21PGA - Horngren'S Financial And Managerial Accounting

Question

Sea Blue manufactures flotation vests in Charleston, South Carolina. Sea Blue’s contribution margin income statement for the month ended December 31, 2018, contains the following data:

SEA BLUE

Income Statement

For the Month Ended December 31, 2018

Sales in units                                                                                         32,000

Net Sales Revenue                                                                                \(608,000

Variable Costs:

          Manufacturing                                                                             96,000

          Selling and Administrative                                                          108,000

Total Variable Costs                                                                              204,000

Contribution Margin                                                                              404,000

Fixed Costs:

          Manufacturing                                                                             124,000

          Selling and Administrative                                                           94,000

Total Fixed Costs                                                                                   218,000

Operating Income                                                                                   \)186,000

 

Suppose Overboard wishes to buy 4,600 vests from Sea Blue. Sea Blue will not incur any variable selling and administrative expenses on the special order. The Sea Blue plant has enough unused capacity to manufacture the additional vests. Overboard has offered \(15 per vest, which is below the normal sales price of \)19.

 

Requirements 

1. Identify each cost in the income statement as either relevant or irrelevant to Sea Blue’s decision. 

2. Prepare a differential analysis to determine whether Sea Blue should accept this special sales order. 

3. Identify long-term factors Sea Blue should consider in deciding whether to accept the special sales order.

Step-by-Step Solution

Answer

The company should accept the special sales order because it will increase the revenues.

Step 1: Meaning of Income Statement

An income statement refers to a report prepared by business entities to ascertain the net profits generated or net losses incurred during an accounting period from the operating and non-operating events of the business concerns.

Step 2: Identification of costs

Costs are generally bifurcated into two categories—namely, relevant costs and irrelevant costs in the decision-making process. According to the given information, the bifurcation of costs is as follows:

 

Particulars	Amount ($)	Category
Variable costs:
Manufacturing	96,000	Relevant
Selling and administrative	108,000	Irrelevant
Fixed costs:
Manufacturing	124,000	Irrelevant
Selling and administrative	94,000	Irrelevant

Step 3: Preparation of differential analysis

Particulars	Amount ($)
Expected increase in revenue (4600*15)	69,000
Less: Expected increase in variable cost (3*4600) (Working Notes)	(13,800)
Net increase in revenue	$55,200

Working Notes:

Computation of variable manufacturing cost per unit:

 $\begin{array}{rcl}\mathbf{Variable}\mathbf{ }\mathbf{manupacturing}\mathbf{ }\mathbf{cost}\mathbf{ }\mathbf{per}\mathbf{ }\mathbf{unit}& \mathbf{=}& \frac{\mathbf{Total}\mathbf{ }\mathbf{variable}\mathbf{ }\mathbf{manufacturing}\mathbf{ }\mathbf{cost}}{\mathbf{Number}\mathbf{ }\mathbf{of}\mathbf{ }\mathbf{units}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{96}\mathbf{,}\mathbf{000}}{\mathbf{\$}\mathbf{32}\mathbf{,}\mathbf{000}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{3}\mathbf{ }\mathbf{per}\mathbf{ }\mathbf{unit}\end{array}$ 

 

Comment: 

According to differential analysis, the company’s revenues will be increased by $55,200. Hence, the special order should be accepted.

Step 4: Final decision

The long-term factors that should be considered by the company while making decisions on the acceptance of the special orders are as follows: 

• The company must consider whether the price of a special order will start a price war in the market among competitors.
• Another important consideration is the chances of demanding lower prices from regular customers.