Question

Cornell Corporation manufactures faucets. Several weeks ago, the firm received a special-order inquiry from Yale, Inc. Yale desires to market a faucet similar to Cornell's model no. 55 and has offered to purchase 3,000 units. The following data are available:

• Cost data for Cornell's model no. 55 faucet: direct materials, $48; direct labor, $30 (2 hours at $15 per hour); and manufacturing overhead, $70 (2 hours at $35 per hour).

• The normal selling price of model no. 55 is $180; however, Yale has offered Cornell only $124 because of the large quantity it is willing to purchase.

• Yale requires a modification of the design that will allow a $7 reduction in direct-material cost.

• Cornell's production supervisor notes that the company will incur $6,433 in additional set-up costs and will have to purchase an $21,700 special device to manufacture these units. The device will be discarded once the special order is completed.

• Total manufacturing overhead costs are applied to production based on direct labor hours. Total budgeted overhead is $840,000. This figure is based on budgeted yearly fixed overhead of $624,000, a budgeted variable overhead of $216,000, and a budgeted activity level of 24,000 direct labor hours.

• Cornell will allocate $8,000 of existing fixed administrative costs to the order as “…part of the cost of doing business.

” Required: A. One of Cornell's staff accountants wants to reject the special order because “financially, it's a loser.” Do you agree with this conclusion if Cornell currently has excess capacity? Show calculations to determine the incremental profit or loss on this special order to support your answer.

B.If Cornell currently has no excess capacity, should the order be rejected? (Assume for part B that Cornell cannot acquire excess capacity via overtime or any other way.) Briefly explain.

Answer 1

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Part A
			Per Unit	Total
Selling Price			$       124	$ 372,000
Less: Variable Cost
Direct Material	$30-$7	$           23
Direct Labor		$           30
Variable Overheads	$216,000/24,000 Hours*2 Hours	$           18	$        -71	$-213,000
Contribution Margin			$         53	$ 159,000
Less: Fixed Cost
Set up cost		$      6,433
New Device cost		$    21,700		$ -28,133
Net Income				$ 130,867
Order should be accepted as it is giving Net profit of $130,867
Part B
Net Income from Special Order				$ 130,867
Less: Contribution Margin Lost on 3000 Units
Selling Price	3,000*$180	$ 540,000
Less: Variable Cost
Direct Material	3,000*$48	$-144,000
Direct Labor	3,000*$30	$ -90,000
Variable Overheads	3,000*$18	$ -54,000
Contribution Margin				$-252,000
Net Loss				$-121,133
Should reject as it will give net loss