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Management Product & Pricing Decisions: Special Order; Incremental Analysis - Accounting video - YouTube
Channel: Dr. Brian Routh
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This is part two in our Management
Product and Pricing Decisions or
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short-term business decisions series and
we're going to be talking about special
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orders. Special orders are our
one-time orders and usually a reduced
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sales price is given on these special
orders. There's a few things that
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management must think about when
deciding whether or not to accept a
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special order. One of those is does the
company have excess capacity to fill
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this order? So if you do not have excess
capacity and you're considering the
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order that means you would have to
reduce your current production level to
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accept the order. How is that going to
affect your current business? Will the
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reduced sales price be high enough to
cover the incremental cost of filling
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the order? So the reduced sales price
that you're offering for this order will
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that be enough to cover the increased
cost of filling this order? Will the
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special order affect regular sales in
the long run? So that goes back to the
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first bullet there we talked about. So if
we have to reduce our current capacity
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to be able to fill this order, how will
that affect the bottom line? So let's
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look at the decision rule. Should we
accept or reject a special order? If your
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expected revenues exceed your expected
increase in variable and fixed cost then
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you should accept the special order. If
your expected increase in revenues is
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less than your expected increase in
variable and fixed cost you should
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reject the special order. So let's take a
look at an example here. Suppose the
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Baseball Hall of Fame in Cooperstown, New
York, has approached Sports-Cardz with a
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special order. The Hall of Fame wishes to
purchase 50,000 baseball card packs
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for a special promotional campaign and
offers $.37 cent per pack, a total of
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$18,500.
Sports-Cardz total production cost is
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$.57 cent per pack as follows. So we have our
variable cost, direct materials are
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$.14 cents per pack, direct labor is $.07 cents
per pack, and variable overhead is $0.11
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per pack and our fixed overhead is $.25
cent per pack for a total cost per pack
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of $0.57 cents. Sports-Cardz has enough excess
capacity to handle the special order.
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Prepare an incremental analysis to
determine whether Sports-Cardz should
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accept the special order. So an
incremental analysis is we want to take
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a look at the expected increase in
revenues compared to the expected
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increase in expenses. Again remember
whether deciding whether to accept or
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reject we want to ensure that the
expected increase in revenues is higher
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than the expected increase in expenses.
So if we look at the expected increase
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in revenues we know that's $18,500. We
need to calculate our expected increase
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in expenses. So the variable cost is
what's going to increase here. We're
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going to have 50,000 cards that's going
to cost us $.32 cent per pack. The $.32 cent
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is the variable cost. Our fixed cost per
pack is not going to change, so that's
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not going to affect our decision here. Our expected change in operating income
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will be $2,500. Therefore, since the
expected increase in revenues exceeds
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the expected increase in expenses, we
would accept this special order.
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