Radivarius Violin Company

Igor Radivarius operates a small violin company. He manufactures two product lines: Standard Violins, which is available from many other suppliers, and a special-order, Custom Viola product line.

Radivarius' annual estimated income statement (below) for the upcoming year was prepared by his accountant. The costs were allocated across the two product lines as follows:

• Radivarius uses a standard cost system whereby overhead costs are allocated based on the total expected/budgeted costs for the upcoming year and the total expected/budgeted amount of the allocation bases.
• The Depreciation expense is for all of the production machines used in the factory and is allocated using a single cost pool (that is, all machine depreciation costs go into the same cost pool) and the single allocation base is machine hours.
• The Power expense is allocated based on machine hours. From prior experience, total power costs vary proportionately with machine hours. That is, power costs go up or down as total machine hours increase or decrease, respectively. Each machine consumes approximately the same amount of electricity per hour of use. Custom Violas take 1 Machine hour each while Standard Violins take Machine hour each.
• Rent is for the long-term factory lease. Heat & Light represents the costs of heating/cooling the factory and for the overhead lights. These costs are unrelated to the level of production. Rent and Heat & Light costs are allocated based on the amount of floor space occupied by each product line.
• Othercostsinclude franchise fees, accounting and legal costs, and patent payments. Other costs are allocated based on the number of product lines. These costs are unrelated to the level of production. Currently there are two product lines - Custom Violas and Standard Violins.

A potential customer asked Radivarius to manufacture a new product line: 5,000 specially customized cellos over the upcoming year. The customer offered to pay 675 for each and informed Igor that this would be a one-time order. Radivarius is working at full capacity right now. He can't increase capacity, and he can't renege on Custom Viola orders previously accepted. Instead, he will have to reduce Standard Violin sales by 50% over the next year if he takes the cello order since half of the space currently occupied with standard violin production will be needed for the production of the cellos. Factory space is the only production constraint.

If Radivarius accepts the cello order, he will also have to buy a special machine for 224,000 to complete the cellos. The machine can only be used to make the cellos and it will be discarded for zero salvage value when the order is completed at the end of the year. The new machine will consume power at roughly the same rate as the existing machines.

The estimated inputs for each cello are as follows:

Direct Materials: 200 per unit

Direct Labor: 360 per unit

Machine Hours: 1.8 machine hours (of which 1 hour is on the existing machines and 0.8 hours is on the new, special machine).

1.By how much will Igor be better/worse off if he accepts the special order? In other words, how much value will be created/destroyed if the cello order is accepted? If Igor is better off (value is created), then compute your answer as a positive number. If Igor is worse off (value is destroyed), then compute your answer as a negative number.

2. Under the current accounting system, what will be the budgeted profit or loss of just the cello order? Assume that Radivarius will not change the structure of the current accounting system if the cello order is accepted. Custom Violas take 1 Machine hour each while Standard Violins take Machine hour each.

Radivarius Violin Shop: Budgeted Income Statement

10,000 20,000

Custom Standard

Violas Violins Total

Revenues 5,000,000 2,300,000 7,300,000

Direct Materials 1,000,000 800,000 1,800,000

Direct Labor 2,000,000 900,000 2,900,000

Depreciation 500,000 500,000 1,000,000

Power 55,000 55,000 110,000

Rent 600,000 100,000 700,000

Heat & Light 60,000 10,000 70,000

Other 60,000 60,000 120,000

Total Expenses 4,275,000 2,425,000 6,700,000

Operating Profit 725,000 -125,000