Deck 12: Activity-Based Management

Question 1

What are value-added activities? Value-added costs?

Answer 1

Value added activities are those activities which are necessary to remain in the business. These are some required activities, which are necessary to comply with the legal mandates. For example, Securities and Exchange Commission and Internal Revenue Service. These activities are not primary activities of the business but they add value to the overall activities.
After identifying the value added activities we can the define value added costs. Value added costs are those costs which are incurred to perform the value added activities with good efficiency.

Question 2

Value-Added and Non-Value-Added Costs, Unused Capacity
For Situations 1 through 6, provide the following information:
a. An estimate of the non-value-added cost caused by each activity
b. The root causes of the activity cost (such as plant layout, process design, and product design)
c. The appropriate cost reduction measure: activity elimination, activity reduction, activity sharing, or activity selection
1. It takes 45 minutes and six pounds of material to produce a product using a traditional manufacturing process. A process reengineering study provided a new manufacturing process design (using existing technology) that would take 15 minutes and four pounds of material. The cost per labor hour is $12, and the cost per pound of material is $8.
2. With its original design, a product requires 15 hours of setup time. Redesigning the product could reduce the setup time to an absolute minimum of 30 minutes. The cost per hour of setup time is $200.
3. A product currently requires eight moves. By redesigning the manufacturing layout, the number of moves can be reduced from eight to zero. The cost per move is $10.
4. Inspection time for a plant is 8,000 hours per year. The cost of inspection consists of salaries of four inspectors, totaling $120,000. Inspection also uses supplies costing $2 per inspection hour. A supplier evaluation program, product redesign, and process redesign reduced the need for inspection by creating a zero-defect environment.
5. Each unit of a product requires five components. The average number of components is 5.3 due to component failure, requiring rework and extra components. By developing relations with the right suppliers and increasing the quality of the purchased component, the average number of components can be reduced to five components per unit. The cost per component is $600.
6. A plant produces 100 different electronic products. Each product requires an average of eight components that are purchased externally. The components are different for each part. By redesigning the products, it is possible to produce the 100 products so that they all have four components in common. This will reduce the demand for purchasing, receiving, and paying bills. Estimated savings from the reduced demand are $900,000 per year.

Answer 2

Non-value-added costs are costs that are caused either by non-value-added activities or the inefficient performance of value-added activities.
The formula used to compute non-value-added costs is as follows:
Where,
AQ is the actual quantity used of flexible resources or the practical activity capacity acquired for committed resources.
SQ is the value-added output level for an activity.
And,
SP is the standard price per unit of activity output measure.
Calculate non-value-added cost in each case as follows:
Case 1
Case 2
Case 3
Case 4
Case 5
Case 6
The required information should be provided as follows:

Question 3

Activity Flexible Budgeting, Performance Report, Volume Variance
Novo, Inc., wants to develop an activity flexible budget for the activity of moving materials. Novo uses eight forklifts to move materials from receiving to stores. The forklifts are also used to move materials from stores to the production area. The forklifts are obtained through an operating lease that costs $18,000 per year per forklift. Novo employs 25 forklift operators who receive an average salary of $50,000 per year, including benefits. Each move requires the use of a crate. The crates are used to store the parts and are emptied only when used in production. Crates are disposed of after one cycle (two moves), where a cycle is defined as a move from receiving to stores to production. Each crate costs $1.80. Fuel for a forklift costs $3.60 per gallon. A gallon of gas is used every 20 moves. Forklifts can make three moves per hour and are available for 280 days per year, 24 hours per day (the remaining time is downtime for various reasons). Each operator works 40 hours per week and 50 weeks per year.
Required:
1. Prepare a flexible budget for the activity of moving materials, using the number of cycles as the activity driver.
2. Calculate the activity capacity for moving materials. Suppose Novo works at 80 percent of activity capacity and incurs the following costs:

Prepare the budget for the 80 percent level and then prepare a performance report for the moving materials activity.
3. Calculate and interpret the volume variance for moving materials.
4. Suppose that a redesign of the plant layout reduces the demand for moving materials to one-third of the original capacity. What would be the budget formula for this new activity level? What is the budgeted cost for this new activity level? Has activity performance improved? How does this activity performance evaluation differ from that described in Requirement 2? Explain.

