Chapter 12, Problem 27P

Tom Young, vice president of Dunn Company (a producer of plastic products), has been supervising the implementation of an activity-based cost management system. One of Tom’s objectives is to improve process efficiency by improving the activities that define the processes. To illustrate the potential of the new system to the president, Tom has decided to focus on two processes: production and customer service.

Within each process, one activity will be selected for improvement: molding for production and sustaining engineering for customer service. (Sustaining engineers are responsible for redesigning products based on customer needs and feedback.) Value-added standards are identified for each activity. For molding, the value-added standard calls for nine pounds per mold. (Although the products differ in shape and function, their size, as measured by weight, is uniform.) The value-added standard is based on the elimination of all waste due to defective molds (materials is by far the major cost for the molding activity). The standard price for molding is $15 per pound. For sustaining engineering, the standard is 60 percent of current practical activity capacity. This standard is based on the fact that about 40 percent of the complaints have to do with design features that could have been avoided or anticipated by the company.

Current practical capacity (the first year) is defined by the following requirements: 18,000 engineering hours for each product group that has been on the market or in development for five years or less, and 7,200 hours per product group of more than five years. Four product groups have less than five years’ experience, and 10 product groups have more. There are 72 engineers, each paid a salary of $70,000. Each engineer can provide 2,000 hours of service per year. There are no other significant costs for the engineering activity.

For the first year, actual pounds used for molding were 25 percent above the level called for by the value-added standard; engineering usage was 138,000 hours. There were 240,000 units of output produced. Tom and the operational managers have selected some improvement measures that promise to reduce non-value-added activity usage by 30 percent in the second year. Selected actual results achieved for the second year are as follows:

The actual prices paid per pound and per engineering hour are identical to the standard or budgeted prices.

Required:

1. 1. For the first year, calculate the non-value-added usage and costs for molding and sustaining engineering. Also, calculate the cost of unused capacity for the engineering activity.
2. 2. Using the targeted reduction, establish kaizen standards for molding and engineering (for the second year).
3. 3. Using the kaizen standards prepared in Requirement 2, compute the second-year usage variances, expressed in both physical and financial measures, for molding and engineering. (For engineering, explain why it is necessary to compare actual resource usage with the kaizen standard.) Comment on the company’s ability to achieve its targeted reductions. In particular, discuss what measures the company must take to capture any realized reductions in resource usage.

To determine

Ascertain the non-value-added usage and costs for molding and sustaining engineering and also determine the cost of unused capacity for the engineering activity.

Explanation of Solution

Compute non-value-added usage and costs for the first year:

Non-value-added costs: Non-value-added costs are the costs that are incurred due to non-value-added activities or the inefficient performance of value-added activities. Due to the increased competition, many firms are trying to eliminate non-value-added activities and an insignificant portion of value-added activities, as they consume unnecessary costs and prevent performance.

$\text{Non-value-added cost = SP}\left(\text{AQ}-\text{SQ}\right)$

Particulars	AQ	SQ	Non-value-added usage (AQ-SQ)	Non-value-added cost [SP (AQ-SQ)]
Moulding	2,700,000 (1)	2,160,000 (3)	540,000	$ 8,100,000
Engineering	144,000 (2)	86,400 (4)	57,600	$ 2,016,000
				$ 10,116,000

Table (1)

Working notes:

(1)

$\begin{array}{c}\text{Actual quantity used }\left(\text{AQ}\right)=\left(\begin{array}{l}\text{Actual pounds used for moulding }\times \\ \text{Value-added standard calls }\times \text{Units produced}\end{array}\right)\\ =\left(\begin{array}{c}1.25\left[25\%\text{}\text{ above the level called for by the value added standard}\right]\\ \times 9\text{pounds per molds}\times \text{240,000 units}\end{array}\right)\\ =2,700,000\text{units}\end{array}$

(2)

$\begin{array}{c}\text{AQ for engineering}=\left[\begin{array}{l}\left(\begin{array}{l}\text{Number of product groups}\times \text{current practical capacity}\\ \left\{5\text{}\text{years or less}\right\}\end{array}\right)\\ +\left(\begin{array}{l}\text{Number of product groups}\times \\ \text{current practical capacity}\left\{\text{more than }5\text{}\text{years}\right\}\end{array}\right)\end{array}\right]\\ =\left[\begin{array}{l}\left(\text{4}\text{×}\text{18,000}\text{engineering hours}\right)+\\ \left(10\times 7,200\text{engineering hours}\right)\end{array}\right]\\ =72,000\text{engineering hours}\text{+}\text{72,000 engineering hours}\\ \text{=144,000}\text{engineering hours}\end{array}$

