Special Order Analysis

Introduction:
On rare occasions a company can be offered the opportunity to increase production through a special order. These orders can only be accepted during periods when the company is not at full production since the offer is often for a price lower than what a company normally receives at market. Issues to take into account for these types of special orders are variable cost and revenues. Any increase in fixed cost resulting from the order must also be taken into consideration. When considering a special order, normal fixed cost should not be added into the analysis, since these costs do not fluctuate due to increases in production as a whole. For a presentation on the topic of “Special Order Analysis” go to this web-link: http://prezi.com/oixfy4ljytz5/special-order-analysis/

Example problem:
Francisco Company produces wooden picture frames, which it normally sells to retail shops for $6 each. The cost of manufacturing 30,000 frames is as follows: Expenses Dollar Amount Material $15,000 Labor 25,500 Variable overhead 30,000 Fixed overhead 50,000 Total Expenses $120,500

Nichols Corporation offers Francisco $3.00 per frame for 5,000 frames. Nichols would sell the frames under its own brand name in foreign markets not yet served by Francisco. If Francisco accepts the offer, its fixed overhead will increase from $50,000 to $55,000 due to the purchase of a new cutting blade. Instructions: (1) Prepare an incremental analysis for the special order. (2) Should Francisco accept the special order? Explain why or why not?

12/2013 MJC

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Special Order Analysis
Answer:
Unit Cost Calculations:
Revenues from special order: $3.00 X 5,000 units = $15,000 Materials Cost for special order: $15,000 normal material cost/ 30,000 normal units = $0.50 cost per unit X 5,000 special order units = $2,500 Labor Cost for special order: $25,500 normal labor cost / 30,000 normal units = $0.85 per unit X 5,000 special order units = $4,250 Variable overhead for special order: $30,000 normal overhead cost/ 30,000 normal units = $1.00 per unit X 5,000 special order units = $5,000. Fixed Cost for special order: $55,000 – 50,000 = $5,000.

Format for Analysis of Special Order:

Reject Order Accept Order Revenues Material cost Labor Cost Fixed Cost Income/Loss $0 0 0 0 $0 $15,000 2,500 4,250 5,000 $3,250

New Income Increase or (Decrease) $15,000 (2,500) (4,250) (5,000) $3,250

Special order analysis requires four columns. Label the lines in the left column. Label the headers for both accepting the order and rejecting the order. Label the column for increase or decrease in income. Note that in this column revenue is a positive number while expenses are negative. If the order is rejected, Francisco will incur no expenses and receive no added revenues. The analysis shows that if the order is accepted Francisco will increase profits by $3,250.

12/2013 MJC

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