Question

Happy Chairs manufactures desk chairs for use in schools and universities. The costs per chair are as follows:

Direct materials per unit 26.50
Direct labour per unit 1.00
Variable overhead per unit 1.75
Fixed overhead (per month) 25,000

Happy Chairs currently manufactures and sells 100,000 chairs per month and has the capacity, without increasing overhead costs, to manufacture a total of 125,000 chairs. Fixed overhead costs are allocated on the basis of chairs manufactured. One of the company's major customers has offered to purchase 30,000 chairs for $1,800,000. This is a one-off special order which will not be repeated.

REQUIRED:
Explain whether or not Happy Chairs should accept the special order?

Answer 1

Happy Chairs should accept the special order.

Here's why:

1. Analyze the costs:

Calculate the total cost per chair excluding fixed overhead: 26.50 (material) + 1.00 (labor) + 1.75 (variable overhead) = $29.25

Calculate the fixed overhead cost per chair based on current production: 25,000 (fixed overhead) / 100,000 (chairs) = $0.25 per chair

Add the fixed overhead cost per chair to the variable cost per chair to get the total cost per chair: 29.25 + 0.25 = $29.50

2. Evaluate the special order:

Calculate the contribution margin per chair for the special order: 1,800,000 (total revenue) / 30,000 (chairs) - 29.50 (cost per chair) = $45.50

Compare the contribution margin of the special order to the regular production: 45.50 > 17.25 (regular contribution margin per chair)

3. Conclusion:

The special order offers a significantly higher contribution margin per chair than Happy Chairs' regular production. This means that even though the price per chair is lower, the additional revenue generated from the 30,000 chairs will contribute more to the company's overall profit without requiring any increase in fixed overhead costs.

Additional factors to consider:

The availability of raw materials and labor to fulfill the special order without impacting regular production.

The potential impact on existing customer relationships if the special order affects delivery times or availability of regular chairs.

Any one-time setup costs associated with the special order.

Overall, based on the provided information, accepting the special order is a financially sound decision for Happy Chairs.