Question

Polaski Company manufactures and sells a single product called a Ret. Operating at capacity, the company can produce and sell 38,000 Rets per year. Costs associated with this level of production and sales are given below:

	Unit				Total
Direct materials	$	20			$	760,000
Direct labor		6				228,000
Variable manufacturing overhead		3				114,000
Fixed manufacturing overhead		7				266,000
Variable selling expense		2				76,000
Fixed selling expense		6				228,000
Total cost	$	44			$	1,672,000

The Rets normally sell for $49 each. Fixed manufacturing overhead is $266,000 per year within the range of 31,000 through 38,000 Rets per year.

Required:

1. Assume that due to a recession, Polaski Company expects to sell only 31,000 Rets through regular channels next year. A large retail chain has offered to purchase 7,000 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 7,000 units. This machine would cost $14,000. Polaski Company has no assurance that the retail chain will purchase additional units in the future. What is the financial advantage (disadvantage) of accepting the special order? (Round your intermediate calculations to 2 decimal places.)

2. Refer to the original data. Assume again that Polaski Company expects to sell only 31,000 Rets through regular channels next year. The U.S. Army would like to make a one-time-only purchase of 7,000 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. What is the financial advantage (disadvantage) of accepting the U.S. Army's special order?

3. Assume the same situation as described in (2) above, except that the company expects to sell 38,000 Rets through regular channels next year. Thus, accepting the U.S. Army’s order would require giving up regular sales of 7,000 Rets. Given this new information, what is the financial advantage (disadvantage) of accepting the U.S. Army's special order?

1.) Financial Advantage

2.) Financial Advantage

3.) Financial (DisAdvantage)

Answer 1

Solution- 1: $67,620 profit.

• It should be noted that Company is having spare capacity of 7,000 rets after producing and selling 31,000 rets. Since regular sale is not affected there is no opportunity cost.
• It is worthwhile to understand that Fixed Manufacturing Overhead $266,000 and Fixed Selling overhead of 228,000 would remain same and will not be impacted from the current order of 7,000 rets.
• Cost to the company per unit for this 7,000 rets order would be 20+6+3+0.5= 29.5 (Direct Material + Direct Labor+ variable Manufacturing overhead+ 25% of selling expenses (100% -75%)
• Normal Selling Price is $49 per unit. After 16% discount, the selling price for this order would be 41.16. So, the company gets a profit of 11.66 ($41.16- $29.5).
• But the company will incur an additional cost of machine as $14,000 which is a cost of $2 per unit if the company expects order wouldn’t be received again.
• After deduction of extra cost of $2 per unit, net contribution left would be $9.66

Financial Advantage: So, a net profit of $9.66 per unit. 7,000*9.66= $67,620 profit.

Solution-2: Advantage $9,800

• For US Army, there would not be any variable cost for selling (as stated in question).
• The Final cost for this special order, relevant cost per unit would be $29 [20+6+3 ((Direct Material + Direct Labor+ variable manufacturing overhead).]
• A Fixed Fees of $1.4 per ret would be given by Army while the total relevant cost for this order is $29.
• Fixed Overhead will not be asked by Polaski since fixed cost will not change due to acceptance of this order. Hence fixed cost will be considered as irrelevant cost for this order.
• Polaski should ask for reimbursement of $29 + $1.4 = $30.4

Financial Advantage: Total money received – relevant cost for the order

= ($30.4) * 7000- $29*7000

= $9,800

Increase in Profit = $9,800

Solution 3: Decrease in Profit = $116,200

Since Polaski is operating at full capacity, it will have to forego the contribution made on regular sales if the order is accepted.

If the order is not accepted, Polaski could have earned the normal contribution from regular sale.

Normal Contribution per unit for Polaski is

= Sales Price - (Direct Material + Direct Labor+ variable Manufacturing overhead+ Selling expenses)

= $49 – $(20+6+3+2)

= $18

No. of Units in question = 7000 units

Contribution could have been earned on regular sales= 7000*18 = $126,000

Actual Contribution earned on army sales= $9,800(calculated in part 2)

Decrease in Profit = $126,000 - $9,800 = $116,200