Question

Problem 12-22 Special Order Decisions [LO12-4]

Polaski Company manufactures and sells a single product called a Ret. Operating at capacity, the company can produce and sell 50,000 Rets per year. Costs associated with this level of production and sales are given below:

	Unit				Total
Direct materials	$	20			$	1,000,000
Direct labor		10				500,000
Variable manufacturing overhead		3				150,000
Fixed manufacturing overhead		7				350,000
Variable selling expense		2				100,000
Fixed selling expense		6				300,000
Total cost	$	48			$	2,400,000

The Rets normally sell for $53 each. Fixed manufacturing overhead is $350,000 per year within the range of 44,000 through 50,000 Rets per year.

Required:

1. Assume that due to a recession, Polaski Company expects to sell only 44,000 Rets through regular channels next year. A large retail chain has offered to purchase 6,000 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 6,000 units. This machine would cost $12,000. Polaski Company has no assurance that the retail chain will purchase additional units in the future. What is the financial advantage (disadvantage) of accepting the special order? (Round your intermediate calculations to 2 decimal places.)

2. Refer to the original data. Assume again that Polaski Company expects to sell only 44,000 Rets through regular channels next year. The U.S. Army would like to make a one-time-only purchase of 6,000 Rets. The Army would pay a fixed fee of $1.60 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. What is the financial advantage (disadvantage) of accepting the U.S. Army's special order?

3. Assume the same situation as described in (2) above, except that the company expects to sell 50,000 Rets through regular channels next year. Thus, accepting the U.S. Army’s order would require giving up regular sales of 6,000 Rets. Given this new information, what is the financial advantage (disadvantage) of accepting the U.S. Army's special order?

Answer 1

1). As the polaski company expects to sell only 44,000 Rets through regular channels next year.
It receives a special order for purchase of 6000 units.
For this order relevant cost to be considered is only variable cost and not fixed cost.
Relevant cost for this special order:-
Direct Material = $20
Direct Labor = $10
Var. manufacturing = $3
Var. selling = ($2*25%) = $0.50
Total variable cost per unit = $33.50
Total variable cost = $33.50 * 6000 = $201,000
Add: Machine cost = $12000
Total cost of producing 6000 units = $213,000

Selling price = $53 - 16% = $44.52
Sales value = $44.52 * 6000 = $267,120

Advantage / (Disadvantage) = $267,120 - $213,000 = $54,120

2). The offer of Army would be accepted because it will result in profit of flat $1.60 per unit as the cost of manufacturing will be reimbursed by the army.
Advantage of accepting the offer = $1.60 * 6000 units = $9600.

3). If the external demand is 50000 units.
There is a profit of $5 i.e. ($53 -$48) per unit when the sales are through regular channels, but if the company accepts the offer its profit will be $1.6 per unit. Hence there is a loss of $3.4 per unit in accepting the offer.
Disadvantage of accepting the order = $3.4 * 6000 = $20400