Chapter 5 Activity-Based Management ANSWERS TO REVIEW QUESTIONS 5.1 ABC and ABM are both based on the concept that the work of an organization can be described as a set of related activities or processes. Costs of goods or services can be measured as the costs of the activities performed to provide the good or service. ABM goes another major step by analyzing activities for their degree of customer value-added. After identifying activities that add little or no customer value, ABM looks for ways to reduce or eliminate them by redesigning activities and processes. 5.2 Knowing the activities performed to provide a product or service, and knowing the cost of these activities, allows cost managers to estimate currently feasible costs. If these are in excess of target costs, cost managers can analyze current activities – perhaps starting with the low value-added activities – to find ways to achieve the target cost reduction. 5.3 The target cost is a function of the sales price and the organization’s target return. For example, if the sales price per unit is $10 and the company requires a minimum return of 15% on sales, the target cost would be $8.50 [= $10 – (.15 x $10)]. If the target cost cannot be met through process change (say $9 is the best the company can do), then the company can either increase the sales price to achieve the desired return on sales of 15%, or decrease the required return on sales. 5.4 The primary advantage of using current processes to evaluate the feasibility of future processes is that the company has a working knowledge of the activities and costs required to perform current activities. Assuming future processes are similar, existing costs can be modified to reflect these future processes making for a more accurate estimate than if the company had no previous experience. The primary disadvantage is that current processes may have inertia and workers involved in the processes may have little incentive or ability to think about improving them. 5.5 Examples of value-added activities: • Assembling products • Making customer contacts and sales • Providing before- and after-sale service • Designing products for ease of repair Examples of non-value-added activities: • Reworking or repairing faulty products • Storing excess inventory • Manual data entry • Moving inventory from the assembly line to the finished goods warehouse 5.6 Non-value-added activities consume scarce resources but do not add to the organization’s ability to earn revenue or create markets for future sales. Similarly, waste consumes resources but does not result in salable products or services. Both are candidates for reduction or elimination by organizations seeking to become more efficient. 5.7 If one eliminates non-value-added activities carefully, wasted resources should be reduced or eliminated, too. However, one cannot just stop performing non-value-added activities without redesigning the work and processes of the organization. Without redesigning processes, eliminating non-value-added activities may mean even more waste because products and services may not be completed in a timely manner or with all their necessary attributes. 5.8 The questions that help discriminate between value-added and non-value-added activities are: • "Would an external customer encourage the organization to do more of that activity?" • "Would the organization be more likely to reach its goal by performing that activity?" 5.9 A good example of how organizations can reduce spending by eliminating non-value-added activities is eliminating the rework of defective products. If reworking defective products is no longer needed (as a result of process improvements), then costs for labor, space, and materials may no longer be incurred. However, these savings are dependent on the elimination of resources supplied (e.g., labor and space), or the reassignment of resources supplied to another activity within the company that is value-added. An additional benefit of eliminating non-value-added activities is the improvement of existing processes and activities, which typically leads to improved products at lower cost. 5.10 A pilot project is like an experiment on a small scale to test the feasibility of a proposed change and to learn about the activities that will be necessary to implement the change on a larger scale. When contemplating a major, systematic change that will affect most of the processes and individuals in an organization, a pilot project is a sensible way to begin. If the pilot project goes badly, few resources will have been wasted, and the organization may learn what NOT to do next time. 5.11 ABM looks for ways to improve processes by eliminating non-value-added activities. These activities may be an employee’s primary job, and the employee will naturally resist eliminating the activities unless she is involved and is assured of obtaining work elsewhere within the company. Also, employees often resist ABM if it is not explained well and does not solicit and use input from those affected by the change. 5.12 Most users of ABM recognize that perfectly accurate information will never be available for any project, but that does not stop forward progress. As long as the ABM information is reasonably accurate and reliable, organizations can use it with assurance that improvements will be made. How much accuracy is needed before decision makers can act with comfort depends on the importance and impact of the decision, how easily decisions can be changed, and the expertise and judgment of the decision makers. ANSWERS TO CRITICAL ANALYSIS 5.13 One should anticipate some resistance to process improvements that may be accomplished by eliminating non-value-added activities. Some individuals will seek to protect their current situation because it is either comfortable to not change or threatening to change. Educating individuals about the needs and benefits of process improvements is almost always necessary before designing and implementing changes that will directly affect people’s work routines and responsibilities. 5.14 If more highly trained employees are hired, the company must do something with the other employees – fire them or reassign them. This may create an unwanted company reputation of making employees expendable. An alternative may be to provide training to existing employees to decrease the number of mistakes made, and to emphasize the importance of continually improving processes. In addition to training, perhaps a bonus system could be implemented to encourage employees to make process improvement recommendations. 5.15 This choice is based on the costs and benefits of detailed versus broad analysis. Providing 100 small activities for a process would provide a level of detail that might reveal many non-value-added uses of scarce resources. The ultimate decision is based on the resources available to perform the analysis (100 costs more than 10), and how the resulting information will be used (more detail is only helpful if the information is used productively). 5.16 Some activities can simultaneously be non-value-added from a customer’s perspective and absolutely essential from a business perspective. Tax reporting is one of these activities that cannot be eliminated without serious consequences. However, because these activities are non-value-added, the organization should seek to conduct them at the lowest possible cost while maintaining the required level of quality. ABM does not purport to eliminate all non-value-added activities. It does help identify them, so if they cannot be eliminated, the organization can minimize the use of its resources on them. Many believe this outlook is responsible for the tremendous growth of outsourcing in recent years. 