Question

Smooth Move Company manufactures professional paperweights and has been approached by a new customer with an offer to purchase 15,000 units at a per-unit price of $9.00. The new customer is geographically separated from Smooth Move's other customers, and existing sales will not be affected. Smooth Move normally produces 90,000 units but plans to produce and sell only 65,000 in the coming year. The normal sales price is $16 per unit. Unit cost information is as follows:

Direct materials	$3.10
Direct labor	2.50
Variable overhead	1.15
Fixed overhead	1.80
Total	$8.55

If Smooth Move accepts the order, no fixed manufacturing activities will be affected because there is sufficient excess capacity.

Required:

1. What are the alternatives for Smooth Move?

2. CONCEPTUAL CONNECTION: Should Smooth Move accept the special order?
Yes

By how much will profit increase or decrease if the order is accepted?
$

3. CONCEPTUAL CONNECTION: Briefly explain the significance of the statement in the exercise that “existing sales will not be affected” (by the special sale).

Answer 1

Solution

Smooth Move

1. Alternatives for Smooth Move:

Smooth Move has an offer for 15,000 units at a per unit price of $9.00.

The company can accept or reject the offer to sell 15,000 units at a unit price of $9.

1. Yes

Determination of the amount of increase or decrease in profit on acceptance of special order:

Selling price	$9
Variable cost -
Direct materials	$3.10
Direct labor	$2.50
Variable OH	$1.15
Total variable cost	$6.75
Contribution margin	$2.25
Number of units	15,000
Increase in Profit	$33,750	($2.25 x 15,000)

Hence, profit increases by $33,750 if Smooth Move accepts the special offer.

1. Significance of existing sales will not be affected –

The special offer involves a selling price of $9 unlike the normal selling price of $16.

In ordinary circumstances, when a company accepts a special offer at reduced selling price, the existing customers might also demand for similar price. Such price might not be enough to cover the fixed cost and normal profit percentage.

However, in the given situation, the new customer is geographically separated from the company’s other customers, and hence the existing customers would have no knowledge of this kind of offer. So, the existing customers are expected to continue purchasing at normal selling price.

Also, since the company has excess capacity of 15,000 units (90,000 – 65,000) the contribution margin from acceptance of special offer would contribute to absorb the fixed costs.