Pietarsaari Oy, a Finnish company, produces cross-country ski poles that it sell
ID: 2475647 • Letter: P
Question
Pietarsaari Oy, a Finnish company, produces cross-country ski poles that it sells for €31 a pair. (The Finnish unit of currency, the euro, is denoted by €.) Operating at capacity, the company can produce 51,000 pairs of ski poles a year. Costs associated with this level of production and sales are given below:
1.) The Finnish army would like to make a one-time-only purchase of 9,400 pairs of ski poles for its mountain troops. The army would pay a fixed fee of €4 per pair, and in addition it would reimburse the Pietarsaari Oy company for its unit manufacturing costs (both fixed and variable). Due to a recession, the company would otherwise produce and sell only 41,600 pairs of ski poles this year. (Total fixed manufacturing overhead cost would be the same whether 41,600 pairs or 51,000 pairs of ski poles were produced.) The company would not incur its usual variable selling expenses with this special order.
If the Pietarsaari Oy company accepts the army’s offer, by how much would net operating income increase or decrease from what it would be if only 41,600 pairs of ski poles were produced and sold during the year?
2.) Assume the same situation as described in (1) above, except that the company is already operating at capacity and could sell 51,000 pairs of ski poles through regular channels. Thus, accepting the army’s offer would require giving up sales of 9,400 pairs at the normal price of €31 a pair. If the army’s offer is accepted, by how much will net operating income increase or decrease from what it would be if the 9,400 pairs were sold through regular channels?
Per Pair Total 11 3 Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead Variable selling expense Fixed selling expense 561,000 153,000 51,000 306,000 51,000 255,000 6 Total cost 27 1,377,000Explanation / Answer
Answer:
Selling price per pair under normal situation = Euro 31
Less: Direct Material Cost per unit = Euro 11
Less: Direct Labour Cost per unit = Euro 3
Less: Variable manufacturing overhead per unit = Euro 1
Contribution per unit of production = Euro 16 (Contribution under special order with no selling expense)
Less: Variable Selling Expense per unit = Euro 1
Contribution per unit of Sales = Euro 15 (Contribution under normal sales)
Scenario 1: Where the Company could otherwise sell only 41,600 pairs;
The increase in net operating profit due to Army's Order = Euro 166,400 - (Euro 15 x 41,600 - Euro 306,000 - Euro 255,000) = Euro 166,400 - Euro 63,000 = Euro 103,400
Scenario 2: Where the Company is capable of selling 51,000 pairs by itself
Net Profit if Company sells 51,000 pairs by itself = Euro 15 x 51,000 - Euro 306,000 - Euro 255,000 = Euro 204,000
Since, the Company can earn Euro 204,000 by selling 51,000 pairs itself therefore, it can earn additonal profit of Euro 204,000 - Euro 166,400 = Euro 37,600. Or we can say that if the Company will accept the Army's proposal then its net profit will decrease by Euro 37,600.
Particulars Sale of 41,600 Units Sale of 9,400 units under Army Order Total Total Contribution / Total Fees in case of Army 41,600 x Euro 15 = Euro 624,000 9,400 x Euro 4 = Euro 37,600 Euro 661,600 Less: Fixed Manufacturing Over head Euro 306,000 Less: Fixed Selling Expense Euro 255,000 Add: Reimbursement from Army for Manufacturing Costs Euro 65,800 (9400 x 6 + 9400) Net Profit under this Scenario Euro 166,400