PencilPal Ltd(PP) specializes in making unique plastic pencils and have been doing so for a decade. The unique feature of unbreakable lead allows PencilPal Ltd to have an edge over its plastic pencil competitors. PP has dominated 35% of the local market share based on recent market report. PP has done the market survey and the research has shown that the selling price of the plastic pencil at 55 cents per unit is widely accepted by their existing customers. The management received a special order from a customer ordering 3D pencils, which is a unique 3D printing plastic colour pencil of which the customer is willing to pay S$3 per unit. Based on the estimation, the variable cost for one 3D pencil will be S$2.40. The variable cost is higher because of the special feature of 3D effects when using the colour pencil. Besides that, the complicated manufacturing process for 3D printing requires a longer time for production. With the capability of the existing machine, the production output will be 40 units of 3D pencils per machine hour. The customer has ordered 100 thousand units. Besides, PP has to incur Twenty Thousand Singapore Dollars to purchase a 3D printer especially for the special order. Currently, they are using a special moulding machine for making their products. The machine is capable of producing 100 plastic pencil per hour. Assume the maximum capacity of the machine is 10,000 machine hours during the period in which the customer wants the delivery of their special order. The variable cost of the plastic pencil is 25 cents.
a) The demand for their existing plastic pencil is 750 thousand units. Assume that the special order of the 3D colour pencil is accepted by PencilPal Ltd then the company will be committed to supplying 100 thousand units. . Should the company accept the special order? In your answer, you should factor in the constraints of the machine hours available.
b) Critically discuss the qualitative factors that the company will need to take into consideration before accepting the special order of supplying 100 thousand units to the customer.
In order to determine if we should or should not accept the special offer of 3D pencils, we need to check the availability of the resource which is a limiting factor. Limiting factor is the resource required for production, which is available to us in a limited quantity and has to be used wisely. In our case it is the limited availability of machine hours.
In order to satisfy the demand for 750 thousand plastic pencils, we would require the 7500 machine hours (750000/100). This leaves us with a surplus of 2500 machine hours. Let us now check the machine hour requirement for the special order of 3D pencils. It would be 2500 machine hours (100000/40). Both of which sums to 10000 machine hour. Therefore we have sufficient machine hours in order to proceed with the production of both plastic pencils and 3D pencils.
|Machine hours required for plastic pencils||7500|
|Machine hours required for 3D Pencils||2500|
|Total Machine Hours Required||10000|
|Total Machine Hours Available||10000|
Let us now calculate the profit position of the company if both of these demands are met:
|Profit From Plastic Pencils|
|Less: Variable Cost||187,500|
|Profit from Special Order|
|Less: Variable Cost||240,000|
|Less: Special Machine||20,000|
Total profit for the company if only plastic pencils are manufactured amounts to $225000. Profit for the company is the special order is also accepted amounts to $265,000. Therefore, we see that the company has extra resources which remain unutilised even after the normal demand was met. The company had a scope for using this extra resource for production of 3D pencils. Therefore, the company should accept the special order for 100 thousand units of 3D pencils.
A special order is the order which made to the company over and above the existing normal demand for particular products. The special order may require a few changes or a few unique features in the product. These types of orders are to be either totally accepted or totally rejected by the company (Atkinson, 2012). The company cannot accept only a part of it. Before taking the decision of acceptance or rejection of special order the company needs to check few details. The company should check the availability of resources, profitability of special order, affect of special order on existing production, etc (Boyd, 2013). Let us now discuss these points in details:
- Availability of resources: the company before accepting the special order should check if they have enough resources available to produce the products of special order. They should first identify the limiting factor. Then the use of this limiting factor should be first kept aside for meeting the normal demand. If there remains any extra resource, it should be checked if they are enough to satisfy the production of special order .
- Profitability: sometimes even if the resources are not sufficient to meet the normal demand, profitability generated per unit of limiting factor under both normal and special circumstances are checked. The option generating higher profitability is then chosen. Sometimes special order require extra expenses which are to be incurred only of the order is accepted, therefore, this should also be considered before taking the decision of acceptance of special offer (Horngren, Datar and Rajan, 2014). The overall profitability of the company should improve if the offer is being accepted.
- Affect of special offer on normal demand: in order to accept the special order the company should not harm the normal demand. The special order may or may not come in future, but disrupting the normal demand may harm the future sales for the company. Therefore the special order should be accepted if there are extra resources only and it generates profitability of the company (Kaplan and Anderson, 2009).
The special order is a onetime offer which generally involves higher cost and higher revenues for the product. Our decision to accept or reject the offer will help the company maximise its profits (Ryan and Ryan, n.d.). These types of orders should be accepted only if the revenue generated from them excess the costs which are to be incurred on them. Also, they should not affect the normal sales generated by the company. The fixed costs which are a part of the cost structure of the company are not allocated to special orders. They are allocated to only normal demand products; therefore the profitability of the special order depends only on the variable costs of the product. Also, these types of offers help the management to maintain relationships with various outsiders (Weygandt, Kieso and Kimmel, n.d.).
Atkinson, A. (2012). Management accounting. 1st ed. Upper Saddle River, N.J.: Pearson.
Boyd, K. (2013). Cost accounting for dummies. 1st ed. Hoboken, N.J.: Wiley.
Horngren, C., Datar, S. and Rajan, M. (2014). Cost accounting. 1st ed. Boston: Pearson.
Kaplan, R. and Anderson, S. (2009). Time-driven activity-based costing. 1st ed. Boston, Mass: Harvard Business School Press.
Ryan, F. and Ryan, M. (n.d.). Revolutionizing accounting for decision making. 1st ed.
Weygandt, J., Kieso, D. and Kimmel, P. (n.d.). Managerial accounting. 1st ed.