8.2 Review - Accepting or Rejecting Special Orders

Assuming a firm has excess capacity, which of the following is not a reason that the firm would decide to reduce the normal price of a product or service in order to obtain a special order?

Market demand is strong and the firm is able to produce more products and still sell them at normal price

In making a decision about whether or not to fill a special order, fixed costs that are incurred regardless of whether the order is accepted should:

Not be considered because they will be incurred whether or not the order is accepted

A special order is an:

Order that is priced below the normal price in order to utilize excess capacity

When pricing special orders, management can often approximate additional costs by the:

Variable costs of making the product

Lumens Corporation makes ornamental lamps. The costs per lamp are the following: Direct materials $ 35 Direct labor 45 Manufacturing overhead 50 Total $130 The manufacturing overhead can be divided into 40% variable manufacturing overhead and 60% fixed manufacturing overhead. Refer above. A major department store has offered to buy 1,000 of the lamps from Lumens for $120 each. Given this information, if Lumens has sufficient idle capacity, by how much would Lumens increase its profits by selling the lamps to the store?

Variable costs: $35 + $45 + ($50 x 40%) = $100 Increase in profits: 1,000 x ($120 - $100) = $20,000

Lumens Corporation makes ornamental lamps. The costs per lamp are the following: Direct materials $ 35 Direct labor 45 Manufacturing overhead 50 Total $130 The manufacturing overhead can be divided into 40% variable manufacturing overhead and 60% fixed manufacturing overhead. Refer above. To earn a reasonable return and cover administrative and selling expenses, Lumens normally sells its lamps for $200 each. Given this information, Lumens's variable cost of making each lamp is:

Variable costs: $35 + $45 + ($50 x 40%) = $100

When pricing special orders in a situation where there is unused capacity, management should charge a price that is greater than the:

Additional costs of manufacturing the product

If a decision regarding special orders is based only on costs, management should:

Accept any order where the payoff covers the variable costs and the direct fixed costs

When managers are deciding what price to charge for a special order, they should consider:

Both additional costs and qualitative factors

Packer Corporation makes vases, the costs of which are: Direct materials $ 70 Direct labor 90 Manufacturing overhead 120 Total $280 The manufacturing overhead can be divided into 60% variable manufacturing overhead and 40% fixed manufacturing overhead. A major department store has offered to buy 1,000 of the vases from Packer for $250 each. Given this information, if Packer has sufficient idle capacity and no adverse qualitative factors, should Packer accept the special order?

Differential costs: $70 + $90 + ($120 x 60%) = $232 Total profits earned: 1,000 x ($250 - $232) = $18,000

A firm can increase profits if:

The selling price exceeds the total variable and differential fixed costs

Which type of data might cause a manager to erroneously reject an order?

Total cost

West Star Company manufactures computers. The following cost information for the manufacture of one computer has been compiled: Direct materials $55 Direct labor 95 Variable manufacturing overhead 60 Variable selling and administrative expenses 30 Fixed manufacturing overhead 40 West Star received an offer for a special order for 1,000 computers. In addition to normal costs, West Star would also incur a $10 shipping charge per computer. In negotiating a price, what is the minimum selling price West Star should accept? (Assume that other variables do not change and West Star has enough capacity to fulfill the order.)

Total variable costs: $55 + $95 + $60 + $30 + $10 = $250

Napa Company manufactures computers. The following cost information for the manufacture of one computer has been compiled: Direct materials $96 Direct labor 180 Variable manufacturing overhead 124 Variable selling and administrative expenses 80 Fixed manufacturing overhead 80 If Napa receives a special order for 500 computers at a price of $550, what will be the effect on the company's profit if the order is accepted? (Assume that other variables do not change.)

Total variable costs: $96 + $180 + $124 + $80 = $480 Change in profit: ($550 - $480) x 500 = $35,000 increase