We have just received an order from ABC for a batch of 5,000 units of microscopic lenses. However, they are only willing to pay $35 for each and they want it next month. We are currently selling them for $45 each and I don’t see how we can accept the price they have offered.
These are the costs of producing the lenses:
Direct materials: $9
Direct labour: $8
Manufacturing overhead: $10
Total manufacturing cost: $27

The unit manufacturing overhead is based on a $4 variable cost per unit and $120,000 fixed costs. The nonmanufacturing costs, which are all variable, are $8 per unit. ABC has indicated that they will share the nonmanufacturing cost equally with us. Our monthly production capacity is 20,000 units, but we are currently producing 16,000 units. And as I have mentioned already, we are currently selling these lenses for $45 each but they want it at $35 each.”
What is the minimum price that we could charge ABC for its order?

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Originally Posted by Henry789

We have just received an order from ABC for a batch of 5,000 units of microscopic lenses. However, they are only willing to pay $35 for each and they want it next month. We are currently selling them for $45 each and I don't see how we can accept the price they have offered.
These are the costs of producing the lenses:
Direct materials: $9
Direct labour: $8
Manufacturing overhead: $10
Total manufacturing cost: $27

The unit manufacturing overhead is based on a $4 variable cost per unit and $120,000 fixed costs. The nonmanufacturing costs, which are all variable, are $8 per unit. ABC has indicated that they will share the nonmanufacturing cost equally with us. Our monthly production capacity is 20,000 units, but we are currently producing 16,000 units. And as I have mentioned already, we are currently selling these lenses for $45 each but they want it at $35 each.”
What is the minimum price that we could charge ABC for its order?

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Here you see the falacy of absorption costing

Your direct cost of manufacturing is $21 giving a contribution margin of $14 at a selling price of $35. At the moment you have unrecovered overhead of $6 x 4000 units or $24,000. That impacts your bottom line so activity that offsets that is worthwhile. Your minimum price to breakeven on the deal is $25 ie: your net variable costs.

What you have to do here is produce an income statement with both scenarios. Think outside the box as you are currently running under capacity you could produce the units over two months