Lessons · Accounting · an order at less than the usual price
An order at less than the usual price
With spare capacity, a one-off order is worth taking if its price exceeds the variable cost of filling it, because every pound above that is extra contribution. The usual full cost is not the test.
Hone is a place to practise a career, one idea a day. This is one of its lessons, written out in full and free to read without an account.
In beta. This lesson was written for Hone and has not yet been checked by a qualified accountant. Practice material, not professional advice. What that means.
What it is for
Businesses refuse profitable work constantly on the grounds that the price is below cost, meaning below full absorbed cost. If the factory is idle and the fixed costs are being paid anyway, an order above variable cost leaves the business better off than an empty machine does.
How to think about it
Check there is genuinely spare capacity. Compare the offered price with variable cost per unit. Multiply the difference by the quantity. Then consider what it does to your existing customers, which is a real cost even though it is not on this page.
Worked example
Full cost 22.00 a unit, of which variable is 15.00The 7.00 difference is absorbed fixed cost.
Offer: 2,000 units at 19.00Below full cost, above variable cost.
Extra contribution = (19.00 − 15.00) × 2,000 = 8,000The business is 8,000 better off than refusing.
Provided the capacity is genuinely spareWithout spare capacity the lost contribution from displaced work joins the comparison.
Your turn
Offer 19.00, variable cost 15.00, 2,000 units. Write the line for the extra contribution.
Extra contribution = (19.00 − ) × 2,000 = 8,000
Solve one, graded on the server
The trap
Refusing because the price is below full cost. Full cost includes fixed overhead that is being paid whether the machine runs or not, so it answers a question about the long run while the order is a question about next month.