Answer 3

1)Flexible budget is budget that shows the expected results of a responsibility centre for several activities at different levels. Flexible budget is a series of static budgets for different levels of activity.
Salary for 25 forklift is 50, 00 per each forklift therefore total is
and 8 forklift are taken as lease where each forklift costs 18,000 therefore total is
.
Each gallon is cost 3.60 this each gallon will used to move the 20 times. Therefore feel cost for each move is
Prepare Flexible Budget:
Flexible Budget
2)Capacity is determined by forklift capacity or operator capacity whichever is lower. Forklift capacity is 161,280 moves or 80,640 cycles
. Operator capacity is 150,000 moves or 75,000 cycles
.
Hence, Lower of Forklift capacity and Operator capacity is operator capacity. Thus, the activity capacity will be 75,000 and 80% of that capacity is 60,000 cycles.
Prepare Budget for the 80% level:
Budget for the 80% level
Explanation:
Salary for 25 forklift is 50, 00 per each forklift therefore total is
and 8 forklift are taken as lease where each forklift costs 18,000 therefore total is
.
Each gallon is cost 3.60 this each gallon will used to move the 20 times. Therefore feel cost for each move is
Prepare N Company Performance Report:
N Company Performance Report
3)Since, Standard Quantity is zero, the volume variance will be the capacity acquisition cost i.e. Fixed cost of $1,394,000.
4)Prepare Budget for the one-third level:
Budget for the one-third level
Note:
Each gallon is cost 3.60 this each gallon will used to move the 20 times. Therefore feel cost for each move is
Every operator delivers a capacity of 3,000 cycles
and each forklift provides a capacity of 10,080 cycles
. If the demand will be reduced to 25,000 cycles then it will require 9 operators
and 3 forklifts (25,000/10,080). The cost incurred in performing the activity has effectively reduced (comparing the cost of 80% capacity i.e. $1,512,800 with the $553,500). This is the critical performance measure.
In requirement 2 the activity performance report only compares the difference between the budgeted costs for 80% capacity with the actual input cost. It doesn't show the waste in the activity as it is a non-value added activity.

Question 4

Activity Capacity Management
Uchdorf Manufacturing just completed a study of its purchasing activity with the objective of improving its efficiency. The driver for the activity is number of purchase orders. The following data pertain to the activity for the most recent year:
Activity supply: five purchasing agents capable of processing 2,400 orders per year (12,000 orders)
Purchasing agent cost (salary): $45,600 per year
Actual usage: 10,600 orders per year
Value-added quantity: 7,000 orders per year
Required:
1. Calculate the volume variance and explain its significance.
2. Calculate the unused capacity variance and explain its use.
3. What if the actual usage drops to 9,000 orders? What effect will this have on capacity management? What will be the level of spending reduction if the value-added standard is met?

Question 5

Explain how lack of integration of an ABM system may cause its failure.

Question 6

Activity-Based Management, Non-Value-Added Costs, Target Costs, Kaizen Costing
Joseph Hansen, president of Electronica, Inc., was concerned about the end-of-the-year marketing report that he had just received. According to Kylee Hepworth, marketing manager, a price decrease for the coming year was again needed to maintain the company's annual sales volume of integrated circuit boards (CBs). This would make a bad situation worse. The current selling price of $27 per unit was producing a $3-per-unit profit-half the customary $6-per-unit profit. Foreign competitors keep reducing their prices. To match the latest reduction would reduce the price from $27 to $21. This would put the price below the cost to produce and sell it. How could the foreign firms sell for such a low price? Determined to find out if there were problems with the company's operations, Joseph decided to hire Carsen Hepworth, a well-known consultant and brother of Kylee, who specializes in methods of continuous improvement. Carsen indicated that he felt that an activity-based management system needed to be implemented. After three weeks, Carsen had identified the following activities and costs:

a Diodes, resistors, and integrated circuits are inserted manually into the circuit board.
b This total cost produces a unit cost of $24 for last year's sales volume.
Carsen indicated that some preliminary activity analysis shows that per-unit costs can be reduced by at least $10.50. Since Kylee had indicated that the market share (sales volume) for the boards could be increased by 50 percent if the price could be reduced to $18, Joseph became quite excited.
Required:
1. What is activity-based management? What connection does it have to continuous improvement?
2. Identify as many non-value-added costs as possible. Compute the cost savings per unit that would be realized if these costs were eliminated. Was Carsen correct in his preliminary cost reduction assessment? Discuss actions that the company can take to reduce or eliminate the non-value-added activities.
3. Compute the target cost required to maintain current market share, while earning a profit of $6 per unit. Now, compute the target cost required to expand sales by 50 percent. How much cost reduction would be required to achieve each target?
4. Assume that Carsen suggested that kaizen costing be used to help reduce costs. The first suggested kaizen initiative is described by the following: switching to automated insertion would save $90,000 of engineering support and $135,000 of direct labor. Now, what is the total potential cost reduction per unit available? With these additional reductions, can Electronica achieve the target cost to maintain current sales? To increase it by 50 percent? What form of activity analysis is this kaizen initiative: reduction, sharing, elimination, or selection?
5. Calculate income based on current sales, prices, and costs. Now, calculate the income using a $21 price and an $18 price, assuming that the maximum cost reduction possible is achieved (including Requirement 4's kaizen reduction). What price should be selected?

Question 7

What are non-value-added activities? Non-value-added costs? Give an example of each.

