Question

Green Grow Inc. (GGI) manufactures lawn fertilizer. Because of the product’s very high quality, GGI often receives special orders from agricultural research groups. For each type of fertilizer sold, each bag is carefully filled to have the precise mix of components advertised for that type of fertilizer. GGI’s operating capacity is 40,000 one-hundred-pound bags per month, and it currently is selling 38,000 bags manufactured in 38 batches of 1,000 bags each. The firm just received a request for a special order of 8,600 one-hundred-pound bags of fertilizer for $250,000 from APAC, a research organization. The production costs would be the same, but there would be no variable selling costs. Delivery and other packaging and distribution services would cause a one-time $5,300 cost for GGI. The special order would be processed in two batches of 4,300 bags each. (No incremental batch-level costs are anticipated. Most of the batch-level costs in this case are short-term fixed costs, such as salaries and depreciation.) The following information is provided about GGI’s current operations: Sales and production cost data for 38,000 bags, per bag: Sales price $ 46 Variable manufacturing costs 21 Variable selling costs 3 Fixed manufacturing costs 16 Fixed marketing costs 4 No marketing costs would be associated with the special order. Because the order would be used in research and consistency is critical, APAC requires that GGI fill the entire order of 8,600 bags. Required: 1. What is the total relevant cost of filling this special sales order? 2. What would be the change in operating income if the special order is accepted? 3. What is the break-even selling price per unit for the special sales order (i.e., what is the selling price that would result in a zero effect on operating income)? 4. Prepare comparative income statements, using the contribution format, for both the current situation and assuming the special order is accepted at the break-even price determined in requirement 3.

Answer 1

Solution:

1)The total relevant cost of filling this special sales order

Out of pocket costs:
Variable costs:
Manufacturing cost (8,600 * 21 per unit)		$180,600
Fixed costs:
One time packing & delivery cost		$5,300
Opportunity cost:
No of lost unit sales(8,600 - 40,000 +38,000)	6,600
CM per unit, regular sales:
Selling price, per unit($46)
Variable manufacturing cost($21)
Variable selling cost($3)	$22	$145,200
Total relevant cost		$331,100

2)Effect on short term operating income of accepting the special sales order:

Offering price , special order	$250,000
Less: Relevant costs	$331,100
Income effect of accepting special sales order	($81,100)

Since the relevant cost of $331,100 exceed the price of the special order ($250,000), ther woukd be a loss of $81,100 if the special order were accepted. Therefore, GGi should not accept the order.

3)Breakeven selling price per unit:

Total relevant cost	$331,100
Divided by no of units in the special sales order	8,600
Break even selling price per unit	$38.5

4) Comparative income statements, contribution basis

	Current situation	Current situation + Special sales order
Sales:
Regular(@42 per unit)	$1,596,000		$1,318,800
Special order(@38.5 per unit)	$0	$1,596,000	$331,100	$1,649,900
Less: Variable costs:
Manufacturing (@21 per unit)	$798,000		$840,000
Marketing(@ 3 per unit)	$114,000	($912,000)	$120,000	($960,000)
Contribution margin		$684,000		$689,900
Less: Fixed costs:
Manufacturing(@16)	$608,000		$608,000
Marketing(@4)	$152,000		$152,000
One time packing/delivery	$0	($760,000)	$5,300	($765,300)
Operating income/ loss		($76,000)		($75,400)

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