5.17 In those years, many organizations were obsessed with downsizing, which sought to reduce spending levels to achieve competitiveness. What many organizations failed to recognize was that simply cutting resources without redesigning the work that needed to be done could be a recipe for reduced competitiveness. Many employees were exhorted to “work smarter,” but they learned that this really meant “work longer,” because the same work had to be done with fewer resources. Across the board budget cuts are symptomatic of a misguided approach to improving competitiveness. ABM, on the other hand, seeks to reduce spending (if that is desired) by identifying what activities should be eliminated because they do not add value and which should be retained or enhanced because they do add value. 5.18 Kodak apparently sought to save costs by reducing its workforce, without redesigning the work that had to be done by the fewer remaining employees. As a result, it had to outsource some of the work that it no longer could complete. For Kodak to gain financially from this arrangement, the quality of the work by the outsourced service provider would have to be at least as high as before, and the out-of-pocket cost savings from reduced benefits, equipment, and space would have to be equivalent to $50 per hour ($65 paid to the contractor less the $15 that was paid to the former employee). Other factors to consider are (a) reduced morale and productivity in the remaining workers, and (b) increased flexibility from having a smaller workforce. 5.19 This is another manifestation of a short-sighted approach to improving profitability. Management has many ways to cut current costs that can benefit the bottom line today but may adversely affect the bottom line in the future. For example, cutting workers with key skills could leave the company unable to accommodate new challenges. Reducing training or research and development can reduce current expenses, but may result in less intellectual capital and future returns. The Wall Street Journal referred to many efforts as “dumbsizing” because apparently no thought was given to the future impacts of reckless cost cutting and downsizing actions. 5.20 Connecticut Mutual has reduced its labor costs (salaries and benefits) dramatically by the buyout plan. However, because it lost mostly senior employees, a lot of human capital walked out the door. New, less experienced employees may be less expensive, but they also may be less capable and knowledgeable. The company may have to spend more than they expected for training, supervision, and systems to help inexperienced workers respond to complex problems. 5.21 Across-the-board cuts in resources have the real possibility of leaving the organization worse off than before. The reason is that these “fair” cuts run the risk of eliminating value-added and non-value-added activities alike. This is a quick and dirty way to reduce spending, but in most cases will do as much harm as good. An ABM approach takes more time, and if begun before there is a crisis, can generate lasting benefits from increased knowledge about processes and proven ways to continuously improve. Because government agencies seem to lag private firms in the adoption of new management techniques, across the board cuts still are common in government agencies and may be the only way to achieve cuts. The attitude may be, “Let’s get the cuts in the only way we can, and then figure out how to get the work done with fewer resources.” This is not how one would choose to improve efficiency with ABM, but it may reflect a political reality. SOLUTIONS TO EXERCISES 5.22 (15 min) Activity analysis Answers will vary. One possible list of sub-activities follows. We leave it to students to assign value scores. (We think the sub-activities under “4” are most important, but then we are professors.) 1. Gather study materials 1.1 Borrow notes from others 1.2 Download homework and example problem solutions 1.3 Find textbook 2. Organize study materials 2.1 Copy notes from other students 2.2 Print problem solutions 2.3 Print practice exam 3. Organize support materials 3.1 Buy junk food and coffee 3.2 Find lost CD’s 3.3 Clean room to make study area 4. Study 4.1 Outline chapters 4.2 Review lecture notes and chapter outlines 4.3 Work homework and example problems 4.4 Work practice exam 5.23 (15 min) Steps in ABC and ABM ABC: • Identify and classify the activities related to the company’s goods and services • Estimate the cost of the activities • Calculate a cost-driver rate • Assign activity costs to goods and services ABM: • Identify activities as value-added or non-value added • Score each activity as high or low value-added as perceived by the customer • Identify opportunities to enhance value-added activities and to reduce or eliminate non-value-added activities 5.24 (20 min) ABC and ABM steps ABC: • Identify and classify the activities related to the company’s goods and services • Estimate the cost of the activities • Calculate a cost-driver rate • Assign activity costs to goods and services ABM: • Identify activities as value-added or non-value-added • Score each activity as high or low value-added as perceived by the customer • Identify opportunities to enhance value-added activities and to reduce or eliminate non-value-added activities 5.25 (20 min) Activity analysis Answers will vary. No. Activity Hours 1.0 Receive beverages 1.1 unload vehicle 1,200 1.2 compare products to purchase order 400 1.3 check products for damage 500 1.4 return damaged products to supplier 300 1.5 return incorrect products to supplier 300 1.6 update inventory records when product received 200 2.0 Store beverages 2.1 identify where to locate product 700 2.2 physically store products 1,400 3.0 Pack, mark and prepare customer orders for shipping 3.1 retrieve products from storage 1,500 3.2 package and label products by customer order 400 3.3 place orders on loading dock for shipment 300 4.0 Ship customer orders 4.1 prepare invoice and notification of shipment 500 4.2 load vehicle 1,400 4.3 update inventory records when product shipped out 500 5.26 (20 min.) Value-added analysis Answers will vary depending on the value scores assigned to each activity. One possible answer follows: No. Activity Hours Value 1.0 Receive beverages 1.1 unload vehicle 1,200 2 1.2 compare products to purchase order 400 1 1.3 check products for damage 500 2 1.4 return damaged products to supplier 300 1 1.5 return incorrect products to supplier 300 1 1.6 update inventory records when product received 200 1 2.0 Store beverages 2.1 identify where to locate product 700 1 2.2 physically store products 1,400 2 3.0 Pack, mark and prepare customer orders for shipping 3.1 retrieve products from storage 1,500 3 3.2 package and label products by customer order 400 3 3.3 place orders on loading dock for shipment 300 3 4.0 Ship customer orders 4.1 prepare invoice and notification of shipment 500 4 4.2 load vehicle 1,400 5 4.3 update inventory records when product shipped out 500 2 5.27 (20 min) Value-added analysis No. Activity Hours Cost (= Hours x $20) Value 1.0 Receive beverages 1.1 unload vehicle 1,200 $24,000 2 1.2 compare products to purchase order 400 $8,000 1 1.3 check products for damage 500 $10,000 2 1.4 return damaged