Question

Pina Colada Company is a leading manufacturer of sunglasses. One of Pina Colada’s products protects the eyes from ultraviolet rays. An upscale sporting goods store has contacted Pina Colada about purchasing 16,300 pairs of these sunglasses. Pina Colada’s unit manufacturing cost, based on a full capacity of 112,000 units, is as follows:

Direct materials $7

Direct labor 4

Manufacturing overhead (60% fixed) 20

Total manufacturing costs $31

Pina Colada also incurs selling and administrative expenses of $75,620 plus $3 per pair for sales commissions. The company has plenty of excess manufacturing capacity to use in manufacturing the sunglasses. Pina Colada’s normal price for these sunglasses is $43 per pair. The sporting goods store has offered to pay $36 per pair. Since the special order was initiated by the sporting goods store, no sales commission will be paid.

What would be the effect on Pina Colada’s income if the special order were accepted?

Pina Colada’s income will ____ by $____

Answer 1

Solution:

In this question, company has idle capacity so the only expense they will incur in producing the special order is Relevant Cost.

Calculation of Relevant Cost to be incurred by the company related to special order:

	$$
Direct materials	$7
Direct labor	$4
Variable manufacturing overhead ($20*40%)	$8
Relevant Cost per Unit	$19
Special Order units	16,300 Pairs
Total Relevant Cost ($19 * 16,300 Pairs)	$309,700

Effect on Net Operating Income by accepting Special Order

	$$
Direct materials	$7
Direct labor	$4
Variable manufacturing overhead ($20*40%)	$8
Relevant Cost per Unit for Special Order	$19
Special Order units	16,300 Pairs
Total Relevant Cost ($19 * 16,300 Pairs)	$309,700
Effect on Net Operating Income by accepting Special Order
	$$
Unit Sale Price (as offered)	$36
Less: Total Relevant costs per unit (refer above)	$19
Profit per unit from special order	$17
Special Order units	16,300 Pairs
Total Profit from Special Order (16,300*$17)	$277,100
Financial advantage i.e. Increase in Net Operating Income from Special Order	$277,100

If the special order is accepted, the net operating income will increase by $277,100