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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

Sea Blue manufactures flotation vests in Charleston, South Carolina. Sea Blue’s contribution margin income statement for the month ended December 31, 2018, contains the following data:

SEA BLUE

Income Statement

For the Month Ended December 31, 2018

Sales in units 32,000

Net Sales Revenue \(608,000

Variable Costs:

Manufacturing 96,000

Selling and Administrative 108,000

Total Variable Costs 204,000

Contribution Margin 404,000

Fixed Costs:

Manufacturing 124,000

Selling and Administrative 94,000

Total Fixed Costs 218,000

Operating Income \)186,000

Suppose Overboard wishes to buy 4,600 vests from Sea Blue. Sea Blue will not incur any variable selling and administrative expenses on the special order. The Sea Blue plant has enough unused capacity to manufacture the additional vests. Overboard has offered \(15 per vest, which is below the normal sales price of \)19.

Requirements

1. Identify each cost in the income statement as either relevant or irrelevant to Sea Blue’s decision.

2. Prepare a differential analysis to determine whether Sea Blue should accept this special sales order.

3. Identify long-term factors Sea Blue should consider in deciding whether to accept the special sales order.

Brik, located in San Antonio, Texas, produces two lines of electric toothbrushes: deluxe and standard. Because Brik can sell all the toothbrushes it can produce, the owners are expanding the plant. They are deciding which product line to emphasize. To make this decision, they assemble the following data:

Per Unit

Deluxe Toothbrush Standard Toothbrush

Sales price \(88 \)54

Variable expense 22 18

Contribution margin \(66 \)36

Contribution margin ratio 75.0% 66.7%

After expansion, the factory will have a production capacity of 4,900 machine hours per month. The plant can manufacture 65 standard electric toothbrushes or 27 deluxe electric toothbrushes per machine hour.

Requirements

1. Identify the constraining factor for Brik.

2. Prepare an analysis to show which product line the company should emphasize.

What is cost-plus pricing? Who uses it?

What questions should managers answer when setting regular prices?

What are the two keys in short-term decision making?

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