Wheatridge Machining is operating at 85% of capacity. An offer to produce 16,000 units of a specially designed tool has just been received. The offering price is $6 per unit. The prod¬

uct normally sells for $9.50. The activity-based accounting system provides the following information:

Expansion of activity capacity for setups, inspection, and machining must be done in steps (whole units). Eor setups, each whole unit provides an additional 25 hours of setup activity and is priced at the fixed activity rate. For inspection, activity capacity is expanded by 2,000 hours per year and the cost is $20,000 per year (the salary for an additional inspector). Ma¬ chine capacity can be leased for a year at a rate of $20 per machine hour. Machine capacity must be acquired, however, in steps of 2,500 machine hours.

Required:
1. Compute the change in income for Wheatridge Machining if the order is accepted. Com¬
ment on whether or not the order should be accepted. (In particular, discuss the strate¬
gic issues.)
2. Suppose that the setup activity has 60 hours of unused capacity. How is the analysis affected?
3. Suppose that the setup activity has 60 hours of unused capacity and that the machin¬
ing activity has 3,000 hours of unused capacity. How is the analysis affected?

Transcribed Image Text:

Activity Driver Unused Capacity Quantity Demanded** Fixed Activity Rate* Variable Direct materials Units 8,000 $ 7 Direct labor Direct labor hours 0 500 12 Setups Setup hours 30 50 $200 Inspection Inspection hours 400 200 10 Machining Machine hours 6,000 4,000 20 24 'This is expected activity cost divided by activity capacity. This only represents the amount of resources demanded by the special order being considered.