Chapter 19, Problem 2CTC

a.

To determine

Determine whether it is value-added or non-value-added for each activity.

Explanation of Solution

A Value-added activity:

A Value-added activity is an activity that adds to the desirability of the product or services in the eyes of the customers. For example,

• Clear and truthful marketing
• Timely distribution of products
• Being easily accessible to the customer

A non-value-added activity:

A non-value-added activity is an activity that does not add to the desirability of the product. For example,

• Misleading marketing
• Delays in production
• Supplying poor quality deliveries

Each of the activity is classified as value-added or non-value-added:

Activity	Classification
Setups	Non-value-added
Materials handling	Non-value-added
Inspection	Non-value-added
Customer support	Value-added
Customer complaints	Non-value-added
Warranty expense	Non-value-added
Storage	Non-value-added
Rework	Non-value-added
Direct materials	Value-added
Utilities	Value-added
Manual insertion labor	Value-added
Other direct labor	Value-added

Table (1)

Note: Utilities costs are usually considered value-added since, they are necessary to run machinery and support direct labor workers, both of which are value-added activities.

b.

To determine

State the way in which the cost per Circuit Board would decrease if all the non-value-added activities could be eliminated.

Explanation of Solution

Calculate the non-value-added cost per unit:

$\begin{array}{c}\text{Non-value-added}\text{per}\text{unit}\text{=}\frac{\text{Total}\text{non-}\text{value-added}\text{costs}}{\text{Number}\text{of}\text{units}\text{produced}}\\ \text{=}\frac{\text{\$852,000}(1)}{\text{120,000}\text{units}}\\ \text{=\$7}\text{.10}\end{array}$

Therefore, if all non-value-added costs are be eliminated, the cost per unit is decrease by $7.10.

Working note:

Calculate the cost of non-value –added activities:

Activity	Cost
Setups	$125,000
Materials handling	$180,000
Inspection	$122,000
Customer complaints	$100,000
Warranty expense	$170,000
Storage	$80,000
Rework	$75,000
Total non-value-added costs	$852,000

Table (2)

(1)

c.

To determine

Calculate the target cost required to maintain Current market share of Company M while earning the usual profit $ 4 per unit, calculate the target cost required to expand sales by 50 percent and state the way in which the cost per unit need to be reduced to achieve each target.

Explanation of Solution

Target costing:

Target costing is a business procedure that targets at the earliest stages of new product and service development, before creating and designing of production techniques.

• For maintaining the current market share, the selling price per circuit board must fall to $14. Given a target profit of $4, the target cost per circuit board equals $10 $\left(\text{\$14}-\text{\$4}\right)\text{.}$
• The current cost per unit is $16 (2) so that, in order to reach the target, the costs must be reduced by $6 $\left(\text{\$16}-\text{\$10}\right)\text{.}$
• For increasing the market share by 50%, the selling price per circuit board must fall to $12. Given a target profit of $4, the target cost per circuit board equals $8 $\left(\text{\$12}-\text{\$4}\right)\text{.}$
• The current cost per unit is $16 (2) so that, in order to reach the target, costs must be reduced by $8 $\left(\text{\$16}-\text{\$8}\right)\text{.}$

Working note:

Calculate the cost per unit:

$\begin{array}{c}\text{Cost}\text{per}\text{unit=}\frac{\text{Total}\text{costs}}{\text{Number}\text{units}\text{produced}}\\ \text{=}\frac{\text{\$1,920,000}}{\text{120,000}\text{units}}\\ \text{=}\text{\$16}\end{array}$

(2)

d.

To determine

States the potential cost reduction per unit with the additional information provided and ascertain whether the Company M can achieve the target cost to maintain its current market share.

Explanation of Solution

• The net cost reduction of switching to automated insertion is $100. Per unit cost reduction would be $0.83(4).
• To maintain current market share, the cost per unit must be reduced by $6 from subpart c. Switching to automated insertion does not result in enough cost savings to attain the target cost.