products to supplier 300 $6,000 1 1.5 return incorrect products to supplier 300 $6,000 1 1.6 update inventory records when product received 200 $4,000 1 2.0 Store beverages 2.1 identify where to locate product 700 $14,000 1 2.2 physically store products 1,400 $28,000 2 3.0 Pack, mark and prepare customer orders for shipping 3.1 retrieve products from storage 1,500 $30,000 3 3.2 package and label products by customer order 400 $8,000 3 3.3 place orders on loading dock for shipment 300 $6,000 3 4.0 Ship customer orders 4.1 prepare invoice and notification of shipment 500 $10,000 4 4.2 load vehicle 1,400 $28,000 5 4.3 update inventory records when product shipped out 500 $10,000 2 Total $192,000 5.28 (30 min) ABM Answers will vary depending on the value scores assigned to each activity. The following answer is based on the value scores from the previous two exercises. Sum of Annual cost Customer value Total 1 $ 38,000 2 72,000 3 44,000 4 10,000 5 28,000 Total $ 192,000 Whether LDC could save the costs assigned to low-valued activities (rated 1 or 2), depends on whether LDC can eliminate the need for the resources. Employees would have to be dismissed, reassigned to another area of the company, or given other tasks in order to save the expenditures. In that case, the work would have to be redesigned to eliminate the need for those low-valued activities. Some of the lowest-valued activities are associated with incorrect or damaged incoming products. Physically storing products also consumes considerable resources for little return in customer value. Some companies have outsourced inventory activities to suppliers who ship directly to customers. LDC would have to be assured that suppliers would exercise the same care and provide the same level of customer services as LDC would for this to be successful. 5.29 (20 min) Activity-based analysis Answers will vary. No. Activity Hours 1.0 Receive claims 1.1 take phone call 1,000 1.2 refer phone call by claim type 800 1.3 open mail 700 1.4 sort mail by claim type 200 1.5 log in claim 500 2.0 Check information 2.1 verify completeness of information on written claim 900 2.2 verify accuracy of policy information on written claim 1,000 2.3 compare coverage in policy to casualty or loss claim 800 3.0 Analyze claim 3.1 return incorrect claims to policyholders 400 3.2 review incorrect claims with policyholders 500 4.0 Forward claim to adjuster 4.1 file multiple copies of claims 1,400 4.2 package copy of claim and policy for shipment to adjuster 500 4.3 send claim and policy copy to adjuster 400 4.4 log out claim 500 EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 5.30 (20 min) Value-added analysis Answers will vary depending on the value scores assigned to each activity. One possible answer follows: No. Activity Hours Value 1.0 Receive claims 1.1 take phone call 1,000 5 1.2 refer phone call by claim type 800 4 1.3 open mail 700 4 1.4 sort mail by claim type 200 4 1.5 log in claim 500 2 2.0 Check information 2.1 verify completeness of information on written claim 900 3 2.2 verify accuracy of policy information on written claim 1,000 3 2.3 compare coverage in policy to casualty or loss claim 800 2 3.0 Analyze claim 3.1 return incorrect claims to policyholders 400 1 3.2 review incorrect claims with policyholders 500 5 4.0 Forward claim to adjuster 4.1 file multiple copies of claims 1,400 1 4.2 package copy of claim and policy for shipment to adjuster 500 1 4.3 send claim and policy copy to adjuster 400 1 4.4 log out claim 500 1 EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 5.31 (20 min) Value-added analysis Answers will vary depending on the value scores assigned to each activity. This answer is consistent with the previous exercise. No. Activity Hours Cost (= Hours x $20) Value 1.0 Receive claims 1.1 take phone call 1,000 $20,000 5 1.2 refer phone call by claim type 800 $16,000 4 1.3 open mail 700 $14,000 4 1.4 sort mail by claim type 200 $4,000 4 1.5 log in claim 500 $10,000 2 2.0 Check information 2.1 verify completeness of information on written claim 900 $18,000 3 2.2 verify accuracy of policy information on written claim 1,000 $20,000 3 2.3 compare coverage in policy to casualty or loss claim 800 $16,000 2 3.0 Analyze claim 3.1 return incorrect claims to policyholders 400 $8,000 1 3.2 review incorrect claims with policyholders 500 $10,000 5 4.0 Forward claim to adjuster 4.1 file multiple copies of claims 1,400 $28,000 1 4.2 package copy of claim and policy for shipment to adjuster 500 $10,000 1 4.3 send claim and policy copy to adjuster 400 $8,000 1 4.4 log out claim 500 $10,000 1 Total 9,600 $192,000 EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 5.32 (30 min) Activity-based management Answers will vary depending on the value scores assigned to each activity. The following answer is consistent with the previous exercise. Sum of Annual cost Customer value Total 1 $ 64,000 2 26,000 3 38,000 4 34,000 5 30,000 Total $ 192,000 Whether MII could save the $90,000 in costs assigned to low-valued activities (rated 1 or 2), depends on whether MII can eliminate the need for the resources used on those activities. Employees would have to be dismissed or reassigned to another area of the company in order to save this much. But before the employees could be dismissed or reassigned, the work would have to be redesigned to eliminate the need for those low-valued activities. The lowest-valued activities are associated with incorrect incoming information and record keeping, which have little return in customer value. Some companies have turned to electronic data entry via the Internet to eliminate errors and to provide quick feedback to customers. EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 5.33 (30 min) Identify opportunities for process improvement Answers will vary, but should clearly identify a significant non-value-added activity, such as correcting registration errors or grading errors on exams. The answer should show serious thought about why the activity is performed, how the activity can be minimized or eliminated, and what complications might arise from eliminating or changing the activity. 5.34 (45 min) Target costing Answers for requirements (a) and (b) are based on analysis presented below. a. The monthly cost reduction target changes to $46,200 from the original $49,400 (a reduction of $3,200). b. The cost reduction target as a percentage of currently feasible costs decreases to 13.4 percent (from the original 15.4 percent). Target Cost Calculation Expected monthly revenue per MegaBurger contract $374,000 (22,000 units x $17 per unit) Less required return on sales (20% of revenue) (74,800) Target cost per month $299,200 Cost-driver Total Currently feasible costs per month Cost-driver rate* base* estimated cost Unit-level resources and activities Acquire and use materials $12 per unit 22,000 units $264,000 Batch-level resources and activities Setup and quality control - computer controlled equipment $600 per batch 10 batches $6,000 Product-level resources and activities Design and manufacture of molds $2,000 per mold 2 molds $4,000 Use computer controlled equipment $40,000 per product 1 product $40,000 Customer-level resources and activities Consult customers $200 per consultation 40 consultations $8,000 Provide additional warehousing $0.30 per cubic foot 10,000 cubic ft. $3,000 Facility-level resources and activities Manage workers 40% of production $6,000 prod'n labor costs labor costs $2,400 Use building space $3 per square foot 