27PGB - Horngren'S Financial And Managerial Accounting

Question

Nautical manufactures flotation vests in Tampa, Florida. Nautical’s contribution margin income statement for the month ended December 31, 2018, contains the following data:

NAUTICAL

Income Statement

For the Month Ended December 31, 2018

Sales in Units                                                                    29,000

Net Sales Revenue                                                            \(551,000

Variable Costs:                

          Manufacturing                                                         116,000

          Selling and Administrative                                      111,000

Total Variable Costs                                                          227,000

Contribution Margin                                                          324,000

Fixed Costs:

          Manufacturing                                                         123,000

          Selling and Administrative                                      92,000

Total Fixed Expenses                                                        215,000

Operating Income                                                              \)109,000

 

Suppose Water Works wishes to buy 4,800 vests from Nautical. Nautical will not incur any variable selling and administrative expenses on the special order. The Nautical plant has enough unused capacity to manufacture the additional vests. Water Works 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 Nautical’s decision. 

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

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

Step-by-Step Solution

Answer

The variable manufacturing cost per unit is $4. 

Step 1: Meaning of Special Order

The term special order in business activities defines the situation where a company receives a non-regular order from a customer to deliver a unique product or provide a different kind of service. It helps the business to earn more profit from this position or special order.

Step 2: Identification of costs

According to the above-given data, the variable manufacturing cost is relevant in the decision-making process. In addition, the variable selling and administrative expenses would be irrelevant in decision making.

Also, the fixed cost would remain the same irrespective of whether the company chooses to produce additional 4800 units or not; hence it is irrelevant in decision making.

Step 3: Preparation of differential analysis

Particulars	Details	Amounts ($)
Expected increase in revenue	4800*15	72,000
Less: Expected increase in variable manufacturing cost (Working Notes)	4800*4	(19,200)
Expected increase in operating income		$52,800

 

Working Notes:

Computation of variable manufacturing cost per unit:

 

$\begin{array}{rcl}\mathbf{Variable}\mathbf{ }\mathbf{manupacturing}\mathbf{ }\mathbf{cost}\mathbf{ }\mathbf{per}\mathbf{ }\mathbf{unit}& \mathbf{=}& \frac{\mathbf{Total}\mathbf{ }\mathbf{variable}\mathbf{ }\mathbf{manupacturing}\mathbf{ }\mathbf{cost}}{\mathbf{Number}\mathbf{ }\mathbf{of}\mathbf{ }\mathbf{units}}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{116}\mathbf{,}\mathbf{000}}{\mathbf{29}\mathbf{,}\mathbf{000}}\\ & \mathbf{=}& \mathbf{\$}\mathbf{4}\end{array}$

Step 4: Additional factors to be considered

The following factors should be considered by the company when deciding on long-term decisions associated with the special orders:

• The company should ensure the on-time deliveries, quality, and efficiency factors linked with special orders.
• In addition, the company should determine the additional costs required for such special orders and the impact of the same on the profits.