Alexis Klark, managing director of Pharsalia Electronics (PE), is concerned about the prospects of one of its major products. She has been reviewing a marketing report with Jeff Keller, the marketing product manager for that product. The report indicates that a price reduction is needed to meet anticipated reductions by competitors. The current selling price of the product is $700 per unit. It is expected that PEs two major competitors will be selling a very similar product for $600 per unit within three months. The competition concerns Klark because the current cost of producing and selling their product is $630, which yields a $70 profit on each unit sold.

The situation is alarming because PE implemented an activity-based management system about two years ago. The ABM system helped them better identify activity costs, root cause cost drivers and cost reduction opportunities. Changes made due to adopting ABM reduced costs on this product by approximately 15 per cent over the last two years. Now it appears that costs will need to be reduced considerably more to remain competitive and make a profit on the product. Total unit costs to produce, sell and service the products are as follows:

Product costs per unit Material

Purchased components $220

All other material 80 Manufacturing activities

Setups 32 Material handling 34 Inspection 46 Cutting, shaping and drilling 60 Bending and finishing 48

Other

Finished goods warehousing 10 Selling costs 60 Customer service 40

Total unit cost $630

Klark has decided to hire Donald Collins, a consultant, to review the situation and implement any needed changes. After two weeks of review, discussion, and analysis, Collins suggested that PE adopt a just-in- time (JIT) system to help reduce costs. He also suggested that using target costing would help in meeting the new target price of $600.

By changing to a JIT manufacturing system, PE expects material handling, inspection, and finished goods warehousing to be eliminated. However, the cost of other manufacturing activities will increase by 10 per cent due to the need for more highly skilled labour. Customer service costs are expected to be reduced by 50 per cent.

2

Required

1. What are the relation between PEs target cost per unit and the current profit, assuming that the current

profit margin remains unchanged (8 Marks)?

2. Explain If the JIT system is implemented, will PE meet the target cost (4 Marks)?

3. Explain four steps in ABM to reduce the product cost (4 Marks).