Question

Sato Jewellers has had a request for a special order for 10 gold bangles for the members of a wedding party. The normal selling price of a gold bangle is $343.50 and its unit product cost is $229.00, as shown below:

Direct materials	$	127.00
Direct labour		78.00
Manufacturing overhead		24.00
Unit product cost	$	229.00

Most of the manufacturing overhead is fixed and unaffected by variations in how much jewellery is produced in any given period. However, $6 of the overhead is variable, depending on the number of bangles produced. The customer would like special filigree applied to the bangles. This filigree would require additional materials costing $5 per bangle and would also require acquisition of a special tool costing $435 that would have no other use once the special order was completed. This order would have no effect on the company’s regular sales, and the order could be filled using the company’s existing capacity without affecting any other order.

Required:
a.	What effect would accepting this order have on the company’s operating income if a special price of $293.50 is offered per bangle for this order? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
	net operating income_____ by ______

       

b.	Should the special order be accepted at this price?
	Yes No

Answer 1

The fixed cost is sunk cost since it will have to be incurred whether the special order is accepted or not. Hence, it it irrelevant for decision-making.
Further, since the jeweller has existing capacity to fulfil the order of the wedding party, we can say the company is not losing any contribution that it could earn from external customers.
1. Computation of increase/(decrease) in operating income upon accepting the special order from the wedding party
Particulars	Amount in $
Revenue due to the order (10 bangles @ $293.50)	$2,935.00
Less: Direct materials cost (10 bangles @ $127)	$1,270.00
Less: Direct labor cost (10 bangles @ $78)	$780.00
Less: Variable manufactuing overhead (10 bangles @ $6)	$60.00
Less: Additional cost for filigree (10 bangles @ $5 per bangle)	$50.00
Less: Cost of special tool incurred for the order	$435.00
Increase in operating income due to the special order	$340.00
Hence, the net operating income would increase by $340 due to the special order.
2. Since the special order is resulting in an increase in the net operating income of $340, it should accept the order.