BCO322 BUDGETING AND CONTROL
Week 11: Activity-Based Management (chapter 19)
EXERCISE 19.3 Value-Added versus Non-Value-Added Activities
Dainty Diners, Inc., produces various types of bird feeders. The following is
a detailed description of the steps involved in the production of wooden
1. Raw materials, such as wood, nails, and clear plastic are
2. The raw materials are unloaded from the delivery truck into a raw
materials storage area. Non-value-added. Although the materials
must be unloaded, it would be more efficient if they were delivered
straight to the Cutting Department as they were needed.
3. The purchase order is checked for accuracy by an employee doing a
visual count of the items. Non-value-added. The cost and/or time
required to verify purchase orders could be minimized by
employing a bar coding system rather than visually counting items.
4. The materials are inspected for defects such as rotting, excessive
knots, and scratches. Non-value-added. The need for an inspection
could be eliminated by having the supplier guarantee the quality of
the items delivered.
5. The Cutting Department orders raw materials by sending a
requisition form to the raw materials storage area. Non-valueadded. The process of obtaining raw materials could be sped up by
using an electronic ordering system connected directly to the
6. When a requisition is received, raw materials are moved from the
storage area to the Cutting Department. Non-value-added. This
step could be eliminated if raw materials could be delivered by the
supplier directly to the Cutting Department.
7. The wood and plastic are cut into properly sized pieces. Valueadded.
8. The cut pieces are stacked and moved to a work in process
warehouse. Non-value-added. This step could be eliminated if cut
materials were produced and delivered to the Assembly
Department as needed.
9. The Assembly Department orders cut pieces when they are needed
by sending a requisition form to the work in process warehouse.
Non-value-added. The process of obtaining cut materials could be
improved by electronically signaling the Cutting Department to
produce and send over more materials.
10. When a requisition is received, cut pieces are moved from the
work in process warehouse to the Assembly Department. Nonvalue-added. This additional movement could be eliminated if raw
materials were delivered directly from the Cutting Department.
11. The cut pieces are assembled into a bird feeder. Value-added.
a. For each of these steps, indicate whether it is a valueadded or non-value-added activity.
b. For each of the non-value-added activities, determine
whether it can be eliminated; if it cannot be eliminated,
suggest ways in which the costs could be minimized or
productive efficiency increased.
EXERCISE 19.4 Activity-Based Management
Blake Furniture, Inc., maintains an Accounts Receivable Department that
currently employs eight people. Blake is interested in doing an activity
analysis because an outside firm has offered to take over a portion of the
activities currently handled by the Accounts Receivable Department. The
four main activities handled by the department are (1) billing and recording
payments, (2) customer service activities, (3) financial reporting and
analysis, and (4) collecting delinquent accounts.
The salaries paid to the departmentâ€™s employees are as follows.
Manager, 1 @ $65,000 per year $ 65,000
Clerks, 5 @ $30,000 per year 150,000
Account specialists, 2 @ $38,000 per year 76,000
It is estimated that the manager of the Accounts Receivable Department
spends an equal amount of her time supervising the four main activities. The
clerks spend approximately half of their time on billing and recording
payments. Their remaining time is divided equally between reporting
activities and customer service. The two account specialists spend half of
their time on delinquent account activities, and the rest of their time is split
equally between financial analysis activities and customer service activities
that the clerks are not qualified to perform.
Paypro, Inc., has proposed that it can perform all the activities related to
collecting delinquent accounts for a fee of $50,000 per year. The manager of
Paypro argues that Blake can save $26,000 because the $76,000 in salaries
paid to the specialists who currently handle all delinquent accounts can be
eliminated. If the contract is accepted, it is estimated that the manager of the
Accounts Receivable Department would need to devote a quarter of her time
to dealing with Paypro employees.
a. Using the information given, prepare an Activity Cost Analyses to
calculate the labor cost for personnel devoted to each of the four
main activities of the Accounts Receivable Department.
b. Should Blake accept Payproâ€™s offer to take over its delinquent
a. BLAKE FURNITURE, INC.
Accounts Receivable Department
Â¼ time Â¼ time Â¼ time Â¼ time
$ 16 250 $ 16 250 $ 16 250 $ 16 250 $ 65 000
Â½ time Â¼ time Â¼ time 0
$ 75 000 $ 37 500 $ 37 500 $ 0 $ 150 000
0 Â¼ time Â¼ time Â½ time
$ 0 $ 19 000 $ 19 000 $ 38 000 $ 76 000
Resources $ 91 250 $ 72 750 $ 72 750 $ 54 250 $ 291 000
b. In addition to handling delinquent account activities, the account specialists
perform customer service activities and analysis activities that are not
covered by the contract from Paypro. Thus, the $76,000 in salary savings is
an overestimate. If the contract were accepted, Blake would still need one
full-time specialist to perform these additional activities at a salary of
$38,000 and the change would not save any of the managerâ€™s time. Thus, if
the contract were accepted, Blake would pay Paypro $50,000 while only
saving $38,000 in salary costs, for a net increase in costs of $12,000. Based
on the activity analysis, the contract from Paypro should not be accepted.
