Chapter 13, Problem 13.18E

Target operating income, value-added costs, service company. Calvert Associates prepares architectural drawings to conform to local structural-safety codes. Its income statement for 2017 is as follows:

Revenues	$701,250
Salaries of professional staff (7,500 hours × $52 per hour)	390,000
Travel	15,000
Administrative and support costs	171,600
Total costs	576,600
Operating income	$124,650

The percentage of time spent by professional staff on various activities follows:

Making calculations and preparing drawings for clients	77%
Checking calculations and drawings	3
Correcting errors found in drawings (not billed to clients)	8
Making changes in response to client requests (billed to clients)	5
Correcting own errors regarding building codes (not billed to clients)	7
Total	100%

Assume administrative and support costs vary with professional-labor costs. Consider each requirement independently.

1. 1. How much of the total costs in 2017 are value-added, non-value-added, or in the gray area between? Explain your answers briefly. What actions can Calvert take to reduce its costs? Required
2. 2. What are the consequences of misclassifying a non-value-added cost as a value-added cost? When in doubt, would you classify a cost as a value-added or non-value-added cost? Explain briefly.
3. 3. Suppose Calvert could eliminate all errors so that it did not need to spend any time making corrections and, as a result, could proportionately reduce professional-labor costs. Calculate Calvert’s operating income for 2017.
4. 4. Now suppose Calvert could take on as much business as it could complete, but it could not add more professional staff. Assume Calvert could eliminate all errors so that it does not need to spend any time correcting errors. Assume Calvert could use the time saved to increase revenues proportionately. Assume travel costs will remain at $15,000. Calculate Calvert’s operating income for 2017.