Special Orders
Jet, Inc.
Contribution Income Statement
Revenue (5,000 × $20)
$ 100,000
Variable costs:
Direct materials
$ 20,000
Direct labor
5,000
Manufacturing overhead
10,000 $8 variable cost
Marketing costs
5,000
Total variable costs
40,000
Contribution margin
60,000
Fixed costs:
Manufacturing overhead $ 28,000
Marketing costs
20,000
Total fixed costs
48,000
Net operating income
$ 12,000
McGraw-Hill/Irwin
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Special Orders
If Jet accepts the offer, net operating income
will increase by $6,000.
Increase in revenue (3,000 × $10)
Increase in costs (3,000 × $8 variable cost)
Increase in net income
$ 30,000
24,000
$ 6,000
Note: This answer assumes that fixed costs are
unaffected by the order and that variable marketing
costs must be incurred on the special order.
McGraw-Hill/Irwin
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Quick Check 
Northern Optical ordinarily sells the X-lens for
$50. The variable production cost is $10, the
fixed production cost is $18 per unit, and the
variable selling cost is $1. A customer has
requested a special order for 10,000 units of the
X-lens to be imprinted with the customer’s logo.
This special order would not involve any selling
costs, but Northern Optical would have to
purchase an imprinting machine for $50,000.
(see the next page)
McGraw-Hill/Irwin
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Quick Check 
What is the rock bottom minimum price below
which Northern Optical should not go in its
negotiations with the customer? In other words,
below what price would Northern Optical
actually be losing money on the sale? There is
ample idle capacity to fulfill the order.
a. $50
b. $10
c. $15
d. $29
McGraw-Hill/Irwin
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Quick Check 
What is the rock bottom minimum price below
Variable production cost
$100,000
which Northern Optical should not go in its
Additional fixed cost
50,000
negotiations with the customer? In other words,
Total relevant cost
$150,000
below what price would Northern Optical
Number of units
10,000
actually be losing money on the sale? There is
Average cost per unit
$15
ample idle capacity to fulfill the order.
a. $50
b. $10
c. $15
d. $29
McGraw-Hill/Irwin
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Utilization of a Constrained
Resource
Firms often face the problem of deciding how
to best utilize a constrained resource.
Usually fixed costs are not affected by this
particular decision, so management can focus
on maximizing total contribution margin.
Let’s look at the Ensign Company example.
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Source: Norfolk Southern
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Source: Norfolk Southern
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Source: Norfolk Southern
© The McGraw-Hill Companies, Inc., 2003
Utilization of a Constrained
Resource
Ensign Company produces two products and
selected data is shown below:
Product
2
1
Selling price per unit
Less variable expenses per unit
Contribution margin per unit
Current demand per week (units)
Contribution margin ratio
Processing time required
on machine A1 per unit
McGraw-Hill/Irwin
$
60
36
$ 24
2,000
40%
1.00 min.
$
50
35
$ 15
2,200
30%
0.50 min.
© The McGraw-Hill Companies, Inc., 2003
Utilization of a Constrained
Resource
Machine A1 is the constrained resource
and is being used at 100% of its capacity.
There is excess capacity on all other
machines.
Machine A1 has a capacity of 2,400
minutes per week.
Should Ensign focus its efforts on
Product 1 or 2?
McGraw-Hill/Irwin
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Quick Check 
How many units of each product can
be processed through Machine A1 in
one minute?
a.
b.
c.
d.
McGraw-Hill/Irwin
Product 1
1 unit
1 unit
2 units
2 units
Product 2
0.5 unit
2.0 units
1.0 unit
0.5 unit
© The McGraw-Hill Companies, Inc., 2003
Quick Check 
How many units of each product can
be processed through Machine A1 in
one minute?
a.
b.
c.
d.
Product 1
1 unit
1 unit
2 units
2 units
Product 2
0.5 unit
2.0 units
1.0 unit
0.5 unit
I was just checking to make sure you are with us.
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Quick Check 
What generates more profit for the company,
using one minute of machine A1 to process
Product 1 or using one minute of machine A1 to
process Product 2?
a. Product 1
b. Product 2
c. They both would generate the same profit
d. Cannot be determined
McGraw-Hill/Irwin
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Quick Check 
With one minute of machine A1, we could make 1 unit
of What
Product
1, with a contribution
$24, or 2
generates
more profit margin
for the of
company,
units
of Product
2, each
a contribution
margin of
using
one minute
ofwith
machine
A1 to process
$15.