6,000 square ft. $18,000 Total feasible costs per month $345,400 Monthly cost reduction target $46,200 Percent cost reduction target 13.4% * Information is from Exhibit 5-1, except for the 22,000 units which is given in the problem. EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 5.35 (45 min) Target costing Answers for requirements (a) and (b) are based on the analysis presented below. a. The monthly cost reduction target changes to $17,400 from the original $49,400 (a reduction of $32,000). b. The cost reduction target as a percentage of currently feasible costs decreases to 5.4 percent (from the original 15.4 percent). Target Cost Calculation Expected monthly revenue per MegaBurger contract $380,000 (20,000 units x $19 per unit) Less required return on sales (20% of revenue) (76,000) Target cost per month $304,000 Cost-driver Total Currently feasible costs per month Cost-driver rate* base* estimated cost Unit-level resources and activities Acquire and use materials $12 per unit 20,000 units $240,000 Batch-level resources and activities Setup and quality control - computer controlled equipment $600 per batch 10 batches $6,000 Product-level resources and activities Design and manufacture of molds $2,000 per mold 2 molds $4,000 Use computer controlled equipment $40,000 per product 1 product $40,000 Customer-level resources and activities Consult customers $200 per consultation 40 consultations $8,000 Provide additional warehousing $0.30 per cubic foot 10,000 cubic ft. $3,000 Facility-level resources and activities Manage workers 40% of production $6,000 prod'n labor costs labor costs $2,400 Use building space $3 per square foot 6,000 square ft. $18,000 Total feasible costs per month $321,400 Monthly cost reduction target $17,400 Percent cost reduction target 5.4% * Information is from Exhibit 5-1. EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 5.36 (45 min) Target costing Answers for requirements (a) and (b) are based on the analysis presented below. a. The monthly cost reduction target changes to $35,800 from the original $49,400 (a reduction of $13,600). b. The cost reduction target as a percentage of currently feasible costs decreases to 11.1 percent (from the original 15.4 percent). Target Cost Calculation Expected monthly revenue per MegaBurger contract $340,000 (20,000 units x $17 per unit) Less required return on sales (16% of revenue) (54,400) Target cost per month $285,600 Cost-driver Total Currently feasible costs per month Cost-driver rate* base* estimated cost Unit-level resources and activities Acquire and use materials $12 per unit 20,000 units $240,000 Batch-level resources and activities Setup and quality control - computer controlled equipment $600 per batch 10 batches $6,000 Product-level resources and activities Design and manufacture of molds $2,000 per mold 2 molds $4,000 Use computer controlled equipment $40,000 per product 1 product $40,000 Customer-level resources and activities Consult customers $200 per consultation 40 consultations $8,000 Provide additional warehousing $0.30 per cubic foot 10,000 cubic ft. $3,000 Facility-level resources and activities Manage workers 40% of production $6,000 prod'n labor costs labor costs $2,400 Use building space $3 per square foot 6,000 square ft. $18,000 Total feasible costs per month $321,400 Monthly cost reduction target $35,800 Percent cost reduction target 11.1% * Information is from Exhibit 5-1. EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 5.37 (10 min) Resources supplied versus resources used Resources Resources Unused Activity Supplied Used* Resources* * Energy $7,300 $6,600 $700 Marketing 5,500 5,000 500 * Resources used = Cost driver rate x Cost driver volume ** Unused resources = Resources supplied – Resources used 5.38 (10 min) Resources supplied versus resources used Resources Resources Unused Activity Supplied Used* Resources** Machine setups $10,000 $8,000 $2,000 Administrative 3,500 3,300 200 * Resources used = Cost driver rate x Cost driver volume ** Unused resources = Resources supplied – Resources used 5.39 (25 min) Resources supplied versus resources used a. Resources Resources Unused Activity Supplied Used* Resources** Materials $50,000 $50,000 $ 0 Energy 8,000 6,300 1,700 Setups 3,500 3,000 500 Purchasing 3,000 2,600 400 Customer service 3,200 3,000 200 Long-term labor 12,000 10,500 1,500 Administrative 24,000 20,000 4,000 * Resources used = Cost driver rate x Cost driver volume ** Unused resources = Resources supplied – Resources used b. Managers should know what resources are unused so they can make better decisions regarding the elimination of unused resources or utilizing unused resources for some other purpose or product. Also, this information can be used to assess the impact that increasing production would have on costs. For example, the company can do 10 more setups without increasing the supply of resources (= $500 resources unused ÷ $50 per setup). SOLUTIONS TO PROBLEMS 5.40 (20 min) Implementing ABC and ABM a. Employees may have opposed ABC/ABM at Chrysler for several reasons: • Perhaps the employees were not involved in the decision to convert to an ABC/ABM system, and therefore, had no vested interest in making it work. • Employees may have enjoyed working in areas where inefficient processes were identified by the ABC/ABM process. • The ABC/ABM system likely represented a threat to the employees’ jobs, particularly where processes were to be changed. b. Several steps could have been taken to mitigate the resistance of employees: • Management could have tried a pilot project in a specific area of the company to enhance the learning and development that must take place early on in the implementation of ABC/ABM. This would identify the difficulties and benefits of the new system in a localized area before taking the project to the entire company. • Sufficient resources should be provided along with management support to provide a realistic chance of the new cost management system to succeed. • Employees at all levels within the company should have been involved in the process, and reassured that they would have meaningful jobs within the redesigned organization. Note: For an excellent discussion about issues in implementing ABC in the auto industry, see the book, Implementing management innovations: lessons learned from activity-based costing in the automobile industry, by Shannon Anderson and S. Mark Young, published by Kluwer Academic Publishers, Boston, 2001. 