Question

Armstrong Derailleur manufactures a technically superior line of bicycle derailleurs (which are the mechanisms for changing gears on bicycles). Its product is marketed to companies that assemble bikes from components made by many manufacturers. These assemblers then market the finished bikes through retailers. The quality of a bike is determined by the quality of the components used in assembly. Armstrong is proud of the quality of its derailleurs. Because of this product's technical superiority and high price, it is used on only the finest bikes sold. Armstrong makes three different models of derailleurs, which it sells to assemblers at an average price of $250. The growing popularity of cycle racing has been driving up demand for high-end components, including derailleurs. The previous year, the company sold 5,600 derailleurs, and it has capacity to produce a total of 7,100 derailleurs annually. Because the market is growing, Armstrong expects an increase in sales next year, but it does not know how great the increase will be. Last year's income statement is given below: $1,400,000 Revenue Direct Materials 160,000 320,000 60,000 350.000 890,000 260,000 140,000 135.000 535,000 ($25.000) Direct Labour Variable overhead Fixed overhead Cost of Goods Sold Marketing Commissions Administration Expenses Operating Loss The Company's president is Vince Armstrong. Two different bike assemblers have recently approached him with requests that he supply derailleurs for their bikes. Neither of these companies has been a customer before. Miettunen Cycles is a Finnish cycle manufacturer that wants to buy 1,000 derailleurs at an average price of $125. The derailleurs would be used on high-end bikes for exclusive sale in Finland, a market in which Armstrong has no existing sales. Dodds Cycles wants Vince to supply them with 1,000 derailleurs, which it would use for mid-range bicycles to be sold in North America. Dodds is offering to buy the product at an average price of $150. These offers are tempting, as the company would face no new marketing, commission, or administration costs as a result of the orders. Vince Armstrong is interested in these offers, even though the price would be well below normal price. Vince has turned to you, well-respected local consultants, for help in deciding what to do. REQUIRED: Prepare a report to Vince Armstrong with your recommendation.

Answer 1

In accepting the special order, only Variable Cost is to be taken in to consideration.

Variable Cost = Direct Material+Direct Labour+Variable Overhead

Fixed Cost is not taken in to consideration.

The reason behind this is, the Fixed cost is the cost which is already incurred.

which will not influence the decision making.

Please go through the following attachment for solution.

Report on Special Order To Vince Armstrong Case issue: Company has received a special order from two customers Whether to accept the order from both customers or accept only one customer offering higher price. Company Capacity Armstrong Company's total capacity is 7,100 derailleurs. Total Capacity Less: Existing Sales Excess Capacity 7100 5600 1500 Total derailleurs from both customers is 2,000. But Armstrong can supply only to the extent of 1,500 derailleurs. Options Available: Option 1: Dodds Cycles offering higher price, so supply full 1000 units to Dodds cycles. Balance of 500 units available will be supplied to Miettunen Cycles This option cannot be opted, if Miettunen Cycles rejected to accept supply less than 1000 units. Profit under this option is 67,855 $ Option 2: Supply 1000 units only to Dodds as the Miettunen rejected the order less than 1000 units. Profit under this option is 53,570 $ Option 3: Supply 1000 units to Miettunen and 500 units to Dodds. In this case, Dodds accept the order less than 1000 units Profit under this option is 55,355 $ Recommendations: Go with Option 1, which is the most profitable option. In case Miettunen Cycles, reject the offer less than 1000 units, request Dodds to accept the offer of 500 units. If the Dodds accept offer less than 1000 units, go with option 3. In case Dodds rejects the offer less than 1000 units, supply only to Dodds cycles, which is Option 2. In case the company want to supply to both customers with 2000 units, company has to spend additional Fixed overhead cost.

In determining Cost for the special order when there is surplus capacity, Only variable Cost is considered. Determination of Cost of Special Order Particulars Amount Units Cost per unit A A/B а Direct Materials 160000 5600 28.57 b Direct Labour 320000 5600 57.14 Variable Overheads 60000 5600 10.71 a+b+c Total 96.43 The Variable Cost per unit is 96.43 $. Since the Price offered by both customers is above the variable cost, both orders can be accepted. Option 1: 1000 units to Dodds and 500 units to Miettunen a b c=a*b Particulars Selling Price Units Sale Value Less: Variable Cost Dodds Miettunen Total 150 125 1000 500 1,50,000 62,500 96,430 48,215 96.43*1000 96.43*500 53,570 14,285 67,855 e=c-d Net Profit Option 2: Supply 1000 units only Dodds, as the Miettunen rejected the order lessthan 1000 units. Particulars Selling Price Units Sale Value Less: Variable Cost c=a*b d Dodds Miettunen Total 150 1000 1,50,000 96,430 96.43*1000 53,570 53,570 e=c-d Net Profit Option 3: Supply 1000 units to Miettunen and 500 units to Dodds. In this case, Dodds accept the order lessthan 1000 units Particulars Selling Price Units Sale Value Less: Variable Cost c=a*b Dodds Miettunen Total 150 125 500 1000 75,000 1,25,000 48,215 96,430 96.43*500 96.43*1000 26,785 28,570 55,355 d e=c-d Net Profit