Question

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E8-22A Special order decision and considerations (Learning Objective 3) Jasper McKnight Sunglasses sell for about $150 per pair. Suppose the company incurs the following average costs per pair: $40 12 Direct materials ...... Direct labor Variable manufacturing overhead.... Variable marketing expenses. Fixed manufacturing overhead .......... Total costs...... *$2,100,000 total fixed manufacturing overhead/84,000 pairs of sunglasses $88 Jasper McKnight has enough idle capacity to accept a one-time-only special order from Arizona Glasses for 17,000 pairs of sunglasses at $63 per pair. Jasper Mcknight will not incur any variable marketing expenses for the order. Requirements 1. How would accepting the order affect Jasper McKnight's operating income? In addition to the special order's effect on profits, what other (longer-term qualitative) factors should Jasper Mcknight's managers consider in deciding whether to accept the order? 2. Jasper Mcknight's marketing manager, Nick Ferritto, argues against accepting the special order because the offer price of $63 is less than Jasper Mcknight's $88 cost to make the sunglasses. Ferritto asks you, as one of Jasper Mcknight's staff accountants, to explain whether his analysis is correct.

Answer 1

F G H $ 1,071,000 sales revenue from special order less: relevant costs direct materials direct labor variable manufacturing overhead total relevant costs net increase in operating income from special order $ 680,000 $ 204,000 $ 136,000 $ 1,020,000 $ 51,000 longer term qualitative factors to be considered - |i) the probability of receiving more orders from Arizona Glasses in future. ii) the quality should not be compromised on the sunglasses in special order. iii) evaluation of any possible adverse impact on existing customers because of low price on special order. the marketing manager's analysis is INCORRECT reason - the marketing manager should not compare the special order price with the total cost of production of regular units. Instead, he must compare the special order price with the relevant cost of fulfiling the special order. The relevant cost of fulfiling the special order is ($40 +$12 + $8) i.e. $60 and the special order price is $63. So, the company is earning $3 per unit from the special order and ($3 * 17,000) i.e $51,000 in total from the special order.

for formulas and calculations, refer to the image below -

B2 A B =17000*63 sales revenue from special order less: relevant costs direct materials direct labor variable manufacturing overhead total relevant costs net increase in operating income from special order =17000*40 =17000*12 =17000*8 ESCOLAWN =SUM(D4:06) =E2-E7 longer term qualitative factors to be considered - i) the probability of receiving more orders from Arizona Glasses in future. ii) the quality should not be compromised on the sunglasses in special order. iii) evaluation of any possible adverse impact on existing customers because of low price on special order. 2 the marketing manager's analysis is INCORRECT reason - the marketing manager should not compare the special order price with the total cost of production of regular units. Instead, he must compare the special order price with the relevant cost of fulfiling the special order. The relevant cost of fulfiling the special order is ($40 + $12 + $8) i.e. $60 and the special order price is $63. So, the company is earning $3 per unit from the special order and ($3 * 17,000) i.e $51,000 in total from the special order.

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