Question

Li Company produces a product that sells for \(84 per unit. A customer contacts Li and offers to purchase 2,000 units of its product at a price of \)68 per unit. Variable production costs with this order would be \(30 per unit, and variable selling expenses would be \)18 per unit. Assuming that this special order would not require any additional fixed costs, and that Li has sufficient capacity to produce the product without affecting regular sales, explain to Li’s management why it might be a good decision to accept this special order.

Short answer

The management should accept special order because it will increase net income by $40,000.

Step-by-step solution

Meaning of Special Orders

Special orders refer to the orders offered to a business entity at reduced prices. Such orders are usually provided for one time and, in the short run, do not impact the normal sales of the business.

Explanation to management

Computation of incremental income:

Particulars	Details	Amounts ($)
Sales	(2000*68)	$136,000
Less: Variable production cost	(2000*30)	60,000
Less: Variable selling expenses	(2000*18)	36,000
Incremental income		$40,000

As per the above calculations, it is advisable that the management should accept special order because it requires onlyvariable costs,andno additional fixed charges will burden the company.

Also, the acceptance of such an order will lead to an increase in income by $40,000.