Differential Analysis: Special Order Pricing
Managers must often decide between two or more alternatives. Differential analysis is used in decision making. When using differential analysis, it is important to only include those amounts that are different between the alternatives. Differential cost is subtracted from differential revenue to determine differential income/loss.
When calculating differential cost, sunk costs are:
SelectFixed costsIrrelevant costsRelevant costsVariable costsCorrect 1 of Item 1
For example, a manufacturing company may receive an offer to sell a product at a price less than the normal price. The decision to accept or reject this offer is often called special order pricing and uses differential analysis to assist in the decision-making process. Fixed factory overhead must be carefully investigated when making a special order decision. In many cases, the special order does not increase fixed factory overhead and is not relevant. (Click herefor further explanation of fixed factory overhead and special order pricing.)
Differential analysis is only one step in deciding to accept or reject the special offer. Management must also take into consideration nonquantitative data. If the company accepts the offer, will the additional units of product on the market affect the market price of the product? If other customers find out that the product is being sold for less than the normal market price, will they become dissatisfied and stop buying from the company? These nonquantitative issues will influence the success or failure of a make-or-buy decision.
APPLY THE CONCEPTS: Calculate differential costs in a special order decision
Galaxy Corporation currently produces and sells 15,000 soccer balls per month at a price of $15. All sales are made in the United States. Its factory is capable of producing 20,000 soccer balls per month.
A European retail store has recently contacted Galaxy Corporation and offered to buy 4,000 soccer balls at $8 each. If the offer is accepted, the sale is not expected to have any effect on the current level of sales or the current selling price in the United States.
The accounting department has provided the cost data per soccer ball. Direct materials $2.00 Direct labor 3.25 Variable factory overhead 1.75 Shipping 1.50 Packaging 0.25 Selling commission 1.00 Fixed factory overhead 2.25 Total cost $12.00
Galaxy Corporation has excess manufacturing capacity to produce the components without incurring additional fixed factory overhead. Since the European retailer has approached Galaxy Corporation about the sale, no selling commission will be paid on this sale. What per-unit manufacturing cost should be used in determining whether Coname Corporation should accept the special order?
Select$12$8.75$11$7Correct 1 of Item 2
APPLY THE CONCEPTS: Calculate differential income in a special order decision
Complete the table to compare the per-unit cost analysis for the special order. Enter all amounts as positive numbers except for a net loss. If an amount is zero, enter “0”. The cost data for the special order is given below: Direct materials $2.00 Direct labor 3.25 Variable factory overhead 1.75 Shipping 1.50 Packaging 0.25 Selling commission 1.00 Fixed factory overhead 2.25 Total cost $12.00 Alternatives Differential Accept Reject Effect on Income (Complete all columns on a per-unit basis.) Revenues $ $ $ Direct materials Direct labor Variable factory overhead Shipping Packaging Selling commission Fixed factory overhead Income/loss $ $ $
Based on the analysis, Galaxy Corporation should SelectrejectacceptCorrect 28 of Item 3 the special order. If the order is accepted, its overall income will SelectdecreaseincreaseCorrect 29 of Item 3 by $.