ACC 202 Module 7 Relevant Cost Decision Analysis example

Counting Only What Changes: A Special Order and a Product Line Decision at a Composite Candle Maker

[Student Name]

Southern New Hampshire University

ACC 202: Managerial Accounting

Module Seven Assignment

[Instructor Name]

[Date]

The organization, setting and figures below are a composite written as a model document. No real employer, client, colleague or patient is described.

Counting Only What Changes: A Special Order and a Product Line Decision at a Composite Candle Maker

The Rule

Short-term decisions turn on one question: what will be different if we choose one alternative over another? Costs that will be the same either way, such as rent, and costs already incurred, such as the price of equipment bought last year, cannot affect the choice and should be left out. Only future costs and revenues that differ between the alternatives are relevant (Franklin et al., 2019). Cedarline Candle Co., the project company, faces two decisions that test the rule, and in both its habit of using a full cost per candle, which spreads fixed costs over every unit, points to the wrong answer.

Decision One: The Hotel Special Order

A regional boutique hotel chain offers to buy 750 candles in January, with the hotel's name printed on the label, at 17 dollars each. Cedarline's regular price is 24 dollars, and the owner's first reaction was to decline, because her full cost per candle, variable cost of 13.20 dollars plus fixed costs of 16,130 dollars spread over a typical 2,100 candles, is about 20.88 dollars.

Capacity comes first. January sales are budgeted at 1,700 candles, and the workshop can produce 2,500 a month within its relevant range, so there are 800 candles of idle capacity. The 750-candle order fits without displacing any regular sale or adding fixed cost, so there is no opportunity cost. The relevant costs are therefore only those that change because of the order.

The Incremental Analysis

Table 1 shows the effect of accepting the order.

Table 1

Incremental Analysis of the Hotel Special Order

Note. Composite figures. The order is sold directly by the owner, so no commission is paid.

Why the Full-Cost View Misleads

Accepting the order increases January profit by about 3,090 dollars. The full-cost view suggested a loss of 3.88 dollars a candle, or 2,910 dollars on the order, because it charged each candle 7.68 dollars of fixed cost. But Cedarline will pay its rent, salaries and insurance in January whether it fills the hotel order or not. Charging those costs to the order does not make them go away if the order is refused; it only hides the contribution the order would have made toward paying them. In a slow month with idle capacity, a price above incremental cost is profitable.

What Would Change the Answer

The conclusion depends on idle capacity, and it is worth testing what happens without it. Suppose the hotel asked for 1,200 candles in January instead of 750. The workshop has room for only 800 more candles, so 400 candles of regular January sales would have to be given up or pushed into February. The order itself would contribute 1,200 times the 4.60 dollar margin, less 360 dollars of setups, or 5,160 dollars. But the 400 displaced regular candles would each have contributed 10.80 dollars, an opportunity cost of 4,320 dollars. The net gain would shrink to about 840 dollars, and any customer lost because of the delay would turn it negative. The same order placed in November, when every candle of capacity is needed for holiday sales at full price, would reduce profit outright. This is why the analysis always starts with capacity: an order that is clearly profitable in January can be unprofitable in November with identical costs, because the cost of the capacity it uses has changed.

Decision Two: Dropping the Sea Salt Line

Cedarline's Sea Salt scent sells about 180 candles a month, the fewest of its eight lines. The owner's product profitability report, which divides all fixed costs equally among the eight scents, shows Sea Salt losing money: its contribution margin of 180 times 10.80 dollars, or 1,944 dollars, is less than its one-eighth share of fixed costs, about 2,016 dollars. That suggests dropping it.

The relevant question is which of those fixed costs would disappear. Almost none would. Rent, salaries, equipment depreciation, insurance and software would continue unchanged; only a 45 dollar monthly fragrance storage fee and about 60 dollars of setup time are specific to the line. Dropping Sea Salt would therefore give up 1,944 dollars of contribution margin to save about 105 dollars of avoidable cost, reducing monthly profit by roughly 1,839 dollars, unless its customers switched to other scents. The allocated fixed costs are irrelevant because they are shared costs that will remain; the report that made the line look unprofitable was measuring an accounting allocation, not an economic loss (Datar & Rajan, 2021).

Qualitative Factors

Numbers are necessary but not sufficient. For the hotel order, the owner should consider whether the 17 dollar price could become known to regular retailers who pay 24 dollars; because the candles carry the hotel's label and are sold only in hotel rooms, that risk is low. The order also introduces the brand to hotel guests, a possible source of website sales. She should confirm that the hotel will not expect the same price during the holiday peak, when capacity is full and the opportunity cost of each candle would be the full 10.80 dollar contribution margin. For Sea Salt, the owner should consider its role in the product range: several retailers buy it as part of a coastal collection, and dropping it could cost some of their orders for other scents, which would make the decision even less attractive.

Recommendations

Cedarline should accept the hotel order for January delivery, with a written agreement that the price applies only to orders placed for delivery between January and March, when capacity is idle. It should keep the Sea Salt line, because dropping it would lower profit, and it should revise its product profitability report to show contribution margin by scent first and allocated fixed costs separately, so that the report stops signaling losses that do not exist. More broadly, the owner should replace the single full-cost figure she uses for pricing with the contribution margin view developed in this project, reserving full cost for long-run questions such as whether the business as a whole covers all its costs (Kaplan & Anderson, 2004).

References

Datar, S. M., & Rajan, M. V. (2021). Horngren's cost accounting: A managerial emphasis (17th ed.). Pearson.

Franklin, M., Graybeal, P., & Cooper, D. (2019). Principles of accounting, volume 2: Managerial accounting. OpenStax. https://openstax.org/details/books/principles-managerial-accounting

Kaplan, R. S., & Anderson, S. R. (2004). Time-driven activity-based costing. Harvard Business Review, 82(11), 131-138.