When evaluating a special order, management should:
|a. Only accept the order if the incremental revenue exceeds all product costs.|
b. Only accept the order if the incremental revenue exceeds fixed product costs.
c. Only accept the order if the incremental revenue exceeds total variable product costs.
d. Only accept the order if the incremental revenue exceeds full absorption product costs.
e. Only accept the order if the incremental revenue exceeds regular sales revenue.
The Correct Answer Is:
- a. Only accept the order if the incremental revenue exceeds all product costs.
When evaluating a special order, management should only accept the order if the incremental revenue exceeds all product costs. A special-order decision involves deciding whether to accept unusual orders from customers. In most cases, these orders require special handling or request a low price. Special orders are ultimately determined by whether a seller can generate some incremental profit by processing them. The incremental change in revenue for the seller must be compared with the incremental change in costs when making this decision. Additionally, it is important to consider whether additional production capacity is available to process the additional order.
In order to measure profit, businesses often consider the number of units sold at a set price. Increasing sales generates incremental revenue, which represents additional profits for companies. Marketing and sales professionals can benefit from learning about incremental revenue. It is common to compare incremental revenue to the cost of a product. To generate a profit, businesses must ensure the incremental revenue is higher than the incremental cost of the product. Companies use incremental revenue to calculate profit margins since it doesn’t take overhead costs into account.
In order to calculate profit, businesses use incremental revenue in the following areas:
- Production: Sales of products at a specific price are used to measure incremental revenue in manufacturing. By increasing sales or changing the quantity of sales, revenue is earned.
- Marketing: Marketers calculate incremental revenue by calculating the additional sales generated by advertising. Business professionals use incremental revenue to determine the return on investment (ROI) of marketing campaigns. Business owners can also use incremental revenue calculations to determine how much marketing they need to spend to generate certain sales.
- Investing: The incremental revenue formula is used by investors to analyze and compare different portfolio options. They can then allocate their funds accordingly.