Activity-Based Management, Nonvalue-Added CostsDanna Martin, president of Mays Electronics, was concerned about the end-of-the year marketingreport that she had just received. According to Larry Savage, marketing manager, a price decreasefor the coming year was again needed to maintain the company’s annual sales volume of integratedcircuit boards (CBs). This would make a bad situation worse. The current selling price of $18 perunit was producing a $2-per-unit profit—half the customary $4-per-unit profit. Foreign competitors kept reducing their prices. To match the latest reduction would reduce the price from $18 to$14. This would put the price below the cost to produce and sell it. How could these firms sell forsuch a low price? Determined to find out if there were problems with the company’s operations,Danna decided to hire a consultant to evaluate the way in which the CBs were produced and sold.After two weeks, the consultant had identified the following activities and costs:Setting up equipment $ 125,000Materials handling 180,000Inspecting products 122,000Engineering support 120,000Handling customer complaints 100,000Filling warranties 170,000Storing goods 80,000Expediting goods 75,000Using materials 500,000Using power 48,000Manual insertion labora 250,000Other direct labor 150,000Total costs $1,920,000baDiodes, resistors, and integrated circuits are inserted manually into the circuit board.bThis total cost produces a unit cost of $16 for last year’s sales volume. The consultant indicated that some preliminary activity analysis shows that per-unit costscan be reduced by at least $7. Since the marketing manager had indicated that the market share(sales volume) for the boards could be increased by 50% if the price could be reduced to $12,Danna became quite excited.Required:1. CONCEPTUAL CONNECTION What is activity-based management? What phases ofactivity analysis did the consultant provide? What else remains to be done?2. CONCEPTUAL CONNECTION Identify as many nonvalue-added costs as possible.Compute the cost savings per unit that would be realized if these costs were eliminated.Was the consultant correct in the preliminary cost reduction assessment? Discuss actionsthat the company can take to reduce or eliminate the nonvalue-added activities.3. Compute the unit cost required to maintain current market share, while earning a profitof $4 per unit. Now compute the unit cost required to expand sales by 50%, assuming aper-unit profit of $4. How much cost reduction would be required to achieve each unitcost?4. Assume that further activity analysis revealed the following: switching to automatedinsertion would save $60,000 of engineering support and $90,000 of direct labor. Now,what is the total potential cost reduction per unit available from activity analysis? Withthese additional reductions, can Mays achieve the unit cost to maintain current sales? Toincrease it by 50%? What form of activity analysis is this: reduction, sharing, elimination,or selection?5. CONCEPTUAL CONNECTION Calculate income based on current sales, prices, andcosts. Then calculate the income by using a $14 price and a $12 price, assuming that themaximum cost reduction possible is achieved (including Requirement 4’s reduction).What price should be selected?
Activity-Based Management, Nonvalue-Added Costs
Danna Martin, president of Mays Electronics, was concerned about the end-of-the year marketing
report that she had just received. According to Larry Savage, 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 $18 per
unit was producing a $2-per-unit profit—half the customary $4-per-unit profit. Foreign competitors kept reducing their prices. To match the latest reduction would reduce the price from $18 to
$14. This would put the price below the cost to produce and sell it. How could these firms sell for
such a low price? Determined to find out if there were problems with the company’s operations,
Danna decided to hire a consultant to evaluate the way in which the CBs were produced and sold.
After two weeks, the consultant had identified the following activities and costs:
Setting up equipment $ 125,000
Materials handling 180,000
Inspecting products 122,000
Engineering support 120,000
Handling customer complaints 100,000
Filling warranties 170,000
Storing goods 80,000
Expediting goods 75,000
Using materials 500,000
Using power 48,000
Manual insertion labora 250,000
Other direct labor 150,000
Total costs $1,920,000b
a
Diodes, resistors, and integrated circuits are inserted manually into the circuit board.
b
This total cost produces a unit cost of $16 for last year’s sales volume.
The consultant indicated that some preliminary activity analysis shows that per-unit costs
can be reduced by at least $7. Since the marketing manager had indicated that the market share
(sales volume) for the boards could be increased by 50% if the price could be reduced to $12,
Danna became quite excited.
Required:
1. CONCEPTUAL CONNECTION What is activity-based management? What phases of
activity analysis did the consultant provide? What else remains to be done?
2. CONCEPTUAL CONNECTION Identify as many nonvalue-added costs as possible.
Compute the cost savings per unit that would be realized if these costs were eliminated.
Was the consultant correct in the preliminary cost reduction assessment? Discuss actions
that the company can take to reduce or eliminate the nonvalue-added activities.
3. Compute the unit cost required to maintain current market share, while earning a profit
of $4 per unit. Now compute the unit cost required to expand sales by 50%, assuming a
per-unit profit of $4. How much cost reduction would be required to achieve each unit
cost?
4. Assume that further activity analysis revealed the following: switching to automated
insertion would save $60,000 of engineering support and $90,000 of direct labor. Now,
what is the total potential cost reduction per unit available from activity analysis? With
these additional reductions, can Mays achieve the unit cost to maintain current sales? To
increase it by 50%? What form of activity analysis is this: reduction, sharing, elimination,
or selection?
5. CONCEPTUAL CONNECTION Calculate income based on current sales, prices, and
costs. Then calculate the income by using a $14 price and a $12 price, assuming that the
maximum cost reduction possible is achieved (including Requirement 4’s reduction).
What price should be selected?
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