Question

Polaski Company manufactures and sells a single product called a Ret. Operating at capacity, the company can produce and sell 34,000 Rets per year. Costs associated with this level of production and sales are given below: Unit Total Direct materials $ 20 $ 680,000 Direct labor 6 204,000 Variable manufacturing overhead 3 102,000 Fixed manufacturing overhead 5 170,000 Variable selling expense 2 68,000 Fixed selling expense 6 204,000 Total cost $ 42 $ 1,428,000 The Rets normally sell for $47 each. Fixed manufacturing overhead is constant at $170,000 per year within the range of 28,000 through 34,000 Rets per year.

Required: 1. Assume that due to a recession, Polaski Company expects to sell only 28,000 Rets through regular channels next year. A large retail chain has offered to purchase 6,000 Rets if Polaski is willing to accept a 16% discount off the regular price. There would be no sales commissions on this order; thus, variable selling expenses would be slashed by 75%. However, Polaski Company would have to purchase a special machine to engrave the retail chain’s name on the 6,000 units. This machine would cost $12,000. Polaski 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.

2. Refer to the original data. Assume again that Polaski Company expects to sell only 28,000 Rets through regular channels next year. The U.S. Army would like to make a one-time-only purchase of 6,000 Rets. The Army would pay a fixed fee of $1.40 per Ret, and it would reimburse Polaski Company for all costs of production (variable and fixed) associated with the units. Because the army would pick up the Rets with its own trucks, there would be no variable selling expenses associated with this order. If Polaski Company accepts the order, by how much will profits increase or decrease for the year?

3. Assume the same situation as that described in (2) above, except that the company expects to sell 34,000 Rets through regular channels next year. Thus, accepting the U.S. Army’s order would require giving up regular sales of 6,000 Rets. If the Army’s order is accepted, by how much will profits increase or decrease from what they would be if the 6,000 Rets were sold through regular channels?

Answer 1

Answer 1.
Statement of Incremental Profit
if Special Order is accepted - 6,000 Rets
Incremental Revenue
Sales Revenue from Special Order - 6000 Nos X $39.48		236,880.00
Incremental Cost
Direct Material - 6,000 Nos X $20	(120,000.00)
Direct Labor - 6,000 Nos X $6	(36,000.00)
Variable MOH - 6,000 Nos X $3	(18,000.00)
Variable Selling Exp. - 6000 Nos X ($2 X 25%)	(3,000.00)
Purchase of Spaecial Machine	12,000.00	(165,000.00)
Incremental Net Income / (Loss)		71,880.00
Answer 2.
Calculation of Sales Price to US Army per Unit
Direct Material	20.00
Direct Labor	6.00
Variable MOH	3.00
Fixed MOH	5.00
Total Cost	34.00
Add: Mark Up	1.40
Total Selling price	35.40
Statement of Incremental Profit
if Special Order is accepted -6,000 rets
Incremental Revenue
Sales Revenue from Special Order - 6000 Nos X $35.40		212,400.00
.
Incremental Cost
Direct Material - 6000 Nos X 20	(120,000.00)
Direct Labor - 6000 Nos X 6	(36,000.00)
Variable MOH - 6,000 x $3	(18,000.00)	(174,000.00)
Incremental Net Income / (Loss)		38,400.00
Answer 3.
Statement of Incremental Profit
if Special Order is accepted
Incremental Revenue
Sales Revenue from Special Order - 6000 Nos X $35.40	212,400.00
Savings of Variable Selling Exp. - 6000 Nos X $2	12,000.00	224,400.00
Incremental Cost
Direct Material - 6000 Nos X 20	(120,000.00)
Direct Labor - 6000 Nos X $6	(36,000.00)
Variable MOH - 6000 Nos X 3	(18,000.00)
Loss of Contribution from regular Sales - 6000 Nos X ($47 - $31)	(96,000.00)	(270,000.00)
Incremental Net Income / (Loss)		(45,600.00)