ACCT 2102 1st Edition Lecture 23 Outline of Last Lecture I Comprehension Quiz In Class Outline of Current Lecture II Special Order Decisions III Special Order Example Current Lecture Relevant Costs for Short Term Decisions Chapter 8 Here are a few rules of thumb to keep in mind whenever you make a business decision Identify and focus on relevant information Consider qualitative factors Analyze variable costs and fixed costs separately using a contribution margin approach o Be careful about using unit cost data unless it is purely a variable cost per unit II Special Order Decisions Do we have excess capacity available to fill this order Excess Capacity Full Capacity Current Production Will the reduced sales price be high enough to cover the incremental costs of filling the order the variable costs of filling the order and any additional fixed costs VC is any change in DM DL Variable MOH and variable SG A Expenses Special Units Sales Price Special Units Variable Cost FC is any change in total FC Usually increases It also includes the cost of equipment that will only be used in the special order Will the special order affect regular sales in the long run Be careful when cutting long term sales for a short term profit III Special Order Example These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute Jif makes brand name peanut butter which sells for 2 50 per jar Plant capacity is 100 000 jars per month The company is currently operating at 80 of capacity resulting in the following production cost per jar Direct material 1 00 Direct labor 0 05 Variable MOH 0 25 Fixed MOH 0 60 Total product cost per unit 1 90 A company that sells generic foods would like Jif to supply them with a special order of 18 000 jars of generic peanut butter this month at a special price of 1 75 per jar Jif will use the same recipe ingredients jars and manufacturing process for this order as it does for its regular product so the only thing that will change is the label The new customer will supply the artwork to be used on the jar labels Should Jif accept this special order How would the decision to accept the order affect Jif s operating income Total Fixed MOH 60 18 000 10 800 Excess Capacity 100 000 100 000 80 20 000 Regular Sales Price SP Unit VC Unit Contribution Margin 2 50 1 75 1 30 1 30 1 20 0 45 Amount Given Up Special Order Excess Capacity Amount Given Up 18 000 20 000 2 000 Get Give Up 18 000 0 45 2 000 1 20 8 100 0 Special Order The differential is a gain of 8 100 since you get more than you give up If the special order falls within the excess capacity you do not have to give anything up Say the special order customer wanted 25 000 jars and it was an all or nothing deal Should Jif accept the order How would it affect operating income What qualitative factors should Jif consider Total Fixed MOH 60 25 000 15 000 Excess Capacity 100 000 100 000 80 20 000 Regular Sales Price SP Unit VC Unit Contribution Margin Special Order 2 50 1 75 1 30 1 30 1 20 0 45 Amount Given Up Special Order Excess Capacity Amount Given Up 25 000 20 000 5 000 Get Give Up 25 000 0 45 5 000 1 20 11 250 6 000 The differential is a gain of 5 250 since you get more than you give up Let s once again assume a special order volume of 18 000 units This time let s assume the contract allows Jif to use lower quality ingredients and slightly smaller containers for this special order In turn the special order company would only pay 1 60 per jar of peanut butter Jif s variable cost savings should run 0 25 per jar of peanut butter However Jif will have to incur 2 000 of legal fees to draft new contracts with its suppliers of peanuts and containers What affect would this special order have on Jif s operating income DL has not been changed FC always remain the same unless otherwise noted VC remain at 25 jar therefore DM will need to be altered so that all costs 1 60 Direct material 0 70 Direct labor 0 05 Variable MOH 0 25 Fixed MOH 0 60 Total product cost per unit 1 60 Total Fixed MOH 60 18 000 10 800 Excess Capacity 100 000 100 000 80 20 000 Regular Sales Price SP Unit VC Unit Contribution Margin Special Order 2 50 1 60 1 00 1 00 1 50 0 60 Amount Given Up Special Order Excess Capacity Amount Given Up 18 000 20 000 2 000 Get Give Up 18 000 0 60 2 000 1 50 10 800 0 2 000 2 000 8 800 2 000 The differential is a gain of 6 800 since you get more than you give up