ACCT20001 Lecture Notes - Lecture 9: Alexon Group, Contribution Margin, Opportunity Cost
5 Jun 2018
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ACCT20001 Cost Management - Tutorial Week 9
1. Bhimani 12.11
Relevant-cost approach to short-run pricing decisions.
a. Analysis of special order:
Sales, 3,000 units × €80 €240,000
Variable costs:
Direct materials, 3,000 units × €35 €105,000
Direct manufacturing labour, 3,000 units × €10 30,000
Variable manufacturing overhead, 3,000 units × €5 15,000
Other variable costs, 3,000 units × €5 15,000
Sales commission 6,000
Total variable costs 171,000
Contribution margin €69,000
Note that the variable costs, except for commissions, are affected by production volume, not sales euros.
If the special order is accepted, operating income would be €1,000,000 + €69,000 = €1,069,000.
b. Whether García-Salve is making a correct decision to quote full price depends on many factors. He is incorrect if
his objective is to increase operating profit in the short term but his decision causes Xucla to look elsewhere for a
supplier, resulting in continued idle capacity. If the offer to supply at full price is rejected, Alexon, in effect, is
willing to invest €69,000 in immediate gains forgone (an opportunity cost) to preserve the long-run selling-price
structure. The decision to take up the special order at a lower price of $80 may cause future price concessions to
customers (if other customers find out about and also demand the $80 price) which will hurt Alexon’s operating
income by more than €69,000. A special (lower) price whenever there is excess capacity may also cause some of
its customers to wait for excess capacity (and price reduction) before placing an order. García-Salve is correct to
stick to a full price quote if he thinks that the combined negative effect of these 2 scenarios (if the lower price of
$80 was accepted) exceed the $69,000 in short term profits that Alexon would gain.
There is also the possibility that Xuclà Mecàniques Fluvià could become a long-term customer if their experience on the
special order is a positive one. If this happens, and Alexon is able to charge XMF the normal price for future order, then
this adds to the benefit of taking up this special order at a price of $80.
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Document Summary
Acct20001 cost management - tutorial week 9: bhimani 12. 11. Relevant-cost approach to short-run pricing decisions: analysis of special order: Note that the variable costs, except for commissions, are affected by production volume, not sales euros. If the special order is accepted, operating income would be 1,000,000 + 69,000 = 1,069,000: whether garc a-salve is making a correct decision to quote full price depends on many factors. He is incorrect if his objective is to increase operating profit in the short term but his decision causes xucla to look elsewhere for a supplier, resulting in continued idle capacity. If the offer to supply at full price is rejected, alexon, in effect, is willing to invest 69,000 in immediate gains forgone (an opportunity cost) to preserve the long-run selling-price structure. A special (lower) price whenever there is excess capacity may also cause some of its customers to wait for excess capacity (and price reduction) before placing an order.
