Question

New Customer Proposal II

Davidson Company produces one product and has the capacity to make 50,000 units per month. The cost that is associated with producing 40,000 units is shown below.

Account	Per Unit	Cost at 40,000 units
Direct Materials	$ 10.00	$400,000.00
Direct Labor	$ 15.00	$600,000.00
Variable Manufacturing overhead	$ 5.00	$200,000.00
Fixed Manufacturing overhead	$ 12.50	$500,000.00
Variable selling and administrative expenses	$ 3.00	$120,000.00
Fixed selling and administrative expenses	$ 8.00	$320,000.00
Totals	$ 53.50	$2,140,000.00

The selling price per unit is $80. The Davidson company was contacted by a perspective customer that is interested in purchasing 10,000 units for $50. Management is considering this offer and in the meeting about this new prospect you (the management accountant) stated that the fixed cost will remain the same, but the variable cost will increase along with $5 shipping expense due to the customer international location. Management has asked you to determine if they should accept or reject the new customer proposal and what nonmonetary factors should be considered.

Answer 1

Answer

The offer should be accepted because there is an incremental gain of $ 120,000.

Workings:

Particulars	Total (10,000 units)	Per unit
Sales	$           500,000.00	$   50.00
Less: Costs
Direct Materials	$           100,000.00	$   10.00
Direct Labor	$           150,000.00	$   15.00
Variable Manufacturing overhead	$             50,000.00	$     5.00
Fixed Manufacturing overhead	$                            -	$          -
Variable selling and administrative expenses	$             30,000.00	$     3.00
Fixed selling and administrative expenses	$                            -	$          -
Additional Selling Cost	$             50,000.00	$     5.00
Total Costs	$           380,000.00	$   38.00
Net Profit	$           120,000.00	$   12.00

Non Monetary Factors

• As the price for the new customer is reduced, the quality of that product must not get affected.
• Further, as the customer is offered the same product at $ 50 instead of regular price of $ 80, this might have an impact on normal customers (as they may want cheaper products too)

in case of any doubt, please comment.