5.41 (60 min) ABC and target costing a. Target Cost Calculation Expected monthly revenue $324,000 (18,000 units x $18 per unit) Less required return on sales (20% of revenue) (64,800) Target cost per month $259,200 Times 36 months (product life) 36 Target cost for 3 years (product life) $9,331,200 Cost-driver Total Currently feasible costs for three years Cost-driver rate1 base estimated cost Unit-level resources and activities Acquire and use materials $12 per unit 18,000 units $216,000 Batch-level resources and activities Set up manually controlled machines $600 per batch 12 batches $7,200 Product-level resources and activities Design and manufacture of molds $4,000 per mold 2 molds $8,000 Use manually controlled equipment $40,000 per set of machines 1 set of machines $40,000 Customer-level resources and activities Consult customers $200 per consultation 20 consultations $4,000 Provide additional warehousing none $0 Facility-level resources and activities Manage workers $4,000 per month n.a. $4,000 Use building space $12,000 per month n.a. $12,000 Total feasible costs per month $291,200 Times 36 months x 36 Total feasible costs for three years $10,483,200 Three year cost reduction target $1,152,000 Percent cost reduction target 11% 1 Information provided as part of the problem b. The manager responsible for making this decision would recommend to produce the product only if the company could find ways to reduce its costs by at least 11 percent ($1,152,000) over three years. Perhaps through the use of ABC and ABM, PMI can find areas within the company performing non-value-added activities that can be reduced or eliminated. In addition, PMI may be willing to reduce its return on sales target of 20%. Another alternative, in addition to addressing activities within the company, might be to have further negotiations with the customer to discuss an increase in sales price from $18 per unit. It is also important to point out that this is a 3-year project. The analysis above does not consider the time value of money. As a result, the manager making the decision will likely want to look at the present value of all future cash flows in assessing this product. EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 5.42 (60 min) ABC and target costing a. Target Cost Calculation Expected monthly revenue $384,000 (24,000 units x $16 per unit) Less required return on sales (30% of revenue) (115,200) Target cost per month $268,800 Times 36 months (product life) 36 Target cost for 3 years (product life) $9,676,800 Cost-driver Total Currently feasible costs for three years Cost-driver rate1 base estimated cost Unit-level resources and activities Acquire and use materials $11 per unit 24,000 units $264,000 Batch-level resources and activities Set up manually controlled machines $600 per batch 12 batches $7,200 Product-level resources and activities Design and manufacture of molds $3,000 per mold 2 molds $6,000 Use manually controlled equipment $40,000 per set of machines 1 set of machines $40,000 Customer-level resources and activities Consult customers $300 per consultation 24 consultations $7,200 Provide additional warehousing $0.30 per cubic foot 8,000 cubic feet $2,400 Facility-level resources and activities Manage workers 30% $8,000 $2,400 Use building space $20,000 per month n.a. $20,000 Total feasible costs per month 349,200 Times 36 months x 36 Total feasible costs for three years $12,571,200 Three year cost reduction target $2,894,400 Percent cost reduction target 23.02% 1 Information provided as part of the problem b. The manager responsible for making this decision would recommend to produce the product only if the company could find ways to reduce its costs by at least 23.02 percent, or $2,894,400 over three years --- a significant amount. Perhaps through the use of ABC and ABM, PMI can find areas within the company performing non-value-added activities that can be reduced or eliminated. In addition, PMI may be willing to reduce its return on sales target of 30%. Another alternative, in addition to addressing activities within the company, might be to have further negotiations with the customer to discuss an increase in sales price from $16 per unit. It is also important to point out that this is a 3-year project. The analysis above does not consider the time value of money. As a result, the manager making the decision will likely want to look at the present value of all future cash flows in assessing this product. EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 5.43 (60 min) ABC and target costing a. Target Cost Calculation Expected monthly revenue $285,000 (15,000 units x $19 per unit) Less required return on sales (25% of revenue) (71,250) Target cost per month $213,750 Times 36 months (product life) 36 Target cost for 3 years (product life) $7,695,000 Cost-driver Total Currently feasible costs for three years Cost-driver rate1 base estimated cost Unit-level resources and activities Acquire and use materials $9 per unit 15,000 units $135,000 Batch-level resources and activities Set up manually controlled machines $800 per batch 12 batches $9,600 Product-level resources and activities Design and manufacture of molds $3,000 per month 2 molds $6,000 Use manually controlled equipment $40,000 per set of machines 1 set of machines $40,000 Customer-level resources and activities Consult customers $150 per consultation 15 consultations $2,250 Provide additional warehousing none $0 Facility-level resources and activities Manage workers $2,000 per month n.a. $2,000 Use building space $14,000 per month n.a. $14,000 Total feasible costs per month $208,850 Times 36 months x 36 Total feasible costs for three years $7,518,600 Three year cost reduction target ($176,400) Percent cost reduction target (2.34%) 1 Information provided as part of the problem b. Note that the total feasible costs ($7,518,600) are below the target costs ($7,695,000). This indicates that the company would meet its target costs (and therefore its target profits) without having to make any changes in its production process. Assuming the estimates are relatively accurate, the manager would likely opt to produce this product. The analysis above indicates that the product would exceed the company’s required rate of return on sales of 25 percent. However, the analysis above does not consider the time value of money. As a result, the manager making the decision will likely want to look at the present value of all future cash flows in assessing this product. EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 5.44 (30 min) Value-added analysis a. The customer value scores should come from those who are objective and knowledgeable about what customers value and what the organization must do to meet its goals. It is unlikely, however, that one person could measure value reliably and without bias. Thus, it is typically best to have groups of employees determine value scores, perhaps using customer input (from surveys, focus groups, etc.). Values in the last column of the table should reflect customer value as perceived by the customer (i.e., the co-op grocery store). One could argue that some of these activities are for support purposes and probably are not perceived by customers as adding value to the product (e.g., hardware, software, and infrastructure for Hoffman). These activities are appropriately rated low because they do not in themselves add value to the co-op grocery store. b. Value Total Cost Percent Activity 1 $ 6,000 11.8 1.6 2 16,000 31.4 1.5 3 None 4 11,000 21.6 1.1, 1.3 5 18,000 35.3 1.2, 1.4 Total $51,000 100.0% (rounded) 57 percent of the processes within the major activity “marketing and design” are valued highly by the customer (rated 4 and 5), and the remaining 43 percent of the processes are not valued highly by the customer (rated 1 and 2). This indicates that Hoffman should direct its resources to the activities that are highly valued by customers (e.g., marketing research for the customer, programming and constructing the site, etc.), and minimize the resources spent on low-valued activities (e.g., payroll services, personnel administrations, etc.). EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 5.45 (45 min.) Value-added analysis, group project Answers will vary by group. Students should address the activities in a restaurant for two different types of events – a favorite place for a meal, and a place to have a meeting. Activities should be identified, and a valuation assigned, for each of the following areas: 1) the steps involved to prepare a meal; 2) the steps involved to serve a customer; and 3) the steps involved to clean up after the meal has been served. 