Question

Polaski Company manufactures and sells a single product called a Ret. Operating at capacity, the company can produce and sell 36,000 Rets per year. Costs associated with this level of production and sales are given below:

  

	Unit			Total
Direct materials	$	25		$	900,000
Direct labor		8			288,000
Variable manufacturing overhead		3			108,000
Fixed manufacturing overhead		5			180,000
Variable selling expense		4			144,000
Fixed selling expense		6			216,000
Total cost	$	51		$	1,836,000

   

The Rets normally sell for $56 each. Fixed manufacturing overhead is constant at $180,000 per year within the range of 29,000 through 36,000 Rets per year.

  

Required:
1.	Assume that due to a recession, Polaski Company expects to sell only 29,000 Rets through regular channels next year. A large retail chain has offered to purchase 7,000 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 7,000 units. This machine would cost $14,000. Polaski Company has no assurance that the retail chain will purchase additional units in the future. Determine the impact on profits next year if this special order is accepted.

     

2.

Refer to the original data. Assume again that Polaski Company expects to sell only 29,000 Rets through regular channels next year. The U.S. Army would like to make a one-time-only purchase of 7,000 Rets. The Army would pay a fixed fee of $1.60 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. If Polaski Company accepts the order, by how much will profits increase or decrease for the year?

     

3.

Assume the same situation as that described in (2) above, except that the company expects to sell 36,000 Rets through regular channels next year. Thus, accepting the U.S. Army’s order would require giving up regular sales of 7,000 Rets. If the Army’s order is accepted, by how much will profits increase or decrease from what they would be if the 7,000 Rets were sold through regular channels?

Answer 1

Concepts and reason

Job order costing: It is a method of cost accounting, in which the cost is collected and accumulated for each job, work order, or project separately. Especially, the job order costing is followed in organizations where customized goods are produced. The costs of goods manufactured incurred in each job, or project, and work order are determined in the Cost of Good Manufactured Schedule.

Direct materials: Direct materials are the raw materials that are directly related with the production of the goods.

Direct labor cost: The labor cost includes the wages or salaries paid to employees who produce goods or services. Labor refers to the actual work that the employees perform to produce products. Labor costs refer to the amount that the employer pays the employees to complete the work.

Manufacturing Overhead costs: The costs that do not relate directly with the manufacturing of products, are referred to as manufacturing overhead costs or indirect costs. For example, insurance cost related to factory operations and depreciation incurred on factory equipment.

Fundamentals

Incremental analysis: Incremental analysis is a technique used for decision making. It is also known as differential analysis, marginal analysis, and relevant cost approach. This analysis helps to find the true cost between available alternatives. Make or buy decision, accepting additional business, elimination of segment, and retain or replace decision are the examples of incremental analysis.

Make or buy decision: It is a decision made by the management whether to manufacture the product in-house or purchase it from the market. The following are the reasons for making the product.

Market price is higher than manufacturing cost.

Requirements of direct control over the product.

Quality control.

Non availability of suppliers.

The following are the reasons for buying the product.

Manufacturing cost is higher than market price.

Lack of technical skills.

Insufficient capacity to make internally.

Quality products available in the market at lower rates.

Make or buy decision: It is the process of analysing and deciding whether to make a product-in-house or to buy the same product from other vendor based on cost and benefits estimation.

1)

Determine the profit impact if the special order is accepted:

Therefore, the net profit is increased by $56,280 if the special order is accepted.

2)

Determine the increase or decrease in profits while accepting the order:

Therefore, the net increase in profit for accepting the order is $46,200.

3)

Determine the increase or decrease in the net profit for accepting the order:

Therefore, the net decrease in profits is ($65,800).

Ans: Part 1

The net profit is increased by $56,280 if the special order is accepted.

Part 2

The net increase in profit for accepting the order is $46,200.

Part 3

The net decrease in profits is ($65,800).