The following information relates to a product produced by Creamer Company: Fixed selling costs are $500,000 per year, and variable selling costs are $12 per unit sold. Although production capacity is 600,000 units per year, the company expects to produce only 400,000 units next year. The product normally sells for $120 each. A customer has offered to buy 60,000 units for $90 each.
If the firm produces the special order, the effect on income would be a
A) $360,000 increase.
B) $360,000 decrease.
C) $540,000 increase.
D) $540,000 decrease.

Question

The following information relates to a product produced by Creamer Company:  Fixed selling costs are $500,000 per year, and variable selling costs are $12 per unit sold. Although production capacity is 600,000 units per year, the company expects to produce only 400,000 units next year. The product normally sells for $120 each. A customer has offered to buy 60,000 units for $90 each.
If the firm produces the special order, the effect on income would be a
A) $360,000 increase. 
B) $360,000 decrease. 
C) $540,000 increase. 
D) $540,000 decrease.

Quizplus · Accepted Answer

First, we need to calculate the total cost of producing 60,000 units.

Variable cost per unit = $12 
Total variable cost for 60,000 units = $12 x 60,000 = $720,000

Fixed selling costs = $500,000

Total cost = variable cost + fixed selling cost 
Total cost = $720,000 + $500,000 = $1,220,000

Next, we need to calculate the revenue earned from the special order.

Selling price per unit = $90 
Total revenue for 60,000 units = $90 x 60,000 = $5,400,000

To determine the effect on income, we can use the following formula:

Income = revenue - total cost

Income = $5,400,000 - $1,220,000 = $4,180,000

Compared to the income if the company produced 400,000 units at the normal selling price of $120:

Revenue = $120 x 400,000 = $48,000,000 
Total cost = variable cost per unit x units produced + fixed selling cost 
Total cost = $12 x 400,000 + $500,000 = $5,300,000 
Income = $48,000,000 - $5,300,000 = $42,700,000

Therefore, the special order would result in an increase in income of:

$4,180,000 - $42,700,000 = $540,000

Thus, the best choice is C.

The Following Information Relates to a Product Produced by Creamer