Question

Problem 11-22 Special Order Decisions [LO11-4]

Polaski Company manufactures and sells a single product called a Ret. Operating at capacity, the company can produce and sell 48,000 Rets per year. Costs associated with this level of production and sales are given below:

	Unit				Total
Direct materials	$	20			$	960,000
Direct labor		10				480,000
Variable manufacturing overhead		3				144,000
Fixed manufacturing overhead		7				336,000
Variable selling expense		4				192,000
Fixed selling expense		6				288,000
Total cost	$	50			$	2,400,000

The Rets normally sell for $55 each. Fixed manufacturing overhead is $336,000 per year within the range of 42,000 through 48,000 Rets per year.

Required:

1. Assume that due to a recession, Polaski Company expects to sell only 42,000 Rets through regular channels next year. A large retail chain has offered to purchase 6,000 Rets if Polaski is willing to accept a 16% discount off the regular price. There would be no sales commissions on this order; thus, variable selling expenses would be slashed by 75%. However, Polaski Company would have to purchase a special machine to engrave the retail chain’s name on the 6,000 units. This machine would cost $12,000. Polaski Company has no assurance that the retail chain will purchase additional units in the future. What is the financial advantage (disadvantage) of accepting the special order? (Round your intermediate calculations to 2 decimal places.)

2. Refer to the original data. Assume again that Polaski Company expects to sell only 42,000 Rets through regular channels next year. The U.S. Army would like to make a one-time-only purchase of 6,000 Rets. The Army would pay a fixed fee of $2.00 per Ret, and it would reimburse Polaski Company for all costs of production (variable and fixed) associated with the units. Because the army would pick up the Rets with its own trucks, there would be no variable selling expenses associated with this order. What is the financial advantage (disadvantage) of accepting the U.S. Army's special order?

3. Assume the same situation as described in (2) above, except that the company expects to sell 48,000 Rets through regular channels next year. Thus, accepting the U.S. Army’s order would require giving up regular sales of 6,000 Rets. Given this new information, what is the financial advantage (disadvantage) of accepting the U.S. Army's special order?

1	Financial advantage
2	Financial advantage
3	Financial (disadvantage)

Answer 1

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Polaski
Particulars	Details	Amount	Price per unit
No. of units produced	48,000.00	48,000.00
Sell price per unit			55.00	A
Direct Material		960,000.00	20.00
Direct Labor		480,000.00	10.00
Variable Manufacturing overhead		144,000.00	3.00
Variable selling expense		192,000.00	4.00	C
Total Variable cost per unit			37.00
Contribution per unit			18.00	G
Fixed Manufacturing overhead		336,000.00	7.00
Fixed selling expense		288,000.00	6.00
Total Fixed cost per unit			13.00

Current Scenario
Units Sold	42,000.00
Contribution earned		756,000.00
Less:
Fixed Manufacturing overhead		336,000.00
Fixed selling expense		288,000.00
Net Profit		132,000.00

Situation 1- Offer of Retail Chain
Reduction in Sell price by	16%
Reduction in Sell price per unit	8.80			B=A*16%
Reduction in Variable selling expense	75%
Reduction in Variable selling expense	3.00			D=C*75%
Revised Sell price per unit		46.20		E=A-B
Less:
Direct Material		20.00
Direct Labor		10.00
Variable Manufacturing overhead		3.00
Variable selling expense		1.00		F=C-D
Total Variable cost per unit		34.00
Contribution per unit		12.20
No. of Units		6,000.00
Total Contribution		73,200.00
Less: Cost of special machine		12,000.00
Net income / Financial advantage		61,200.00

Conclusion: By selling the remaining 6,000 units Polaski Company can earn an additional profit $ 61,200. So they should accept this project.

Note: Fixed manufacturing and selling expenses are sunk cost and they should not be considered for this order.

Situation 2- US Army
Fixed Fee per unit	2.00
Fixed manufacturing overhead per unit	7.00
Net received per unit	9.00
No. of Units	6,000.00
Total received/ Financial advantage	54,000.00

Conclusion: By selling the remaining 6,000 units to US army Polaski Company can earn an additional profit $ 54,000. So they should accept this project.

Situation 3- US Army
Particulars		Sales through regular channel	US Army
Units Sold		48,000.00	42,000.00	H
Contribution earned		864,000.00	756,000.00	I=H*G
Less:
Fixed Manufacturing overhead		336,000.00	336,000.00
Fixed selling expense		288,000.00	288,000.00
Net Income		240,000.00	132,000.00
Add: Total received from US Army			54,000.00	Calculated in Situation 2 above
Net Profit		240,000.00	186,000.00
Variance/ Financial disadvantage			54,000.00

Conclusion: If Polaski company is able to sell all its units through regular channel then it should not sell to US Army. Because it will lose $ 54,000 if it will sell to US Army.