2 × $15
$24 one minute of machine A1 to
Product
1 or> using
process Product 2?
a. Product 1
b. Product 2
c. They both would generate the same profit
d. Cannot be determined
McGraw-Hill/Irwin
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Utilization of a Constrained
Resource
The key is the contribution margin per unit of the
constrained resource.
Product
1
Contribution margin per unit
Time required to produce one unit
Contribution margin per minute
2
$
÷
24
$
15
1.00 min. ÷
0.50 min.
$ 24 min.
$ 30 min.
Product 2 should be emphasized. Provides more
valuable use of the constrained resource machine A1,
yielding a contribution margin of $30 per minute as
opposed to $24 for Product 1.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
Utilization of a Constrained
Resource
The key is the contribution margin per unit of the
constrained resource.
Product
1
Contribution margin per unit
Time required to produce one unit
Contribution margin per minute
2
$
÷
24
$
15
1.00 min. ÷
0.50 min.
$ 24 min.
$ 30 min.
If there are no other considerations, the best
plan would be to produce to meet current
demand for Product 2 and then use remaining
capacity to make Product 1.
McGraw-Hill/Irwin
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Utilization of a Constrained
Resource
Let’s see how this plan would work.
Alloting Our Constrained Recource (Machine A1)
Weekly demand for Product 2
Time required per unit
Total time required to make
Product 2
McGraw-Hill/Irwin
×
2,200 units
0.50 min.
1,100 min.
© The McGraw-Hill Companies, Inc., 2003
Utilization of a Constrained
Resource
Let’s see how this plan would work.
Alloting Our Constrained Recource (Machine A1)
Weekly demand for Product 2
Time required per unit
Total time required to make
Product 2
Total time available
Time used to make Product 2
Time available for Product 1
McGraw-Hill/Irwin
×
2,200 units
0.50 min.
1,100 min.
2,400 min.
1,100 min.
1,300 min.
© The McGraw-Hill Companies, Inc., 2003
Utilization of a Constrained
Resource
Let’s see how this plan would work.
Alloting Our Constrained Recource (Machine A1)
Weekly demand for Product 2
Time required per unit
Total time required to make
Product 2
Total time available
Time used to make Product 2
Time available for Product 1
Time required per unit
Production of Product 1
McGraw-Hill/Irwin
×
2,200 units
0.50 min.
1,100 min.
÷
2,400
1,100
1,300
1.00
1,300
min.
min.
min.
min.
units
© The McGraw-Hill Companies, Inc., 2003
Utilization of a Constrained
Resource
According to the plan, we will produce 2,200
units of Product 2 and 1,300 of Product 1.
Our contribution margin looks like this.
Production and sales (units)
Contribution margin per unit
Total contribution margin
Product 1
1,300
$
24
$ 31,200
Product 2
2,200
$
15
$ 33,000
The total contribution margin for Ensign is $64,200.
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
Quick Check 
Colonial Heritage makes reproduction colonial
furniture from select hardwoods.
Chairs
Selling price per unit
$80
Variable cost per unit
$30
Board feet per unit
2
Monthly demand
600
Tables
$400
$200
10
100
The company’s supplier of hardwood will only
be able to supply 2,000 board feet this month. Is
this enough hardwood to satisfy demand?
a. Yes
b. No
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
Quick Check 
Colonial Heritage makes reproduction colonial
furniture from select hardwoods.
Chairs
Selling price per unit
$80
Variable cost per unit
$30
Board feet per unit
2
Monthly demand
600
Tables
$400
$200
10
100
The company’s supplier of hardwood will only
be able to supply 2,000 board feet this month. Is
this enough hardwood to satisfy demand?
a. Yes
2  600 + 10  100 = 2,200 > 2,000
b. No
McGraw-Hill/Irwin
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Quick Check 
Chairs
Selling price per unit
$80
Variable cost per unit
$30
Board feet per unit
2
Monthly demand
600
Tables
$400
$200
10
100
The company’s supplier of hardwood will only be
able to supply 2,000 board feet this month. What
plan would maximize profits?
a. 500 chairs and 100 tables
b. 600 chairs and 80 tables
c. 500 chairs and 80 tables
d. 600 chairs and 100 tables
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
Quick Check 
Chairs Tables
Selling price
$ 80 $ 400
Variable cost
30
200
Contribution
marginTables
$ 50 $ 200
Chairs
Selling price per
unitfeet $80
$400 2
Board
10
Variable cost per unit
$30
CM per board
foot $200
$ 25 $ 20
Board feet per unit
Monthly demand
2
600
10
100
Production of chairs
600
The company’s supplier
of hardwood
only be
Board feet
required will
1,200
able to supply 2,000
board
feet this month.