Question 8

Calculation of Value-Added and Non-Value-Added Costs, Activity Volume and Unused Capacity Variances
Maquina Company produces custom-made machine parts. Maquina recently has implemented an activity-based management (ABM) system with the objective of reducing costs. Maquina has begun analyzing each activity to determine ways to increase its efficiency. Setting up equipment was among the first group of activities to be carefully studied. The study revealed that setup hours was a good driver for the activity. During the last year, the company incurred fixed setup costs of $504,000 (salaries of 14 employees). The fixed costs provide a capacity of 28,000 hours (2,000 per employee at practical capacity). The setup activity was viewed as necessary, and the value-added standard was set at 2,000 hours. Actual setup hours used in the most recent period were 26,200.
Required:
1. Calculate the volume and unused capacity variances for the setup activity. Explain what each variance means.
2. Prepare a report that presents value-added, non-value-added, and actual costs for setup. Explain why highlighting the non-value-added costs is important.
3. Assume that management is able to reduce the demand for the setup activity so that the actual hours needed drop from 26,200 to 4,000. What actions should now be taken regarding activity capacity management?
4. Another activity studied was inspection of supplier materials and components. Explain why inspecting incoming goods should be viewed as a non-value-added activity. In providing your explanation, consider the following counterargument: "Inspecting incoming goods adds value because it reduces the demand for other unnecessary activities such as rework, reordering, and warranty work."

Question 9

Value-Added and Kaizen Standards, Non-Value-Added Costs, Volume Variance, Unused Capacity
Tom Young, vice president of Dunn Company (a producer of plastic products), has been supervising the implementation of an activity-based cost management system. One of Tom's objectives is to improve process efficiency by improving the activities that define the processes. To illustrate the potential of the new system to the president, Tom has decided to focus on two processes: production and customer service.
Within each process, one activity will be selected for improvement: molding for production and sustaining engineering for customer service. (Sustaining engineers are responsible for redesigning products based on customer needs and feedback.) Value-added standards are identified for each activity. For molding, the value-added standard calls for nine pounds per mold. (Although the products differ in shape and function, their size, as measured by weight, is uniform.) The value-added standard is based on the elimination of all waste due to defective molds (materials is by far the major cost for the molding activity). The standard price for molding is $15 per pound. For sustaining engineering, the standard is 60 percent of current practical activity capacity. This standard is based on the fact that about 40 percent of the complaints have to do with design features that could have been avoided or anticipated by the company.
Current practical capacity (the first year) is defined by the following requirements: 18,000 engineering hours for each product group that has been on the market or in development for five years or less, and 7,200 hours per product group of more than five years. Four product groups have less than five years' experience, and 10 product groups have more. There are 72 engineers, each paid a salary of $70,000. Each engineer can provide 2,000 hours of service per year. There are no other significant costs for the engineering activity.
For the first year, actual pounds used for molding were 25 percent above the level called for by the value-added standard; engineering usage was 138,000 hours. There were 240,000 units of output produced. Tom and the operational managers have selected some improvement measures that promise to reduce non-value-added activity usage by 30 percent in the second year. Selected actual results achieved for the second year are as follows:

The actual prices paid per pound and per engineering hour are identical to the standard or budgeted prices.
Required:
1. For the first year, calculate the non-value-added usage and costs for molding and sustaining engineering. Also, calculate the cost of unused capacity for the engineering activity.
2. Using the targeted reduction, establish kaizen standards for molding and engineering (for the second year).
3. Using the kaizen standards prepared in Requirement 2, compute the second-year usage variances, expressed in both physical and financial measures, for molding and engineering. (For engineering, explain why it is necessary to compare actual resource usage with the kaizen standard.) Comment on the company's ability to achieve its targeted reductions. In particular, discuss what measures the company must take to capture any realized reductions in resource usage.

Question 10

Identify and define four different ways to manage activities so that costs can be reduced.

Question 11

Describe a financial-based responsibility accounting system.

Question 12

Benchmarking and Non-Value-Added Costs, Target Costing
Bienestar, Inc., has two plants that manufacture a line of wheelchairs. One is located in Kansas City, and the other in Tulsa. Each plant is set up as a profit center. During the past year, both plants sold their tilt wheelchair model for $1,620. Sales volume averages 20,000 units per year in each plant. Recently, the Kansas City plant reduced the price of the tilt model to $1,440. Discussion with the Kansas City manager revealed that the price reduction was possible because the plant had reduced its manufacturing and selling costs by reducing what was called "non-value- added costs." The Kansas City manufacturing and selling costs for the tilt model were $1,260 per unit. The Kansas City manager offered to loan the Tulsa plant his cost accounting manager to help it achieve similar results. The Tulsa plant manager readily agreed, knowing that his plant must keep pace-not only with the Kansas City plant but also with competitors. A local competitor had also reduced its price on a similar model, and Tulsa's marketing manager had indicated that the price must be matched or sales would drop dramatically. In fact, the marketing manager suggested that if the price were dropped to $1,404 by the end of the year, the plant could expand its share of the market by 20 percent. The plant manager agreed but insisted that the current profit per unit must be maintained. He also wants to know if the plant can at least match the $1,260 per-unit cost of the Kansas City plant and if the plant can achieve the cost reduction using the approach of the Kansas City plant.
The plant controller and the Kansas City cost accounting manager have assembled the following data for the most recent year. The actual cost of inputs, their value-added (ideal) quantity levels, and the actual quantity levels are provided (for production of 20,000 units). Assume there is no difference between actual prices of activity units and standard prices.

