Air Production Company produces pneumatic lifts used to assist emergency rescue

Question

Air Production Company produces pneumatic lifts used to assist emergency rescue teams used to assist victims of auto and other accidents. The costs of manufacturing and marketing the pneumatic lifts at the company’s normal volume of 3000 per month are shown in Exhibit 1.

Exhibit 1

Unit manufacturing costs:

Variable materials $495

Variable labor $795

Variable Overhead $475

Fixed Overhead $640

Total unit manufacturing costs $2,405

Unit marketing costs:

Variable $235

Fixed $745

Total unit marketing costs $980

Total unit costs $3,385

Questions:

The following refers to the data given in exhibit 1. Treat each problem separately. Unless otherwise stated, assume a selling price of $4250 per lift. Ignore income taxes. Assume no beginning or ending inventories.

3. A government agency on April 1 offers a contract to Air Production to supply 500 units to supply federal emergency medical teams across the region. The delivery must be made by May 1. Because this is a rush order along with several other rush orders, Air Production plans to produce and sell 4000 units in April. If the government order is accepted, 500 units normally available to regular customers will be lost. The government contract will reimburse Air Production for the government’s share of April production costs, plus pay an additional fixed fee (profit) of $250,000. There are no variable marketing costs incurred on the government contract.   

What impact would accepting the government contract special order have on April operating income for Air Products? Explain the impact both financially and from an operations and business perspective.

Explanation / Answer

The profits of Air Production Company would reduce on accepting the government order since the co. earns a contribution of $2,250.00 per unit if sold to regular customers whereas when sold to government under a contract it earns a contribution of $500.00 per unit. The order from a business perpective is good for the co.since it enables the co. eligible to secure further government orders which will be helpfull during a recessionary period.

Particulars Amount (in $) Particulars Amount (in $) Unit Manufacturing costs Variable Costs Variable materials 495.00 Variable materials 495.00 Variable labor 795.00 Variable labor 795.00 Variable Overhead 475.00 Variable Overhead 475.00 Fixed Overhead 640.00 Variable Marketing Costs 235.00 Total unit manufacturing costs 2405.00 Total Variable costs 2000.00 Unit marketing costs Fixed Costs Variable 235.00 Fixed Manufacturing costs 640.00 Fixed 745.00 Fixed Marketing costs 745.00 Total unit marketing costs 980.00 Total Fixed Costs 1385.00 Total unit costs 3385.00 Total unit costs 3385.00 Sellings Price 4250.00 Less: Variable Costs 2000.00 Contribution 2250.00 Less: Fixed Costs 1385.00 Profit 865.00 Contribution on 500 units 1125000.00 Profit on 500 units 432500.00 Total Fixed Overhead 1920000.00 Total Fixed Marketing costs 2235000.00 Cost incurred for government order Variable Costs Variable materials 495.00 Variable labor 795.00 Variable Overhead 475.00 Variable Marketing Costs 0 Total Variable costs 1765.00 Profit 500.00

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