Special Order Pricing at a Furniture Unit
Sunrise Furniture makes study tables in a rented workshop. Normal capacity is 1,000 tables a month; current output is 700. A distributor offers a one-time order of 200 tables at ₹1,850 each. The cost records show direct material ₹700, direct labour ₹400 and variable overhead ₹150 per table. Fixed overhead is ₹5,00,000 a month and is absorbed at ₹500 per table at normal capacity. The order would need an additional supervisor at ₹30,000 and a special jig costing ₹20,000, which can be sold for ₹5,000 afterwards. A market survey costing ₹15,000 was already completed. There is enough idle capacity for the order, and no regular sales will be lost. The marketing manager wants to reject the order because the offered price is only slightly above the full cost of ₹1,750.
1. Identify the relevant and irrelevant costs and compute the minimum price per table for the special order. Should the order be accepted at ₹1,850?
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Relevant costs per table
| Item | ₹/table |
|---|---|
| Direct material | 700 |
| Direct labour | 400 |
| Variable overhead | 150 |
| Additional supervisor (₹30,000 ÷ 200) | 150 |
| Net cost of special jig (₹20,000 − ₹5,000) ÷ 200 | 75 |
| Minimum relevant cost | 1,475 |
The market survey of ₹15,000 is a sunk cost. The absorbed fixed overhead of ₹500 per table is not relevant because total fixed overhead remains ₹5,00,000 whether or not the order is accepted.
At ₹1,850, contribution per table is ₹1,850 − ₹1,475 = ₹375, or ₹75,000 for the order. Accept the order, subject to qualitative checks such as whether it will spoil future regular prices or create a precedent.
2. Assume the order can be executed only by displacing 100 regular tables, each earning a contribution of ₹1,150. Recalculate the minimum price and revise your decision.
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The idle-capacity assumption is no longer valid. The opportunity cost is the lost contribution from 100 regular tables:
- Lost contribution = 100 × ₹1,150 = ₹1,15,000
- Opportunity cost per special-order table = ₹1,15,000 ÷ 200 = ₹575
- Revised minimum price = ₹1,475 + ₹575 = ₹2,050 per table
At ₹1,850, the order gives a relevant contribution of 200 × (₹1,850 − ₹1,475) = ₹75,000 but sacrifices ₹1,15,000 of regular contribution. Net effect = ₹75,000 − ₹1,15,000 = −₹40,000.
Reject the order at ₹1,850 unless there are strong strategic reasons. The minimum acceptable price is ₹2,050.
3. The accountant argues that fixed overhead at ₹500 per table must be included before accepting any order. Evaluate this view in the context of idle capacity.
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Including absorbed fixed overhead gives a full cost of ₹1,750, which is useful for long-run normal pricing because all costs must eventually be recovered. But for a short-run special order using otherwise idle capacity, the ₹5,00,000 fixed overhead is unavoidable and does not increase with the order. Loading ₹500 per table into the decision makes the order look less attractive without changing cash flows.
The relevant floor is ₹1,475 when capacity is idle. However, the accountant’s concern becomes valid if the order is repeated, if it displaces regular sales, or if it sets a low market price that regular customers will demand. Use relevant cost for the one-time idle-capacity decision; use full cost for long-run pricing and for assessing whether total capacity is viable.