Question

11-32 Special Order Award Plus Co. manufactures medals for winners of athletic events and other contests. Its manufacturing plant has the capacity to produce 10,000 medals each month; current monthly production is 7,500 medals. The company normally charges $225 per medal. Variable costs and fixed costs for the current activity level of 75% follow:

		Current Product Costs
Variable costs
Manufacturing
Labor		$   375,000
Material		300,000
Marketing		187,500
Total variable costs		$   862,500
Fixed costs
Manufacturing		$   275,000
Marketing		225,000
Total fixed costs		$   500,000
Total costs		$1,362,500

Award Plus has just received a special one-time order for 2,500 medals at $115 per medal. For this particular order, no variable marketing costs will be incurred. Cathy Senna, a management accountant with Award Plus, has been assigned the task of analyzing this order and recommending whether the company should accept or reject it. After examining the costs, Senna suggested to her supervisor, Gerard LePenn, who is the controller, that they request competitive bids from vendors for the raw materials because the current quote seems high. LePenn insisted that the prices are in line with those of other vendors and told her that she was not to discuss her observations with anyone else. Senna later discovered that LePenn is a brother-in-law of the owner of the current raw materials supply vendor.

Required

1. Calculate both the old (i.e., prior to the special order) average cost per unit and the revised average cost per unit, including the effect of the special sales order. (Round both answers to 2 decimal places.) Are either of these two figures relevant for evaluating whether to accept or reject the special order? Explain.
2. What is the short-term effect on operating profit (to the nearest whole dollar) if Award Plus Co. accepts the special sales order? (Round answer to nearest whole number.)
3. What is the breakeven selling price per unit for the special sales order, rounded to 2 decimal places?
4. Discuss at least three other considerations that Cathy Senna should include in her analysis of the special sales order.
5. Explain how Cathy Senna should try to resolve the ethical conflict arising out of the controller’s insistence that the company avoid competitive bidding.

Answer 1

Details given in the question :

Current manufacturing capacity =	10,000
Curent production output =	7,500
Normal sales price per unit =	$225

Current Product Costs:
Variable Costs:
Manufacturing:		Per Unit
Labor	$375,000	$50
Material	$300,000	$40
Marketing	$187,500	$25
Total Variable Costs	$862,500
Fixed Costs:
Manufacturing	$275,000
Marketing	$225,000
Total Fixed Costs	$500,000
Total (i.e., Full Manufacturing) Cost	$1,362,500

Information regarding the special sales order:
Number of units	2,500
Offer price, per unit	$115

Answers:

1.

Old (prior to special order) average cost per unit:

Total Cost/month	$1,362,500
Total Output/month	7,500
Average cost/unit	$181.67

Recalculated Average Cost, including Special Sales Order:

Old Total Cost/month	$1,362,500
Special-Order Costs:
Direct manufacturing labor	$125,000
Material	$100,000
Total Costs	$1,587,500
Total Output (units)	10,000
New average cost/unit	$158.75

Both of the above two cost figures are irrelevant to the decision: both includes sunk cost, which is in the form of fixed manufacturing overhead and fixed marketing costs. That is, these costs will likely be the same irrespective of whether or not we accept the special order. As such, they are irrelevant for this decision.

2.

Short-term profit impact of accepting the special sales order:

Incremental cost for Special Order	$225,000
Number of units in special order	2,500
Incremental cost/unit	$90.00

Effect on short-term profit of accepting the special order:

Incremental Revenues	$287,500
Incremental Costs	$225,000
Incremental operating profit (loss)	$62,500

3. Breakeven price on special sales order:

Relevant Costs:
Incremental Direct manufacturing labor	$125,000
Incremental Material	$100,000
Total Incremental Cost	$225,000
Number of Units	2,500
Breakeven selling price per unit	$90.00

4. Cathy Senna should include below details in analysis of the special sales order:

a) is the order likely to take to more regular business with this customer?

b) Will the order help to support or undermine the company's desired image in the market?

c) while Award Plus have enough capacity to complete the special order?  will there be additional costs other than variable manufacturing costs to complete the order like setup costs?

d). Regarding the conflict of interest of the Controller relating to the raw material sourcing.

5.  The controller - Gerard LePenn has a conflict of interest in the raw material sourcing. Cathy Senna has the ethical responsibility as she is a Management Accountant, to take this issue to the appropriate person in charge in the company. As Gerard LePennis who is the controller, Cathy Senna could contact Vice President of Finance, the CFO, any member of the top management or board, also the audit committee if any.