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ACCA Strategic Professional · Strategic Business Leader · Cost and management accounting

Halden Foods has spare capacity and receives a one-off order for 5,000 units at $14 per unit. Full absorption cost is $18 per unit, made up of materials $6, labour $4, variable overhead $2 and fixed overhead $6. Labour is a paid-for permanent workforce with no alternative use, and fixed costs will not change. Which approach to the decision is correct, and what is the effect on profit of accepting the order?

Accept the order, adding $30,000 to profit. Only materials of $6 and variable overhead of $2 are relevant, so incremental cost is $8 per unit against a $14 price. Labour is already paid for and fixed overhead does not change, so neither affects the decision.

  1. AReject, because the price is below full cost, losing $20,000
  2. BAccept, because relevant cost is $8 per unit, adding $30,000 to profitCorrect
  3. CAccept, because relevant cost is $12 per unit, adding $10,000 to profit
  4. DAccept, because relevant cost is $14 per unit, adding nothing to profit

Explanation

Relevant costs are materials $6 and variable overhead $2 = $8 per unit, as labour is already paid for and fixed overhead is unchanged. Contribution is $14 - $8 = $6 per unit, so 5,000 x $6 = $30,000. Including labour gives $12 and $10,000, which wrongly treats a sunk cost as relevant.

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