Question

Ayayai Company is a leading manufacturer of sunglasses. One of Ayayai’s products protects the eyes from ultraviolet rays. An upscale sporting goods store has contacted Ayayai about purchasing 17,600 pairs of these sunglasses. Ayayai’s unit manufacturing cost, based on a full capacity of 109,000 units, is as follows: Direct materials $6 Direct labor 5 Manufacturing overhead (60% fixed) 15 Total manufacturing costs $26 Ayayai also incurs selling and administrative expenses of $77,090 plus $2 per pair for sales commissions. The company has plenty of excess manufacturing capacity to use in manufacturing the sunglasses. Ayayai’s normal price for these sunglasses is $42 per pair. The sporting goods store has offered to pay $36 per pair. Since the special order was initiated by the sporting goods store, no sales commission will be paid. What would be the effect on Ayayai’s income if the special order were accepted?

Answer 1

Secial Order =17,600 pairs of the sunglasses., Direct materials $6, Direct labor 5 ,Manufacturing overhead (60% fixed) 15, Normal price = $42 per pair,Special order price= $36 per pair.

Calculation of Incremental Revenue of 17,600 units

Particulars	Price per unit	Total cost(units*rate per unit)	Incrementa Revenue
Sales	36	633600
Revenue    (A)	36	633600	633600
Less: Variable Cost
Direct Material	6	105,600
Direct Labour	5	88,000
Manufacturing Overhead(Given 60% fixed that means 40% Variable) (15*40%)	6	105,600
Cost (B)	17	299,200	299,200
Incrental Revenue (A-B)	19		334,400

Since the Incremental cost per unit (17) is less than the price offered for the Special Order, the Company should accept it. Accepting the special order would generate Additional Contribution of (17600*19) =334,400 revenue in Total.

Decision: Ayayi should Accept the offer as it generate Additional revenue of $334,400

Note 1)Fixed cost are omitted while calculating incremental revenue because these cost does not change with Production volume and so Selling and distribution cost would not be considered.

Note2)Given in the question that Sales commission would not be paid .

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