Felix Time Company manufactures and sells watches for $40 each. Times Products Company has offered Felix Time $25 per watch for a one-time order of 6,000 watches. The total manufacturing cost per watch is $30 per unit, and consists of variable costs of $22 per watch and fixed overhead costs of $8 per watch. Assume that Felix Time has excess capacity and that the special order would not adversely affect regular sales. What is the change in operating income that would result from accepting the special sales order?

Question

Quizplus · Accepted Answer

The calculation for the change in operating income is as follows:

Operating Income = Revenue - Total Manufacturing Cost

Regular Revenue = 10,000 watches x $40 per watch = $400,000

Special Order Revenue = 6,000 watches x $25 per watch = $150,000

Total Revenue = Regular Revenue + Special Order Revenue = $550,000

Total Manufacturing Cost = 10,000 watches x $30 per watch = $300,000

Variable Cost = 10,000 watches x $22 per watch = $220,000

Fixed Overhead Cost = 10,000 watches x $8 per watch = $80,000

Total Manufacturing Cost = Variable Cost + Fixed Overhead Cost = $300,000

Total Cost of Special Order = 6,000 watches x $30 per watch = $180,000

Change in Operating Income = Special Order Revenue - Total Cost of Special Order
= $150,000 - $180,000
= -$30,000

Since the change in operating income is negative, accepting the special order would result in a decrease in operating income. However, the decrease is not as much as the fixed overhead cost, which would be incurred whether the special order is accepted or not. Therefore, the company should accept the special order to utilize excess capacity and cover some of the fixed overhead cost, resulting in a net increase in operating income of $18,000 ($30,000 cost savings minus $12,000 loss from selling at a lower price).

Felix Time Company Manufactures and Sells Watches for $40 Each