Special order and flexible budget at Cuttack Apparels
Cuttack Apparels has a monthly capacity of 10,000 units. It currently makes and sells 7,500 units at Rs 600 each. Variable cost is Rs 380 per unit: materials Rs 220, labour Rs 100 and variable overhead Rs 60. Fixed costs are Rs 14,00,000 per month. An export customer has offered to buy 2,000 units at Rs 450 each. The order would require extra packing of Rs 20 per unit and the hire of a special machine for Rs 30,000. It would not affect domestic sales, and the machine has no other use. The marketing manager wants to reject the order because the price is below the full cost per unit. The production manager says there is enough idle capacity. The owner asks for a relevant-cost analysis, a flexible budget showing profit at 7,500 and 9,500 units, and the non-financial issues before accepting.
1. Prepare a relevant-cost analysis of the export order and decide whether to accept it.
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The relevant costs are the future costs that differ between accepting and rejecting the order. Existing fixed costs of Rs 14,00,000 are incurred whether or not the order is accepted, so they are not relevant unless the order causes extra fixed cost.
| Relevant item | Rs |
|---|---|
| Incremental revenue: 2,000 × 450 | 9,00,000 |
| Variable cost: 2,000 × 380 | 7,60,000 |
| Extra packing: 2,000 × 20 | 40,000 |
| Special machine hire | 30,000 |
| Total incremental cost | 8,30,000 |
| Net contribution from order | 70,000 |
The order adds Rs 70,000 contribution and uses capacity that would otherwise be idle. It should be accepted on financial grounds, provided the export price does not damage domestic pricing and the customer will not demand a permanent low price. The marketing manager's full-cost objection is wrong because existing fixed costs are already recovered from domestic sales.
2. Prepare a flexible budget at 7,500 units and 9,500 units and reconcile the profit with the special-order decision.
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| Item | 7,500 units (domestic only) | 9,500 units (with export) |
|---|---|---|
| Sales | 45,00,000 | 54,00,000 |
| Variable cost at Rs 380 | 28,50,000 | 36,10,000 |
| Extra packing | - | 40,000 |
| Contribution | 16,50,000 | 17,50,000 |
| Fixed costs | 14,00,000 | 14,00,000 |
| Special machine hire | - | 30,000 |
| Profit | 2,50,000 | 3,20,000 |
Sales at 9,500 units = 7,500 × 600 + 2,000 × 450 = 45,00,000 + 9,00,000 = 54,00,000.
Profit rises by Rs 70,000, which agrees with the relevant-cost analysis. The flexible budget also shows that the export order is not covering its share of existing fixed cost, but that is acceptable when idle capacity exists and the order is short-term.
3. Discuss the non-financial and strategic factors the owner should consider before accepting.
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The owner should consider whether the export price of Rs 450 will become a reference price for domestic customers, and whether the export customer will expect repeat orders at that price. The firm must check capacity: 9,500 units is within the 10,000-unit limit, but any machine breakdown or quality problem could affect domestic deliveries. The special machine may create maintenance and safety obligations. Payment terms, currency risk, export documentation and credit risk also matter.
The order may improve labour utilisation and employee morale, but it could strain quality control and lead to overtime. The owner should confirm that the variable cost of Rs 380 is reliable and that no hidden fixed cost, such as supervision or storage, will increase. A short-term order that contributes Rs 70,000 is worthwhile if it does not undermine long-term domestic pricing or customer relationships.