Question

Ehrling, Inc., manufactures metal racks for hanging clothing in retail stores. Ehrling was approached by the CEO of Carly’s Corner, a regional nonprofit food bank, with an offer to buy 350 heavy-duty metal racks for storing canned goods and dry food products. While racks normally sell for $245 each, Carly’s Corner offered $75 per rack. The CEO explained that the number of families they served had grown significantly over the past two years, and that the charity needed additional storage for the donated food items. Since Ehrling is operating at 80 percent of capacity, and Ehrling employees have "adopted" Carly’s Corner as their annual charity, the company wants to make the special order work. Ehrling’s controller looked into the cost of the storage racks using the following information from the activity-based accounting system:
Activity Rate**
Activity Driver Unused
Capacity Quantity
Demanded* Fixed Variable
Direct materials Number of racks 0 350 - $82
Direct labor Direct labor hours 0 525 - 15
Setups Setup hours 60 1 $150 5
Inspection Inspection hours 800 20 10 5
Machining Machine hours 6,000 175 40 3
*This represents only the amount of resources demanded by the special order being considered.
**This is expected activity cost divided by activity capacity.
Expansion of activity capacity for setups, inspection, and machining must be done in steps. For setups, each step provides an additional 20 hours of setup activity and costs $3,000. For inspection, activity capacity is expanded by 2,000 hours per year, and the cost is $20,000 per year (the salary for an additional inspector). Machine capacity can be leased for a year at a rate of $40 per machine hour. Machine capacity must be acquired, however, in steps of 1,500 machine hours.

Required:

1. Compute the change in income for Ehrling, Inc., if the order is accepted.
$

2. Suppose that the packing activity can be eliminated for this order since the customer is in town and does not need to have the racks boxed and shipped. Because of this, direct materials can be reduced by $13 per unit, and direct labor can be reduced by 0.5 hour per unit. How is the analysis affected?

It is now a $_____ loss if the special order is accepted.

Answer 1

Answer:

additional revenue = $26,250

relevant costs:

direct materials =350 x $82 = $28,700

direct labor = 525 x $15 = $7,875

setup hours = 1 x $5 = $5

inspection costs = 20 x $5 = $100

machining = 175 x $3 = $525

total relevant costs = $37,205

1) change in income if order is accepted:

total revenue - total relevant costs = $26,250 - $37,205 = -$10,955

the company will incur in $10,955 in losses if order is accepted.

2) if direct materials are reduced by $13 per unit = $13 x 350 = $4,550, and direct labor costs can be reduced by 0.5 x 350 = 175 hours (= 175 x $15 = $2,625) ⇒ total relevant costs will decrease by $7,175.

It is now a $3,780 (= $10,955 - $7,175) loss if the special order is accepted.