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Newtown Sunglasses sell for about \(154 per pair. Suppose that the company incurs the following average costs per pair:

Direct materials \)39

Direct labor 15

Variable manufacturing overhead 6

Variable selling expenses 3

Fixed manufacturing overhead 20*

Total cost \(83

* \)2,050,000 Total fixed manufacturing overhead / 102,500 Pairs of sunglasses

Newtown has enough idle capacity to accept a one-time-only special order from Water Shades for 17,000 pairs of sunglasses at \(80 per pair. Newtown will not incur any variable selling expenses for the order.

Requirements

1. How would accepting the order affect Newtown’s operating income? In addition to the special order’s effect on profits, what other (longer-term qualitative) factors should Newtown’s managers consider in deciding whether to accept the order?

2. Newtown’s marketing manager, Peter Kyler, argues against accepting the special order because the offer price of \)80 is less than Newtown’s $83 cost to make the sunglasses. Kyler asks you, as one of Newtown’s staff accountants, to explain whether his analysis is correct. What would you say?

Short Answer

Expert verified

Answer

The expected increase in the operating income of the company would be$340,000.

Step by step solution

01

Step-by-Step SolutionStep 1: Meaning of Special Orders

Special orders refer to the orders received by the business entities fromspecial customers (other than regular ones). Such orders are received forspecial prices, often less than the regular prices.

02

Computation of operating income

Particulars

Amounts ($)

Expected increase in revenues (17000*80)

1,360,000

Less: Expected increase in variable manufacturing costs (17000*60) (Working notes)

(1,020,000)

Expected increase in operating income

$340,000

Working notes:

Computation of total variable cost:

Particulars

Amounts ($)

Direct materials

39

Direct labor

15

Variable manufacturing overhead

6

Total relevant variable cost

$60

Consideration of factors while accepting special orders:

A manager must consider the following factors:

  • A manager must review the price demanded by a customer placing a special order with the company.
  • It must be reviewed whether such a customer would deal with the company repeatedly or not.
  • In addition, the manager must consider what impact the special order prices may have on the competitors.
03

Comment on the analysis

As per the given information and data, the analysis is inappropriate because $83 represents the mixed cost that the company incurs to produce a product.

In addition, while making decisions on acceptance and rejection of the special orders, only a variable part of the manufacturing cost is considered because other costs remain the same and are not considered relevant for making decisions.

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Most popular questions from this chapter

Refer to Exercise E25-13. Assume that Video Avenue can avoid $39,000 of direct fixed costs by dropping the DVD product line. Prepare a differential analysis to show whether Video Avenue should stop selling DVDs.

Grimm Company makes decorative wedding cakes. The company is considering buying the cakes rather than baking them, which will allow it to concentrate on decorating. The company averages 100 wedding cakes per year and incurs the following costs from baking wedding cakes:

Direct materials \(500

Direct labor 1,000

Variable manufacturing overhead 200

Fixed manufacturing overhead 1,200

Total manufacturing cost \)2,900

Number of cakes ÷ 100

Cost per cake \(29

Fixed costs are primarily the depreciation on kitchen equipment such as ovens and mixers. Grimm expects to retain the equipment. Grimm can buy the cakes for \)25.

  1. Should Grimm make the cakes or buy them? Why?
  2. If Grimm decides to buy the cakes, what are some qualitative factors that Grimm should also consider?

When should special pricing orders be accepted?

Edna Fashions operates three departments: Men’s, Women’s, and Accessories. Departmental operating income data for the third quarter of 2018 are as follows:

EDNA FASHIONS

Income Statement

For the Quarter Ended September 30, 2018

Department

Men’s Women’s Accessories Total

Net Sales Revenue \(101,000 \)59,000 \(102,000 \)262,000

Variable Costs 65,000 35,000 91,000 191,000

Contribution Margin 36,000 24,000 11,000 71,000

Fixed Costs 27,000 19,000 29,000 75,000

Operating Income \(9,000 \)5,000 \((18,000) \)(4,000)

Assume that the fixed costs assigned to each department include only direct fixed costs of the department:

• Salary of the department’s manager

• Cost of advertising directly related to that department

If Edna Fashions drops a department, it will not incur these fixed costs. Under these circumstances, should Edna Fashions drop any of the departments? Give your reasoning.

Thomas Company makes a product that regularly sells for \(12.50 per unit. The product has variable manufacturing costs of \)8.50 per unit and fixed manufacturing costs of \(2.00 per unit (based on \)200,000 total fixed costs at current production of 100,000 units). Therefore, the total production cost is \(10.50 per unit. Thomas Company receives an offer from Wesley Company to purchase 5,000 units for \)9.00 each. Selling and administrative costs and future sales will not be affected by the sale, and Thomas does not expect any additional fixed costs.

1. If Thomas Company has excess capacity, should it accept the offer from Wesley? Show your calculations.

2. Does your answer change if Thomas Company is operating at capacity? Why or why not?

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