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 (the net operating income will increased but I'm not sure by what)?

Answer 1

Concepts and reason

Costing is a system which is used to assign cost any element of the business. System of costing is used to evaluate the cost that an organization has to incur on any particular element. There are many types of costing techniques in costing system like absorption costing, marginal costing etc.

Under absorption costing we study past cost data that has already been incurred, but in marginal costing decisions are taken for future projects by evaluating expected cost data. There are wide categories of decisions that we take under marginal costing, for example make or buy decision, lease or buy decision, shut down now or later, incremental costing etc.

Fundamentals

Under incremental costing only those costs which are relevant for taking decision are considered. Sunk costs and irrelevant costs are not considered while taking decision under incremental costing because those costs will continue to occur whether the proposed project is accepted or not. Examples of sunk costs are fixed cost like supervisor’s salary, factory rent etc.

Sometimes fixed cost must be incurred, if the proposed proposal is accepted. These fixed costs become relevant cost for the decision because these costs will not be incurred if the proposal is not accepted. These costs vary with the decision of acceptance or rejection of the project. Examples of these fixed costs are new machinery purchased for the proposed project, new supervisor hired for the project, etc.

The incremental cost is computed as follows:

The incremental net operating income is computed as follows:

Ans:

The incremental net operating income from the special order of bracelet is $449.