Question

Activity-Based Management, Nonvalue-Added Costs

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	$125,000
Materials handling	180,000
Inspecting products	122,000
Engineering support	120,000
Handling customer complaints	100,000
Filing warranties	170,000
Storing goods	80,000
Expediting goods	75,000
Using materials	500,000
Using power	48,000
Manual insertion labor*	250,000
Other direct labor	150,000
Total costs**	$1,920,000

* Diodes, resistors, and integrated circuits are inserted manually into the circuit board. ** This total cost produces a unit cost of $16 for last year’s sales volume.

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.

Question 5:

Activity-Based Management, Nonvalue-Added Costs

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	$125,000
Materials handling	180,000
Inspecting products	122,000
Engineering support	120,000
Handling customer complaints	100,000
Filing warranties	170,000
Storing goods	80,000
Expediting goods	75,000
Using materials	500,000
Using power	48,000
Manual insertion labor*	250,000
Other direct labor	150,000
Total costs**	$1,920,000

* Diodes, resistors, and integrated circuits are inserted manually into the circuit board. ** This total cost produces a unit cost of $16 for last year’s sales volume.

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.	CONCEPTUAL CONNECTION: What is activity-based management? What phases of activity analysis did the consultant provide? What else remains to be done?
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? Identify actions that the company can take to reduce or eliminate the nonvalue-added activities. Round your answers to two decimal places.
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.	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? Round your answers to two decimal places.
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? For those boxes in which you must enter subtracted or negative numbers use a minus sign.

5. CONCEPTUAL CONNECTION: Complete (a)-(d) below.

(a) Calculate income based on current sales, prices, and costs. For those boxes in which you must enter subtracted or negative numbers use a minus sign.

Mays Electronics

Income Based on Current Pricing

1	Sales
2	Costs
3	Income

(b) Calculate the income by using a $14 price (assume that current market share is maintained). For those boxes in which you must enter subtracted or negative numbers use a minus sign.

Mays Electronics

Income Based on Maintaining Current Market Share

1	Sales
2	Costs
3	Income

(c) Calculate the income by using a $12 price, assuming that the maximum cost reduction possible is achieved (including Requirement 4's reduction). For those boxes in which you must enter subtracted or negative numbers use a minus sign.

Mays Electronics

Income Based on Increasing Market Share

1	Sales
2	Costs
3	Income

(d) The price that produces the greatest benefit is a price of (Choose One: $14/$18/$12) per unit.

Answer 1

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Part -1
Activity-based management is a system-wide, integrated approach that focuses management’s attention on activities.
It involves two dimensions: a cost dimension and a process dimension.
Key elements in activity management are identifying activities, asseassing their value, and retaining only value-adding activities.
The consultant identified the activities but did not formally classify the activities as value-added or nonvalue-added. Nor did the consultant offer any suggestions for increasing efficiency—at least not formally.
The consultant apparently had tentatively identified potential savings through eliminating nonvalue-added activities.
Management must still decide how to reduce, eliminate, share, and select activities to achieve cost reductions.
Part - 2
Setup	$     125,000
Materials handling	$     180,000
Inspection	$     122,000
Customer complaints	$     100,000
Warranties	$     170,000
Storing	$        80,000
Expediting	$        75,000
Total Cost reduction as per consultant	$     852,000
Unit produced and Sold ($1,920,000/$16)	120,000
Potential Unit cost reduction ($852,000/120,000)	$            7.10
The consultant’s estimate of cost reduction was on target.
Cost reductions can be accomplished through some of the following actions:
reduce manual insertion labor
reduce inspections
reduce expediting
Part -3
Unit cost to maintain sales	$14-$4		$                  10
Unit cost to expand sales	$12-$4		$                    8
Current cost			$                  16
Cost reduction to maintain	$16-$10		$                    6
Cost reduction to expand	$16-$8		$                    8
Part -4
Total Cost reduction as per consultant	$     852,000
Cost reduction from Automation	$     150,000
Total Cost Reduction	$ 1,002,000
Reduction per unit ($1,002,000/120,000)	8.3500
Costs can be reduced by at least $7, enabling the company to maintain current market share
Further, if all the nonvalue-added costs are eliminated, then the cost reduction needed to increase market share is also possible.
Activity selection is the form of activity management used here.
Part -5
		Current	At $14	At $12
Sales (120,000*Price) and $12*180,000		$   2,160,000	$   1,680,000	$   2,160,000
Costs ($16-$8.35=$7.65)*Units		$ (1,920,000)	$     (918,000)	$ (1,377,000)
Income		$       240,000	$       762,000	$       783,000