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Differential analysis involves knowing which costs are relevant, i.e. future costs that vary among alternatives. It is important to know what information to use and not just how to execute the analysis.

Lewis Company (accounting information provided in the prior module) receives an offer to make a new product, called C, for a new customer. The customer wants to buy 1,100 units. Product C has the same cost structure as product B with three exceptions. The new customer is only willing to pay $260 per unit, direct materials costs will decrease by $10 per unit and Lewis does not have to incur any variable selling and administrative expenses.

  • Make a list of the expenses and amounts that are relevant for this decision. How much with the sale of this product contribute to the profitability of Lewis?
  • What if the company only pays $210 per unit? How does this change the contribution towards profitability?
  • If you were the manager, would you accept this order? What considerations, other than financial would enter into your decision? 


Product information

Prod B

Beginning inventory

0

Units produced

10,000

Units sold

9,000

 

 

Selling price per unit

$300

Variable costs per unit

 

Direct material

120

Direct labor

60

Variable overhead

40

Variable selling and administrative

10

 

 

Fixed costs

 

Fixed manufacturing overhead

250,000

Fixed selling and administrative

100,000

 

Lewis Company

Absorption Income Statement

For the period ending Dec. 31, 2015

Sales

$2,700,000

Cost of goods sold

2,205,000

Gross profit (margin)

$495,000

Selling and administrative expenses

190,000

Net income

$305,000



a

 

Relevant

 

expenses

 

Direct

 

material

 

Direct labor

 

Variable

 

overhead

 

Total

 

Profit per unit

 

Increase in profit per unit

 

$ 110

 

$ 60 $ 40 $ 210 Total

 

$

 

$ 121,000

 

66,000 $

 

$ 44,000

 

231,000 $

 

$ 50

 

55,000...

 


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