The decision to accept or reject a specially priced order is common in both service industry and manufacturing firms. Manufacturers are often faced with decisions about selling products in a special order at less than full price. The correct analysis of such decisions focuses on the relevant costs and benefits.
The correct analysis of cost and revenue employs the relevant cost approach. Irrelevant costs should be avoided from the analysis. Fixed costs, which often are allocated to individual unit of product or service, are usually irrelevant. Fixed costs typically will not change in total, whether the order is accepted or rejected. But incremental fixed cost is relevant cost. But there is no harm in including such irrelevant item in an analysis so long as they are included under every alternative being considered.
When excess capacity exists, the only relevant cost usually will be the variable costs associated with the special order. When there is no excess capacity, the opportunity cost of using the firm's facilities for the special order are also relevant to the decision.
The decision to accept or reject special order depends upon how the acceptance of the order will affect the short term financial result.
The overall profit will increase if the future total revenue from the special order exceeds the relevant cost. If the future total revenue is lower than the relevant cost, the special order should not be accepted.
The correct analysis of cost and revenue employs the relevant cost approach. Irrelevant costs should be avoided from the analysis. Fixed costs, which often are allocated to individual unit of product or service, are usually irrelevant. Fixed costs typically will not change in total, whether the order is accepted or rejected. But incremental fixed cost is relevant cost. But there is no harm in including such irrelevant item in an analysis so long as they are included under every alternative being considered.
When excess capacity exists, the only relevant cost usually will be the variable costs associated with the special order. When there is no excess capacity, the opportunity cost of using the firm's facilities for the special order are also relevant to the decision.
The decision to accept or reject special order depends upon how the acceptance of the order will affect the short term financial result.
The overall profit will increase if the future total revenue from the special order exceeds the relevant cost. If the future total revenue is lower than the relevant cost, the special order should not be accepted.