Gundy Company manufactures a product with the following costs per unit at the expected production of 30,000 units: $\begin{array}{llr}
\text { Direct materials} &\$4\
\text { Direct labour } &12\
\text { Variable manufacturing overhead } &6\
\text { Fixed manufacturing overhead } &8\
\end{array}$
The company has the capacity to produce 40,000 units.The product regularly sells for $40.A wholesaler has offered to pay $32 a unit for 2,000 units.
If the firm is at capacity and the special order is accepted,what would be the effect on operating income?

Question

Gundy Company manufactures a product with the following costs per unit at the expected production of 30,000 units: $\begin{array}{llr}
  \text {  Direct materials} &\$4\
 \text { Direct labour } &12\
 \text { Variable manufacturing overhead } &6\
 \text { Fixed manufacturing overhead } &8\
\end{array}$
 The company has the capacity to produce 40,000 units.The product regularly sells for $40.A wholesaler has offered to pay $32 a unit for 2,000 units.
If the firm is at capacity and the special order is accepted,what would be the effect on operating income?

Quizplus · Accepted Answer

Since the firm is at capacity, accepting the special order would require displacing 2,000 units of regular sales. The contribution margin lost on the displaced units is $40 (regular sales price) - $20 (variable costs: $4 direct materials + $12 direct labor + $4 variable manufacturing overhead) = $20 per unit. For 2,000 units, this amounts to a $40,000 loss. The special order provides $32 per unit, totaling $64,000 for 2,000 units. However, the variable costs remain the same ($20 per unit), leading to a contribution of $12 per unit or $24,000 for 2,000 units. The net effect is a $16,000 decrease in operating income ($24,000 from the special order - $40,000 lost from displaced regular sales).

Gundy Company Manufactures a Product with the Following Costs Per