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Accepting or Rejecting an Order/Foreign Orders or Exploring New Markets
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The companies may get special orders from their customers for the supply of their regular products. In such cases they have to decide whether the order should be accepted or rejected. The special orders may be either from the domestic or foreign customers. The customers will be quoting a price lesser than the normal selling price for such special orders. The companies usually take decision in such circumstances on the basis of differential cost analysis. So they compare the incremental revenue with the differential cost. A company should consider the following factors before taking the accept/reject decision:
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The effect on the future revenue due to temporary reduction in selling price.
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The impact of reduced selling price on the existing customers when they come to know the price reduction for special order.
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Possibility of selling extra units for new customers other than the special order.
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Reliability of the cost estimates for the special order.
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The effect of the present and future capacity in terms of plant expansion, finance, human resources etc.
Illustration
A factory manufacturing mechanical toys presents the following information for the year 2004:
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Particulars
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Rs.
(Present 30,000 units level)
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Material cost
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2,40,000
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Labor cost
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4,80,000
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Fixed overheads
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2,40,000
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Variable overheads
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1,20,000
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Units produced
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30,000 units
Rs.40
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Selling price per unit
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The available capacity is a production of 40,000 units per year. The firm has an offer for the purchase of 10,000 additional units at a price of Rs.30 per unit. It is expected that by accepting this offer, there will be a saving of Re.1 per unit in material cost on all units manufactured; the fixed overheads will increase by Rs.40,000 and the overall efficiency will drop by 3% on production.
Prepare a statement showing the variation of net profits resulting from the acceptance of the order.
Solution
Statement Showing the Variation of Net Profit
Resulting from the Acceptance of the Order
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Particulars
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30,000 units
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40,000 units
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Variation
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Material
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2,40,000
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2,80,000
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40,000
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Labor
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4,80,000
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6,59,794
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1,79,794
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Variable overheads
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1,20,000
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1,60,000
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40,000
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i.
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Total variable cost
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8,40,000
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10,99,794
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2,59,794
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ii.
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Sales
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12,00,000
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15,00,000
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3,00,000
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[30,000 @ Rs.40 per unit]
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+10,000 @Rs.30 per unit]
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iii.
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Contribution (ii - i)
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3,60,000
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4,00,206
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40,206
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iv.
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Fixed cost
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2,40,000
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2,80,000
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40,000
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v.
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Profit
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1,20,000
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1,20,206
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206
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The net profit will increase by Rs.206 by the acceptance of additional order of 10,000 units.
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