Chapter 5, Problem 61P

John Thomas, vice president of Mallett Company (a producer of a variety of plastic products), has been supervising the implementation of an ABC management system. John wants to improve process efficiency by improving the activities that define the processes. To illustrate the potential of the new system to the president, John has decided to focus on two processes: production and customer service.

Within each process, one activity will be selected for improvement: materials usage 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 materials usage, the value-added standard calls for six pounds per unit of output (the products differ in shape and function, but their weight is uniform). The value-added standard is based on the elimination of all waste due to defective molds. The standard price of materials is $5 per pound. For sustaining engineering, the standard is 58% of current practical activity capacity. This standard is based on the fact that about 42% of the complaints have to do with design features that could have been avoided or anticipated by the company.

Current practical capacity (at the end of 20X1) is defined by the following requirements: 6,000 engineering hours for each product group that has been on the market or in development for 5 years or less and 2,400 hours per product group of more than 5 years. Four product groups have less than 5 years’ experience, and 10 product groups have more. Each of the 24 engineers is paid a salary of $60,000. Each engineer can provide 2,000 hours of service per year. No other significant costs are incurred for the engineering activity.

Actual materials usage for 20X1 was 25% above the level called for by the value-added standard; engineering usage was 46,000 hours. A total of 80,000 units of output were produced. John and the operational managers have selected some improvement measures that promise to reduce nonvalue-added activity usage by 40% in 20X2. Selected actual results achieved for 20X2 are as follows:

The actual prices paid for materials and engineering hours are identical to the standard or budgeted prices.

Required:

1. 1. For 20X1, calculate the nonvalue-added usage and costs for materials usage and sustaining engineering.
2. 2. CONCEPTUAL CONNECTION Using the budgeted improvements, calculate the expected activity usage levels for 20X2. Now, compute the 20X2 usage variances (the difference between the expected and actual values), expressed in both physical and financial measures, for materials and engineering. 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

Calculate the value of accounting costs which is apportion to a backpack before the duffle-bag line was added with the help of plant wide rate approach. Also, identify whether this approach is accurate or not.

Explanation of Solution

Non-Value Added Cost:

Non-value added cost refers to the cash and cash equivalents which are incurred due to the non-value activities or by the ineffective presentation of value-added activities.

Calculation of non-value added usage and costs for 20X1:

Particulars	Actual Quantity (A)	Value added Quantity (B)	Non-value usage (C) $\left(C=A-B\right)$	Standard Price (D)	Non-value cost $\left(C\times D\right)$ ($)
Materials	600,0001	480,0003	120,000	5	600,000
Engineering	48,0002	27,8404	20,160	305	604,800

Table (1)

Working Note:

1.

Calculation of actual quantity of material:

$\begin{array}{c}\text{Actual Quantity}=\text{Actual Material Usage}\times \text{Standard Calls}\times \text{Units Produced}\\ =\text{1}\text{.25}\times \text{6}\times \text{80,000}\\ =\text{600,000}\end{array}$

2.

Calculation of actual quantity of engineering:

$\begin{array}{c}\text{Actual Quantity}=\left[\begin{array}{c}\left(\text{Engineering hours}\times \text{Standard Calls}\right)\\ \text{+}\left(\text{Engineering hours}\times \text{Number of Product Groups}\right)\end{array}\right]\\ =\left(4\times 6,000\right)+\left(10\times 2,400\right)\\ =\text{48,000}\end{array}$

3.

Calculation of value added quantity of material:

$\begin{array}{c}\text{Value Added Quantity}=\text{Standard Calls}\times \text{Units Produced}\\ =\text{6}\times \text{80,000}\\ =\text{480,000}\end{array}$

4.

Calculation of value added quantity of engineering:

$\begin{array}{c}\text{Value Added Quantity}=\left[\begin{array}{c}\left(\text{Practical Activity Capacity}\times \text{Engineer Hours}\right)\\ \text{+}\left(\text{Practical Activity Capacity}\times \text{Engineer Hours}\right)\end{array}\right]\\ =\left(0.58+24,000\right)+\left(0.58+24,000\right)\\ =27,840\end{array}$

5.

Calculation of standard price of engineering:

$\begin{array}{c}\text{Standard Price}=\frac{\text{Number of Engineers}\times \text{Salary of each Engineer}}{\text{Actual Quantity of Engineering}}\\ =\frac{\text{24×\$60,000}}{\text{48,000}}\\ =\text{\$30}\end{array}$

To determine

Compute the value of expected activity usage levels for 20X2 with the help of budgeted improvements. Also, calculate the value of usage variances for 20X2. Explain the measures that company should take to capture any reductions in resource usage.

Explanation of Solution

Use the following formula to calculate expected activity usage levels for materials:

$\text{Expected Activity Usage Levels}=\left[\begin{array}{l}\text{Value Added Quantity}\\ \text{+}\left(\text{Value Added Activity Usage}\times \text{Non-Value Usage}\right)\end{array}\right]$

Substitute $480,000 for value added quantity, 60% for value added activity usage and 120,000 for non-value usage in the above formula.

$\begin{array}{c}\text{Expected Activity Usage Levels}=\left[\text{480,000+}\left(\text{60\%}\times 120,000\right)\right]\\ =552,00\text{0 pounds}\end{array}$

Therefore, an expected activity usage level for materials is 552,000 pounds.

Use the following formula to calculate expected activity usage levels for engineering:

$\text{Expected Activity Usage Levels}=\left[\begin{array}{l}\text{Value Added Quantity}\\ \text{+}\left(\text{Value Added Activity Usage}\times \text{Non-Value Usage}\right)\end{array}\right]$

Substitute $27,840 for value added quantity, 60% for value added activity usage and 20,160 for non-value usage in the above formula.

$\begin{array}{c}\text{Expected Activity Usage Levels}=\left[\text{27,840+}\left(\text{60\%}\times 20,160\right)\right]\\ =39,936\text{ hours}\end{array}$

Therefore, an expected activity usage level for engineering is 39,936 hours.

Calculation of non-value added usage and costs for 20X2:

Particulars	Actual Quantity (A)	Expected Quantity (B)	Excess Non-value usage (C) $\left(C=A-B\right)$	Standard Price (D)	Excess Non-value cost $\left(C\times D\right)$ ($)
Materials	584,800	552,000	32,800	5	164,000(U)
Engineering	35,400	39,936	4,536	30	136,080(F)

Table (2)

According to the above calculations, company is not able to attain the material standard but successfully achieve the engineering standard. The actual consumption of engineering is 35,400 hours and the activity usage is 48,000. Therefore, company is able to create an unused capacity of engineering of 12,600 hours $\left(48,000-35,400\right)$. For saving the engineering cost, company should use he available resources in an effective and efficient manner. The company takes various steps to save the cost. The various steps include:

• Company lay off the six engineers to increase the total profits of the organization by saving the salaries amount of $360,000.
• Company should reassign the activities that have insufficient resources it will also helps to the organization in saving the engineering cost.