Cornerstones of Cost Management Study Set 4

Business

Quiz 12 :

Activity-Based Management

Quiz 12 :

Activity-Based Management

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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: img The consumption patterns of the two products are as follows: img 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.
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1)Calculation of unit overhead cost of Special model using machine hours is as follows:
Activity based costing (ABC) is the method of costing used to calculate the cost of the product based on their activities rather than other bases like original costing. Under this method overhead cost of activity is identified and assigned to the units based on their number of activities. This method can be helpful to calculate the accurate cost of the product.
Calculation of unit overhead cost of Special model using ABC is as follows:
Machining cost = $5,400,000
Machine hours = 90,000
img Rework cost = $1,800,000
Total rework hours = 45,000
img Inspection cost = $3,600,000
Total inspections = 45,000
img Calculate total plant wide rate:
img img Calculate total Overhead Cost:
img Calculate Unit Overhead Cost:
img By using the ABC model, the unit overhead cost reduces by $19 ($60 - $41) but the required reduction is $20, which is still not achieved. This shows that cost should be further reduced to achieve the desired level.
2)Compute the cost of special model:
The activity rate will remain same with the change in inspection and rework costs and inspection and rework time by 50% but the Total overhead cost will change as follows:
Actual inspection hours = 10,000
50% reduced = 5,000
Actual rework hours = 7,500
After reduced 50% hours = $3,750
Total Overhead Cost:
img Unit Overhead Cost:
img Now, the cost is reduced by $24.50 ($60 - $35.50) from the original cost, which shows that the desired level of reduction of $20 has been achieved by management. ABC deals with how the costs are assigned, whereas ABM deals with assignment of cost as well as reduction of costs.
Hence, ABM has two aspects i.e. Cost accuracy and Cost reduction.

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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.
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1.Flexible budget formula for the welding activity:
Acquired in advance of usage:
img Calculations:
img Acquired as needed:
img 2.Performance report for the welding activity:
img img 3. img The cost of welding equipment is fixed, the variable cot s the $30 per hour of welding equipment plus the $100 per hour for parts and supplies.

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In implementing an ABM system, what are some of the planning considerations?
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List the planning considerations while implementing an ABM system:
Planning must be capable of:
• Determining the usage and goals of an ABM system,
• Its deadline for adoption,
• The allocated authorities and responsibilities,
• Resource requirement,
• The existed and planned future competitive position,
• The business operations and product mix, and
• The capability of the company to adopt the advanced system and to know the application of the latest information generated

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What is activity analysis? Why is this approach compatible with the goal of continuous improvement?
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What is a kaizen standard? Describe the kaizen and maintenance subcycles.
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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: img 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?
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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?
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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.
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Explain how activity flexible budgeting differs from unit-based flexible budgeting.
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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.
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Identify and define four different ways to manage activities so that costs can be reduced.
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What is driver analysis? What role does it play in process value analysis?
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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): img 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?
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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.
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What are value-added activities? Value-added costs?
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What are non-value-added activities? Non-value-added costs? Give an example of each.
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Explain how benchmarking can be used to improve activity performance.
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What are the two dimensions of the activity-based management model? How do they differ?
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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?
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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: img 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.
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