One-Time-Only Special Orders

One type of decision that affects output levels involves accepting or rejecting special orders when there is idle capacity and the special orders have no long-run implications. We use the term one-time-only special order to describe these conditions.

The management accountant gathers the following additional information.

• No subsequent sales to Azelia are anticipated.
• Fixed manufacturing costs are based on the 45,000-towel production capacity. That is, fixed manufacturing costs relate to the production capacity available and not the actual capacity used. If Surf Gear accepts the special order, it will use existing idle capacity to produce the 5,000 towels and fixed manufacturing costs will not change.
• No marketing costs will be necessary for the 5,000-unit one-time-only special order.
• Accepting this special order is not expected to affect the selling price or the quantity of towels sold to regular customers.

The management accountant prepares the data shown in Exhibit 12-4 on an absorption-costing basis (that is, as required by Generally Accepted Accounting Principles, both variable and fixed manufacturing costs are included in inventoriable costs and cost of goods sold). In this exhibit, therefore, the manufacturing cost of $12 per unit and the marketing cost of $7 per unit include both variable and fixed costs. The sum of all costs (variable and fixed) in a particular business function of the value chain, such as manufacturing costs or marketing costs, are called business function costs. Full costs of the product, in this case $19 per unit, are the sum of all variable and fixed costs in all business functions of the value chain (research and development [R&D], design, production, marketing, distribution, and customer service). For Surf Gear, full costs of the product consist of costs in manufacturing and marketing because these are the only business functions. Because no marketing costs are necessary for the special order, the manager of Surf Gear will focus only on manufacturing costs. Based on the manufacturing cost per unit of $12, which is greater than the $11-per-unit price Azelia offered, the manager might decide to reject the offer.

In Exhibit 12-5, the management accountant separates manufacturing and marketing costs into their variable- and fixed-cost components and presents data in the format of a contribution income statement. The relevant revenues and costs are the expected future revenues and costs that differ as a result of Surf Gear accepting the special offer: revenues of $55,000 $(\mathrm{\$}11\text{per unit}\times \text{5,000}\text{units})$ and variable manufacturing costs of $37,500 $(\mathrm{\$}7.50\text{per unit}\times \text{5,000}\text{units})\text{.}$ The fixed manufacturing costs and all marketing costs (including variable marketing costs) are irrelevant in this case because these costs will not change in total whether the special order is accepted or rejected. Surf Gear would gain an additional $17,500 (relevant revenues, $\mathrm{\$}\text{55,000}-\text{relevant costs},\mathrm{\$}\text{37,500})$ in operating income by accepting the special order. In this example, by comparing total amounts for 30,000 units versus 35,000 units or focusing only on the relevant amounts in the difference column in Exhibit 12-5, the manager avoids a misleading implication: to reject the special order because the $11-per-unit selling price is lower than the manufacturing cost per unit of $12 (Exhibit 12-4), which includes both variable and fixed manufacturing costs.

The assumption of no long-run or strategic implications is crucial to a manager’s analysis of the one-time-only special-order decision. Suppose the manager concludes that the retail department stores (Surf Gear’s regular customers) will demand a lower price if Surf Gear sells towels at $11 apiece to Azelia. In this case, revenues from regular customers will be relevant. Why? Because the future revenues from regular customers will differ depending on whether Surf Gear accepts the special order. The Surf Gear manager would need to modify the relevant-revenue and relevant-cost analysis of the Azelia order to consider both the short-run benefits from accepting the order and the long-run consequences on profitability if Surf Gear lowered prices to all regular customers.