Develop an ability to identify and assume an assigned role. • Identify and rank the importance of explicit issues. • Illustrate the importance of hidden (undirected) issues that arise from a detailed analysis. • Identify accounting issues, assess their implications, generate alternatives, and provide recommendations. • Write a coherent report and integrated analysis that meets specific user needs.
West Coast Digital (WCD) produces high-quality audio and video equipment. One of the company’s most popular products is a high-definition personal video recorder (PVR) for use with digital television systems. Demand has increased rapidly for the PVR over the past three years, given the appeal to customers of being able to easily record programs while they watch live television, watch recorded programs while they record a different program, and save dozens of programs for future viewing on the unit’s large internal hard drive. A complex production process is utilized for the PVR involving both laser and imaging equipment. WCD has a monthly production capacity of 4,000 hours on its laser machine and 1,000 hours on its image machine. However, given the recent increase in demand for the PVR, both machines are currently operating at 90% of capacity every moth, based on existing orders from customers. Direct labor costs are $15 and $20 per hour to operate, respectively, the laser and image machines. The revenue and costs on a per unit basis for the PVR are as follows: Selling price $320.00 Cost to manufacture: Direct materials $50.00 Direct labour – laser process 60.00 Direct labour – image process 20.00 Variable overhead 40.00 Fixed overhead 50.00 Variable selling costs 20.00 240.00 Operating profit $80.00 On December 1, Dave Nance, vice-president of Sales and Marketing at WCD, received a special-order request from a prospective customer, Scottie Barnes Limited, which has offered to buy 250 PVR’s at $280 per unit if the product can be delivered by December 31st. Scottie Barnes Limited is a large retailer with outlets that specialize in audio and video equipment. This special order from Scottie Barnes Limited is in addition to orders from existing customers that are utilizing 90% of the production capacity each month. Variable selling costs would not be incurred on this special order. Scottie Barnes Limited is not willing to accept anything less than the 250 PVR’s requested (i.e. EDC cannot partially fill the order). Before responding to the customer, Nance decided to meet with Dianne Davis, the product manager for the PVR, to discuss whether to accept the offer from Scottie Barnes Limited. An excerpt from their conversation follows: Nance: I’m not sure we should accept the offer. This customer is really playing hardball with its terms and conditions. Davis: Agreed, but it is a reputable company and I suspect this is the way it typically deals with its suppliers. Plus, this could be the beginning of a profitable relationship with Scottie Barnes Limited since the company may be interested in some of our other product offerings in the future. Nance: That may be true, but I’m not sure we should be willing to incur such a large opportunity cost just to get our foot in the door with this client. 3 Davis: Have you calculated the opportunity cost? Nance: Sure, that was simple. Scottie Barnes Limited is offering $280 per unit and we sell to our regular customers at $320 per unit. Therefore, we’re losing $40 per unit, which at 250 units is $10,000 in lost revenue. That’s our opportunity cost and it’s clearly relevant to the decision. Davis: I sort of follow your logic, but I think the fact that we’re not currently operating at full capacity needs to be taken into consideration. Nance: How so? Davis: Well, your approach to calculating the opportunity cost ignores the fact that we aren’t currently selling all of the PVRs that we could produce. So, in that sense we aren’t really losing $40 per unit on all 250 units required by Scottie Barnes Limited . Nance: I see your point but I’m not clear on how we should calculate the opportunity cost. Davis: This really isn’t my area of expertise either, but it seems appropriate to start by trying to figure out how many of the 250 units required by Scottie Barnes Limited we could produce without disrupting our ability to fill existing orders. Then we could determine how many units we would have to forgo selling to existing customers to make up the 250-unit order. That would then be our opportunity cost in terms of the number of physical units involved. Make sense? Nance: I think so. So, to get the dollar amount of the opportunity cost of accepting the 250-unit order from Scottie Barnes Limited we’d then simply multiply the number of units we’d have to forgo selling to existing customers by $40. Correct? Davis: I’m not so sure about the $40. I think we somehow need to factor in the incremental profit we typically earn by selling each PVR to existing customers to really get to the true opportunity cost. Nance: Now I’m getting really confused. Can you work through the numbers and get back to me? Davis: I’ll try. Nance: Thanks. And by the way, Scottie Barnes Limited is calling in an hour and wants our answer.
Required: 1. Is Davis’s general approach to calculating the opportunity cost in terms of the physical units involved, correct? Explain. 2. Assuming productive capacity cannot be increased for either machine in December, how many PVRs would WCD have to forgo selling to existing customers to fill the special order from Scottie Barnes Limited ? 3. Calculate the opportunity cost of accepting the special order. 4. Calculate the net effect on profits of accepting the special order. 5. Now assume that WCD is operating at 75% of capacity in December. What is the minimum price WCD should be willing to accept on the special order? 4 6. What are some qualitative issues that should be considered when accepting special orders such as that proposed by Scottie Barnes Limited ? with in text citations and references
West Coast Digital (WCD) is facing a significant decision regarding a special order from Scottie Barnes Limited, a reputable retailer. This essay will evaluate the opportunity cost associated with accepting the special order, calculate the required production quantity, assess the opportunity cost, determine the net effect on profits, and discuss the pricing strategy when operating at 75% capacity. Additionally, qualitative issues relevant to accepting special orders will be considered.
Dianne Davis, the product manager at WCD, suggests calculating the opportunity cost in terms of the physical units involved. Her approach is generally correct because it recognizes that the company is not operating at full capacity and needs to determine the number of units that could be produced without disrupting existing orders.
To calculate the number of PVRs WCD would have to forgo selling to existing customers, we need to determine how many units are available for the special order. With a monthly production capacity of 4,000 hours on the laser machine and 1,000 hours on the image machine, both currently operating at 90% capacity, the available capacity is as follows:
Laser machine: 4,000 hours * 90% = 3,600 hours Image machine: 1,000 hours * 90% = 900 hours
To produce one PVR, it takes 60 hours on the laser machine and 20 hours on the image machine. Therefore, the number of PVRs that can be produced without disrupting existing orders is limited by the machine with the least available hours. In this case, it’s the image machine, which can produce 900 / 20 = 45 PVRs.
The opportunity cost can be calculated by determining the number of units that could have been sold to existing customers at the regular price but will be forgone due to the special order. With 250 units in the special order and a loss of $40 per unit, the opportunity cost is 250 units * $40 = $10,000.
The net effect on profits can be calculated by comparing the revenue from the special order with the opportunity cost. The revenue from the special order is 250 units * ($280 – $240) = $10,000. Subtracting the opportunity cost of $10,000, the net effect on profits is $10,000 – $10,000 = $0.
If WCD is operating at 75% capacity, the minimum price for the special order should cover the variable cost per unit ($240) and a portion of the fixed costs. It should also consider the potential long-term benefits of establishing a relationship with Scottie Barnes Limited.
Several qualitative issues should be considered when accepting special orders. These include the potential for future business with the customer, reputation management, the impact on existing customer relationships, and the overall strategic alignment with the company’s objectives.
In conclusion, Dianne Davis’s approach to calculating the opportunity cost in terms of physical units is correct. WCD would need to forgo selling 45 PVRs to existing customers to fulfill the special order, resulting in a $10,000 opportunity cost. The net effect on profits is zero, indicating that accepting the special order does not harm or benefit the company financially in the short term. When operating at 75% capacity, the minimum price should be set to cover variable costs and consider long-term strategic benefits. Qualitative factors such as future business prospects and reputation management should also be taken into account when making special order decisions.
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