5.46 (45 min.) Value-added analysis, group project Answers will vary by group. Students should address the activities in two different health care provider settings – a campus health care center (to be treated for influenza), and a hospital (to have major surgery). Activities should be identified, and a valuation assigned, for each of the following areas: 1) the steps involved to serve a patient; and 2) the steps involved to clean up after the patient has been discharged. 5.47 (40 min) ABM and process improvements a. & b. See table on the next page. With the current revenue and cost structure, this does not appear to be a profitable venture. She needs to find activities where she can cut current costs. This seems challenging because the largest cost is perhaps the least changeable – purchasing service from AT&T, which probably has a monopoly on local phone service and little incentive to cut prices to small operators like Ema. She should evaluate other options. For example, she might increase the number of customers by reducing her price. 5.47 (continued) A B C D E Expected service price $40 Less required return on sales 20% x $40 ($8) Target cost per unit of service $32 Multiplied by number of customers 1,000 Total target cost for one month $32,000 Currently feasible costs: Unit-level activities Purchase of phone service $ 20.00 x 1,000 $ 20,000 Invoicing and billing 3.00 x 1,000 3,000 Customer-level activities Credit analysis, new customers 25.00 x 100* 2,500 Service installation, new customers 45.00 x 100* 4,500 Facility-level activities Bill collecting 960.00 x 1 960 Advertising and promotion 400.00 x 1 400 Building occupancy 1,000.00 x 1 1,000 Equipment utilization 300.00 x 1 300 Business planning and analysis 1,600.00 x 1 1,600 Monthly currently feasible costs 34,260 Monthly cost reduction target $ 2,260 Percent monthly cost reduction target 6.6% *100 = 10% new customers each month times 1,000 total customers c. Build your own spreadsheet EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 5.48 (60 min) ABM and process improvements a. This problem is open ended with lots of opportunity for discussion. Here are some key points. First, it is likely that the only expenditures saved would be advertising and relocation expenses if the lab does not recruit for the position. The remainder of the costs are committed costs that the lab will incur because of its decisions to maintain the personnel involved in the recruiting process. These personnel spend most of their time on other tasks, and are likely salaried personnel. Therefore, the cost savings is the savings in opportunity costs from having people give up their time doing other tasks to work on the recruitment. b. We like to divide students into groups to assign values to activities. Expect to find some variation among the groups. We point out that the objective of this work is to identify non-value-added activities (there should be some that all groups agree upon). Then the class should brainstorm ways to reduce the costs of those activities. Our approach is to pretend that we are the customers (i.e., doctors and patients). As such, we care about the quality of the work done, so we want the facility to hire an excellent medical technologist. The problem asks for a distinction only between value-added and non-value-added activities. Using a two point scale (5 = value-added, 1 = non-value-added), one could label the activities as shown below. Recruitment activity Personnel Hourly rate Recruitment cost Value Review need to retain position HR director $40 $ 160 1 Revise job description HR analyst 15 120 1 Assess labor trends and compensation HR director 40 320 1 Prepare and post job advertisement HR analyst 15 120 1 Screen applications, verify credentials HR analyst 15 180 5 Schedule personal interviews HR analyst 15 90 1 Conduct personal interviews Lab director 60 720 5 HR director 40 240 5 Select finalist and make offer Lab director 60 120 5 HR director 40 40 5 Process new employee paperwork HR analyst 15 60 1 Pay relocation expenses for new employee 1,000 5 Provide orientation and training for new employee HR analyst 15 60 5 Lab director 60 120 5 Technician 30 1,200 5 Total recruitment cost (i.e., based on out of pocket cost) $4,550 5.48 (continued) The ratio of non-value-added to value-added is 19:81: Value Total Percent 1 $ 870 19% 5 3,680 81% Grand Total $ 4,550 100% c. The most effective way to increase the HR department’s proportion of value-added activities is to start with the costliest non-value-added activities and find ways to minimize or eliminate these activities. The costliest non-value-added activity is the HR director’s assessment of labor trends and compensation. The company should consider having someone else in the HR department take this on at a lower hourly rate, or outsourcing this activity. Next, one could look for ways to reduce the amount of time spent by the HR director and HR analyst to review the need for the position, revise the job description, prepare and post the advertisement, schedule interviews, and process new employee paperwork. EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 5.49 (30 min) ABM income statement a. Resources Unused Resources Used Capacity Supplied Sales $ 100,000 Unit-level activity costs Materials $ 15,000 $ - $ 15,000 Energy 5,000 - 5,000 Short-term labor 2,000 400 2,400 Contracts 3,000 - 3,000 $ 25,000 $ 400 $ 25,400 Batch-level activity costs Setups $ 9,000 $ 2,000 $ 11,000 Quality inspections 4,500 500 5,000 $ 13,500 $ 2,500 $ 16,000 Product-level activity costs Parts management $ 3,000 $ 500 $ 3,500 Marketing 7,000 500 7,500 Engineering 4,000 - 4,000 $ 14,000 $ 1,000 $ 15,000 Customer-level activity costs Customer service $ 1,000 $ 1,000 $ 2,000 Facility-level activity costs Long-term labor $ 2,500 $ 1,000 $ 3,500 Depreciation 6,000 4,000 10,000 Administrative 5,000 2,000 7,000 $ 13,500 $ 7,000 $ 20,500 Total costs $ 67,000 $ 11,900 $ 78,900 Operating profit $ 21,100 b. ABM income statements differentiate between resources used and resources supplied. Providing information on unused resources helps managers make better decisions to lower costs or use resources more efficiently. The relatively significant unused resources – setups and depreciation -- signal areas of potential savings for management. Unused resources provided for batch setups might be reduced or utilized to build up inventory in preparation for peak demand seasons. Depreciation is the reduction in value of a resource. In this case, only 60% of the reduced value was used in production, implying that 40% of this resource is available for other uses. Perhaps unused capacity can be leased to another firm or utilized by other departments in the company. EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE 5.50 (30 min) ABM income statement EXCEL SOLUTIONS ARE FOUND IN EXCEL SOLUTIONS FILE a. Resources Unused Resources Used Capacity Supplied Sales $ 350,000 Unit-level activity costs Materials $ 60,000 $ - $ 60,000 Energy 20,000 1,000 21,000 Short-term labor 7,000 - 7,000 Outside contracts* 12,000 - 12,000 $ 99,000 $ 1,000 $ 100,000 Batch-level activity costs Setups $ 17,000 $ 3,000 $ 20,000 Quality inspections 15,000 -- 15,000 $ 32,000 $ 3,000 $ 35,000 Product-level activity costs Parts management $ 15,000 $ 1,000 $ 16,000 Marketing 28,000 2,000 30,000 Engineering changes 