Polaski Company manufactures and sells a single product called a Ret. Operating
ID: 2476001 • Letter: P
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 beloww Unit Total Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead Variable selling expense $20 720,000 216,000 108,000 324,000 72.000 216,000 riable selling expense Fixed selling expense Total cost $ 46 1,656,000 The Rets normally sell for $51 each. Fixed manufacturing overhead is constant at $324,000 per year within the range of 27,000 through 36,000 Rets per year Required 1. Assume that due to a recession, Polaski Company expects to sell only 27,000 Rets through regular 9,000 Rets if Polaski is wiing 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 9,000 units. This machine would cost $18,000. Polaski Company has no assurance that the retail chain will purchase additional units in channels next year. A large retail chain has offered to purchase the future. Determine the impact on profits next year if this special order is accepted ofitExplanation / Answer
Solution:
1) Determination of impact on profits next year if this special order is accepted.
There are some rules for this type of decision making like whether to accept special order and if accept what are the costs to be considered while evaluating the profitability of this type order.
One of them is when there the company has idle capacity then the decision should be made as follows:
The company has capacity to produce 36,000 units per year. Due to recession the company expects to sell only 27,000 Units next year. It means company will not utilize their full capacity. Resulting 9,000 Units will become idle capacity.
In case where company has idle capacity, the evaluation of further order is done by comparing variable cost associated / incurred due to accepting special order and the price offered by the customer for special order. Since Fixed Manufacturing Overheads is constant at $324,000 per year within range 27,000 to 36,000 Units. It means whether company accept or not accept the order, fixed overhead & fixed selling expenses will remain constant. Hence fixed manufacturing overheads are irrelevant for this decision making to accept or reject the order. Fixed Manufacturing overheads & Fixed Selling Expenses are treated as SUNK COST hence ignored in decision making.
Statement of Profitability from Special Order
$ / Unit
Sale Value
Special Order Quantity
9,000 Units
Sale Price offered by Customer ($51 - $51*16%)
$42.84
$385,560
Variable Costs:
Direct Material
20
$180,000
Direct Labor
6
$54,000
Variable Manufacturing overhead
3
$27,000
Variable selling expenses ($2 - $2*75%)
$0.50
$4,500
Total Variable Cost
29.5
$265,500
Contribution Margin (Sales - Total Variable Cost)
$120,060
Less: Cost of Machine
($18,000)
Net Profit from Special Order
$102,060
Note – Fixed Manufacturing Cost and Fixed Selling Cost are SUNK Cost, hence not considered in above decision making. Sunk Costs are those costs which have already been incurred in past. They do not play any role in decision making.
If this special order is accepted the Net Profit increase by $102,060
2) Calculation of Increase or decrease in profit if army’s order is accepted
$ / Unit
Sale Value
Special Order Quantity
9,000 Units
Calculation of Total Cost
Direct Material
$20
$180,000
Direct Labor
$6
$54,000
Variable Manufacturing overhead
$3
$27,000
Fixed Manufacturing Overhead
$9
$81,000
Fixed Selling Expenses
$6
$54,000
Total Cost
$396,000
Price offered by Army (Total Cost + $1.8*9000)
$412,200
Net Profit Increase
$16,200
Net Profit increase by $16,200
3) Calculation of Increase or decrease in profit if army’s order is accepted
In this case, company does not have idle capacity. If the company accept the order of army they need to reduce their regular sale (it means there will be a contribution loss) and then sale to the army.
Loss of Contribution from regular Sale:
Regular Sale Price $51 per unit
Total Variable Cost (20+6+3+2) = $31 Per Unit
Contribution Loss ($51 - $31)*9,000 Units
($180,000)
Increase in Profit due to Army Order as calculated in part 2
$16,200
Net Decrease in Profit
($163,800)
Net Profit decrease by $163,800
$ / Unit
Sale Value
Special Order Quantity
9,000 Units
Sale Price offered by Customer ($51 - $51*16%)
$42.84
$385,560
Variable Costs:
Direct Material
20
$180,000
Direct Labor
6
$54,000
Variable Manufacturing overhead
3
$27,000
Variable selling expenses ($2 - $2*75%)
$0.50
$4,500
Total Variable Cost
29.5
$265,500
Contribution Margin (Sales - Total Variable Cost)
$120,060
Less: Cost of Machine
($18,000)
Net Profit from Special Order
$102,060