EXERCISE 19.5 Target Costing
On Point, Inc., is interested in producing and selling a deluxe electric pencil sharpener.
Market research indicates that customers are willing to pay $30 for such a sharpener and
that 20,000 units could be sold each year at this price. The cost to produce the sharpener
is currently estimated to be $14.
a. If On Point requires a 25 percent return on sales to undertake production of a
product, what is the target cost for the new pencil sharpener?
b. If a competitor sells basically the same sharpener for $28, what would On
Pointâ€™s target cost be to maintain a 25 percent return on sales?
c. At a price of $28, On Point estimates that it can sell 22,000 sharpeners per
year. Assuming target costs are reached, would On Point earn more or less
profit per year at the $28 selling price compared to the original estimated
selling price of $30?
a. Target Cost = Target Price – Target Profit
Target Price = $30.00
Target Profit = 25% Ã— $30 = $7.50
Target Cost = $30.00 – $7.50 = $22.50
b. Since the competitor is selling essentially the same product for $28.00, On
Point should set its target price at that level to remain competitive.
Target Cost = Target Price – Target Profit
Target Price = $28.00
Target Profit = 25% Ã— $28 = $7.00
Target Cost = $28.00 – $7.00 = $21.00
c. The original estimated selling price of $30 would yield a profit of $7.50 per
unit once the target cost had been achieved. Total yearly profits would be:
20,000 units Ã— $7.50 = $150,000
At a selling price of $28, the profit per unit once the target cost had been
reached would be $7.00. Given the expected increase in sales volume, the
total yearly profits under this price would be:
22,000 units Ã— $7.00 = $154,000
Thus, total yearly profits would be $4,000 higher under the $28 selling price.
EXERCISE 19.6 Just-in-Time Manufacturing
Carts Corporation is trying to determine how long it takes for one product to pass through
the production process. The following information was gathered regarding how many
days the product spent in various production activities.
Activity Number of Days
a. Which of these activities are value-added?
b. What is Cartsâ€™ total cycle time?
c. Determine Cartsâ€™ manufacturing efficiency ratio.
d. If Carts implements a total quality management program and a just-in-time
inventory system, which of these activities could be eliminated? What would
be the change in Cartsâ€™ manufacturing efficiency ratio?
a. The only value-added activities are assembly and painting.
b. Total cycle is 18 days (4+ 3 + 5 + 2 + 3 + 1)
(5 days in assembly
+ 3 days in painting)
Total Cycle Time
= 8/18 = 44,44%
d. JIT and TQM implementation would allow for the elimination of inspection
and storage time, which would reduce cycle time to 11 days (18 – 4 – 3). Cartâ€™s
new manufacturing efficiency ratio would be:
(5 days in assembly
+ 3 days in painting)
Total Cycle Time
= 8/11 = 72,73%
EXERCISE 19.7 Cost of Quality
Charles Berkle is the manager of Nogain Manufacturing and is interested in
doing a cost of quality analysis. The following cost and revenue data are
available for the most recent year ended December 31.
Sales revenue $500,000
Cost of goods sold 272,000
Warranty expense 34,000
Inspection costs 15,000
Scrap and rework 10,600
Product returns due to defects 6,000
Depreciation expense 32,000
Machine maintenance expense 11,000
Wage expense 135,000
Machine breakdown costs 5,400
Estimated lost sales due to poor quality 10,000
a. Classify each of these costs into the four quality cost categories and
prepare a cost of quality report for Nogain.
b. What percentage of sales revenue is being spent on prevention and
c. What percentage of sales revenue is being spent on internal and
external failure costs?
a. NOGAIN MANUFACTURING
Quality Cost Report
For the Current Year Ended December 31
Machine maintenance â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦.. $ 11 000
Inspections â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦ $ 15 000
Internal failure costs:
Scrap and rework â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦ $ 10 600
5 400 $ 16 000
External failure costs:
Warranties â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦ $ 34 000
10 000 $ 50 000
Total quality costs
$ 92 000
b. Prevention and
Appraisal Costs as a
Percentage of Sales
($11,000 + $15,000)
= 5,2% $500 000 $500 000
c. Internal and External
Failure Costs as a
Percentage of Sales
($16,000 + $50,000)
= 13,2% $500 000 $500 000
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