Managerial Accounting
Differential revenues and costs are those that are incremental to the decision at hand. In general, the company should take on any project that adds to the profitability of the company. There is no indication that this project is mutually exclusive to any other decision. Thus, the financials for this product are as follows:
Herrestad Product C
Volume
Price
Revenue
Direct Materials
Direct Labor
Variable Overhead
Contribution
The variables that are relevant to this decision are what will be incurred as a result of taking on this project. Thus, fixed costs are not relevant. Variable revenue and variable costs are all relevant. Thus, the decision as to whether or not to take on this project resets on the contribution that the project offers to the company. If the project has a positive contribution to fixed costs,...
If the project does not have a positive contribution, then it will reduce the profitability of the company and should therefore be rejected.
The sale of this product therefore does not contribute the profitability at Herrestad. The contribution is negative, meaning that the production of this product, if sold at this price ($180) will lower the profitability of the company.
If the company is only willing to pay $160, the profitability of this product is, naturally, even worse:
Herrestad Product C
Volume
Price
Revenue
160000
Direct Materials
105000
Direct Labor
60000
Variable Overhead
40000
Contribution
-45000
If I was the manager, I would not accept this order. The product has a…
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