10,000 2,000 12,000 $ 53,000 $ 5,000 $ 58,000 Customer-level activity costs Customer service $ 6,000 $ 2,000 $ 8,000 Facility-level activity costs Long-term labor $ 10,000 $ 4,000 $ 14,000 Depreciation 24,000 16,000 40,000 Administrative 20,000 10,000 30,000 $ 54,000 $ 30,000 $ 84,000 Total costs $ 244,000 $ 41,000 $ 285,000 Operating profit $ 65,000 * This is an appropriate categorization of “contracts” if the contracts are for materials or short term labor. Otherwise, it would be appropriate to categorize contracts elsewhere. b. ABM income statements differentiate between resources used and resources supplied. Providing information on unused resources helps managers make better decisions to lower costs or use resources more efficiently. Substantial unused capacity exists for setups, depreciation, and administrative. Unused resources provided for batch setups might be reduced or utilized to build up inventory in preparation for peak demand seasons. Depreciation is the reduction in value of a resource. In this case, only 60% of the reduced value was used in production, implying that 40% of this resource is available for other uses. Perhaps unused space in the building can be leased to another firm or utilized by other departments in the company. Administrative activities should be scrutinized for potential areas of savings. SOLUTIONS TO CASES 5.51 (45 min) Reengineering the accounting function a. The benchmarking approach to process improvement seeks to emulate successful best practices employed by other organizations. Somewhat in contrast, the ABM approach scrutinizes existing processes for evidence of wasteful uses of resources. The ABM approach identifies opportunities for improvement by eliminating waste and redesigning work to accommodate or effect the elimination of non-value-added activities. Because benchmarking looks outside the organization for solutions, and ABM looks at internal processes for improvement opportunities, it seems reasonable that they could be used in concert. Benchmarking can find successful solutions to redesigning work that eliminates the non-value-added activities identified by ABM. Using benchmarking alone could be a top-down approach that imposes solutions, whereas using ABM alone could reinvent the wheel and fail to recognize that others companies’ solutions could be applied. b. As a group, the project team would have to understand (1) the objectives of accounts payable systems, (2) the needs for information and control of the process, (3) the impacts of changes in accounts payable on other individuals and parts of the organization (e.g., other accounting functions, purchasing, logistics, treasury), and (4) how to lead and effect change. The functional skills needed are accounting, information systems, finance, logistics, and human resources. c. Cummins tried to ensure success by (1) demonstrating the need for change, (2) using a cross-functional team, (3) gaining commitment from top management for change and protection of affected employees, (4) using a pilot study to gauge the requirements for a full-scale implementation, (5) thoroughly evaluating the information technology implications of the change, and (6) enforcing target completion dates. d. The Cummins effort appears to be an imposed, top-down solution; we don’t know how much input was solicited or used from people in accounts payable or accounting in general. Though this technical solution may be fine, the method has the possibility of alienating employees and stifling their recommendations for improvement. Without laying off accounts payable employees, which is laudable, it is difficult to know where real cost savings come from, especially when new information systems often are more expensive (hardware, software, personnel) than old systems. Costs of excess accounts payable positions may be saved through attrition, but this will take time. Strict adherence to completion dates will motivate people to get the work done on time, but there is a danger of cutting corners if the due date is approaching and the project is behind schedule. 5.52 (30 min) Effects of changing cost drivers a. First, it appears that the VP of marketing has made an error in assessing determinants of customer satisfaction. He has surveyed current customers, not potential customers. If TGA wants to increase market share, the airline must attract customers away from other airlines. It would be interesting to know the proportion of TGA’s repeat customers. If that proportion already is high, there may be little to gain by spending resources to make them happier. Customer satisfaction of existing customers may increase, but market share will not. Worse, profitability could decline if TGA spends significant amounts to improve food, etc., but does not see an even greater increase in revenues. b. Nearly all passengers on all airlines complain about food, personnel, storage space, leg room, extra charges, and inflexible upgrades. Yet they continue to fly with other airlines, not TGA. Why? Could it be because their choice is based on ticket prices and flight schedules? If so, TGA should seek to compete on those attributes of air travel. A good strategy for you may be to assess the costs of improving each of the items the marketing VP has targeted, as you were asked to do. In addition, you should be able to compare TGA’s ticket prices and flight schedules against competitors’ prices and schedules in selected markets where TGA would like to gain market share. Knowing the costs of TGA’s activities that would be necessary to meet the competition should allow you to estimate the costs of competing on the dimensions of price and schedule. 5.53 (45 min) ABM in a university. a. Whether ASP is consistent with the goals of the university is clearly controversial. External pressures are growing to force universities to be more business-like, but many within the academic community resist that pressure with almost religious fervor. Students are sure to sense this difference in attitude across the campus. Even within business schools and departments of economics, there are those that understand the pressures of markets intellectually but resist them when they hit close to home. University administration would enter this discussion at its own risk! b. The objective of ASP is to “improve the University’s human resources and financial management business practices by simplifying work, increasing information access, minimizing future administrative costs, and implementing enabling technologies” . . . and to “continually change how it does business.” Many within the University may feel is it not the University’s goal to become more “business-like.” Instead, they might argue that the University has an obligation to serve its students and its employees. If serving the students and employees results in some inefficiencies, change is not necessarily the best answer, particularly at the cost of losing employees. c. The university is responsible to its many constituents, whose interests do not always align. For example: Students – high quality, easily accessible educational, social, and recreational opportunities at a low price Faculty – favorable working and professional conditions, which include teaching, research, and governing the university, with high salaries and benefits Staff - favorable working and professional conditions, which include having both voice and choice in university decisions affecting them, with high salaries and benefits Trustees – meeting the