Question

Ludolph Industries has an annual plant capacity of 68,000 units; current production is 50,000 units per year. At the current production volume, the variable cost per unit is $33.00 and the fixed cost per unit is $4.80. The normal selling price of Ludolph's product is $49.00 per unit. Ludolph has been asked by Abbott Company to fill a special order for 14,000 units of the product at a special sales price of $22.00 per unit. Abbott is located in a foreign country where Ludolph does not currently operate. Abbott will market the units in its country under its own brand name, so the special order is not expected to have any effect on Ludolph's regular sales.
Requirement

1. How would accepting the special order impact Ludolph​'s operating​ income? Should Ludolph accept the special​ order?

Complete the following incremental analysis to determine the impact on Ludolph​'s operating income if it accepts this special order

Revenue from special order _______
Less expenses associated with the order:
Variable manufacturing cost_______
Contribution margin_______
Less: Additional fixed expenses associated with the order_______
Increase (decrease) in operating income from the special order. _______

Answer 1

Answer:

1) Accepting would decrease operating income by $154,000. As a result Ludolph should not accept the order.

Revenue = $308,000

Variable cost = -$426,000

Contribution margin = -$154,000

Less Fixed cost = $0

Decrease in operating income = $154,000

Explanation:

Contribution = sales - Variable cost

                        = (14,000*$22) - (14,000*33)

                       =$308,000 - $426,000

                      = -$154,000

Factors to considers when dealing with special orders:

Fixed costs in total do not change and are not a relevant factor.

Direct material is obviously going to increase as more units are to be produced.

Factory overheads will increase too

Direct labor depends on whether the labor is paid for based on  full capacity even though it is producing less if yes then there will not be an increase in labor until the extra effort above the full capacity. If Labor is paid for what it is currently producing then for every extra unit it produces it will be paid meaning direct labor will increase as well just like in our activity here.

There are no selling and marketing costs because the order already has an intended customer.

Answer 2

Answer:

Requirement 1 - This special order is loss-making. So Ludolph not accept the special order

Requirement 2- In this case, a special order is profit making. So Ludolph accepts the special order.

Explanation:

Requirement 1

Incremental analysis of special                                                    Total order

   sales order decision                                                                    14000 units

Revenue from special order           14000*22                                     308000

                                                     

Less: variable cost                           14000*33                                  462000

                                                                                                                                   

Contribution margin                                                                          -154000

Less: fixed cost

                                                                                                               0

Additional net loss                                                                             -154000

This special order is loss-making. So Ludolph not accept the special order

Requirement 2

Incremental analysis of special                                                    Total order

   sales order decision                                                                    14000 units

Revenue from special order            14000*36                                 504000

                                                     

Less: variable cost                           14000*33                                 462000

                                                                                                                                   

Contribution margin                                                                          42000

Less: fixed cost

                                                                                                            13000

Additional net loss                                                                               29000

                                                     

In this case, a special order is profit making. So Ludolph accepts the special order.