Required:
1. Calculate the target cost for expanding the Tulsa plant's market share by 20 percent, assuming that the per-unit profitability is maintained as requested by the plant manager.
2. Calculate the non-value-added cost per unit. Assuming that non-value-added costs can be reduced to zero, can the Tulsa plant match the Kansas City per-unit cost? Can the target cost for expanding market share be achieved? What actions would you take if you were the plant manager?
3. Describe the role that benchmarking played in the effort of the Tulsa plant to protect and improve its competitive position.

Question 13

ABC Versus ABM
Harvey Company produces two models of blenders: the "Super Model" (priced at $400) and the "Special Model" (priced at $200). Recently, Harvey has been losing market share with its Special Model because of competitors offering blenders with the same quality and features but at a lower price. A careful market study revealed that if Harvey could reduce the price of its Special Model to $180, it would regain its former share of the market. Management, however, is convinced that any price reduction must be accompanied by a cost reduction of the same amount so that per-unit profitability is not affected. Earl Wise, company controller, has indicated that poor overhead costing assignments may be distorting management's view of each product's cost and, therefore, the ability to know how to set selling prices. Earl has identified the following overhead activities: machining, inspection, and rework. The three activities, their costs, and practical capacities are as follows:

The consumption patterns of the two products are as follows:

Harvey assigns overhead costs to the two products using a plantwide rate based on machine hours.
Required:
1. Calculate the unit overhead cost of the Special Model using machine hours to assign overhead costs. Now, repeat the calculation using ABC to assign overhead costs. Did improving the accuracy of cost assignments solve Harvey's competitive problem? What did it reveal?
2. Now, assume that in addition to improving the accuracy of cost assignments, Earl observes that defective supplier components are the root cause of both the inspection and rework activities. Suppose further that Harvey has found a new supplier that provides higherquality components such that inspection and rework costs are reduced by 50 percent. Now, calculate the cost of the Special Model (assuming that inspection and rework times are also reduced by 50 percent) using ABC. The relative consumption patterns also remain the same. Comment on the difference between ABC and ABM.

Question 14

Cost Report, Value-Added and Non-Value-Added Costs
Sanford, Inc., has developed value-added standards for four activities: purchasing parts, receiving parts, moving parts, and setting up equipment. The activities, the activity drivers, the standard and actual quantities, and the price standards for 2013 are as follows:

The actual prices paid per unit of each activity driver were equal to the standard prices.
Required:
1. Prepare a cost report that lists the value-added, non-value-added, and actual costs for each activity.
2. Which activities are non-value-added? Explain why. Also, explain why value-added activities can have non-value-added costs.

Question 15

Financial versus Activity Flexible Budgeting
Kelly Gray, production manager, was upset with the latest performance report, which indicated that she was $100,000 over budget. Given the efforts that she and her workers had made, she was confident that they had met or beat the budget. Now, she was not only upset but also genuinely puzzled over the results. Three items-direct labor, power, and setups-were over budget. The actual costs for these three items follow:

Kelly knew that her operation had produced more units than originally had been budgeted, so more power and labor had naturally been used. She also knew that the uncertainty in scheduling had led to more setups than planned. When she pointed this out to John Huang, the controller, he assured her that the budgeted costs had been adjusted for the increase in productive activity. Curious, Kelly questioned John about the methods used to make the adjustment.
JOHN : If the actual level of activity differs from the original planned level, we adjust the budget by using budget formulas-formulas that allow us to predict what the costs will be for different levels of activity.
KELLY : The approach sounds reasonable. However, I'm sure something is wrong here. Tell me exactly how you adjusted the costs of labor, power, and setups.
JOHN : First, we obtain formulas for the individual items in the budget by using the method of least squares. We assume that cost variations can be explained by variations in productive activity where activity is measured by direct labor hours. Here is a list of the cost formulas for the three items you mentioned. The variable X is the number of direct labor hours:
Labor cost = $10 X
Power cost = $5,000 + $4 X
Setup cost = $100,000
KELLY : I think I see the problem. Power costs don't have a lot to do with direct labor hours. They have more to do with machine hours. As production increases, machine hours increase more rapidly than direct labor hours. Also, …
JOHN : You know, you have a point. The coefficient of determination for power cost is only about 50 percent. That leaves a lot of unexplained cost variation. The coefficient for labor, however, is much better-it explains about 96 percent of the cost variation. Setup costs, of course, are fixed.
KELLY : Well, as I was about to say, setup costs also have very little to do with direct labor hours. And I might add that they certainly are not fixed-at least not all of them. We had to do more setups than our original plan called for because of the scheduling changes. And we have to pay our people when they work extra hours. It seems as if we are always paying overtime. I wonder if we simply do not have enough people for the setup activity. Supplies are used for each setup, and these are not cheap. Did you build these extra costs of increased setup activity into your budget?
JOHN : No, we assumed that setup costs were fixed. I see now that some of them could vary as the number of setups increases. Kelly, let me see if I can develop some cost formulas based on better explanatory variables. I'll get back with you in a few days.
Assume that after a few days' work, John developed the following cost formulas, all with a coefficient of determination greater than 90 percent:
Labor cost = $10 X ; where X = Direct labor hours
Power cost = $68,000 + 0.9 Y ; where Y = Machine hours
Setup cost = $98,000 + $400 Z ; where Z = Number of setups
The actual measures of each of the activity drivers are as follows:

