Cornell Corporation manufactures faucets. Several weeks ago, the firm received a

Question

Cornell Corporation manufactures faucets. Several weeks ago, the firm received a special-order inquiry from Yale, Inc. Yale desires to market a faucet similar to Cornell's model no. 55 and has offered to purchase 3,000 units. The following data are available:

Cost data for Cornell's model no. 55 faucet: direct materials, $48; direct labor, $30 (2 hours at $15 per hour); and manufacturing overhead, $70 (2 hours at $35 per hour).

The normal selling price of model no. 55 is $180; however, Yale has offered Cornell only $132 because of the large quantity it is willing to purchase.

Yale requires a modification of the design that will allow a $5 reduction in direct-material cost.

Cornell's production supervisor notes that the company will incur $8,623 in additional set-up costs and will have to purchase a $12,800 special device to manufacture these units. The device will be discarded once the special order is completed.

Total manufacturing overhead costs are applied to production based on direct labor hours. Total budgeted overhead is $840,000. This figure is based on budgeted yearly fixed overhead of $624,000, a budgeted variable overhead of $216,000, and a budgeted activity level of 24,000 direct labor hours.

Cornell will allocate $8,000 of existing fixed administrative costs to the order as “…part of the cost of doing business.”

Required:

A. One of Cornell's staff accountants wants to reject the special order because “financially, it's a loser.” Do you agree with this conclusion if Cornell currently has excess capacity? Show calculations to determine the incremental profit or loss on this special order to support your answer.

B.If Cornell currently has no excess capacity, should the order be rejected? (Assume for part B that Cornell cannot acquire excess capacity via overtime or any other way.) Briefly explain.

Explanation / Answer

Budgeted DLH            24,000 Yearly Fixed OH          624,000 Budgeted Fixed OH /DLH 26 Yearly Variable OH          216,000 BudgetedVariable OH/DLH 9 Special Order costing Units 3000 Details per unit Total Sales price 132          396,000 Direct Material 43          129,000 Direct Labor 30            90,000 Variable Manufacturinh OH 18            54,000 Contribution 41          123,000 Special Fixture            12,800 Set up              8,623 Net Incremental revenue          101,577 A when three is excess capacity , we can ignore fixed manufacturing and admin costs and as the special order is generating positive revenue over variable and order specific cost, the order may be accepted. Regular product contribution Units Details per unit Sales price 180 Direct Material 48 Direct Labor 30 Variable Manufacturinh OH 18 Contribution 84 B The contribution margin/unit of regular product is more than that of special order. Therefore , when there is no excess capacity and excess capacity cannot be created , the special order should be rejected.

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