Question

The following are Silver Corporation's unit costs of making and selling an item at a volume of 8,000 units per month (which represents the company's capacity):
Manufacturing:

Direct materials $4
Direct labor $5
Variable overhead $2
Fixed overhead $8

Selling and administrative:
Variable $1
Fixed $6

Present sales amount to 7,000 units per month. An order has been received from a customer in a foreign market for 1,000 units. The order would not affect regular sales. Total fixed costs, both manufacturing and selling and administrative, would not be affected by this order. The variable selling and administrative costs would have to be incurred for this special order as well as all other sales. Assume that direct labor is a variable cost. Assume the company has 50 units left over from last year which have small defects and which will have to be sold at a reduced price for scrap. The sale of these defective units will have no effect on the company's other sales. Which of the following costs is relevant in this decision?

a. $19 unit product cost
b. $11 variable manufacturing cost
c. $26 full cost
d. $1 variable selling and administrative cost

Answer 1

Answer:

$19 unit product cost - Not relevant

b. $11 variable manufacturing cost - Relevant

c. $26 full cost - Not relevant

d. $1 variable selling and administrative cost- Relevant

Explanation:

A relevant cost is an incremental cost future cash cost which is incurred as a direct consequence of a decision. Note that for any of the cost to be considered as relevant for the special order, such cost must satisfy all of the following criteria:

Future, cash flow and a rises a direct consequence.

So we shall apply these criteria to the question

a. $19 unit product cost : Not relevant because it includes an item of fixed cost of $2 which would incurred either way

$11 variable manufacturing cost: Relevant because it includes all the variable costs which would have to be incurred if the order is accepted

$26 full cost Not relevant because it includes items of fixed manufacturing and fixed selling costs of $14  i.e (8+6) which would incurred either way.

$1 variable selling and administrative cost : Relevant because it would be incurred if the special order is accepted

$19 unit product cost - Not relevant

b. $11 variable manufacturing cost - Relevant

c. $26 full cost - Not relevant

d. $1 variable selling and administrative cost- Relevant