ZImmerman Company supplies schools with floor mattresses to use in physical education classes. Zimmerman has received a special order from a large school district to buy 600 mats at $45 each. Acceptance of the special order will not affect fixed costs but will result in $1,200 of shipping costs.

For the first 6 months of 2013, the company reported the following operating results while operating at 80% capacity:

Sales (100,000 units)$7,000,000
Cost of goods sold $4,200,000
Gross profit $2,800,000
Operating expenses $2,000,000
Net income $ 800,000
Cost of goods sold was 75% variable and 25% fixed; operating expenses were 70% variable and 30% fixed.(a) prepare an incremantal analysis for the special order. (b) should gregg company accept the special order?

Answer and Explanation:

(a)

Reject Order

Revenues$ -0-

Cost of Goods Sold-0-

Operating Expense-0-

Net Income$ -0-

Accept order

Revenues$27,000

Cost of Goods Sold $18,900

Operating Expense $9,600

Net Income$ ($1,500)

Net income Increased (Decreased)

Revenues $27,000

Cost of Goods Sold ($18,900)

Operating Expense ($9,600)

Net Income$ ($1,500)

Variable cost of goods sold = $4,200,000 × 75% = $3,150,000.

Variable cost of goods sold per unit =

$3,150,000 ÷ 100,000 = $31.50

Variable cost of goods sold for the special order = 600 × $31.50 = $18,900.

Variable operating expenses = $2,000,000 × 70% = $1,400,000

Variable operating expenses per unit = $1,400,000 ÷ 100,000 = $14

Variable operating expenses for the special order = 600 × $14

= $8,400 + $1,200= $9,600

b)The incremental analysis shows that Gregg Company should not accept the special order reason been that the incremental costs exceed incremental revenues.

a) Contribution   (1,500)

b) Gregg should not accept the order because it lead to a decease in its current contribution by $1,500. A special order would be considered as profitable if it increases contribution

Explanation:

In order to carry out an incremental analysis, only relevant cash flows should be considered.

The relevant cash flows from accepting the special order are the variable  costs and the sales revenue. Please, note that the fixed costs are not relevant for this decision. Simply because they would be incurred either way.

The relevant variable costs include:

Variable cost of goods sold per unit = ( 75% × 4,200,000) = 3,150,000

Variable operating expenses -= 70% × 2,000,000  = 1,400,000

a) Incremental analysis for 600 units

                                                                                           $

Sales revenue --  ($45× 600 )   =                                    27,000        

Variable cost:

Cost of goods sold = ( 600/100,000 × 3,150,000) =     (18,900)

Operating expenses = (600/100,000 × 1,400,000 ) =   (8,400)

Shipping cost                                                                 ( 1,200)

Contribution                                                                    (1,500)

b) Gregg should not accept the order because it would lead to a decease in its current contribution by $1,500. A special order would only be considered as profitable if it increases contribution all other things being equal.

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