Imperial Jewelers is considering a special order for 20 handcrafted gold bracele

Question

Imperial Jewelers is considering a special order for 20 handcrafted gold bracelets to be given as gifts to members of a wedding party. The normal selling price of a gold bracelet is $189.95 and its unit product cost is $149.00 as shown below:


Direct materials $84.00
Direct labor 45.00
Manufacturing overhead 20.00
Unit product cost
$149.00

Most of the manufacturing overhead is fixed and unaffected by variations in how much jewelry is produced in any given period. However, $4.00 of the overhead is variable with respect to the number of bracelets produced. The customer who is interested in the special bracelet order would like special filigree applied to the bracelets. This filigree would require additional materials costing $2.00 per bracelet and would also require acquisition of a special tool costing $250 that would have no other use once the special order is completed. This order would have no effect on the company's regular sales and the order could be fulfilled using the company's existing capacity without affecting any other order.


What effect would accepting this order have on the company's net operating income if a special price of $169.95 per bracelet is offered for this order?

Explanation / Answer

Only the incremental costs and benefits are relevant. Because the existing fixed manufacturing
overhead costs would not be effected by the order, they are not relevant.
The incremental net operating income would be computed as follows:    
    
    
Particulars                                          Cost per unit           Total 20 bracelets
Incremental Revenue                            $169.95                      $3,399.00

Less incremental costs
Variable costs:
Direct Materials                                     $84.00                      $1,680.00
Direct labor                                           $45.00                       $900.00
Variable manufacturing overhead             $4.00                           $80.00
Special modifications                               $2.00                           $40.00
Total variable cost (a)                          $135.00                       $2,700.00         

Fixed costs
Purchase bracelets                                                                     $250.00
Total fixed cost (b)                                                                     $250.00
Total incremental cost (a+b)                                                    $2,950.00
Incremental net operating income                                              $449.00

Therefore, the net operating income will increase by $449 if the order is accepted.
In general, a special order is profitable if the incremental revenue from the special order exceeds
the incremental costs of the order.

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