In: Accounting
Trophies R Us manufactures medals for winners of athletic events and other contests. Its manufacturing plant has the capacity to produce 10,000 medals each month; current monthly production is 7,500 medals. The company normally charges $225 per medal. Variable costs and fixed costs for the current activity level of 75% follow:
Current product costs |
|
Variable costs |
|
Manufacturing |
|
Labor |
$375,000 |
Materials |
300,000 |
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 |
Trophies R Us 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. As a management accountant with Trophies R Us, you have been assigned the task of analyzing this order and recommending whether the company should accept or reject it..
1) Calculate both the old (i.e., prior to the special order) average cost per unit and the recalculated average cost per unit, including the effect of the special sales order. Are either of these two figures relevant for evaluating whether to accept or reject the special order? Explain.
2) Based on a short-term financial analysis, determine if Trophies R Us Co. should accept the special order and why.
3) What is the breakeven selling price per unit for the special sales order?
4) Discuss at least three other considerations that you should include in your analysis of the special order.
(1)
7500 units | 10000 units | ||||
Total Cost | Per Unit Cost | Total Cost | Per Unit Cost | ||
1 | Variable costs | ||||
a | Manufacturing | ||||
- | Labor | 375000 | 50.00 | 500000 | 50.00 |
(375000/7500) | (10000 x 50) | (500000/10000) | |||
- | Materials | 300000 | 40.00 | 400000 | 40.00 |
(300000/7500) | (10000 x 40) | (400000/10000) | |||
b | Marketing | 187500 | 25.00 | 187500 | 18.75 |
(187500/7500) | (7500 x 25) | (187500/10000) | |||
Total variable costs | 862500 | 115.00 | 1087500 | 108.75 | |
2 | Fixed costs | ||||
a | Manufacturing | 275000 | 36.67 | 275000 | 27.50 |
b | Marketing | 225000 | 30.00 | 225000 | 22.50 |
Total fixed costs | 500000 | 66.67 | 500000 | 50.00 | |
Total costs | 1362500 | 181.67 | 1587500 | 158.75 | |
(1362500/7500) | (1587500/10000) | ||||
Average Cost per Unit (old) | 181.67 | ||||
Average Cost per Unit (new) | 158.75 | ||||
However, for the purposes of accepting the order, neither of the Average costs per unit are relevant | |||||
as for the special order, only relevant costs are variable costs pertaining to only units produced under special order. | |||||
Production of Special order has nothing to do with costs being incurred on other units. | |||||
However, if there are capacity constraints, then one must be familiar with average costs so as to eveluate loss of | |||||
contribution on sacrifice of normal units of production. |
(2)
Cost of Production of Special Order (2500 units) | |||
Labor | (2500 x 50) | 125000 | |
Materials | (2500 x 40) | 100000 | |
Total | 225000 | ||
Cost per unit of | (225000/2500) | 90 | |
Special Order | |||
Price per medal | $ 115 per medal | ||
Total Revenue | (115 * 2500) | 287500 | |
Profit on Special Order | 62500 | ||
Verdict: Accept Special Order |
(3) Breakeven Selling Price per unit of Special Order
= Variable Cost for Production of units of Special Order
= $ 90 per medal
(4) Other considerations for accepting the special order propsal are as follows:
i. Profit margin to be earned on the special order and its comparison with what is earned on normal units of production.
ii. Organisation's commitment to whether entertain any kind of Special Orders.
iii. Special Orders are also usually time bound, ehich may also pose difficulty in completing order within time.