The regular selling price for one Hom is $90. A special order has been received
ID: 2496803 • Letter: T
Question
The regular selling price for one Hom is $90. A special order has been received at Varone from the Fairview Company to purchase 6,700 Homs next year at 20% off the regular selling price. If this special order were accepted, the variable selling expense would be reduced by 30%. However, Varone would have to purchase a specialized machine to engrave the Fairview name on each Hom in the special order. This machine would cost $12,700 and it would have no use after the special order was filled. The total fixed costs, both manufacturing and selling, are constant within the relevant range of 30,000 to 40,000 Homs per year. Assume direct labor is a variable cost. If Varone can expect to sell 30,000 Homs next year through regular channels and the special order is accepted at 20% off the regular selling price, the effect on net operating income next year due to accepting this order would be a: $47,600 increase $52,700 increase $67,000 increase $21,300 decrease
Explanation / Answer
Answer:
Some data is missing in the question. However i would like to explain each and every aspect of this question in order to get effect on net operating income due to accepting special order.
1) Variable Cost is missing which is relevant to evaluate the special order.
2) Variable Selling Expenses also not given..which is also relevant to evaluate the special order.
3) Variable Cost is very important cost in evaluating the new offer or special order. Since it is missing in the question it is difficult to identify the net effect of special order on next year net operating profit.
4) Fixed Cost ---does not play any role in decision making. In the question it is given that in range 30,000 to 40,000 homs per year, fixed cost are constant. that means if company sale 30,000 homs or 40,000 homs, fixed cost will be the same. Hence it should be ignored because fixed cost is treated as sunk cost which has no relevance in decision making.
5) Cost of Specialised Machine $12,700 --- This cost should be considered because this cost occur only and only if the company accept special order otherwise it will not incur. Hence this is relevant cost.
6) Now, it is clear that Contribution margin from Special Order is the net margin which will effect the company's next year net operating income. It can be calculated by using following statement:
* Variable Cost is missing. You can put value of Direct Labour Cost and Variable Selling Expenses to calculate Total Variable Cost. Thereafter deduct total variable cost from Sales Revenue to get Contribution Margin. Since Special Machine Cost is relevant deduct this cost from Contribution Margin, you will get Net Contribution Margin from Special Order which will effect next year net operating income of company.
Particulars Amount Sales Revenue from Special Order (6,700 x $90 x 80%) $482,400 Variable Cost* (i) Direct Labour Cost (6,700 x $ ) (i) Selling Expenses (6,700 x $ x 70%) Total Variable Cost Contribution Margin (Sales - Variable Cost) Less: Special Machine Cost (Relevant Cost) ($12,700) Net Contribution Margin from Special Order