Question

Accept or Reject a Special Order

Moore Company manufactures and sells a single product called a Lop. Operating at capacity, the company can produce and sell 30,000 Lops per year. Costs associated with this level of production and sales are given below:

Unit                     Total

Direct materials                                            $15                    $450,000

Direct labour                                                     8                      240,000

Variable manufacturing overhead                3                        90,000

Fixed manufacturing overhead                     9                      270,000

Variable selling expense                                4                      120,000

Fixed selling expense                                     6                      180,000

Total cost                                                       $45                 $1,350,000

The Lops normally sell for $50 each. Fixed manufacturing overhead is constant at $270,000 per year within the range of 25,000 through 30,000 Lops per year.

Required:

Assume that due to a recession, Moore Company expects to sell only 25,000 Lops through regular channels next year. A large retail chain has offered to purchase 5,000 Lops if Moore is willing to accept a 16% discount off the regular price. There would be no sales commissions on this order; so variable selling expenses would be slashed by 75%. However, Moore Company would have to purchase a special machine to engrave the retail chain's name on the 5,000 units. This machine would cost $10,000. Moore Company has no assurance that the retail chain will purchase additional units in the future. Determine the impact on profits next year if this special order is accepted.

Refer to the original data. Assume again that Moore Company expects to sell only 25,000 Lops through regular channels next year. The provincial government would like to make a one-time- only purchase of 5,000 Lops. The government would pay a fixed fee of $1.80 per Lop, and it would reimburse Moore Company for all costs of production (variable and fixed) associated with the units. Since the government would pick up the Lops with its own trucks, there would be no variable selling expenses associated with this order. If Moore Company accepts the order, by how much will profits increase or decrease for the year?

Assume the same situation as that described in (2) above, except that the company expects to sell 30,000 Lops through regular channels next year, so accepting the government's order would require giving up regular sales of 5,000 Lops. If the government's order is accepted, by how much will profits increase or decrease from what they would be if the 5,000 Lops were sold through regular channels?

Answer 1

Part-1
	25000 Regular Channel		5000 to Retial chain		Working
	Per Unit	Total	Per Unit	Total
Unit		25000		5000
Selling Price	$50	$1,250,000	$42	$210,000	16% discount on seling price to Retail
Variable Cost:
Direct Material	$15	$375,000	$15	$75,000
Direct Labor	$8	$200,000	$8	$40,000
Variable Overhead	$3	$75,000	$3	$15,000
Variable Selling overhead	$4	$100,000	$1	$5,000	Reduced by 75%
Total Variable Cost	$30	$750,000	$27	$135,000
Fixed Cost:
Overhead		$270,000	$0	$0	Aborbed in 25000
Selling Overhead		$180,000	$0	$0	Aborbed in 25000
Total Fixed Cost		$450,000		$0
Special order cost	$0	$0		$10,000
Total Cost		$1,200,000		$145,000
Operating Income		$50,000		$65,000

Part-2
Fee from government			$1.80
Fixed Cost from Government *			$9.00
Total Revenue			$10.80
Units sold			5000
Total Revenue/Profit			$54,000.00
Since Government is reimbursing all production realted cost i.e. material/labor/variable/fixed overhead (not selling), and fixed overhead is irrelevant cost as it already absorbed by 25000 units, we will consider this as revenue.

Part-3
	if 5000 sold to Regular channel	if 5000 sold to Government
Selling Price	250000	54000	From Part-2
Less: Variable Cost
Direct Material 15*5000	75000	0	Since reimbursed by government
Direct Labor 8*5000	40000	0	Since reimbursed by government
Variable Overhead 3*5000	15000	0	Since reimbursed by government
Variable Selling 4*5000	20000	0	Nil as given in que
Margin	100000	54000
Profit will decrease by 100000-54000=46000.