Question

Award Plus Co. manufactures medals for winners of athletic events and other contests. Its manufacturing plant has a capacity to produce 10,000 medals each month; current monthly production is 7,500 medals. The company normally charges $225 per medal. Total variable costs and fixed costs for the current activity level of 75% of capacity are as follows:

                                       Current costs

Variable costs

      Manufacturing

            Material.................... $300,000

            Labor.......................... 375,000

      Marketing......................... 187,500

Total variable costs.............. $862,500

Fixed costs

      Manufacturing................ $275,000

      Marketing......................... 225,000

Total fixed costs................... $500,000

Total costs......................... $1,362,500

Award Plus has just received a special one-time order for 2,500 medals at $115 per medal. For this particular order, no variable marketing costs will be incurred. Cole Smith, a management accountant with Award Plus, has been assigned the task of analyzing this order and recommending whether the company should accept or reject it. After examining the costs, Smith suggested to his supervisor, Gerald Jones, who is the controller, that they request competitive bids from vendors for the raw materials because the current cost seems high. Jones insisted that the prices are reasonable to told Smith that he is not to discuss his observations with anyone else. Smith later discovered that Jones is the brother-in-law of the owner of the current raw material supply vendor.

1.   What is the current operating profit of Award Plus before accepting the special order? Is this operating profit relevant in the company’s decision on whether to accept the special order? Why or why not?

2.   What is the short-term effect on operating profit (to the nearest dollar) if Award Plus accepts the special order?

3.   What is the breakeven selling price per unit for the special order, rounded to the nearest cent?

4.   What are two qualitative factors that Cole Smith should consider in his analysis of the special order?

5.   Explain how Cole Smith should try to resolve the ethical conflict arising out of the controller’s insistence that the company avoids competitive bidding on raw materials.

Answer 1

1)Calculation of current operating profit:

Sales revenue (7500*225)	1687500
Less:Variable cost	(862500)
Contribution margin	825000
less:Fixed cost	(500000)
Operating profit	325000

Since The company has an excess capacity to accept special offer of 2500 medals (10000-7500 = 2500 ),The acceptance of offer will not affect regular sales ,Thus current operating profit is irrelevant to decision making as to acceptance of offer .

2)Variable cost varies with number of units whereas fixed cost remains constant within a relevant range and thus does not varies with output.

So while making decision as to acceptance of offer ,Variable cost is relevant and Fixed cost is irrelevant.

Revenue from special Offer (2500*115)		287500
Less;Variable cost
Material	300000/7500=40	40*2500=100000
Labor	375000/7500=50	50*2500=125000
Marketing		0
Total Variable cost		(225000)
Increase in profit due to acceptance of special offer		62500

short-term effect on operating profit if Award Plus accepts the special order = 62500

3)Breakeven point is a point of no profit no loss or situation where Total revenue is equals to total cost.

So In order to be in breakeven situation ,Selling price must be equals to variable cost.

Breakeven selling price = Total variable cost = 40+50 =$90 per unit

4)The two qualitative factors that Cole Smith should consider in his analysis of the special order :

a)Whether there is any potential for organization to enter new sales area from acceptance of special offer

b)Whether The acceptance of offer have any effect on regular sales to customers.