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Special-Order Decision Smooth Move Company manufactures professional paperweights and has been approached by a new customer with an offer to purchase 15,000 units at a per-unit price of $7.00. The new customer is geographically separated from Smooth Move's other customers, and existing sales will not be affected. Smooth Move normally produces 82,000 units but plans to produce and sell only 65,000 in the coming year. The normal sales price is $12 per unit. Unit cost information is as follows: Direct materials $3.10 Direct labor 2.25 Variable overhead 1.15 Fixed overhead 1.80 Total $8.30 If Smooth Move accepts the order, no fixed manufacturing activities will be affected because there is sufficient excess capacity. Required: 1. What are the alternatives for Smooth Move? Accept or reject the special order 2. CONCEPTUAL CONNECTION: Should Smooth Move accept the special order? By how much will profit increase or decrease if the order is accepted? $ 3. CONCEPTUAL CONNECTION: Briefly explain the significance of the statement in the exercise that "existing sales will not be affected" (by the special sale).

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jepessoa

Answer:

Required: 1. What are the alternatives for Smooth Move? Accept or reject the special order

Smooth Move should accept the special since operating profits will increase by $2,250

2. CONCEPTUAL CONNECTION: Should Smooth Move accept the special order? By how much will profit increase or decrease if the order is accepted?  

operating profits will increase by $2,250

3. CONCEPTUAL CONNECTION: Briefly explain the significance of the statement in the exercise that "existing sales will not be affected" (by the special sale).

The company's productive capacity is 82,000 and since it only plans to sell 65,000, its spare capacity = 82,000 - 65,000 = 17,000.

Also, since the buyer doesn't have any contact with existing customers, it should not resell Smooth's products to the same clients. The normal selling price is $12 per unit, so the new buyer has a $5 margin if it wanted to resell the products.

Explanation:

Since the company's productive capacity is 82,000 units per year, but only 65,000 are scheduled for next year, this special order shouldn't affect budgeted fixed costs.

relevant costs:

  • direct labor $2.25
  • direct materials $3.10
  • variable overhead $1.50
  • fixed overhead (not relevant)
  • total relevant costs = $6.85

financial advantage of accepting order = additional revenue - relevant costs = $7 - $6.85 = $0.15 per unit x 15,000 units = $2,250

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