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 $245 per unit, direct materials costs will decrease by $15 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 $225 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?
Lewis Company Special Order Decision
Relevant costs for this decision
Relevant costs are those that change with a decision. In this case, the decision is whether to accept the special order. If Lewis accepts the special order, it will cost $105 per unit in material, $60 per unit in labor and $40 per unit in variable overhead. So, these are all relevant. The fixed costs and the selling and administrative costs are not relevant because they won't change with the order.
Impact of special order on the profitability of Lewis Company
The special order will increase profits. The $225 sales price is enough to cover the incremental costs of $105 + $60 + $40 = $205 per unit. So, ...
Your tutorial is 426 words and gives a decision and five other considerations that might give you a reason to reject the order even though the order's incremental revenues cover its incremental costs. See excel for tables and computations.