Managerial Accounting: The Cornerstone of Business Decision-Making
Managerial Accounting: The Cornerstone of Business Decision-Making
7th Edition
ISBN: 9781337115773
Author: Maryanne M. Mowen, Don R. Hansen, Dan L. Heitger
Publisher: Cengage Learning
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Textbook Question
Chapter 5, Problem 60P

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:

Chapter 5, Problem 60P, Danna Martin, president of Mays Electronics, was concerned about the end-of-the year marketing

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. 1. CONCEPTUAL CONNECTION What is activity-based management? What phases of activity analysis did the consultant provide? What else remains to be done?
  2. 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. 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. 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. 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?

1.

Expert Solution
Check Mark
To determine

Explain activity based management. Discuss the phases that are provided by the consultant. Also, explain the other phases that need to be done in an organization.

Explanation of Solution

Activity Based Costing (ABC):

Activity based costing is a apportionment of costs that first considers the activity drivers that helps in the allocation of costs to various activities and then allocates costs to different cost objects by using the drivers.

Activity based management is a technique that focuses on the attention of management towards the various activities. It includes two dimensions that is a cost dimension and a process dimension. Activity based management are identifying the activities, evaluating their values and continuing only value-adding activities. The consultant only identifying the activities but does not categorize the activities as value-added activity or non-value added activity. Also, consultant does not give any suggestions for increasing efficiency of use of activities. The consultant only eliminates non-value added activities for increasing the potential savings. Therefore, activity based management suggest how to reduce, remove, share and choose various activities in order to get the cost reductions.

2.

Expert Solution
Check Mark
To determine

Calculate the cost savings per unit that would be realized if these costs were eliminated. Identify whether the consultant correct in the preliminary cost reduction assessment. Also, explain the actions that company can take to reduce or eliminate the non-value added activities.

Explanation of Solution

Particulars

Amount

($)

Setting up equipment125,000
Materials handling180,000
Inspecting products122,000
Handling customer complaints100,000
Filling warranties170,000
Storing goods80,000
Expediting goods75,000
Total (A)852,000
Units produced and sold (B)120,0001
Potential unit cost reduction (AB)7.10

Table (1)

Consultant is able to achieve its target. On the basis of above calculation, per unit costs is reduced by $7.10 and consultant is also able to reduce further costs by improving the value-added activities.

Currently, an organization earns $2 per unit profit. If an organization decreases the cost per unit to $4 per unit, then their current sales and profit is $14 at a price. Also, if an organization savings the cost, then the company is able to earn additional profit.

Working Note:

1.

Calculation of units produced and sold:

Units Produced and Sold=Total CostUnit Cost=$1,920,000$16=$120,000

3.

Expert Solution
Check Mark
To determine

Calculate the unit cost required to maintain the current market share while earning a profit of $4 per unit. Calculate the unit cost required to expand sale by 50%. Also, discuss how much cost reduction is needed to attain the each unit cost.

Explanation of Solution

Use the following formula to calculate the unit cost to maintain sales:

Unit Cost to Maintain Sales=Latest ReductionProfit Per Unit

Substitute $14 for latest reduction and $4 for profit per unit in the above formula.

Unit Cost to Maintain Sales=$14$4=$10

Therefore, unit cost to maintain sales is $10.

Use the following formula to calculate the unit cost to expand sales:

Unit Cost to Expand Sales=Latest ReductionProfit Per Unit

Substitute $12 for latest reduction and $4 for profit per unit in the above formula.

Unit Cost to Expand Sales=$12$4=$8

Therefore, unit cost to expand sales is $8.

Use the following formula to calculate the cost reduction to maintain sales:

Cost Reduction to Maintain Sales=Current SalesUnit Cost to Maintain Sales

Substitute $16 for current sales and $10 for unit cost to maintain sales in the above formula.

Cost Reduction to Maintain Sales=$16$10=$6

Therefore, cost reduction to maintain sales is $6.

Use the following formula to calculate the cost reduction to expand sales:

Cost Reduction to Expand Sales=Current SalesUnit Cost to Expand Sales

Substitute $16 for current sales and $8 for unit cost to expand sales in the above formula.

Cost Reduction to Expand Sales=$16$8=$8

Therefore, cost reduction to expand sales is $8.

4.

Expert Solution
Check Mark
To determine

Calculate the total potential cost reduction per unit. Also, identify the form of activity as a reduction, sharing, elimination or selection.

Explanation of Solution

Particulars

Amount

($)

Total potential reduction852,000
Automated Cost ($60,000+$90,000)150,000
Total (A)1,002,000
Units (B)120,000
Units savings (AB)8.35

Table (2)

Therefore, company needs to decrease the cost by $8.35 to maintain the current market share. If company removes the non-value added costs, then the cost reduction increases the market share. In the given problem, activity selection is uses in the activity management.

5.

Expert Solution
Check Mark
To determine

Compute the income based on current sales, prices and costs. Also, compute the income with the help of $14 price and a $12 price.

