Question

MANAGERIAL ACCOUNTING HANDOUT PROBLEM 11 Name Section Problem (10 points). Cindy Richards, the manager of Rockford Company, was deliberating over an offer for an order requesting 7,000 boxes of birthday greeting cards. Rockford was operating at 70% of its capacity of 30,000 boxes and could use the extra business. Unfortunately, the order's offering price of $7.75 per box was below the cost to produce the cards. The controller was opposed to taking a loss on the deal. However, the personnel manager argued in favor of accepting the order even though a loss would be incurred. Accepting the order would avoid the problem of layoffs and would help maintain the community image of the company. The full cost to produce a box of birthday greeting cards is provided below. The total fixed manufacturing costs would not change if the order is accepted. ROCKFORD COMPANY COSTS TO PRODUCE ONE BOX OF BIRTHDAY GREETING CARDS Direct Materials Direct Labor Variable Manufacturing Overhead Fixed Manufacturing Overhead Total Full Manufacturing Cost s 9.00 The order is from a customer in a region not ordinarily serviced by the company. No variable selling or administrative expenses would be associated with the order. REQUIRED: (1) Assume that the company would accept the order only if it increased total profits. Should the company accept or reject the order? Provide supporting computations. Consider the personnel manager's concerns. Discuss the merits of accepting the order even if it decreases total profits. (2)

Answer 1

(1): In this case the order should be accepted if the additional sales exceed the additional variable costs. As fixed costs remain constant they will not be relevant in this case. Here price is $7.75 and variable costs are = 2+3+1.5 = $6.5 per card. As $7.75 > $6.50 the special order should be accepted.

	(in $) per box	Total for 7,000 boxes (in $)
Sale price	7.75	54,250.00
less: variable expenses
Direct materials	2.00	14,000.00
Direct labor	3.00	21,000.00
Variable mfg. overhead	1.50	10,500.00
Contribution margin = sales - variable costs	1.25	8,750.00

We can see that the order for 7,000 boxes is producing an incremental contribution margin of $8,750 and this will help in furthering bearing the existing fixed costs of manufacturing. Hence the special order should be accepted.

(2): The merits of accepting the orders even if it decreases total profits are that it will solve other problems of the company and this can prove substantially beneficial to the company in the long run. First of all it will be able to utilize its spare capacity and manpower and hence the problem of layoff will be taken care of. This will also help the company to maintain a positive image in the society and this will help the company to stand in good stead in future.