Question

QUESTION 13

1. Carl’s Pudding Co, produces a range of gourmet tinned custard style puddings which it sells at markets and at specialty food stores around the state. Carl has been approached by a chain of independent grocery stores with an offer to purchase 15,000 tins of Carl’s chocolate pudding at a price of $7 per 500g tin, the normal sales price is $12 per tin. Carl’s current costs to produce a tin of Chocolate pudding are as follows:

   Direct Materials	$3.10
   Direct Labour	2.25
   Overhead $2.95 per machine hour (1 hour)	2.95
   Variable selling and administrative costs	0.20

   Total overhead is applied at a rate of $2.95 per machine hour. Total budgeted fixed overhead for the period is $147,600 with denominator volume of 82,000 machine hours. Variable selling and administrative costs are for commission paid to market stall holders which are not required for the special order. Carl’s Pudding Co estimates it will have the capacity to produce the order without affecting regular sales. The independent grocers would like to customise the pudding with a slight variation in the recipe Carl’s uses for their regular pudding by adding Belgium chocolate powder which would increase the materials costs by $0.20. In addition they would like the tin to be embossed with their logo which would require a special machine that will cost $12,000.

   Required:

   1. Should Carl’s Pudding Co accept or reject the special order? Why? Show all supporting computations.
   2. Treat (b) independent of your answer in (a). You overheard Lori, a junior accountant at Carl’s Pudding Co. tell a co-worker that special orders with a price that is ‘below cost’, should not even be considered as every sale must bear its share of the full costs of running a business. Lori also states that if the company sells below full cost that Carl’s will be out of business in no time. What do you think of the Lori’s comments? Is Lori correct in her assertions? Explain why you do or do not agree with Lori.  

Answer 1

(a)

Sales revenue (15000 x $7)		105000
Less: Expenses
Direct materials [15000 x ($3.10 + $0.20)]	49500
Direct labor (15000 x $2.25)	33750
Variable overhead (15000 x $1.15)*	17250
Cost of special machine	12000
Total expenses		112500
Profit (loss) on special order $		-7500

*Variable overheads = Total overheads - Fixed overheads = [($2.95 x 82000) - $147600] = $241900 - $147600 = $94300

Variable overhead per unit = $94300/82000 = $1.15

Carl's Pudding Co. should reject the special order as it will result in a loss of $7500.

(b) Lori is not right in her assertions.

In case excess capacity is available and the company can increase its sales within the excess capacity without affecting the normal sales, it may consider selling below the full cost. Due to the available excess capacity, no additional fixed overheads would be incurred on the additional units produced. The additional units may thus be costed at the variable cost of production and sales and not necessarily the full cost. This would result in a contribution margin which would set off some of the fixed costs thereby increasing the profits for the company.