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:

Setting up equipment $ 125,000 Materials handling 180,000 Inspecting products 122,000 Engineering support 120,000 Handling customer complaints 100,000 Filling warranties 170,000 Storing goods 80,000 Expediting goods 75,000 Using materials 500,000 Using power 48,000 Manual insertion labora 250,000 Other direct labor 150,000 Total costs $1,920,000b a Diodes, resistors, and integrated circuits are inserted manually into the circuit board.

b 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 perunit 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 percent if the price could be reduced to $12, Danna became quite excited.

Required:

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

. 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 his preliminary cost reduction assessment? Discuss actions that the company can take to reduce or eliminate the nonvalue-added activities.

. 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 percent. How much cost reduction would be required to achieve each unit cost?

. 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 percent? What form of activity analysis is this:
reduction, sharing, elimination, or selection? 5.

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?

Problem