Question

Sherene Nili manages a company that produces wedding gowns. She produces both a custom product that is made to order and a standard product that is sold in bridal salons. Her accountant prepared the following forecasted income statement for March, which is a busy month:

	Custom Dresses			Standard Dresses			Total
Number of dresses		10			20			30
Sales revenue	$	53,500		$	33,500		$	87,000
Materials	$	10,700		$	8,700		$	19,400
Labor		20,700			9,700			30,400
Machine depreciation		670			370			1,040
Rent		4,900			3,500			8,400
Heat and light		1,100			700			1,800
Other production costs								3,500
Marketing and administration								8,400
Total costs							$	72,940
Operating profit							$	14,060

Ms. Nili already has orders for the 10 custom dresses reflected in the March forecasted income statement. The depreciation charges are for machines used in the respective product lines. Machines depreciate at the rate of $1 per hour based on hours used, so these are variable costs. In March, cutting and sewing machines are expected to operate for 1,040 hours, of which 670 hours will be used to make custom dresses. The rent is for the building space, which has been leased for several years at $8,400 per month. The rent, heat, and light are allocated to the product lines based on the amount of floor space occupied.

A valued customer, who is a wedding consultant, has asked Ms. Nili for a special favor. This customer has a client who wants to get married in early April. Ms. Nili's company is working at capacity and would have to give up some other business to make this dress. She can't renege on custom orders already agreed to, but she can reduce the number of standard dresses produced in March to 10. Ms. Nili would lose permanently the opportunity to make up the lost production of standard dresses because she has no unused capacity for the foreseeable future. The customer is willing to pay $27,500 for the special order. Materials and labor for the order will cost $6,700 and $10,700, respectively. The special order would require 168 hours of machine time. Ms. Nili's company would save 185 hours of machine time from the standard dress business given up. Rent, heat and light, and other production costs would not be affected by the special order.

Required:

a-1. Calculate the differential operating profit (loss).

a-2. From an operating profit (loss) perspective for March, should Ms. Nili accept the order?

b. What is the minimum price Ms. Nili should accept to take the special order?

	Without Special Order With Special Order Impact Revenue    Materials Labor Machine depreciation Contribution margin Rent Heat and light Other production costs Marketing and administration Operating profit (loss)

From an operating profit (loss) perspective for March, should Ms. Nili accept the order?

Answer 1

Working notes: Special Order Total Custom Dresses 10 $53,500 Standard Dresses 10 $16,750 $27,500 $97,750 Number of Dresses Sales Revenue Less: Costs Materials Labor Machine Depreciation Rent Heat and Light Other production cost Marketing and administration Total Costs Operating Profit $10,700 $20,700 $6701 $4,900 $1,100 $4,350 $4,850 $185 $3,500 $700 $6,7001 $10,700 $168) $21,750 $36,250 $1,023 $1 per machine hour $8,400 $1,800 $3,500 $8,400 $81,123 $16,627 Total Custom Standard Dresses Dresses 670 1851 $6701 $185 Special Order 168 $168 1,023 Machine hours Machine Depreciation ($1 per machine hour) $1,023 Note: Fixed cost allocation will remain same For Standard Dresses variable cost allocation will change proportionate to order Standard Dresses Revenue will be 50% of existing Revenue Direct material and labor will be 50% of existing cost with Special Order Differential Profit /(Loss) $97,750 $10,750 a 1) Differential Operating Profit/Loss) Without Special Order Number of Dresses Sales Revenue $87,000 Less: Variable Cost Materials $19,400 Labor $30,400 Machine Depreciation $1,040 Contribution Margin $36,1601 Less: Fixed cost Rent $8,400 Heat and Light $1,800 Other production cost $3,5001 Marketing and administration $8,4001 Operating Profit $14,060 $21,750 $36,250 $1,023 $38,7271 $2,350 $5,850 -$17 $2,567 $8,400 $1,800 $3,500 $8,400 $16,627 $0 $0 $0 $0 $2,567 a 2) Since there is incremental profit the order should be accepted b) Minimum price to be accepted for special order Existing Sales Revenue $27,500 Less: Incremental profit $2,567 Minimum price $24,933