Board
feet remaining
800What
Boardprofits?
feet per table
10
plan would maximize
of tables
80
a. 500 chairs andProduction
100 tables
b. 600 chairs and 80 tables
c. 500 chairs and 80 tables
d. 600 chairs and 100 tables
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
Quick Check 
As before, Colonial Heritage’s supplier of
hardwood will only be able to supply 2,000 board
feet this month. Assume the company follows the
plan we have proposed. Up to how much should
Colonial Heritage be willing to pay above the usual
price to obtain more hardwood?
a. $40 per board foot
b. $25 per board foot
c. $20 per board foot
d. Zero
McGraw-Hill/Irwin
© The McGraw-Hill Companies, Inc., 2003
Quick Check 
As before, Colonial Heritage’s supplier of
hardwood will only be able to supply 2,000 board
feet
this month.
Assume
company
follows
theIn
The
additional
wood
wouldthe
be used
to make
tables.
plan
weeach
have
proposed.
to how wood
much will
should
this
use,
board
foot of Up
additional
allow
Heritage
to pay
the usual
theColonial
company
to earnbe
an willing
additional
$20above
of contribution
price to
margin
andobtain
profit.more hardwood?
a. $40 per board foot
b. $25 per board foot
c. $20 per board foot
d. Zero
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Managing Constraints
Produce only what
can be sold.
Finding ways to
process more units
through a resource
bottleneck
At the bottleneck itself:
•Improve the process
• Add overtime or another shift
• Hire new workers or acquire
more machines
• Subcontract production
Eliminate waste.
Streamline production process.
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Joint Costs
In some industries, a number of end
products are produced from a single raw
material input.
Two or more products produced from a
common input are called joint products.
The point in the manufacturing process
where each joint product can be recognized
as a separate product is called the split-off
point.
McGraw-Hill/Irwin
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Joint Products
Joint
Costs
Joint
Input
Common
Production
Process
Oil
Gasoline
Chemicals
Split-Off
Point
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Joint Products
Joint
Costs
Joint
Input
Common
Production
Process
Oil
Gasoline
Chemicals
Split-Off
Point
McGraw-Hill/Irwin
Separate
Processing
Final
Sale
Final
Sale
Separate
Processing
Final
Sale
Separate
Product
Costs
© The McGraw-Hill Companies, Inc., 2003
Which one sells for $82.00 ?
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The Pitfalls of Allocation
Joint costs are really
common costs incurred to
simultaneously produce a
variety of end products.
Joint costs are often
allocated to end products on
the basis of the relative
sales value of each product
or on some other basis.
McGraw-Hill/Irwin
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Sell or Process Further
It will always profitable to continue
processing a joint product after the splitoff point so long as the incremental
revenue exceeds the incremental
processing costs incurred after the splitoff point.
Let’s look at the Sawmill, Inc. example.
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Sell or Process Further
Sawmill, Inc. cuts logs from which
unfinished lumber and sawdust are the
immediate joint products.
Unfinished lumber is sold “as is” or
processed further into finished lumber.
Sawdust can also be sold “as is” to
gardening wholesalers or processed further
into “presto-logs.”
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Sell or Process Further
Data about Sawmill’s joint products includes:
Sales value at the split-off point
Sales value after further processing
Allocated joint product costs
Cost of further processing
McGraw-Hill/Irwin
Per Log
Lumber
Sawdust
$
140
$
40
270
176
50
50
24
20
© The McGraw-Hill Companies, Inc., 2003
Sell or Process Further
Analysis of Sell or Process Further
Per Log
Sales value after further processing
Sales value at the split-off point
Incremental revenue
McGraw-Hill/Irwin
Lumber
Sawdust
$
$
270
140
130
50
40
10
© The McGraw-Hill Companies, Inc., 2003
Sell or Process Further
Analysis of Sell or Process Further
Per Log
Sales value after further processing
Sales value at the split-off point
Incremental revenue
Cost of further processing
Profit (loss) from further processing
McGraw-Hill/Irwin
Lumber
Sawdust
$
$
$
270
140
130
50
80
$
50
40
10
20
(10)
© The McGraw-Hill Companies, Inc., 2003
Sell or Process Further
Analysis of Sell or Process Further
Per Log
Sales value after further processing
Sales value at the split-off point
Incremental revenue
Cost of further processing
Profit (loss) from further processing
Lumber
Sawdust
$
$
$
270
140
130
50
80
$
50
40
10
20
(10)
Should we process the lumber further
and sell the sawdust “as is?”
McGraw-Hill/Irwin
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End of Chapter 13
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Everything in moderation ….
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