Assignment Question 4

Decision making: special order

Mercury Company manufactures skateboards. Several weeks ago, the firm received an offer from Venus Ltd to purchase 11,000 units of the Champion skateboards if the order can be completed in three months. The costs per unit for Mercurys Champion skateboards are:

Direct material $16.40

Direct labour (0.25 hours @ $18 per hour) 4.50

Total manufacturing overhead (0.5 machine hours @ $40 per hour) 20.00

The following additional information is available:

The normal selling price of the Champion model is $53; however, Venus has offered Mercury only $31.50 because of the large quantity it is willing to purchase.

Venus requires a modification of the design that will allow a $4.20 reduction in direct material cost.

Mercurys production supervisor notes that the company will incur $7400 in additional setup costs and will have to purchase a $4800 special device to manufacture these units. The device will be discarded once the special order is completed.

Total manufacturing overhead costs are applied to production at the rate of $40 per machine hour.

Budgeted yearly fixed overhead is $1,500,000 and planned production activity is 60,000 machine hours (5000 hours per month).

Mercury will allocate $3600 of existing fixed administrative costs to the order as part of the cost of doing business.

Required:

Briefly describe the five-step sequence in a decision making process. Explain the role of the management accountant in this process.

Explain these terms: relevant costs, sunk costs, incremental costs, avoidable costs, opportunity costs. Give an example of each.

Assume that present sales will not be affected. Should the order be accepted from a financial point of view (that is, is it profitable?) Why? Show calculations.

Assume that Mercurys current production activity consumes 70% of planned machine-hour activity. Can the company accept the order and meet Venuss deadline without affecting normal production?

What options might Mercury consider if management truly wanted to do business with Venus in hopes of building a long-term relationship with the firm?