Question

Anchor Company manufactures several different types of jewelry cases. Management estimates that during the third quarter of 2018, the company will operate at 80% capacity. Because the company desires a higher utilization of plant capacity, the company will consider a special order.

Anchor has received special order inquiries from two companies. The first special order is from JCP Inc., which would like to market a jewelry case similar to Anchor’s cases. The JCP jewelry case would be marketed under JCP’s own label. JCP Inc. has offered Anchor $5.75 per jewelry case for 40,000 cases to be shipped by October 1, 2018. The revenue and cost data for an Anchor jewelry case, which would be similar to the specifications of the JCP special order, are as follows:

Revenue per unit for the Anchor jewelry case                                   $9.00

Costs per unit for the Anchor jewelry case:

Direct materials                                                                                   $2.50

Direct manufacturing labor (0.25 labor hours @ $12 per hour)            3.00

Variable manufacturing overhead (0.25 machine hours @ $1.60 per hour)                                                                                                      0.40

Fixed manufacturing overhead (0.25 machine hours @ $2.40 per hour)                                                                                                               0.60

            Total                                                                                         $6.50

According to the specifications provided by JCP Inc., the special order case requires less expensive direct materials. Consequently, the direct materials will only cost $2.25 per case. Management has estimated that the remaining costs, labor time, and machine time will be the same as the Anchor jewelry case.

Krage Company submitted the second special order, for 15,000 cases at $7.50 per case. These jewelry cases would be marketed under the Krage label and have to be shipped by October 1, 2018. However, the Krage jewelry case is different from any jewelry case in the Anchor line. The estimated per unit costs of this case are as follows:

Costs per unit for the Krage jewelry case:

Direct materials                                                                                   $3.25

Direct manufacturing labor (0.25 labor hours @ $12 per hour)            3.00

Variable manufacturing overhead (0.5 machine hours @ $1.60 per hour)                                                                                                               0.80

Fixed manufacturing overhead (0.5 machine hours @ $2.40 per hour)                                                                                                               1.20

            Total                                                                                         $8.25

In addition, Anchor would incur $3,000 in additional set-up costs and would have to purchase a $5,000 special device to manufacture these cases for Krage Company. This device will be discarded once the special order is completed.

The Anchor manufacturing capabilities are limited to the total machine hours available. The plant capacity under normal operations is 180,000 machine hours per year (45,000 machine hours per quarter). The average fixed overhead of $2.40 per machine hour is based on 180,000 machine hours per year. Assume that the direct manufacturing laborers are temporary help and thus can be added and dismissed at will.

Anchor will have the entire third quarter to work on the special orders. Management does not expect any repeat sales to be generated from either special order. Anchor must accept or reject each special order in its entirety. Also, the CEO of Anchor says that it is not allowed to accept both of the special orders. In other words, Anchor is allowed to accept neither or only one.

1.   Should Anchor in theory accept the JCP special order? Show supporting computations.

2.   Should Anchor in theory accept the Krage special order? Show supporting computations.

Answer 1

1) Anchor, operating under capacity, in theory should accept the JCP special order as it contributes $0.10 per unit towards Fixed costs.

Total variable costs = DM $2.25 + DML $3 + VMO $0.40 = $5.65 per unit

JCP special order price = $5.75

Contribution per unit = 5.75 - 5.65 = $0.10

2) Anchor, operating under capacity, in theory should accept the Krage special order as it contributes $0.45 per unit towards Fixed costs.

Total variable costs = DM $3.25 + DML $3 + VMO $0.80 = $7.05 per unit

Krage special order price = $7.50

Contribution per unit = 7.5 - 7.05 = $0.45