Question

The Bancroft Company manufactures skateboards. Several weeks ago, the firm received a special-order inquiry from the Kiger company. Kiger wants to market a skateboard similar to one of Bancroft’s models and has offered to purchase 11,000 units if the order can be completed in three months. The cost data for Bancroft’s model no. 5 skateboard follows:

Cost

Direct material(per unit) $8.20

Direct labor(per unit) $2.25

Total manufacturing overhead (per unit) $10.00

Total (per unit) $20.45

Additional Data:

• The normal selling price of model no. 5 is $26.50; however, Kiger has offered Bancroft only $15.75 because of the large quantity it is willing to purchase.
• Kiger requires a modification of the design that will allow a $2.10 reduction in direct material cost.
• Bancroft’s production supervisor notes that the company will incur $3,700 in additional setup costs and will have to purchase a $2,400 special device to manufacture these units. The device will be discarded once the special order is completed.
• Total manufacturing overhead costs are applied to production at the rate of $20 per machine hour. This figure is based, in part, on budgeted yearly fixed overhead of $750,000 and planned production activity of 60,000 machine hours (5,000 per month).
• Bancroft will allocate $1,800 of existing fixed administrative costs to the order as “…part of the cost of doing business.”

Please answer the following questions about the case:

1. Assume that present sales will not be affected by the order. Should the order be accepted from a financial point of view (i.e., is it profitable?) Why or why not? Show your calculations.
2. Assume that Bancroft’s current production activity consumes 70% of planned machine-hour activity. Can the company accept the order and meet Kiger’s deadline?
3. What options might Bancroft consider if management truly wanted to do business with Kiger in hopes of building a long-term relationships with the firm?

Answer 1

Solution : Computation of profit / loss for demand from Kiger Company for special order of 11000 units :-

Per unit

Selling Price . $ 15.75

Less :

Direct material. $ 6.10 ($ 8.20 - $ 2.10)

Direct labour. $ 2.25

Variable o/h. $ 3.75

_______________

Contribution / unit. $ 3.65

Total contribution for 11000 units = $ 3.65 X 11000 units

= $ 40,150

Less : Additional set up cost. = $ 3,700

Special device. = $ 2,400

Fixed administrative cost = $ 1,800

___________________

Net profit = $ 32,250

So, the Bancroft company should accept the special order from Kiger company, it is profitable to manufacture 11000 extra units for this special order. And, the present sales will not be effected by this order.

Working : Total manufacturing overhead = $ 12,00,000 ( $20 X 60,000 m/ hr)

:Total Fixed manufacturing overhead = $ 7,50,000

So, Total variable overhead = $ 4,50,000

Variable o/h per unit = $ 3.75 ( $4,50,000 X $10 / $ 12,00,000)