4 Special order decision LO 13-2 Packer Concrete Company pours concrete slabs fo

Question

4 Special order decision LO 13-2

Packer Concrete Company pours concrete slabs for single-family dwellings. Wolff Construction Company, which operates outside Packer’s normal sales territory, asks Packer to pour 43 slabs for Wolff’s new development of homes. Packer has the capacity to build 330 slabs and is presently working on 140 of them. Wolff is willing to pay only $2,550 per slab. Packer estimates the cost of a typical job to include unit-level materials, $930; unit-level labor, $590; and an allocated portion of facility-level overhead, $750.

Calculate the contribution to profit from the special order.

CONTRIBUTION TO PROFIT ( )

5 Using the contribution margin approach for a special order decision LO 13-2

Elsea has excess capacity and receives a special order for 5,000 clocks for $22 each. Calculate the contribution margin per unit from the special order.

CONTRIBUTION MARGIN ( ) PER UNIT

8 Asset replacement decision LO 13-5

A machine purchased three years ago for $316,000 has a current book value using straight-line depreciation of $177,000; its operating expenses are $36,000 per year. A replacement machine would cost $239,000, have a useful life of ten years, and would require $10,000 per year in operating expenses. It has an expected salvage value of $71,000 after ten years. The current disposal value of the old machine is $81,000; if it is kept 10 more years, its residual value would be $16,000.

Calculate the total costs in keeping the old machine and purchase a new machine.

KEEP OLD MACHINE PURCHASE NEW MACHINE

TOTAL COSTS ( ) ( )

Packer Concrete Company pours concrete slabs for single-family dwellings. Wolff Construction Company, which operates outside Packer’s normal sales territory, asks Packer to pour 43 slabs for Wolff’s new development of homes. Packer has the capacity to build 330 slabs and is presently working on 140 of them. Wolff is willing to pay only $2,550 per slab. Packer estimates the cost of a typical job to include unit-level materials, $930; unit-level labor, $590; and an allocated portion of facility-level overhead, $750.

Explanation / Answer

Sol) One type of short-term decision that businesses frequently have to make is whether or not to accept special order requests from customers. A special order is an order that the company did not anticipate when developing its budget for the year. Therefore, this is an additional opportunity to generate revenue above sales goals. Special orders typically request a lower price than normally offered and/or might include additional costs.

However, if the order will bring in additional profit, the order should be considered.

When faced with a special order decision, a company should consider the following three items:

1. Does the company have the excess capacity to fulfill this order?

Remember that a special order is an order that the company did not expect. The company must make sure that there is excess capacity to fill this order without harming the original plan developed for the year.

2. Will the order be profitable?

Typically, a special order will have a reduced price and/or additional costs. Will the price be high enough to cover the incremental costs associated with the order. Think back to overhead allocation. When overhead allocation rates were developed at the beginning of the year, they were based on the planned production. These special orders are in addition to the planned production. Therefore, fixed overhead would not be applied to these jobs. This allows the company to make the products needed for the special order at a reduced cost. Although the price might be lower, the company may be able to achieve profit on the job.

3. Will the order affect planned sales, now or in the future?

The company must insure that the special order will not hurt other sales. It is important to make sure that the customer requesting the special order does not compete with existing customers or the company itself, which would result in decreased sales at regular prices. Special orders can also lead to unhappy existing customers if they find out about the special deal you gave someone else. Careful consideration must be made when accepting special orders to protect current and future profits.

Identify the relevant costs

In order to identify the relevant costs associated with a special order decision, we must look at the existing costs to determine which costs will be paid if the order is accepted. Previously incurred fixed costs are never relevant. The only fixed costs that should be considered are fixed costs that are incurred because of the special order. Then consider your variable costs. Are there any variable costs that will not be paid with this special order? Sometimes variable selling costs are excluded from the calculation because no sales commission will be paid on the order. These savings can help decrease the cost and increase the profitability of the job.

Should the company accept the job?

Typically in problems you will do in class, you will only consider the quantitative factors. Use the contribution margin approach to calculate if the job will generate profit or loss:

1. Calculate the contribution margin per unit

Calculate the contribution margin (price – variable costs) per unit for the special order. Exclude irrelevant costs from the calculation.

2. Calculate the total contribution margin

Multiply the number of units in the special order by the contribution margin per unit.

3. Subtract any incremental fixed costs from the contribution margin to determine profit or loss

If there are any incremental fixed costs, subtract those costs from the contribution margin. If there are no incremental fixed costs, the contribution margin is all profit.

4. Determine if you should accept the job

If there are no extenuating qualitative issues, accept the job if it will generate additional profit. If there is a loss on the job, do not accept the job.

Calculating the contribution to profit from the special order:

=2,550 – (930+950)

=2,250 – 1,880

=670 per unit

=28,810this is the contribution to profit.

     5-a-1) Calculate the contribution margin per unit from the special order.

Price per unit given = 30

Variable cost per unit = 228,000 / 12,000 units = 19

Contribution margin = 30-19 = 11 per unit

                   5-a-2) SHOULD ELSEA ACCEPT THE SPECIAL ORDER? YES OR NO

To accept a special order we need to see whether they are generating profit or not,

Profit = contribution – fixed cost

Contribution = 11 per unit * 12,000 units

= 132,000

Profit = 132,000 – 60,000 = 72,000

Here we can accept the order

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