INDIVIDUAL ASSIGNMENT 1

LANGFIELD-SMITH (2013) PROBLEM 16.36, 16.41, 16.44, CASE 16.50.

______________________________________________________________________

PROBLEM 16.36 (30 minutes) Activity-based management; cost cutting: manufacturer

1

Activity-based management refers to the use of activity-based costing information to analyse activities,
cost drivers and performance to improve profitability and customer value by improving processes and
eliminating non-value-added costs. A non-value-added activity is an activity that does not add value to a
product from the customers perspective or for the business. Such activities can be eliminated without
harming overall quality, performance or perceived value of a product.

Cost of non-value-added activities:

Warehousing:
550 moves x $80a
$44 000
Outgoing shipments:
250 shipments x $30b
$ 7 500
Total
$51 500
a
Warehouse: $720 000 9000 inventory moves = $80 per move
b
Outgoing shipments: $450 000 15 000 shipments = $30 per shipment

Extra inventory moves in the warehouse may be caused by books being shelved (i.e. stocked) incorrectly,
poor planning for the arrival and subsequent placement/stocking of new titles and other similar situations.
Extra shipments would likely be the result of errors in order entry and order filling, goods lost in transit,
or damaged merchandise being sent to customers.

As the following figures show, the elimination of non-value-added activities allows Alligator.com to
achieve the target cost percentage for software only.

Cost driver
Activity
quantity
Incoming receipts
2 000
Warehousing
9 000
Outgoing shipments
15 000
*
(9 000 moves x 80%) 550
**
(15 000 shipments x 75%) - 250

Books
Software
70%
30%
80%
20%
25%
75%

Cost driver Cost driver

quantity:
quantity:
Books
Software
1 400
600
6 650*
1 800
3 750
11 000**

Activity
Books
Software
Incoming receipts
1400 purchase orders x $ 300a
$420 000
600 purchase orders x $ 300
$180 000
Warehousing
6650 moves x $ 80
$532 000
1800 moves x $ 80
$144 000
Outgoing shipments
3750 shipments x $ 30
$112 500
11000 shipments x $ 30
$330 000
Total cost
$1 064 500 $654 000
Cost as percentage of sales:
13.65%b
12.58% b
a
Incoming receipts: $ 600 000 2000 purchase orders = $300 per purchase order.
b
$1 064 500 $7 800 000; $654 000 $5 200 000.
5

Additional cost cutting of $50 500 is needed for books to achieve the 13 per cent target of $1 014 000
($7 800 000 x 13 per cent). Tools that the company might use include customer-profitability analysis,
target costing, value engineering, benchmarking and business process re-engineering.

PROBLEM 16.41 (25 minutes) The theory of constraints; business process reengineering: service organisation
1

Only 140 licences per hour can be completed, because this is the capacity of Area D.

Areas C and D need to increase their output to be able to reach the requirement of 250 returns per hour; C
by 100 licenses and D by 110 licences.

Area A has the right staffing.

Area B has eight people who are processing 350 licences per hour, or 43.75 licences per hour each. To
work at the required rate of 250 licences, the section needs 250 / 43.75 = 5.7 staff. Two staff can be
released.
Area C has ten people, who are processing 150 licences per hour, or 15 licences per hour each. To
produce at the right level they need 250 / 15 = 16.7 people; so they need seven more.
Area D has 17 people who are processing 140 licences per hour, or 8.2 licences per hour each. They
need 250 / 8.2 = 30.5 people, or 14 more.
Area E has five people, who are processing 280 returns per hour, or 56 returns per hour each. To get to
the required level it needs 250 / 56 = 4.5 staff, so there is not much spare capacity.
The re-engineered process needs 0 2 + 7 + 14 = 19 more people. This cannot be done within the
constraint of 45 people so the branch manager needs to think of a new process. In fact, the re-engineered
process requires more people to process 250 returns per hour than the original process did! Management
needs to closely study the activities in the major bottlenecks (C and D) to see how average throughput
can be improved. In C, the solution may lie in increasing the number of cameras. The activities in D are
obviously very time-consuming, since this has the slowest throughput per person. Staff may be released
from areas A and B by combining these activities in some fashion. It would appear from the description
that the applications are handled twice, whereas the same person could possibly undertake the two
activities.

