A customer has requested that Inga Corporation fill a special order for 2,400 units of product K81 for $29 a unit. While the product would be modified slightly for the special order, product K81's normal unit product cost is $23.10: Direct materials $ 6.00 Direct labor 6.00 Variable manufacturing overhead 3.10 Fixed manufacturing overhead 8.00 Unit product cost $23.10 Direct labor is a variable cost. The special order would have no effect on the company's total fixed manufacturing overhead costs. The customer would like modifications made to product K81 that would increase the variable costs by $1.60 per unit and that would require an investment of $14,000 in special molds that would have no salvage value. This special order would have no effect on the company's other sales. The company has ample spare capacity for producing the special order. If the special order is accepted, the company's overall net operating income would increase (decrease) by:

Inga Corporation

Special Order:

If the special order is accepted, the company's overall net operating income would decrease by $3,680.00.

Explanation:

a) We need to perform some calculations to get the relevant costs.  Relevant costs are costs that are avoidable if a decision is taken.  Fixed overhead is not a relevant cost because it is unavoidable, especially in this case.

Relevant Costs:

Unit Product cost = $23.10

less Fixed overhead = $8.00

Relevant unit cost = $15.10

b) An income statement is prepared to determine the Operating Income from Special Order:

Sales (2,400 x $29) = $69,600

less Relevant costs:

Unit (2,400 x $15.10) = $40,080

Special Equipment Cost = $14,000

Contribution = $15,520

less Fixed cost ($8.00 x 2,400) = $19,200

Net Operating Income ($3,680)

c) To accept or reject the special order should not be based solely on the net operating loss.  The character of the allocated fixed cost should be investigated and analyzed to understand whether the amount that is avoidable or not.  Avoidable fixed cost is relevant in making such decision.

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