Explanation of Solution

Calculation of the income on the basis of current sales:

Particulars

Amount

($)

Sales (120,000×$18)2,160,000
Less: Costs1,920,000
Income240,000

Table (3)

Calculation of the income when the price is $14:

Particulars

Amount

($)

Sales (120,000×$14)1,680,000
Less: Costs (7.651×120,000)918,000
Income762,000

Table (4)

Calculation of the income when the price is $12:

Particulars

Amount

($)

Sales (180,000×$12)2,160,000
Less: Costs (7.651×180,000)1,377,000
Income783,000

Table (5)

Therefore, if company is adopting the price of $12, then company is able to earn maximum profit.

Working Note:

1.

Calculation of cost rate:

Cost Rate=Latest ReductionUnits Savings=$16$8.35=$7.65

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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: Activities Costs Setting up equipment…

Chapter 5 Solutions

Managerial Accounting: The Cornerstone of Business Decision-Making

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  • Wayne Johnson, president of Banshee Company, recently returned from a conference on quality and productivity. At the conference, he was told that many American firms have quality costs totaling 20 to 30 percent of sales. He, however, was skeptical about this statistic. But even if the quality gurus were right, he was sure that his companys quality costs were much lowerprobably less than 5 percent. On the other hand, if he was wrong, he would be passing up an opportunity to improve profits significantly and simultaneously strengthen his competitive position. The possibility was at least worth exploring. He knew that his company produced most of the information needed for quality cost reportingbut there never was a need to bother with any formal quality data gathering and analysis. This conference, however, had convinced him that a firms profitability can increase significantly by improving qualityprovided the potential for improvement exists. Thus, before committing the company to a quality improvement program, Wayne requested a preliminary estimate of the total quality costs currently being incurred. He also indicated that the costs should be classified into four categories: prevention, appraisal, internal failure, or external failure. He has asked you to prepare a summary of quality costs and to compare the total costs to sales and profits. To assist you in this task, the following information has been prepared from the past year, 20x5: a. Sales revenue, 15,000,000; net income, 1,500,000. b. During the year, customers returned 90,000 units needing repair. Repair cost averages 1 per unit. c. Four inspectors are employed, each earning an annual salary of 60,000. These four inspectors are involved only with final inspection (product acceptance). d. Total scrap is 150,000 units. Of this total, 60 percent is quality related. The cost of scrap is about 5 per unit. e. Each year, approximately 450,000 units are rejected in final inspection. Of these units, 80 percent can be recovered through rework. The cost of rework is 0.75 per unit. f. A customer cancelled an order that would have increased profits by 150,000. The customers reason for cancellation was poor product performance. g. The company employs three full-time employees in its complaint department. Each earns 40,500 a year. h. The company gave sales allowances totaling 45,000 due to substandard products being sent to the customer. i. The company requires all new employees to take its three-hour quality training program. The estimated annual cost of the program is 30,000. Required: 1. Prepare a simple quality cost report classifying costs by category. 2. Compute the quality cost-to-sales ratio. Also, compare the total quality costs with total profits. Should Wayne be concerned with the level of quality costs? 3. Prepare a pie chart for the quality costs. Discuss the distribution of quality costs among the four categories. Are they properly distributed? Explain. 4. Discuss how the company can improve its overall quality and at the same time reduce total quality costs. 5. By how much will profits increase if quality costs are reduced to 2.5 percent of sales?
    Kimball Company has developed the following cost formulas: Materialusage:Ym=80X;r=0.95Laborusage(direct):Yl=20X;r=0.96Overheadactivity:Yo=350,000+100X;r=0.75Sellingactivity:Ys=50,000+10X;r=0.93 where X=Directlaborhours The company has a policy of producing on demand and keeps very little, if any, finished goods inventory (thus, units produced equals units sold). Each unit uses one direct labor hour for production. The president of Kimball Company has recently implemented a policy that any special orders will be accepted if they cover the costs that the orders cause. This policy was implemented because Kimballs industry is in a recession and the company is producing well below capacity (and expects to continue doing so for the coming year). The president is willing to accept orders that minimally cover their variable costs so that the company can keep its employees and avoid layoffs. Also, any orders above variable costs will increase overall profitability of the company. Required: 1. Compute the total unit variable cost. Suppose that Kimball has an opportunity to accept an order for 20,000 units at 220 per unit. Should Kimball accept the order? (The order would not displace any of Kimballs regular orders.) 2. Explain the significance of the coefficient of correlation measures for the cost formulas. Did these measures have a bearing on your answer in Requirement 1? Should they have a bearing? Why or why not? 3. Suppose that a multiple regression equation is developed for overhead costs: Y = 100,000 + 100X1 + 5,000X2 + 300X3, where X1 = direct labor hours, X2 = number of setups, and X3 = engineering hours. The coefficient of determination for the equation is 0.94. Assume that the order of 20,000 units requires 12 setups and 600 engineering hours. Given this new information, should the company accept the special order referred to in Requirement 1? Is there any other information about cost behavior that you would like to have? Explain.
    Variety Artisans has a bottleneck in their production that occurs within the engraving department. Arjun Naipul, the COO, is considering hiring an extra worker, whose salary will be $45,000 per year, to solve the problem. With this extra worker, the company could produce and sell 3,500 more units per year. Currently, the selling price per unit is $18 and the cost per unit is $5.85. Using the information provided, calculate the annual financial impact of hiring the extra worker.
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