PROBLEM 16.44 Life cycle budgeting; life cycle management; target costing:
manufacturer
1

The target cost for the Sunstruck model that will meet the required price of $800 and the required margin
of 30 per cent is:
Target cost=
Target selling price target profit margin
=
$800 ($800 x 0.30)
=
$560
The estimated manufacturing cost is $500. Therefore, the development and introduction of the Sunstruck
model should go ahead as the price of $800 will give a return on sales of (800 500) / 800 = 37.5 per
cent, which is above the required return of 30 per cent on sales.

Life cycle budget for Sunstruck Solar Hot Water Service:

Sales revenue
Less: Cost of goods sold
Gross margin
Less: non-manufacturing costs
Research and development
Product and process design
Marketing
Customer support
Net profit / (loss)

(in thousands of dollars)

Year 1
Year 2
Year 3
$13 600
$7 200
8 500
4 500
5 100
2 700
1 500
3 000
1 000
_____
$(5 500)

700
800
250
$ 3 350

500
800
$1 400

Year 4
$3 200
2 000
1 200

400
750
$50

Year 5

200
$(200)

Total
$24 000
15 000
9 000
1 500
3 700
2 700
2 000
$(900)

The estimated average unit cost of the Sunstruck model over its entire life cycle is:
Total costs / total units = $ 24 900 000 / 30 000 = $830.
On this basis, the development and introduction of the Sunstruck model is not recommended as the price
is less than the average cost per unit. However, the estimate of cost of goods sold should be reviewed
before making this decision, as the applied manufacturing overhead consists of both variable and fixed
overhead. In estimating the manufacturing overhead cost at $125 per unit, the analysis above has failed to
recognise that the fixed component of the overhead cost will not increase proportionately with the volume
of production. In Chapter 19 we discuss the problems associated with using unitised fixed costs as a basis
for decision making.

The company could put more resources into the product and process design phase, and develop cheaper
ways to manufacture. Evidence of life cycle cost behaviour suggests that most manufacturing costs are
actually committed during the design phase. It is difficult to achieve major efficiencies once a product
actually goes into production. Thus, additional spending on design can be more than offset by subsequent
savings in manufacturing costs, and also in customer service costs.

CASE 16.50 (45 minutes) Measuring and managing quality costs: manufacturer

1
Landers Ltd
Quality cost report
Internal failure costs:
Rework on defective wheels
Engineering costs to correct production line quality problems
Lost contribution on time to correct production line quality problems
Cost of faulty components that are scrapped
Cost of rewelding faulty joints discovered during processing
Cost of faulty bikes that are scrapped after finished goods inspection
External failure costs:
Cost of replacement bikes provided under warranty
Cost of bikes returned by customers and scrapped
Cost of repairs under warranty
Sales commissions on faulty bikes returned by customers
Contribution margin forgone on bikes returned by customers
Contribution margin forgone on lost future bike sales
Prevention costs:
Cost of quality training programs
Appraisal costs:
Quality inspection in the goods receiving area
Quality inspections during processing
Laboratory testing of bikes and components
Operating an X-ray machine to detect faulty welds
Inspection of each bike put into finished goods warehouse
Total quality costs

Current
months cost

Percentage
of total

$8 000
15 000
25 000
4 000
19 000
10 000
81 000

4.4
8.2
13.6
2.2
10.4
5.4
44.2

5 000
5 000
1 000
500
1 000
5 000
17 500

2.7
2.7
0.55
0.3
0.55
2.7
9.5

3 000
3 000

1.6

15 000
23 000
13 000
15 000
16 000
82 000
$183 500

8.2
12.5
7.1
8.2
8.7
44.7
100.0

The cost of quality report indicates that Landers costs of quality are very high compared to the overall
manufacturing costs (over 30% of manufacturing costs). It appears that the company achieves its high
quality through extensive appraisal activities. These appraisal activities result in a very high level of
internal failure costs and relatively low external failure costs, as quality problems are detected before the
bikes leave the factory. Prevention costs are very low. The company could reduce its cost of quality by
increasing its expenditure on prevention activities. Effective prevention activities should help the
company get to the point where bikes and components are made right the first time. In this environment it
will be possible to reduce the level of appraisal activities. Internal failure costs will also go down.

It was impossible to identify the cost of quality from the existing accounting system. Many of the quality
costs were hidden in manufacturing overhead cost accounts. Also some of the costs, such as contribution
forgone on current and future sales, are not recorded in conventional accounting systems.