Question

Question 1

Speedy Sports manufactures footballs and has the capacity to produce 80,000 balls per year. Budgeted information for the current year is as follows:

Expected sales (80,000 units) $400,000

Direct Materials $ 100,000

Direct Labour $ 80,000

Manufacturing overhead $ 120,000

They have been approached by a major football team, PSB United, with a request for a special order of 10,000 balls. Because of the large order being placed, PSB are only willing to pay $4 per ball for the special order.

PSB United requires the balls to be stamped with their team logo which will require the purchase of a special machine for $10,000. After Speedy Sports completes the special order they will have no further use for the machine.

In addition, the logo will require a special coloured dye which will add $0.25 to the materials cost per ball.

The budgeted manufacturing overhead is based, in part, on budgeted annual fixed manufacturing overhead of $100,000.

In the middle of the year, prior to PSB requesting the special order, management had estimated that annual sales would amount to only 70,000 units.

Required:

1. Jill, the trainee accountant at Speedy Sports, was asked to do a preliminary analysis and recommends rejecting the special order because it would result in a financial loss. Do you agree with Jill?

2. Explain how Jill may have arrived at her conclusion that the special order would result in a financial loss. Also explain the error in Jill’s approach that you have just outlined.

Answer 1

Financial Gain on Special Order:
Variable Costs:	Amount $
DM	1.25	100000/80000
DL	1	80000/80000
Manuf OH	0.25	(120000-100000)/80000
Special M/c	1	10000/10000
Special Dye	0.25
Total Variable cost per Ball	3.75
Special Order Selling Price	4
Gain on Variable costing Basis	0.25

1) No, we disagree with Jill on recommending the rejection of the special

order because there is no financial loss. The Speedy Sports has been

making $0.25 per ball on the special order because the Fixed Manufacturing

Overhead should not be charged to the special order being sunk cost and

Speedy Sports has to bear it even if special order is not accepted. The gain

of $0.25 is the contribution towards writing off fixed manufacturing costs.

2) Jill has added the fixed manufacturing overhead to the total costs of the

Special Order and counted the total costs per ball on Special Order as $5

(ie.Variable cost 3.75 + Fixed Manuf. OH 1.25) and getting loss of $1. The

error was that on the special order no fixed or sunk cost is counted because

that cost has to be born even through special order is accepted or not.