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