Required:
1. Prepare a performance report for direct labor, power, and setups using the direct-labor-based formulas.
2. Prepare a performance report for direct labor, power, and setups using the multiple cost driver formulas that John developed.
3. Of the two approaches, which provides the most accurate picture of Kelly's performance? Why?
4. After reviewing the approach to performance measurement, a consultant remarked that non-value-added cost trend reports would be a much better performance measurement approach than comparing actual costs with budgeted costs-even if activity flexible budgets were used. Do you agree or disagree? Explain.

Question 16

What is a kaizen standard? Describe the kaizen and maintenance subcycles.

Question 17

Describe an activity-based responsibility accounting system. How does it differ from financial-based responsibility accounting?

Question 18

Activity Flexible Budgeting, Non-Value-Added Costs
Douglas Davis, controller for Marston, Inc., prepared the following budget for manufacturing costs at two different levels of activity for 2013:

During 2013, Marston worked a total of 80,000 direct labor hours, used 250,000 machine hours, made 32,000 moves, and performed 120 batch inspections. The following actual costs were incurred:

Marston applies overhead using rates based on direct labor hours, machine hours, number of moves, and number of batches. The second level of activity (the right column in the preceding table) is the practical level of activity (the available activity for resources acquired in advance of usage) and is used to compute predetermined overhead pool rates.
Required:
1. Prepare a performance report for Marston's manufacturing costs in 2013.
2. Assume that one of the products produced by Marston is budgeted to use 10,000 direct labor hours, 15,000 machine hours, and 500 moves and will be produced in five batches. A total of 10,000 units will be produced during the year. Calculate the budgeted unit manufacturing cost.
3. One of Marston's managers said the following: "Budgeting at the activity level makes a lot of sense. It really helps us manage costs better. But the previous budget really needs to provide more detailed information. For example, I know that the moving materials activity involves the use of forklifts and operators, and this information is lost when only the total cost of the activity for various levels of output is reported. We have four forklifts, each capable of providing 10,000 moves per year. We lease these forklifts for five years, at $10,000 per year. Furthermore, for our two shifts, we need up to eight operators if we run all four forklifts. Each operator is paid a salary of $30,000 per year. Also, I know that fuel costs about $0.25 per move."
Assuming that these are the only three items, expand the detail of the flexible budget for moving materials to reveal the cost of these three resource items for 20,000 moves and 40,000 moves, respectively. Based on these comments, explain how this additional information can help Marston better manage its costs. (Especially consider how activity-based budgeting may provide useful information for non-value-added activities.)

Question 19

Root Cause (Driver Analysis)
For the following two activities, ask a series of "why" questions (with your answers) that reveal the root cause. Once the root cause is identified, use a "how" question to reveal how the activity can be improved (with your answer).
Activity 1: Daily cleaning of a puddle of oil near production machinery.
Activity 2: Providing customers with sales allowances.

Question 20

Trend Report, Non-Value-Added Costs
Refer to Exercise 12.14. Suppose that for 2014, Sanford, Inc., has chosen suppliers that provide higher-quality parts and redesigned its plant layout to reduce material movement. Additionally, Sanford implemented a new setup procedure and provided training for its purchasing agents. As a consequence, less setup time is required and fewer purchasing mistakes are made. At the end of 2014, the information shown on page 668 is provided.

Required:
1. Prepare a report that compares the non-value-added costs for 2014 with those of 2013.
2. What is the role of activity reduction for non-value-added activities? For value-added activities?
3. Comment on the value of a trend report.

Question 21

Explain how benchmarking can be used to improve activity performance.

Question 22

Implementation of Activity-Based Management
Jane Erickson, manager of an electronics division, was not pleased with the results that had recently been reported concerning the division's activity-based management implementation project. For one thing, the project had taken eight months longer than projected and had exceeded the budget by nearly 35 percent. But even more vexatious was the fact that after all was said and done, about three-fourths of the plants were reporting that the activity-based product costs were not much different for most of the products than those of the old costing system. Plant managers were indicating that they were continuing to use the old costs as they were easier to compute and understand. Yet, at the same time, they were complaining that they were having a hard time meeting the bids of competitors. Reliable sources were also revealing that the division's product costs were higher than many competitors'. This outcome perplexed plant managers because their control system still continued to report favorable materials and labor efficiency variances. They complained that ABM had failed to produce any significant improvement in cost performance.
Jane decided to tour several of the plants and talk with the plant managers. After the tour, she realized that her managers did not understand the concept of non-value-added costs nor did they have a good grasp of the concept of kaizen costing. No efforts were being made to carefully consider the activity information that had been produced. One typical plant manager threw up his hands and said: "This is too much data. Why should I care about all this detail? I do not see how this can help me improve my plant's performance. They tell me that inspection is not a necessary activity and does not add value. I simply can't believe that inspecting isn't value-added and necessary. If we did not inspect, we would be making and sending more bad products to customers."
Required:
Explain why Jane's division is having problems with its ABM implementation.

