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5-A2 Special Order Consider the following details of the income statement of the Manteray Pen Company (MPC) for the year ended December 31, 20X0: > Sales Less cost of goods sold Gross margin or gross profit Less selling and administrative expenses Operating income $11,000,000 6,500,000 $ 4,500,000 3,000,000 $ 1,500,000 8 8 1
5-A2 Special Order Consider the following details of the income statement of the Manteray Pen Company (MPC) for the year ended December 31, 20X0: > Sales Less cost of goods sold Gross margin or gross profit Less selling and administrative expenses Operating income $11,000,000 6,500,000 $ 4,500,000 3,000,000 $ 1,500,000 8 8 1. 43. MPC's fixed manufacturing costs were $3.0 million and its fixed selling and administrative costs were $2.2 million. Sales commissions of 3% of sales are included in selling and administrative expenses. The division had produced and sold 2 million pens. Near the end of the year, Pizza Hut offered to buy 150,000 pens on a special order. To fill the order, a special Pizza Hut logo would have to be added to each pen. Pizza Hut intended to use the pens for special promotions in an eastern city during early 20X1. Even though MPC had some idle plant capacity, the president rejected the Pizza Hut offer of $660,000 for the 150,000 pens. He said, 6601 The Pizza Hut offer is too low. We'd avoid paying sales commissions, but we'd have to incur 10 an extra cost of $.40 per pen to add the logo. If MPC sells below its regular selling prices, it will begin a chain reaction of competitors' price cutting and of customers wanting special deals. I believe in pricing ar no lower than 8% above our full costs of $9,500,000 + 2,000,000 units = $4.75 per unit plus the extra $.40 per pen less the savings in commissions. 1. Using the contribution-margin technique, prepare an analysis similar to that in Exhibit 5-6 on page 205. Use four columns without the special order, the effect of the special order (one column total and one column per unit), and totals with the special order. 2. By what percentage would operating income increase or decrease if the order had been accepted? Do you agree with the president's decision? Why?
Expert Solution
1) Variable Cost of goods sold = Total cost of goods sold - Fixed manufacturing costs
Variable cost of goods sold = $ 6,500,000 - $ 3,000,000 = $ 3,500,000
Variable selling and administrative expenses (excluding sales commission ) = Total selling and administrative expenses - [ Fixed selling and administrative expenses + Sales Commission ]
Variable selling and administrative expenses (excluding sales commission) = $ 3,000,000 - [ $ 2,200,000 + { 11,000,000 X 3%}]
Variable selling and administrative expenses (excluding sales commission ) = $ 3,000,000 - [ $ 2,200,000+ $ 330,000 ]
Variable selling and administrative expenses (excluding sales commission )= $ 470,000
Total variable cost incurred (excluding sales commission ) = $ 3,500,000 + $ 470,000 = $ 3,970,000
Total manufactured outputs = 2,000,000
Total variable cost per unit output (excluding sales commission ) = $ 3,970,000 / 2,000,000 = $ 1.985
If, Pizza Hut offer has been accepted then total Extra variable cost incurred to meet that offer = [ $ 1.985 + 0.40 ( for Pizza Hut logo) ] X 150,000 = $ 357,750.
Contracted price of the special order if accepted = $ 660,000
Net operating income = Contract price - variable extra cost incurred to meet the special order
Net operating income = $ 660,000 - $ 357,750 = $ 302,250
| Without special order | Effect of the special order (Total) | Effect of the special order (Units) | Total with special order | |
| Sales | 11,000,000 | 660,000 | 4.400 | 11,660,000 |
| Less:Variable cost | 4,300,000 | 357,750 | 2.385 | 4,657,750 |
| Contribution margin | 6,700,000 | 302,250 | 2.015 | 7,002,250 |
| Less: Fixed Cost | 5,200,000 | Nil | Nil | 5,200,000 |
| Operating Income | 1,500,000 | 302,250 | 2.015 | 1,802,250 |
2) Operating income percentage without special order = [operating income / net sales revenue ] X 100%
Operating income percentage without special order = [ $ 1,500,000 / $ 11,000,000] X 100% = 13.64 %
Operating income percentage with special order = [ $ 1,802,250 / $ 11,660,000] X 100% = 15.46%
If the special order is accepted then operating profit will be increased by [ 15.46% - 13.64%] = 1.82 %
I am not agreed with president's decision , because of the following causes :
If the special order being accepted then (A) It will increase the total operating profits , (B) It will increase percentage of operating profits (C) It can use the available unused facilitates in more economical way (D) The per unit fixed cost of production can also be reduced because no extra fixed expenses are to be incurred and volume of outputs increased.
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