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Loxwood Co is considering whether to sell its product, the tom, or process it further to make a different product, the tig. It has already incurred processing costs of $3 per unit in relation to the tom. If it sells the tom, it will sell 60,000 units at $8 per unit. Each unit of the tig requires 3 units of the tom and Loxwood Co would expect to sell 20,000 units of the tig. Further variable costs associated with the tig would be $6 per unit and further fixed costs would be $150,000. The selling price of the tig would be $40 per unit.
it is not obvious whether the fixed cost is incremental cost or not , as for instant when i read the question it seems like it is not incremental, how can i know?
Incremental costs are those that will change as a result of a specific decision. If the fixed costs of $150,000 are necessary to produce the tig and would not be incurred if the tom is sold instead, then they are considered incremental.
However, if these fixed costs would exist regardless of the decision made (for example, if they are part of the overall operational costs that do not change with the production decision), then they are not incremental.In summary, to identify if the fixed costs are incremental, ask yourself:
Will these fixed costs be incurred only if the tig is produced?
Would these costs remain the same if the tom is sold instead?
If the answer to the first question is yes, then they are incremental costs. If the answer to the second question is yes, then they are not incremental.
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