Chapter 14, Problem 56P

1.

To determine

Identify and explain the costs that will be relevant to Person C’s analysis of special order.

Explanation of Solution

Special order: The order received from special customers (except regular customers) at special price is known as special orders. Such special order price is always lesser than the regular price.

• “The costs that will be relevant to Person C’s analysis of special order those predictable future costs that are applied to a specific decision (the costs that will differ among the alternatives of accepting or rejecting the offer). Only the variable costs of material and labor are relevant”.
• “Since the order is received directly by Incorporation W, variable marketing is irrelevant, for the reason that additional marketing costs will not be earned under this order. Also, the fixed costs are irrelevant, as no additional capital investments are required to meet the order. The firm is operating below full capacity and is having the ability to absorb this order”.

2.

To determine

Ascertain whether Incorporation W must accept the special order and calculate both the new average unit cost and the incremental unit cost for the special order.

Explanation of Solution

• “Incorporation W must accept the offer. Even though the combined average unit cost of $148.75 is greater than the offered price, the incremental average unit cost is only $85.00 for the units in the special order”.
• “Acceptance of the special order would result in a contribution per unit of $15.00 $\left(\$100-\$85\right)$  and a total additional contribution margin of $37,500"$\text{(2,500units}\text{×}\text{\$15}\text{.00)}$”.

The calculations are as follows:

	Current Monthly production	Special order	Combined production
Units produced	$7,500	$2,500	$10,000
Sales  (a)	(1)$1,312,500	(2)$250,000	(3)$1,562,500
Variable costs:
Direct labor	$375,000	$125,000	$500,000
Direct material	$262,500	(4)$87,500	$350,000
Marketing	$ 187,500	$0	$187,500
Total variable costs	$825,000	$212,500	$1,037,500
Fixed costs:
Manufacturing	$275,000	$0	$ 275,000
Marketing	175,000	$0	$175,000
Total fixed costs	$450,000	$0	$ 450,000
Total costs  (b)	$1,275,000	$212,500	$1,487,500
Income before tax  $\left(\text{a}-\text{b}\right)$	$37,500	$ 37,500	$ 75,000
Cost per unit
Variable	$110.00	(5)$85.00	(6)$103.75
Fixed	$60.00	$0	(7) $45.00
Average unit cost	$170.00	$85.00	$148.75

Table (1)

Working notes:

(1)Calculate the sales of current monthly production:

$\begin{array}{c}\text{Sales}\text{=}\left(\begin{array}{l}\text{Price}\text{charged}\text{for}\text{per}\text{medal}\text{×}\\ \text{Number}\text{of}\text{units}\text{produced}\end{array}\right)\\ \text{=}\text{\$175}\text{per}\text{medal}\text{×}\text{7,500}\text{medals}\\ \text{=}\text{\$1,312,500}\end{array}$

(2)Calculate the sales of special order:

$\begin{array}{c}\text{Sales}\text{of}\text{special}\text{order}\text{=}\text{Number}\text{of}\text{units}\text{×}\text{Price}\text{of}\text{per}\text{medal}\\ \text{=}\text{2,500}\text{medals}\text{×}\text{\$100}\\ \text{=\$250,000}\end{array}$

(3)Calculate the direct labor for special order:

$\begin{array}{c}\begin{array}{l}\text{Direct}\text{labor}\text{for}\\ \text{special}\text{order}\end{array}\}\text{=}\left[\begin{array}{l}\left(\frac{\text{Existing}\text{direct}\text{labor}}{\text{Units}\text{produced}\text{for}\text{the}\text{current}\text{month}}\right)\text{×}\\ \text{Number}\text{of}\text{units}\text{produced}\text{for}\text{special}\text{order}\end{array}\right]\\ \text{=}\frac{\text{\$375,000}}{\text{7,500}\text{units}}\text{×}\text{2,500}\text{units}\\ \text{=\$125,000}\end{array}$

(4)Calculate the direct material for special order:

$\begin{array}{c}\begin{array}{l}\text{Direct}\text{material}\text{for}\\ \text{special}\text{order}\end{array}\}\text{=}\left[\begin{array}{l}\left(\frac{\text{Existing}\text{direct}\text{material}}{\text{Units}\text{produced}\text{for}\text{the}\text{current}\text{month}}\right)\text{×}\\ \text{Number}\text{of}\text{units}\text{produced}\text{for}\text{special}\text{order}\end{array}\right]\\ \text{=}\frac{\text{\$262,500}}{\text{7,500}\text{units}}\text{×}\text{2,500}\text{units}\\ \text{=\$87,500}\end{array}$

(5)Calculate the variable cost per unit of special order:

$\begin{array}{c}\begin{array}{l}\text{Variable}\text{cost}\text{per}\text{unit}\\ \text{of}\text{special}\text{order}\end{array}\}\text{=}\frac{\text{Total}\text{variable}\text{costs}}{\text{Units}\text{produced}}\\ \text{=}\frac{\text{\$212,500}}{\text{2,500}\text{units}}\\ \text{=}\text{\$85}\end{array}$

(6)Calculate the variable cost per unit of combined production:

$\begin{array}{c}\begin{array}{l}\text{Variable cost per unit }\\ \text{of combined production}\end{array}\}\text{=}\frac{\text{Total}\text{variable}\text{cost}}{\text{Units}\text{produced}}\\ \text{=}\frac{\text{\$1,037,500}}{\text{10,000}\text{units}}\\ \text{=}\text{\$103}\text{.75}\end{array}$

(7)Calculate the fixed cost per unit of combined production:

$\begin{array}{c}\begin{array}{l}\text{Fixed cost per unit of }\\ \text{combined production}\end{array}\}\text{=}\frac{\text{Total}\text{fixed}\text{costs}}{\text{Units}\text{produced}}\\ \text{=}\frac{\text{\$450,000}}{\text{10,000}\text{units}}\\ \text{=}\text{\$45}\end{array}$

3.

To determine

Discuss if there is any other considerations that Person D must include in the analysis of the special order.

Explanation of Solution

Following are the other considerations that Person D must include in the analysis of the special order:

• “Probable problems with other customers who pressurizes the company for similar treatment”.
• “The buyers’ future customer potential of the special order, producing surplus revenues”.

4.

To determine

List the steps that Person D must take to resolve the ethical conflict arising out of the controllers’ insistence that the company should avoid competitive bidding.

Explanation of Solution

Person D might attempt to solve the ethical conflict arising “out of the controller’s   insistence that the company avoid competitive bidding by taking the following steps”:

• “Person D must follow the established policies of company on such matters”.
• “If such policies do not exist, or if they do not resolve the conflict, Person D should explain the situation with the immediate manager unless, as in this situation, the manager is involved in the conflict. Then, Person D must discuss the condition with the manager’s supervisor”.
• “Suppose, if this approach does not help Person D for resolving the issue, then Person D must continue reporting to the next-higher managerial level, including the audit committee of the board of directors, if it is necessary”.
• “Person D must clear up relevant concepts by private discussions with an objective advisor to get an idea of probable courses of action”.
• “If the ethical conflict still exists, even after trying all of these possibilities of internal review, Person D might have to resign from the company and submit an informative memorandum to the board of director’s.

5.

To determine

Construct an Excel to solve requirement 2 and show the manner in which the answer will change if the sales price is $170 per medal.

Explanation of Solution

Prepare an Excel:

Figure (1)

Figure (2)

Working notes:

Figure (3)

Figure (4)