The following are Carson Company's unit costs of making and selling an item at a volume of 20,000 units per month (which represents the company's capacity):

Manufacturing:

    Direct materials

$2.00

    Direct labor

3.00

    Variable overhead

1.00

    Fixed overhead

2.80

Selling and administrative:

    Variable

5.00

    Fixed

1.20

Assume the company has 100 units left over from last year which have small defects and which will have to be sold at a reduced price as scrap. This would have no effect on the company's other sales. The variable selling and administrative costs would have to be incurred to sell the defective units. What cost is relevant as a guide for setting a minimum price on these defective units?

Question

The following are Carson Company's unit costs of making and selling an item at a volume of 20,000 units per month (which represents the company's capacity):

Manufacturing:

Direct materials

$2.00

Direct labor

3.00

Variable overhead

1.00

Fixed overhead

2.80

Selling and administrative:

Variable

5.00

Fixed

1.20

Assume the company has 100 units left over from last year which have small defects and which will have to be sold at a reduced price as scrap. This would have no effect on the company's other sales. The variable selling and administrative costs would have to be incurred to sell the defective units. What cost is relevant as a guide for setting a minimum price on these defective units?

BlackTom AI · Accepted Answer

Only incremental (future) costs are relevant when setting a minimum selling price for items already produced; sunk manufacturing and fixed costs should be ignored.

1) Relevant knowledge points and concepts
- Sunk costs (past manufacturing costs, fixed overhead) are not relevant because they cannot be changed by the decision.  
- Relevant costs are the additional (incremental) costs that will be incurred if the defective units are sold (i.e., variable costs that change with the sale).  
- If selling the units does not affect other sales or require additional manufacturing, only the variable costs directly caused by the sale matter.

2) Step-by-step reasoning
- The defective units were produced last year; direct materials, direct labor, variable manufacturing overhead and fixed overhead are already spent (sunk). They cannot be recovered or avoided by choosing whether to sell the units now.  
- The statement says the variable selling and administrative costs would have to be incurred to sell the defective units. Those are future, incremental costs caused by the decision to sell.

3) Calculations (intermediate steps)
- Variable selling & administrative cost per unit = $5.00 (given).  
- For 100 units, total incremental cost = 100 units × $5.00/unit = $500.  
- Therefore the minimum price per unit to avoid incurring additional loss (ignoring any desired profit margin) is at least $5.00; total minimum revenue to cover incremental cost = $500.

4) Why the correct answer is correct
- The variable selling & administrative cost is the only cost that will be incurred as a direct consequence of selling the defective units, so it alone guides the minimum acceptable price.

5) Why other options are incorrect
- Including direct materials, direct labor, and variable manufacturing overhead treats sunk production costs as relevant — incorrect.  
- Including fixed overhead is wrong because fixed costs do not change with this decision.  
- Saying “none” or “all costs” ignores the incremental-cost principle and is therefore incorrect.

6) Conclusion
- The variable selling and administrative costs are relevant. This matches the provided correct answer.

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