus on Reported Cost PU i.e 245/- Should have rejected the proposal, because as per them They will see the following: Total Cost 245.00 Offer Price 220.00 Loss PU -25.00 They do not consider the fact that Fixed OH cost is a Sunk cost, it will continue to occur whether we accept the order or not. This decision of them impact the company's profits and beneficial proposals

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