Question

Exercise 4-40 Special Order (LO 4-1, 2)

Fairmount Travel Gear produces backpacks and sells them to vendors who sell them under their own label. The cost of one of its backpacks follows:​

Materials $27.00

Labor 18.00

Variable overhead 7.50

Fixed overhead ($405,000 per year, 45,000 units per year) $9.00

Total $61.50

Riverside Discount Mart, a chain of low-price stores, has asked Fairmount to supply it with 3,000 backpacks for a special promotion Riverside is planning. Riverside has offered to pay Fairmount a unit price of $63 per pack. The regular selling price is $90. The special order would require some modification to the basic model. These modifications would add $6.00 per unit in material cost, $2.50 per unit in labor cost, and $0.70 in variable overhead cost. Although Fairmount has the capacity to produce the 3,000 units without affecting its regular production of 45,000 units, a one-time rental of special testing equipment to meet Riverside’s requirements would be needed. The equipment rental would be $7,500 and would allow Fairmount to test up to 5,000 units.

Required a. Prepare a schedule to show the impact of filling the Riverside order on Fairmont’s profits for the year. (Enter your answers in thousands rounded to 1 decimal place. (i.e., 5,400,400 should be entered as 5,400.4). Select option "higher" or "lower", keeping Status Quo as the base. Select "none" if there is no effect.)

b. Do you agree with the decision to accept the special order? Yes or No

c. Considering only profit, determine the minimum quantity of backpacks in the special order that would make it profitable. (Do not round intermediate calculations.)

Answer 1

Solution a:

Fairmount Travel Gear (All figures in thousands)
Particulars	Status Quo (45000 Units)	Regular Sales + Special order (48000 units	Difference
	Amount	Amount
Revenue	$4,050.0	$4,239.0	$189.0	Higher
Costs:
Direct Material	$1,215.0	$1,314.0	$99.0	Higher
Direct Labor	$810.0	$871.5	$61.5	Higher
Variable Overhead	$337.5	$362.1	$24.6	Higher
Fixed overhead	$405.0	$412.5	$7.5	Higher
Income / (Loss)	$1,282.5	$1,278.9	-$3.6	Lower

Solution b:

No, Special order should not be accepted as it results in a Net loss of $3,600.

Solution c:

Sale price of special order = $63 per pack

Variable cost in special order = $27 + $18+ $7.5 + $6 + $2.5 + $0.70 = $61.70

Contribution margin per unit = $63 - $61.7 = $1.30

Fixed cost due to special order = $7,500

Minimum quantity of backpacks in special order = Fixed Cost / Contribution margin per unit

= $7500 / $1.30 = 5,769.2307 units or say 5770 units