(3)

$\begin{array}{c}\text{Value-added output level for molding}\text{=}\left(\text{Actual pounds used for moulding}\times \text{units produced}\right)\\ =9\text{pound per molds}\times \text{240,000 units}\\ \text{=2,160,000}\text{units}\end{array}$

(4)

$\begin{array}{c}\text{Value-added output level for engineering}\text{=}\left[\left(\text{Current practical capacity}\times \text{60\%}\right)\right]\\ =\left[\left(72,000+72,000\right)\times \frac{60}{100}\right]\\ =144,000\times \frac{60}{100}\\ =86,400\text{ engineering hours}\end{array}$

Therefore, the non-value-added cost for the activities moulding and engineering is $8,100,000 and $2,016,000 respectively.

Compute unused capacity for engineering:

Note:

• Standard price per unit for materials is $15
• Standard price for engineering is $35 $\left(\frac{\$70,000}{2,000}\right)$

There are no price variances because SP = AP

$\begin{array}{c}\text{Cost of unused capacity for engineering =}\left[\left(\text{SP}\times \text{AQ}\right)-\left(\text{SP}\times \text{engineering hours usage}\left(\text{AU}\right)\right)\right]\\ =\left[\left(\$35\times 144,000\text{hours}\right)-\left(\$35\times 138,000\text{hours}\right)\right]\\ =\$210,000\text{F}\end{array}$

Thus, the cost of unused capacity for engineering is $210,000 (favourable).

To determine

Determine the kaizen standards for molding and engineering for the second year.

Explanation of Solution

Kaizen standard: A kaizen standard is the proposed improvement for the future period

Compute kaizen standard for molding and engineering:

$\begin{array}{c}\text{Kaizen standard for molding =}\text{SQ}\text{+}70\%\text{of non-value-added usage}\\ \text{=2,160,000}\text{+}\left(540,000\times \frac{70}{100}\right)\\ =2,160,000+378,000\\ =2,538,000\text{pounds}\end{array}$

$\begin{array}{c}\text{Kaizen standard for engineering =}\text{SQ}\text{+}70\%\text{of non-value-added usage}\\ \text{=86,400}\text{+}\left(57,600\times \frac{70}{100}\right)\\ =86,400+40,320\\ =126,720\text{engineering hours}\end{array}$

Therefore, the kaizen standard for molding and engineering is 2,538,000 pounds and 126,720 engineering hours.

To determine

Ascertain the second year usage variances, expressed in both financial and physical measures, for molding and engineering and comment on the company’s ability to achieve its targeted reductions. Determine the measures that company must take to capture any realized reductions in resource usage.

Explanation of Solution

Compute unused capacity variance:

Particulars	AU	SQ	AU-SQ	SP(AU-SQ)
Materials	2,600,000	2,538,000	62,000	$930,000 U
Engineering	120,000	126,720	-6,720	$235,200 F

Table (2)

Therefore, the unused capacity variance for materials and engineering is $930,000 Unfavourable and $235,200 Favourable.

Note: In the case of engineering, the kaizen standard estimates the volume of resource usage is needed in this year and the growth is ascertained by comparing with AU (Actual usage) and not with AQ (Activity availability). The unused capacity can be measured by using the equation.

The company attains the engineering kaizen standard but it cannot able to attain the molding kaizen standard. The outcomes of engineering have their particular interests. The activity availability for engineering is 144,000 hours and activity usage is 120,000 hours. Each engineer brings the unused capacity of 2,000 hours as a result of generating an overall 24,000 hours of unused engineering capacity by the company. Therefore, to realize the savings for the engineering activity, the company must decide how to use these available resources. The available option for the company is to lay off 12 engineers, thereby the total profit can be increased by the savings in salary ($840,000). Other options available are to include reassignment to activities that have insufficient resources. The significant point is that resource usage restrictions must be converted into reduction in resource spending, or the efforts have been in vain.