Question 23

Non-Value-Added Activities: Non-Value-Added Cost
Thayne Company has 30 clerks that work in its Accounts Payable Department. A study revealed the following activities and the relative time demanded by each activity:

Required:
Classify the four activities as value-added or non-value-added, and calculate the clerical cost of each activity. For non-value-added activities, indicate why they are non-value-added.

Question 24

Financial-Based versus Activity-Based Responsibility Accounting
For each of the following situations, two scenarios are described, labeled A and B. Choose which scenario is descriptive of a setting corresponding to activity-based responsibility accounting and which is descriptive of financial-based responsibility accounting. Provide a brief commentary on the differences between the two systems for each situation, addressing the possible advantages of the activity-based view over the financial-based view.
Situation 1
A: The purchasing manager, receiving manager, and accounts payable manager are given joint responsibility for procurement. The charges given to the group of managers are to reduce costs of acquiring materials, decrease the time required to obtain materials from outside suppliers, and reduce the number of purchasing mistakes (e.g., wrong type of materials or the wrong quantities ordered).
B: The plant manager commended the manager of the Grinding Department for increasing his department's machine utilization rates-and doing so without exceeding the department's budget. The plant manager then asked other department managers to make an effort to obtain similar efficiency improvements.
Situation 2
A: Delivery mistakes had been reduced by 70 percent, saving over $40,000 per year. Furthermore, delivery time to customers had been cut by two days. According to company policy, the team responsible for the savings was given a bonus equal to 25 percent of the savings attributable to improving delivery quality. Company policy also provided a salary increase of 1 percent for every day saved in delivery time.
B: Bill Johnson, manager of the Product Development Department, was pleased with his department's performance on the last quarter's projects. They had managed to complete all projects under budget, virtually assuring Bill of a fat bonus, just in time to help with this year's Christmas purchases.
Situation 3
A: "Harvey, don't worry about the fact that your department is producing at only 70 percent capacity. Increasing your output would simply pile up inventory in front of the next production department. That would be costly for the organization as a whole. Sometimes, one department must reduce its performance so that the performance of the entire organization can improve."
B: "Susan, I am concerned about the fact that your department's performance measures have really dropped over the past quarter. Labor usage variances are unfavorable, and I also see that your machine utilization rates are down. Now, I know you are not a bottleneck department, but I get a lot of flack when my managers' efficiency ratings drop."
Situation 4
A: Colby was muttering to himself. He had just received last quarter's budgetary performance report. Once again, he had managed to spend more than budgeted for both materials and labor. The real question now was how to improve his performance for the next quarter.
B: Great! Cycle time had been reduced and, at the same time, the number of defective products had been cut by 35 percent. Cutting the number of defects reduced production costs by more than planned. Trends were favorable for all three performance measures.
Situation 5
A: Cambry was furious. An across-the-board budget cut! "How can they expect me to provide the computer services required on less money? Management is convinced that costs are out of control, but I would like to know where-at least in my department!"
B: After a careful study of the Accounts Payable Department, it was discovered that 80 percent of an accounts payable clerk's time was spent resolving discrepancies between the purchase order, receiving document, and the supplier's invoice. Other activities such as recording and preparing checks consumed only 20 percent of a clerk's time. A redesign of the procurement process eliminated virtually all discrepancies and produced significant cost savings.
Situation 6
A: Five years ago, the management of Breeann Products commissioned an outside engineering consulting firm to conduct a time-and-motion study so that labor efficiency standards could be developed and used in production. These labor efficiency standards are still in use today and are viewed by management as an important indicator of productive efficiency.
B: Janet was quite satisfied with this quarter's labor performance. When compared with the same quarter of last year, labor productivity had increased by 23 percent. Most of the increase was due to a new assembly approach suggested by production line workers. She was also pleased to see that materials productivity had increased. The increase in materials productivity was attributed to reducing scrap because of improved quality.
Situation 7
A: "The system converts materials into products, not people at work stations. Therefore, process efficiency is more important than labor efficiency-but we also must pay particular attention to those who use the products we produce, whether inside or outside the firm."
B: "I was quite happy to see a revenue increase of 15 percent over last year, especially when the budget called for a 10 percent increase. However, after reading the recent copy of our trade journal, I now wonder whether we are doing so well. I found out that the market expanded by 30 percent, and our leading competitor increased its sales by 40 percent."

