# Special Order Pricing

Special order pricing is a technique used to calculate the lowest price of a product or service at which a special order may be accepted and below which a special order should be rejected. Usually a business receives special orders from customers at a price lower than normal. In such cases, the business will not accept the special order if it can sell all its output at normal price. However when sales are low or when there is idle production capacity, special orders should be accepted if the incremental revenue from special order is greater than incremental costs.

This method of pricing special orders, in which price is set below normal price but the sale still generates some contribution per unit, is called contribution approach to special order pricing. The idea is that it is better to receive something above variable costs, than receiving nothing at all.

The following example is used to illustrate special order pricing:

## Example

A company is producing, on average, 10,000 units of product A per month despite having 30% more capacity. Costs per unit of product A are as follows:

 Direct Material $8.00 Direct Labor 5.00 Variable Factory Overhead 2.00 Variable Selling Expense 0.50 Fixed Factory Overhead 3.00 Fixed Office Expense 2.00$20.50

The company received a special order of 2,000 units of product A at $17.00 per unit from a new customer. Should the company accept the special order, provided that the customer has agreed to pay the variable selling expenses in addition to the price of the product? Solution The increment cost per unit for the special order is calculated as:  Direct Material$8.00 Direct Labor 5.00 Variable Factory Overhead 2.00 $15.00 Since the incremental cost per unit is less that the price offered in the special order, the company should accept it. Accepting special order will generate additional contribution of$2.00 unit and \$4,000 in total.

Written by Irfanullah Jan