Relevant Cost and Special Pricing Model

Relevant Costs/Revenues:[pic 1]

1. Costs:[pic 2]

• Costs to be incurred because of the proposal; and
• Benefits to be lost (opportunity cost) because of the proposal.

1. Revenues:

• Revenues to be gained because of the proposal; and
• Costs to be avoided because of the proposal.

Special Order Pricing Decision:

The lowest price that a firm should be ready to accept in case of a special order situation depends on the following 2 factors:

• If idle capacity exists; or
• If idle capacity does not exist.

Lowest price in first case = A+B:

1. VC of manufacturing the special order item;
2. Any additional fixed cost incurred/ no. of units of special order.

Lowest price in second case = A+B+C:

1. VC of manufacturing the special order item;
2. Any additional fixed cost incurred/ no. of units of special order;
3. Lost contribution from lost sales of existing units.

Decision Criteria: If the price being offered for the special order units is > the lowest acceptable price, as calculated above, the order may be accepted subject to strategic considerations.

Chapter 8

Answer Key for Self-Test Questions

S8.1        a        • variable costs (November) = ($10,000 ÷ 5,000 units) = $2/unit

• variable costs (December) = 10,000 units × $2/unit = $20,000

• fixed costs (December) = fixed costs (November) = $30,000

• mixed costs (December) = total costs $75,000 – variable costs $20,000 – fixed costs $30,000 = $25,000

S8.2        a        • variable cost per unit = change in total costs / change in activity = ($345,000 – $185,000) / (15,000 – 7,000) = $20 per unit

S8.3        c        direct materials (40 × $2.50) + direct labour [(7 × $12) + (4 × $7)] + variable production overhead [(7 + 4) × $5]