Question 25

Value- and Non-Value-Added Cost Reporting
Cicleta Manufacturing has four activities: receiving materials, assembly, expediting products, and storing goods. Receiving and assembly are necessary activities; expediting and storing goods are unnecessary. The following data pertain to the four activities for the year ending 2012 (actual price per unit of the activity driver is assumed to be equal to the standard price):

Required:
1. Prepare a cost report for the year ending 2012 that shows value-added costs, non-valueadded costs, and total costs for each activity.
2. Explain why expediting products and storing goods are non-value-added activities.
3. What if receiving cost is a step-fixed cost with each step being 1,500 orders whereas assembly cost is a variable cost? What is the implication for reducing the cost of waste for each activity?

Question 26

Explain how activity flexible budgeting differs from unit-based flexible budgeting.

Question 27

Which of the following are examples of non-value-added activities? a. Assembling a bicycle
B) Purchasing raw materials
C) Designing a new product
D) Reworking a defective product

Question 28

What are the two dimensions of the activity-based management model? How do they differ?

Question 29

Root Cause (Driver Analysis)
Refer to Exercise 12.8.
Required:
Suppose that clerical error-either Thayne's or the supplier's-is the common root cause of the non-value-added activities. For each non-value-added activity, ask a series of "why" questions that identify clerical error as the activity's root cause.

Question 30

A company is spending $70,000 per year for inspecting, $60,000 per year for purchasing, and $56,000 per year for reworking products. What is a good estimate of non-value-added costs? a. $126,000
B) $70,000
C) $56,000
D) $130,000

Question 31

Trend Reporting for Non-Value-Added Costs
Refer to Cornerstone Exercise 12.1. Assume that at the beginning of 2013, Cicleta trained the assembly workers in a new approach that had the objective of increasing the efficiency of the assembly process. Cicleta also began moving toward a JIT purchasing and manufacturing system. When JIT is fully implemented, the demand for expediting is expected to be virtually eliminated. It is expected to take two to three years for full implementation. Assume that receiving cost is a step-fixed cost with steps of 1,500 orders. The other three activities employ resources that are acquired as used and needed. At the end of 2013, the following results were reported for the four activities:

Required:
1. Prepare a trend report that shows the non-value-added costs for each activity for 2012 and 2013 and the change in costs for the two periods. Discuss the report's implications.
2. Explain the role of activity reduction for receiving and for expediting. What is the expected value of SQ for each activity after JIT is fully implemented?
3. What if at the end of 2013, the selling price of a competing product is reduced by $27 per unit? Assume that the firm produces and sells 20,000 units of its product and that its product is associated only with the four activities being considered. By virtue of the waste-reduction savings, can the competitor's price reduction be matched without reducing the unit profit margin of the product that prevailed at the beginning of the year? If not, how much more waste reduction is needed to achieve this outcome? In this case, what price decision would you recommend?

Question 32

In implementing an ABM system, what are some of the planning considerations?

Question 33

Which of the following is likely to be used to reduce the cost of reworking products? a. Activity sharing
B) Activity elimination
C) Activity reduction
D) Activity selection

Question 34

What is driver analysis? What role does it play in process value analysis?

Question 35

Process Improvement and Innovation
Refer to Exercise 12.8. Suppose that clerical error is the common root cause of the nonvalue- added activities. Paying bills is a subprocess that belongs to the procurement process. The procurement process is made up of three subprocesses: purchasing, receiving, and paying bills.
Required:
1. What is the definition of a process? Identify the common objective for the procurement process. Repeat for each subprocess.
2. Now, suppose that Thayne decides to attack the root cause of the non-value-added activities of the bill-paying process by improving the skills of its purchasing and receiving clerks. As a result, the number of discrepancies found drops by 30 percent. Discuss the potential effect this initiative might have on the bill-paying process. Does this initiative represent process improvement or process innovation? Explain.

Question 36

Activity-based management includes both process value analysis and activity-based costing. Which of the following features is primarily associated with process value analysis? a. Defining root causes of each activity
B) Identifying cost objects and activity drivers
C) Calculating activity rate
D) Assigning costs to cost objects

Question 37

Kaizen Costing
Gordon Company produces custom-made machine parts. A setup activity is required for the batches of parts that it produces. Activity output is measured using setup hours. The valueadded standard (SQ) for this activity is zero. On July 1, at the beginning of the fiscal year, 10 setup hours were allowed and used per batch. The standard wage rate for setup labor is $20 per setup hour. During the first quarter of the new fiscal year, the company is planning to implement a new setup method developed by Gordon's industrial engineers that is expected to reduce setup time by 40 percent. The new procedure was implemented during the first quarter and the improvement expected was realized.
Required:
1. What is the setup standard for setup hours and the associated expected cost at the beginning of the first quarter? The kaizen standard and expected associated cost?
2. What is the setup standard for setup hours and the associated cost at the end of the first quarter? Explain. What is the next step in the kaizen cost reduction process?
3. What if the new procedure implemented in the first quarter only produced a 30 percent reduction in setup time instead of the expected 40 percent reduction? What would the new maintenance standard and cost be? What criteria would you logically expect to be met before maintenance standards and costs are modified?

Question 38

Explain why a detailed task description is needed for ABM but not for ABC.

