Question

Polaski Company manufactures and sells a single product called a Ret. Operating at capacity, the company can produce and sell 46,000 Rets per year. Costs associated with this level of production and sales are given below:

  

	Unit			Total
Direct materials	$	25		$	1,150,000
Direct labor		6			276,000
Variable manufacturing overhead		3			138,000
Fixed manufacturing overhead		7			322,000
Variable selling expense		4			184,000
Fixed selling expense		6			276,000
Total cost	$	51		$	2,346,000

   

The Rets normally sell for $56 each. Fixed manufacturing overhead is constant at $322,000 per year within the range of 37,000 through 46,000 Rets per year.

  

Required:
1.	Assume that due to a recession, Polaski Company expects to sell only 37,000 Rets through regular channels next year. A large retail chain has offered to purchase 9,000 Rets if Polaski is willing to accept a 16% discount off the regular price. There would be no sales commissions on this order; thus, variable selling expenses would be slashed by 75%. However, Polaski Company would have to purchase a special machine to engrave the retail chain’s name on the 9,000 units. This machine would cost $18,000. Polaski Company has no assurance that the retail chain will purchase additional units in the future. Determine the impact on profits next year if this special order is accepted.

     

2.

Refer to the original data. Assume again that Polaski Company expects to sell only 37,000 Rets through regular channels next year. The U.S. Army would like to make a one-time-only purchase of 9,000 Rets. The Army would pay a fixed fee of $1.20 per Ret, and it would reimburse Polaski Company for all costs of production (variable and fixed) associated with the units. Because the army would pick up the Rets with its own trucks, there would be no variable selling expenses associated with this order. If Polaski Company accepts the order, by how much will profits increase or decrease for the year?

     

3.	Assume the same situation as that described in (2) above, except that the company expects to sell 46,000 Rets through regular channels next year. Thus, accepting the U.S. Army’s order would require giving up regular sales of 9,000 Rets. If the Army’s order is accepted, by how much will profits increase or decrease from what they would be if the 9,000 Rets were sold through regular channels?

     

Answer 1

Amounts are in $

(a)

Fixed selling costs are allocation of expenses and doesn't impact the decision making

Fixed manufacturing overhead will remain same from 37,000 to 46,000 units. So need to consider in decision making

New variable selling cost per unit = 4 x 25% = 1 per unit

New selling price per unit = 56 x 84% = 47.04 per unit

Particulars	Per unit	9,000 units
Sales	47.04	423,360
Less :
Materials	25	225,000
Labour	6	54,000
Variable mfg overhead	3	27,000
Variable selling overhead	1	9,000
Machine cost		18,000
Total Cost		333,000
Profit		90,360

Increase in Profits by $90,360

(b)

Particulars	per unit	9,000 units
Sales (25+6+3+7+1.8)	42.8	385,200
Less :
Materials	25	225,000
Labour	6	54,000
Variable manufacturing overhead	3	27,000
Total Cost		306,000
Profit		79,200

Increase in profit by $79,200

(c)

Contribution on normal sales per unit = 56 - 25 - 6 - 3 - 4 = 18 per unit

Total contribution on normal sales = 9,000 x 18 = 162,000

But if we sold these as per Army order, the profit will be 79,200

The profit would decrease by $82,800 if we accept army order than selling through regular channels