When evaluating a special order, management should:
Only accept the order if the special-order price exceeds fixed product costs.
Only accept the order if the special-order price exceeds regular sales revenue.
Only accept the order if the special-order price exceeds total variable product costs.
The Correct Answer and Explanation is:
Correct Answer:
✅ Only accept the order if the special-order price exceeds total variable product costs.
Explanation:
When evaluating a special order, management must focus on relevant costs, which are costs that will change as a result of the decision. In most cases, the relevant cost is the total variable cost of producing the goods for the special order.
Special orders are typically one-time deals offered to a customer at a lower price than normal, often to utilize excess production capacity. The key question is whether the order will contribute positively to net income without disrupting regular business.
Why variable costs matter:
Variable costs include direct materials, direct labor, and variable overhead. These are costs incurred only if the order is accepted. If the special-order price exceeds the total variable cost per unit, then the company makes a contribution margin (revenue minus variable cost), even if the selling price is lower than the regular price.
Fixed costs are not usually relevant:
Fixed costs, such as rent, salaries, and depreciation, do not change with production volume in the short term. Since they are already being paid regardless of the special order, they are not incremental and should not influence the decision. Thus, requiring the special order to cover fixed costs would be unnecessarily restrictive and could result in rejecting profitable orders.
Incorrect answer choices explained:
- “Only accept the order if the special-order price exceeds fixed product costs”: ❌ Incorrect. Fixed product costs are already incurred and don’t change with the order, so they’re irrelevant in the decision.
- “Only accept the order if the special-order price exceeds regular sales revenue”: ❌ Incorrect. This would mean rejecting all discounted orders, even if they bring in extra profit. Special orders are usually priced lower and should not be compared to normal pricing unless they interfere with regular sales.
Conclusion:
Accept the special order if it contributes positively to profit, which happens when the price exceeds variable costs, and there is excess capacity to fulfill the order.