Differential analysis: Lewis Company
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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 $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.
Required
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?
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Solution Summary
Your tutorial is 337 words and gives a decision and five factors that might give you a reason to reject the order even though the order's incremental revenues cover its incremental costs.
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Lewis Company Special Order
Relevant costs
Relevant cost change with the decision. Variable costs are relevant because they go up with a change in activity. If you accept the special order, the variable costs will be incurred but the fixed costs won't change. So, the variable costs are relevant, except the variable selling which we are told will not be incurred on the order.
Profitability Change With Order
The special order will increase profits by $40 x 1,100 units = $44,000. The $225 sales price is enough to cover the incremental costs of $105 + $60 + $40 = $205 per unit, leaving $40 in profit ...
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