Question

Problem 12-22 Special Order Decisions [LO12-4]

Polaski Company manufactures and sells a single product called a Ret. Operating at capacity, the company can produce and sell 40,000 Rets per year. Costs associated with this level of production and sales are given below:

	Unit				Total
Direct materials	$	15			$	600,000
Direct labor		8				320,000
Variable manufacturing overhead		3				120,000
Fixed manufacturing overhead		7				280,000
Variable selling expense		4				160,000
Fixed selling expense		6				240,000
Total cost	$	43			$	1,720,000

The Rets normally sell for $48 each. Fixed manufacturing overhead is $280,000 per year within the range of 30,000 through 40,000 Rets per year.

Required:

1. Assume that due to a recession, Polaski Company expects to sell only 30,000 Rets through regular channels next year. A large retail chain has offered to purchase 10,000 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 10,000 units. This machine would cost $20,000. 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 30,000 Rets through regular channels next year. The U.S. Army would like to make a one-time-only purchase of 10,000 Rets. The Army would pay a fixed fee of $1.80 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 40,000 Rets through regular channels next year. Thus, accepting the U.S. Army’s order would require giving up regular sales of 10,000 Rets. Given this new information, what is the financial advantage (disadvantage) of accepting the U.S. Army's special order?

Answer 1

Question 1- Whether to accept offer from the Large Retail Chain

Product = Ret

Capacity = 40,000

Computation of Variable Cost per unit

Particulars	Amount
Direct Material	$15
Direct Labour	$8
Variable Manufacturing OH	$3
Variable Selling OH	$4
Total Variable Cost per unit	$30

Total Fixed Overhead = $280,000 + $ 240,000 = $520,000

Selling Price for the 10,000 Rets offer = $48- 16% discount = $ 40.32

Total Variable Cost per unit for the offer = $30 - 75% of the Variable Selling OH = $30 - (4 * 75%) = $27

Additional Cost for the purchase of New Machine = $20,000

Computation of Additional Profit / Loss from the offer

Particulars	Amount
Sales Value of 10,000 units ($40.32 * 10,000)	$403,200
Less: Total Variable Cost (27 * 10,000)	$270,000
Total Contribution	$133,200
Less: Cost of New Machinery	$20,000
Additional Profit	$113,200

Note: It is assumed that additional machinery cannot be sold outside after the completion of offer and there is no other use for the machinery for the company.

Question 2- Whether to accept offer from the US Army

Consideration per unit = $ 1.8 + Cost of production per unit

Computation of Cost of production per unit

Particulars	Amount
Total Variable Cost	$30
Less: Variable Selling Cost	$4
Variable Cost of production per unit for the order	$26
Fixed Manufacturing OH per unit	$7
Cost of production per unit	$33

Selling Price of the order = $33 + $1.8 = $34.8

Computation of Variable Cost per unit

Particulars	Amount
Total Variable Cost per unit	$30
Less: Variable Selling OH	$4
Total Variable Cost	$26

Computation of Additional Profit/Loss from the US Army Order

Particulars	Amount
Sales Value of the order ($34.8 * 10,000)	$348,000
Less: Variable Cost of the order ($26 * 10,000)	$260,000
Total Additional Contribution	$88,000
Other Additional Cost	$0
Additional Profit	$88,000

Question 3: Whether to give up normal sales or not

Computation of Contribution from ordinary sales

Particulars	Amount
Selling Price per unit	$48
Less: Variable Cost per unit	$30
Contribution per unit	$18
Total Contribution ($18 * 10,000)	$180,000

Conclusion: Since normal sales give additional contribution of $92,000 ($180,000 - $88,000), it is advised not to accept the offer of US Army.