Question 39

The activity of moving materials uses four forklifts, each leased for $18,000 per year. A forklift is capable of making 5,000 moves per year, where a move is defined as a round trip from the plant to the warehouse and back. During the year, a total of 18,000 moves were made. What is the cost of the unused capacity for the moving goods activity? a. $5,400
B) $1,800
C) $7,200
D) $3,600

Question 40

What is activity analysis? Why is this approach compatible with the goal of continuous improvement?

Question 41

Process Improvement and Innovation
Refer to Exercise 12.10. Suppose that Thayne attacks the root cause of the non-value-added activities by establishing a totally different approach to procurement called electronic data interchange (EDI). EDI gives suppliers access to Thayne's online database that reveals Thayne's production schedule. By knowing Thayne's production schedule, suppliers can deliver the parts and supplies needed just in time for their use. When the parts are shipped, an electronic message is sent from the supplier to Thayne that the shipment is en route. When the order arrives, a bar code is scanned with an electronic wand initiating payment for the goods. EDI involves no paper, no purchase orders, no receiving orders-and no invoices.
Required:
Discuss the potential effects of this solution on Thayne's bill-paying process. Is this process innovation or process improvement? Explain.

Question 42

ABM Implementation, Activity Analysis, Activity Drivers, Driver Analysis, Behavioral Effects
Joseph Fox, controller of Thorpe Company, has been in charge of a project to install an activity-based cost management system. This new system is designed to support the company's efforts to become more competitive. For the past six weeks, he and the project committee members have been identifying and defining activities, associating workers with activities, and assessing the time and resources consumed by individual activities. Now, he and the project committee are focusing on three additional implementation issues: (1) identifying activity drivers, (2) assessing value content, and (3) identifying cost drivers (root causes). Joseph has assigned a committee member the responsibilities of assessing the value content of five activities, choosing a suitable activity driver for each activity, and identifying the possible root causes of the activities. Following are the five activities with possible activity drivers:

The committee member ran a regression analysis for each potential activity driver, using the method of least squares to estimate the variable and fixed cost components. In all five cases, costs were highly correlated with the potential drivers. Thus, all drivers appeared to be good candidates for assigning costs to products. The company plans to reward production managers for reducing product costs.
Required:
1. What is the difference between an activity driver and a cost driver? In answering the question, describe the purpose of each type of driver.
2. For each activity, assess the value content and classify each activity as value-added or nonvalue-added (justify the classification). Identify some possible root causes of each activity, and describe how this knowledge can be used to improve activity performance. For purposes of discussion, assume that the value-added activities are not performed with perfect efficiency.
3. Describe the behavior that each activity driver will encourage, and evaluate the suitability of that behavior for the company's objective of becoming more competitive.

Question 43

Activity-Based Flexible Budgeting
Foy Company has a welding activity and wants to develop a flexible budget formula for the activity. The following resources are used by the activity:
• Four welding units, with a lease cost of $12,000 per year per unit
• Six welding employees each paid a salary of $50,000 per year (A total of 9,000 welding hours are supplied by the six workers.)
• Welding supplies: $300 per job
• Welding hours: Three hours used per job
During the year, the activity operated at 90 percent of capacity and incurred the actual activity and resource costs, shown on page 664.
• Lease cost: $48,000
• Salaries: $315,000
• Parts and supplies: $805,000
Required:
1. Prepare a flexible budget formula for the welding activity using welding hours as the driver.
2. Prepare a performance report for the welding activity.
3. What if welders were hired through outsourcing and paid $30 per hour (the welding equipment is provided by Foy)? Repeat Requirement 1 for the outsourcing case.

Question 44

What are some of the reasons that ABM implementation may lose the support of higher management?

Question 45

ABM, Kaizen Costing
Baker, Inc., supplies wheels for a large bicycle manufacturing company. The bicycle company has recently requested that Baker decrease its delivery time. Baker made a commitment to reduce the lead time for delivery from seven days to one day. To help achieve this goal, engineering and production workers had made the commitment to reduce time for the setup activity (other activities such as moving materials and rework were also being examined simultaneously). Current setup times were 12 hours. Setup cost was $600 per setup hour. For the first quarter, engineering developed a new process design that it believed would reduce the setup time from 12 hours to nine hours. After implementing the design, the actual setup time dropped from 12 hours to seven hours. Engineering believed the actual reduction was sustainable. In the second quarter, production workers suggested a new setup procedure. Engineering gave the suggestion a positive evaluation, and they projected that the new approach would save an additional six hours of setup time. Setup labor was trained to perform the new setup procedures. The actual reduction in setup time based on the suggested changes was four hours.
Required:
1. What kaizen setup standard would be used at the beginning of each quarter?
2. Describe the kaizen subcycle using the two quarters of data provided by Baker.
3. Describe the maintenance subcycle for setups using the two quarters of data provided by Baker.
4. How much non-value-added cost was eliminated by the end of two quarters? Discuss the role of kaizen costing in activity-based management.
5. Explain why kaizen costing is compatible with activity-based responsibility accounting while standard costing is compatible with financial-based responsibility accounting.