Question

Imperial Jewelers is considering a special order for 23 handcrafted gold bracelets to be given as gifts to members of a wedding party. The normal selling price of a gold bracelet is $407.00 and its unit product cost is $275.00 as shown below:

Direct Materials	$149
Direct labor	$87
Manufacturing Overhead	$39
Unit Product cost	$275

Most of the manufacturing overhead is fixed and unaffected by variations in how much jewelry is produced in any given period. However, $11 of the overhead is variable with respectto the number of bracelets produced. The customer who is interested in the special bracelet order would like special filigree applied to the bracelets. This filigree would require additional materials costing $10 per bracelet and would also require acquisition of a special tool costing $452 that would have no other use once the special order is completed. This order would have no effect on the company’s regular sales and the order could be fulfilled using the company’s existing capacity without affecting any other order.

Required:

What effect would accepting this order have on the company’s net operating income if a special price of $367.00 per bracelet is offered for this order?

	Per unit	Total 23 bracelets
Incremental revenue
Incremental costs
Variable costs:
Direct materials
Direct labor
Variable manufacturing overhead
Special filigree
Total variable cost
Fixed costs:
Purchase of special tool
Total incremental cost
Incremental net operating income (loss)

Should the special order be accepted at this price?

Yes

No

Answer 1

Incremental analysis or differential analysis:

Incremental analysis is a decision-making tool in which the relevant costs and revenues of one alternative are compared to the relevant costs and revenues of another alternative

Relevant cost: Costs that are affected by a decision are known as relevant costs.

Irrelevant cost: costs that will not change as the result of a management decision.

Determining the effect of special order of 23 bracelets on the company’s net operating income

	Per unit	Total 23 bracelets
A. Incremental revenue	$367	$8,441 [23 x $367]
B. Incremental costs
Variable costs:
Direct materials	$149	$3,427 [23 x $149]
Direct labor	$87	$2,001 [23 x $87]
Variable manufacturing overhead	$11	$253 [23 x $11]
Special filigree	$10	$230 [23 x $10]
Total variable cost	$257	$5,911
Fixed costs:
Purchase of special tool		$452
Total incremental cost		$6,363
Incremental net operating income [A - B]		$2,078

To Remember while doing Incremental analaysis:

Relevant Cost:

• Relevant costs are the only costs shall be considered while incremental analysis.
• In this question, relevant costs are Direct material, direct labor, Variable manufacturing overhead [$11] and the Special tool entire purchase cost.

Irrelevant Cost:

• Irrelevant costs shall not be considered while doing incremental analysis.
• The reason behind not considering these costs is that these costs won't change with the decision the company will make.[in this question, the decison is on whether to accept special order or not].
• In this question, Irrelevant costs are fixed manufacturing overheads. [$39 - $11 = $28]

Decision:

Therefore, from the above table we can deduce that the company's net operating income will increase by $2,078 if the company accepts the special order.

Since the company is generating the Net Operating income on the special order, the company shall accept the special order.