Working note:

Calculate the net cost reduction of switching to automated insertion:

$\begin{array}{c}\begin{array}{l}\text{Net}\text{cost}\text{reduction}\text{of}\text{switching}\\ \text{to}\text{automated}\text{insertion}\end{array})\text{=}\left(\begin{array}{l}\text{Direct}\text{labour+Rework+}\\ \text{Warranty}\text{costs}-\text{Yearly}\text{cost}\end{array}\right)\\ \text{=}\text{\$90,000+\$20,000+\$40,000}-\text{\$50,000}\\ \text{=\$100,000}\end{array}$

(3)

Calculate the per unit cost reduction:

$\begin{array}{c}\text{Per}\text{unit}\text{cost}\text{reduction}\text{=}\frac{\text{Net}\text{cost}\text{reduction}}{\text{Number}\text{of}\text{units}}\\ \text{=}\frac{\text{\$100,000}\text{(3)}}{\text{120,000}\text{units}}\\ \text{=}\text{\$0}\text{.83}\end{array}$

(4)

e.

To determine

Ascertain whether Company M can reach the target cost needed in order to maintain its current market share is all of the suggestions are implemented.

Explanation of Solution

Target costing:

Target costing is a business procedure that targets at the earliest stages of new product and service development, before creating and designing of production techniques.

Calculate the total net cost reduction per unit:

$\begin{array}{c}\text{Total}\text{net}\text{cost}\text{per}\text{unit}\text{=}\frac{\text{Total}\text{net}\text{cost}\text{reduction}}{\text{Number}\text{of}\text{units}\text{produced}}\\ \text{=}\frac{\text{\$502,000}\text{(5)}}{\text{120,000}\text{units}}\\ \text{=}\text{\$4}\text{.18}\end{array}$

Working note:

Calculate the total net reduction:

Net cost reduction
Automated insertion	$100,000
Factory redesign (6)	$90,000
Leasing machine (7)	$65,000
Just-in-time system (8)	$40,000
Quality training and bonus (9)	$207,000
Total net cost reduction	$502,000

Table (3)

(5)

Calculate the net cost reduction for factory redesign:

$\begin{array}{c}\begin{array}{l}\text{Net}\text{cost}\text{reduction}\\ \text{for}\text{factory}\text{redesign}\end{array})\text{=}\left(\begin{array}{l}\text{Handling}\text{costs+}\text{Rework}\text{costs}\\ -\text{redesign}\text{cost}\end{array}\right)\\ \text{=}\text{\$100,000+\$10,000}-\text{\$20,000}\\ \text{=\$90,000}\end{array}$

(6)

Calculate the net cost reduction for leasing machine:

$\begin{array}{c}\begin{array}{l}\text{Net}\text{cost}\text{reduction}\\ \text{for}\text{leasing}\text{machine}\end{array})\text{=}\left(\text{Set-up}\text{costs}-\text{yearly}\text{cost}\right)\\ \text{=\$80,000}-\text{\$15,000}\\ \text{=\$65,000}\end{array}$

(7)

Calculate the net cost reduction for Just-in-time system:

$\begin{array}{c}\begin{array}{l}\text{Net}\text{cost}\text{reduction}\\ \text{for}\text{Just-in-time}\text{system}\end{array})\text{=}\left(\text{Storage}\text{cost}-\text{shipping}\text{cost}\right)\\ \text{=\$45,000}-\text{\$5,000}\\ \text{=\$40,000}\end{array}$

(8)

Calculate the net cost reduction for Quality training and bonus:

$\begin{array}{c}\begin{array}{l}\text{Net}\text{cost}\text{reduction}\\ \text{for}\text{Quality}\text{and}\text{bonus}\end{array})\text{=}\left(\begin{array}{l}\text{Inspection}\text{costs+cost}\text{incurred}\\ -\text{cost}\text{reduced}\end{array}\right)\\ \text{=\$122,000+\$120,000}-\text{\$35,000}\\ \text{=\$207,000}\end{array}$

(9)

Conclusion

The total net cost reduction per unit is $4.18. From subpart c, the cost per unit must be reduced by $6, so even with the combined actions; the target cost cannot be reached.