Question

QUESTION 7 - Relevant costing on a special order

The following financial data apply to the USB production plant of the Drill Company for May 2015:
Budgeted Manufacturing Cost per USB:
Direct materials $3.20
Direct manufacturing labour 1.80
Variable manufacturing overhead 1.40
Fixed manufacturing overhead 2.00
Total manufacturing cost $8.40

Variable manufacturing overhead varies with the number of USB’s produced. Fixed manufacturing overhead of $2 per USB is based on budgeted fixed manufacturing overhead of $300,000 per month and budgeted production of 150,000 USB’s per month.

The Drill Company sells each USB for $10.
Marketing costs have two components:

Variable marketing costs (sales commissions) of 5% of revenues
Fixed monthly costs of $130,000

During May 2015, Lyn Randell, a Drill Company salesperson, asked the CEO for permission to sell 1,000 USB’s at $8.00 per pack to a customer not in Dill's normal marketing channels. The CEO refused this special order because the selling price was below the total budgeted manufacturing cost.

Required:
(i) What would have been the effect on monthly operating income of accepting the special order?
(ii) Comment on the CEO’s "below manufacturing costs" reasoning for rejecting the special order.
(iii)What other factors should the CEO consider before accepting or rejecting the special order?

Answer 1