Question

12.3 Fit Apparel

Fit Apparel (FA) sells high-quality workout clothing across Canada and the United States. FA is a private company owned by two sisters, Trina and Cora Smith. Ten years ago, the sisters decided to turn their lives around and get healthy. This involved a strict eating plan and an even stricter workout regimen. One thing that they both found motivating was feeling good at the gym, including wearing stylish clothes. The sisters decided to begin manufacturing and selling premium-priced workout apparel to both men and women. After many bumps along the road, 10 years later FA operates as a successful and extremely profitable business.

Fit Apparel doesn’t have physical stores. You must purchase the clothing from an independent consultant. The independent consultants are experts on the product and are very passionate about what they do. It is the role of the independent consultant to market the product. The most common way that this is done is usually by hosting in-home parties. The consultant will visit a customer’s home, and showcase the top-selling apparel items to a group of friends. There are many diff erent incentives for the consultants, which make their job very lucrative; over 80% of the consultants earn more than $130,000 per year. FA has been clear with the independent consultants that the company will never directly compete with them for sales.

The clothing is of premium quality and is priced at a premium amount. The top-selling products include hooded sweatshirts and workout tops, pants, and shorts. Other items that broaden the product range include items such as water bottles, body wash, and running shoes.

A typical customer of FA is a woman between the ages of 25 and 45. She loves to be outdoors and loves to exercise. Being healthy is important to her and she is at peace with herself. She has always felt the need to belong in group settings and loves to shop.

All clothing is priced at total cost plus 60%. The pricing is very high and makes the products “exclusive.” Not everyone can afford to be part of the FA “club.” No item ever goes on sale. If a product doesn’t sell, it goes to waste.

The two sisters have attributed their success to finding a way to make people feel good about themselves. If something makes a person feel good, they are often willing to pay more money. The FA manufacturing plant currently has the capacity to use about 5 million machine hours. It is currently using about 3 million machine hours.

FA has been approached by a well-recognized national charity that supports women’s health. The charity has asked FA to manufacture 1 million cycling jerseys for its annual cycling event. The event requires each participant to raise $2,000 in order to be eligible to ride their bike from one destination to another. Each participant must also purchase the cycling jersey. The charity has suggested that each participant will pay $30 for a jersey. This represents a fraction of the retail selling price of $75 (see Exhibit 1). Although FA currently manufactures cycling jerseys, the sisters are not sure if they should accept this offer. In order to manufacture the jerseys, FA would have to purchase a screen print machine that would cost $200,000 and incur $25,000 of set-up costs. Because of the screen printing, these custom jerseys would require an additional 0.25 labour hours and 0.5 machine hours each.

Required

The sisters decided they needed the help of an expert and have engaged you, a professional accountant, for advice. They have provided you with the current cost to manufacture a similar jersey (Exhibit 1). They have asked you to prepare a report that outlines whether or not they should accept this one-time order. They would like you to consider both qualitative and quantitative factors. Prepare the report for the owners of FA.

EXHIBIT 1 – CYCLING JERSEY COST INFORMATION (PER JERSEY, BASED ON 4 MILLION JERSEYS PRODUCED ANNUALLY)

Material	$10.46
Direct labour: 0.5 hours @$12.15 per hour	$6.08
Overhead—Variable: 0.75 machine hours @$7.10 per hour	$5.33
Overhead—Fixed per jersey	$7.00
Total costs	$28.87
Markup	$46.18
Selling price	$75.00

Answer 1

Here we will consider only the relevant costs i.e. the costs that changes.

Fixed overhead cost is irrelevant and hence will not be considered. Also there is spare capacity in the form of 5 million – 3 million = 2 million machine hours. For the special order machine hours needed = 1 million * (0.75+0.5) = 1,250,000 hours. This is lower than 2 million spare machine hours and so spare capacity is there.

			Total	Per unit = Total/1 million
			Amount (in $)	Amount (in $)
a	Selling price	1 million * $30	30,000,000	30.00
b	Material costs	1 million * $10.46	10,460,000	10.46
c	Direct labor	1 million*((0.5+0.25)*$12.15)	9,112,500	9.11
d	Overhead - variable	1 million*((0.75+0.5)*$7.10)	8,875,000	8.88
e	Contribution margin	a-b-c-d	1,552,500	1.55
f	Screen print cost		200,000	0.20
g	Set up cost		25,000	0.03
h	Profit	e-f-g	1,327,500	1.33

The above analysis shows that accepting the special order will produce an additional profit of $1,327,500 or $1.33 (rounded to 2 decimal place) for jersey. As such  FA should manufacture 1 million cycling jerseys for its annual cycling event.