One type of short-term decision that businesses frequently have to make is whether or not to accept special order requests from customers. A special order is an order that the company did not anticipate when developing its budget for the year. Therefore, this is an additional opportunity to generate revenue above sales goals. Special orders typically request a lower price than normally offered and/or might include additional costs. Often students get caught up in the lower price or lower contribution margin and want to disregard the order immediately. However, if the order will bring in additional profit, the order should be considered.

Make more money now! Try our JOB search.

When faced with a special order decision, a company should consider the following three items:

1. Does the company have the excess capacity to fulfill this order?

Remember that a special order is an order that the company did not expect. The company must make sure that there is excess capacity to fill this order without harming the original plan developed for the year.

2. Will the order be profitable?

Typically, a special order will have a reduced price and/or additional costs. Will the price be high enough to cover the incremental costs associated with the order. Think back to overhead allocation. When overhead allocation rates were developed at the beginning of the year, they were based on the planned production. These special orders are in addition to the planned production. Therefore, fixed overhead would not be applied to these jobs. This allows the company to make the products needed for the special order at a reduced cost. Although the price might be lower, the company may be able to achieve profit on the job.

3. Will the order affect planned sales, now or in the future?

The company must insure that the special order will not hurt other sales. It is important to make sure that the customer requesting the special order does not compete with existing customers or the company itself, which would result in decreased sales at regular prices. Special orders can also lead to unhappy existing customers if they find out about the special deal you gave someone else. Careful consideration must be made when accepting special orders to protect current and future profits.

Identify the relevant costs

In order to identify the relevant costs associated with a special order decision, we must look at the existing costs to determine which costs will be paid if the order is accepted. Previously incurred fixed costs are never relevant. The only fixed costs that should be considered are fixed costs that are incurred because of the special order. Then consider your variable costs. Are there any variable costs that will not be paid with this special order? Sometimes variable selling costs are excluded from the calculation because no sales commission will be paid on the order. These savings can help decrease the cost and increase the profitability of the job.

Carefully read the problem to ensure you have identified the relevant and irrelevant costs properly.

Should the company accept the job?

Typically in problems you will do in class, you will only consider the quantitative factors. Use the contribution margin approach to calculate if the job will generate profit or loss:

1. Calculate the contribution margin per unit

Calculate the contribution margin (price – variable costs) per unit for the special order. Exclude irrelevant costs from the calculation.

2. Calculate the total contribution margin

Multiply the number of units in the special order by the contribution margin per unit.

3. Subtract any incremental fixed costs from the contribution margin to determine profit or loss

If there are any incremental fixed costs, subtract those costs from the contribution margin. If there are no incremental fixed costs, the contribution margin is all profit.

4. Determine if you should accept the job

If there are no extenuating qualitative issues, accept the job if it will generate additional profit. If there is a loss on the job, do not accept the job.

Final Thoughts

These problems are not difficult. The hardest part is to identify the irrelevant costs and remove them from your calculations. Use what you have learned about contribution margin to determine if you have profit on the special order.

Related Video

Special Order Decision Making

Share This:

Related pages

purpose of retained earnings statementdebits are used to record increases inmanagerial accounting journal entriescost of merchandise sold definitionlist of expense account titlestarget costing companiesperpetual inventory formnotes receivable journal entryexamples of prepaid expensesnet sales minus cost of goods soldprincipal formula simple interestpayroll liabilities journal entryprepare adjusting journal entriescash in transit accounting definitionfull accounting cycle examplesprt formularetained earnings definition accountingcalculate tax on paycheckcontra liability accountpaid accounts payable journal entryfinish line hourly paywalmart inventory methodallowance for doubtful accounts normal balancefederal unemployment calculatorcalculate weighted average gradescalculate manufacturing overhead rateinventoriable costaccounting equation calculatoradjusting entries are requiredallowance for doubtful accounts debit balancesocial security tax withholding calculatorcalculate how much federal tax should be withhelddifference between perpetual inventory and periodic inventorycalculate present value of an annuityfiguring payroll taxesoperating profit calculatorcalculate credit salesfica taxes calculatordepreciation with residual valuehow do you calculate asset turnoveronline weighted average calculatorwhat is the journal entry for prepaid rentcalculate depreciation straight line methodsales transaction journal entry2014 fica wage limitdouble declining method of depreciationpv annuitylifo and fifo accountingcalculating dividends from balance sheetwhat are current liabilities examplesdepreciate buildingallowance for doubtful accounts definitionsalvage calculatorcalculate gross pay based on net payhow much are fica taxesfifo inventory systemthe formula for depreciable cost iscogs formula income statementexamples of absorption costinglifo inventory method exampleemployer portion of payroll taxes calculatorclosing stock debit or creditnormal balance for accounts receivablecost minus accumulated depreciationperiodic inventory system journal entriesallowance for sales returns journal entryaccumulated amortization journal entrysupplies expense adjusting entrypayroll taxes ficamanagerial accounting calculatorprepaid rent adjusting entryasset turnover calculationstraight line depreciation method formulas calculatorsales price variance formulawhat is the purpose of closing entries in accountingfiguring depreciationwhat is wip accountingmanufacturing overhead accountingaccounting entries for depreciationpresent value table annuity due