Integrated Masters, Inc. (IMI), is presently operating at 80% of capacity and manufacturing 121,000 units of a patented electronic component. The cost structure of the component is as follows:

Raw materials $ 6.10 per unit
Direct labor 6.10 per unit
Variable overhead 8.10 per unit
Fixed overhead $ 363,000 per year

An Italian firm has offered to purchase 20,100 of the components at a price of $24.5 per unit, FOB IMI's plant. The normal selling price is $32.3 per component. This special order will not affect any of IMI's "normal" business. Management calculated that the cost per component is $23.3, so it is reluctant to accept this special order.

Required:

a. Calculate the fixed overhead per unit? (Round your answer to 2 decimal places.)

b. Is the cost calculation appropriate?

Yes
No
c. Should the offer from the Italian firm be accepted?

The offer should be accepted.
The offer should not be accepted.

a          

Fixed overhead per unit = 363000/121000= $3 per unit      

b          

NO, the cost calculation is not appropriate, as fixed overhead per unit should not be included in cost calculation.

c          

Total relevant cost = 6.1+6.1+8.1 = $20.3        

The offer should be accepted as relevant cost is less than order price of $24.5

A) fixed overhead cost without accepting the Italian special order = $363,000 / 121,000 units = $3 per unit

B) No, it is not appropriate. In this case, we must determine the differential income between rejecting and accepting the Italian special order, therefore you cannot simply determine the cost of manufacturing one unit by adding regular costs. Since fixed costs are not increased by the Italian special order, we must determine how total gross profit is affected.

As you can see on the next part, this special order would increase the company's gross profit by $82,420, but management miscalculated a $24,120 increase only.

C) we must determine if accepting this special order will increase significantly the company's gross profit:

                            gross profit without              gross profit with

                            special order:                        special order:

revenue                $3,908,300                           $4,400,750

direct labor           ($737,100)                              ($860,710)

direct mat.            ($737,100)                              ($860,710)

variable over.       ($980,100)                            ($1,142,910)

fixed costs           ($363,000)                            ($363,000)      

gross income       $1,091,000                             $1,173,420

if the company accepts the special order, gross income will increase by $82,420, which represents a 7.6% increase.

So the company should accept it.