Example+problem+for+Special+Order+Decision+JRH

SPECIAL ORDER DECISION

Ducky Corporation makes rubber duckie's. Floating Toys Inc has approached Ducky Corp with a proposal to buy 1,000 duckie's for $4,000. Ducky has can easily fill the order without jeopardizing current business. The following costs are associated annually with duckie's when 5,000 units are produced: Forty percent of the overhead is variable. All fixed overhead is allocated equally to all products produced. We will now prepare an incremental analysis to analyze whether Ducky should accept the order from Floating Toys Inc. **Step 1: **Find our sunk costs or irrelevant costs. Allocated fixed overhead is not relevant. The total fixed overhead of $2,700 (60%*$4,500) is the same no matter what decision is made, so it is not part of the analysis. **Step 2: ** Determine incremental revenue. The amount of $4,000 is given for this problem. **Step 3: **Determine incremental costs. The variable material cost must be determined:  $10,500/5,000 = $2.10 per unit  You must then multiply unit cost by the total units in the special order:  $2.10 * 2,000 = $2,100 Because variable costs are increased by $2,100, profit will decrease by $2,100, so the amount is shown as a negative in the incremental analysis. **Step 4: ** Direct labor is another incremental variable cost. The variable cost per unit is:  $6,500/5,000 units = $1.30 per unit  The labor cost of all 1,000 units = 1,000*$1.30 = $1,300 <span style="color: black; font-family: 'Adobe Garamond Pro',serif; font-size: 120%;">Because variable costs are increased by $1,300, profit will decrease by $1,300, so this amount is shown as a negative in the incremental analysis. **<span style="color: black; font-family: 'Adobe Garamond Pro',serif;">Step 5: **<span style="color: black; font-family: 'Adobe Garamond Pro',serif;">Only the variable portion of the fixed overhead is relevant. First you must determine the variable overhead per unit which is $4,500/5,000, or $0.90 per unit. Of this amount, 40% is variable amounting to $0.36 per unit. The cost of the variable overhead for the 1,000 units in the special order equal 1,000*$0.36 = $720. This is an increased cost which causes profit to decrease so the amount is shown as a negative in the analysis. <span style="color: black; font-family: 'Adobe Garamond Pro',serif; font-size: 120%;">Below is our analysis: **__<span style="color: black; font-family: 'Adobe Garamond Pro',serif;">Because a loss of $120 if the order is accepted, managers should reject the decision to make and sell an additional 1,000 duckie's at that price when considering non-qualitative analysis. __**
 * <span style="font-family: 'Adobe Garamond Pro',serif; font-size: 120%;">Direct material || <span style="display: block; font-family: 'Adobe Garamond Pro',serif; font-size: 120%; text-align: right;">$10,500 ||
 * <span style="font-family: 'Adobe Garamond Pro',serif; font-size: 120%;">Direct labor || <span style="display: block; font-family: 'Adobe Garamond Pro',serif; font-size: 120%; text-align: right;">6,500 ||
 * <span style="font-family: 'Adobe Garamond Pro',serif; font-size: 120%;">Manufacturing overhead || __<span style="font-family: 'Adobe Garamond Pro',serif;"> 4,500 __  ||
 * <span style="font-family: 'Adobe Garamond Pro',serif; font-size: 120%;">Total || __<span style="font-family: 'Adobe Garamond Pro',serif;">$21,500 __  ||
 * <span style="font-family: 'Adobe Garamond Pro',serif; font-size: 120%;"> Incremental revenue || <span style="display: block; font-family: 'Adobe Garamond Pro',serif; font-size: 120%; text-align: right;">$4,000 ||
 * <span style="font-family: 'Adobe Garamond Pro',serif; font-size: 120%;"> Incremental costs: ||  ||
 * <span style="font-family: 'Adobe Garamond Pro',serif; font-size: 120%;"> Direct materials || <span style="display: block; font-family: 'Adobe Garamond Pro',serif; font-size: 120%; text-align: right;">(2,100) ||
 * <span style="font-family: 'Adobe Garamond Pro',serif; font-size: 120%;"> Direct labor || <span style="display: block; font-family: 'Adobe Garamond Pro',serif; font-size: 120%; text-align: right;">(1,300) ||
 * <span style="font-family: 'Adobe Garamond Pro',serif; font-size: 120%;"> Variable overhead || __<span style="font-family: 'Adobe Garamond Pro',serif;"> (720) __  ||
 * <span style="font-family: 'Adobe Garamond Pro',serif; font-size: 120%;">Incremental increase in profit if the order is accepted || <span style="display: block; font-family: 'Adobe Garamond Pro',serif; font-size: 120%; text-align: right;">($120) ||