by Special order pricing is the price which the company can offer to their customers due to the large quantity or building a good relationship with customers in order to make potential next order. Due to these reasons, the company will try to offer a special price which is usually below the standard price.
One short-term decision that businesses continuously have to make is whether or not to accept special orders. This decision can prove somewhat of a complication to companies because they do not anticipate it when creating their yearly budget.
Special order pricing is a technique used to calculate the lowest price of a product or service at which a special order may be accepted and below which a special order should be rejected. Usually, a business receives special orders from customers at a price lower than normal. In such cases, the business will not accept the special order if it can sell all its output at normal price. However when sales are low or when there is idle production capacity, special orders should be accepted if the incremental revenue from special order is greater than incremental costs.
A company is producing, on average, 10,000 units of product A per month despite having 30% more capacity. Costs per unit of product A are as follows:
| Direct Material | Rs. 8.00 |
| Direct Labor | 5.00 |
| Variable Factory Overhead | 2.00 |
| Variable Selling Expense | 0.50 |
| Fixed Factory Overhead | 3.00 |
| Fixed Office Expense | 2.00 |
| Rs. 20.50 |
The company received a special order of 2,000 units of product A at Rs. 17.00 per unit from a new customer. Should the company accept the special order, provided that the customer has agreed to pay the variable selling expenses in addition to the price of the product?
Solution
The increment cost per unit for the special order is calculated as:
| Direct Material | Rs. 8.00 |
| Direct Labor | 5.00 |
| Variable Factory Overhead | 2.00 |
| Rs. 15.00 |
To further determine if you should accept a special order or not, use the contribution margin approach to do your analysis. This analysis will ascertain if the order will lead to a profit or loss. Follow these steps;
- Determine the contribution margin per unit
The formula for calculating the contribution margin per unit is:
Order Price – Variable Costs per unit.
Exclude irrelevant costs like fixed costs from the calculation.
- Determine the total Contribution Margin
You can determine this by multiplying the contribution margin per unit by the number of units in the special order.
- To determine Profit or Loss, less any Incremental Fixed Costs from the Contribution Margin
If there are any incremental fixed costs, you’ll have to subtract them from the contribution margin. But if there are no fixed costs, your contribution margin is your total profit. It’s that simple.
- Decide whether or not to accept the Job
The general rule is to take the job if it generates a profit and decline if it incurs a loss.
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