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Special Orders

Special orders are one-time orders that businesses have the opportunity to fulfill outside of their normal business operations. Deciding whether a special order should be accepted or not, and at what price, is an important decision for managers. Managers look at incremental costs and benefits to determine whether a special order will provide positive incremental operating income for the business.

For example, Basement Specialist manufactures and sells construction materials for constructing, insulating and waterproofing basements and foundations in Hamilton. In the old part of the city, sewage and rainwater drain into the same sewer system. During high rainfalls, water levels in the sewer system rise and may backtrack into homes without one-way check valves on their sewer lines. As a result, the city of Hamilton has offered the Basement Specialist $2,000/each for the installation of 50 new check-valves.

The cost breakdown for installing a typical sewer check valve is as follows:

Direct materials                      $450
Direct labor                             $500
Administrative overhead         $200
Job cost                                $1150

The variable portion of the above administrative overhead is $50 per job. To fulfill the contract, Basement Specialist would also have to hire a new project manager with a salary of $50,000 for the duration of the project. However, direct materials can be ordered in bulk, saving $100/unit. The special job may also bring in new contracts for other work done on some of these 50 homes. These jobs are expected to provide $150/home net of expenses on average.

The incremental operating income can be computed as follows:

 

Per Unit

Total 100 Check-Valves

Incremental revenue

$2,150

$107,500

Incremental costs:

 

 

    Variable costs:

 

 

       Direct materials

450

22,500

       Direct labor

500

25,000

       Variable Manufacturing Overhead

50

2,500

       Special savings

-100

- 5,000

       Total variable cost

$900

45,000

    Fixed Cost:

 

 

       New project manager

 

50,000

Total incremental cost

 

95,000

Incremental operating income

 

$9,500


Therefore, even though the price on the special order ($279) is below the normal unit product cost ($282) and the order would require incurring additional costs, the order would result in an increase in operating income. In general, a special order is profitable as long as the incremental revenue from the special order exceeds the incremental costs of the order. 

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