educational and budgetary goals set for the university State legislatures (for public universities) – high quality teaching at the lowest possible cost d. As in most large projects of this type, the costs probably will be at least as great as estimated. One should expect even higher costs because, as admitted in the case, ASP costs do not include costs of retraining reassigned staff whose jobs may be displaced. It is not clear that the costs of university personnel who will manage and implement ASP are out-of-pocket costs or if they merely reflect the costs of personnel already in the university’s budget. If the latter is true and if these personnel are not replaced as they are taken from their previous work, this large part of the cost is an overstatement. Because the university has pledged to protect the jobs of current staff, it is not clear where real cost savings will come from. It appears that most or all of the listed savings are, in fact, reassignments of costs to other, unspecified activities. Consider each of the “savings:” Elimination of redundant positions – if these positions more accurately are shifted to other activities in the university, no savings will result unless through attrition from retirement or turnover that is not replaced. If this approach is contemplated, the savings may not be realized for many years. Elimination of shadow personnel and budgeting systems – this must be time that existing personnel in various departments spend to overcome the deficiencies of the current financial system; for example, using spreadsheets to manage information that is unavailable from the current system. This time could be reassigned to other, more valuable activities, but will not be saved. Reduction of data entry requirements – again, this must be time spent by current personnel to re-enter data manually that the new system will perform electronically. There is a danger of double-counting savings unless this time is spent by personnel not affected by the elimination of positions. This time could be reassigned to other, more valuable activities, but will not be saved. Elimination of system reconciliation – this is time spent, again by retained employees, to combine information from different systems, which the new system will perform automatically. This time could be reassigned to other, more valuable activities, but will not be saved. e. At a minimum, one would expect the university administration to communicate openly with affected personnel when contemplating or implementing such a large change. It does not appear that this happened in this case, with predictable turmoil resulting. The project may succeed on technical grounds, but it appears to have alienated a large number of personnel who may be less willing to accommodate change in the future. The statement that the university plans to eliminate 60 jobs but has not decided which ones seems disingenuous. The statement that the university is unclear how to implement the change seems either designed to deflect criticism by denying a clear target or based on an unclear philosophy of managing change. f. It is easier to make recommendations in hindsight, but the university should seek and use input from affected groups. If the university is unclear how to implement the new system, it might be best to start with a pilot project rather than leap into a full scale implementation without understanding the impacts. Presumably the PriceWaterhouseCoopers consultants are experienced in designing and implementing large IT projects. But as one information systems professor (now an advisor to ASP) remarked, “Many of these young ASP consultants were in my class last year, and now PWC is charging them out to the university at a high hourly rate. I’m surprised no one thought to consult the professors who taught the consultants.” 5.54 (45 min.) Banking processes a. ABM takes information about activities and the costs of processes a step further to add considerations of customer value. Identifying non-value-added activities also identifies opportunities for improving processes by reducing costs and/or increasing customer value. First, the bank needs to follow steps of ABC. Second, the bank needs to assign customer-based values for each of the activities. Third, ranking or collecting activities and costs by customer values identifies the sources and magnitudes of possible savings and improvements. b. Many of the activities listed in the case would not be valued highly by customers of the bank. Consider the following examples and possible improvements: Activity Possible improvement Loan applicant picks up and mails application, which is delivered by mail clerk Make applications available on the bank’s homepage, eliminating time and effort to the customer that adds no value. Receiving loan applications by loan processing clerk Electronic applications completely eliminate this entire day of non-value-added time. Transcribing loan application data by credit analyst Again, electronic applications eliminate the need for transcribing data (and correcting errors). If electronic applications are not possible, at least consolidate this and the previous activity into a single job. Separate decisions by consumer-lending specialist and pricing specialist; sequential preparation of approval letters There may be good internal control reasons to separate approval and pricing. However, there seems little need to wait for the pricing decision to complete the approval letter that accompanies the loan terms. These letters should be a standard format that requires only the addition of the name and address of the applicant. Legal review of all loans May not be necessary for standard loans and is a source of non-value-added delay for both bank and customer. c. Internal communications, particularly about planned process changes, can be improved by using the most effective medium or channel of communication. For example, many organizations rely almost exclusively on email, which works well in some organizations but is too impersonal in others. In many organizations, real, two-way communication is more successful face-to-face than by e-mail. Changing processes almost always means changing peoples’ jobs and senses of comfort and security. Anticipating fears, suspicions, and resistance to change should result in more complete and effective communication about the need and method for change. It also is a good idea to avoid extensive use of jargon. Almost no one appreciates communications laden with acronyms or arcane terms understood only by specialists (and we have introduced a number of them in this book). It is better to use plain language that all can understand. External communications with customers can be improved by listening to what they want to know (as illustrated in the following questions), and answering in plain language in a timely manner. Why is the application taking so long? What is the status of my application? Does the bank need more information? What is the bank’s decision? This communication task would be made much easier if applications were electronic and could be tracked easily by customers and by customer-service representatives who may be asked to clarify the status of loan applications. Solution Manual for Cost Management: Strategies for Business Decisions Ronald W. Hilton, Michael W. Maher, Frank H. Selto 9780073526805, 9780072430332, 9780072830088, 9780072299021, 9780072881820, 9780072882551, 9780070874664, 9780072388404, 9780072343533
Download
Close
Close
