An Instructional Case: Cost Concepts and Managerial Analysis L. Melissa Walters and Teresa M. Pergola ABSTRACT: This case is designed to help you 11 velop a working understanding of fundamental cost concepts (cost behavior, cost raceability, cost flexibility, and unit costs) and the proper use of cost data for mana erial analysis purposes. The case narrative describes a business scenario and a pro lematic managerial analysis based on certain cost data. The case requirements ask ou to apply basic cost concepts to analyze the cost data, evaluate the use of cost d ta in the analysis described in the case narrative, and then effectively communicate t e results of your analysis and evaluation in the form of a professional written memo. Keywords: instructional case; cost analysis. CASE MATERIALS-INGLIS UN VERSITY LIBRARY Case Narrative InglisUniversity Library maintains a small book donations department in the basement section of the library. The process for accePti:"g the typical donated book includes searching the current holdings to determine if t e book is already held by the library, placing a small inventory tracking device (a radio equency identification [RFID] tag) in the book, assigning the book a card catalog number and finally entering the book into the library's online computer database/card catalog syst m. The process of accepting a collection of periodicals involves a similar process. Wh n the current holdings search reveals that the library already holds the donated item, an when there is no need for duplicate copies, the items are set aside in a small storage ea and offered for sale twice a year during end-of-semester book sales. Books that are n t sold during the book sale are donated to charity. In the previous year, the library raised $ ,000 from the bi-annual book sales. In recent years, the library's donations departme t has been quite active. Asenath James, the librarian responsible for the donations departme t, has become exceedingly effective at soliciting donations from alumni, retiring academi s, eccentric collectors, and estates all over the world. Many of the items are in-print texts that the library would otherwise have had to purchase at full price. However, some of th donated books are extremely rare or out of print and would be quite expensive if purch sed by the library; some of her more recent acquisitions include obscure books on non- uclidean mathematics, a first edition copy of Robert A. Heinlein's Stranger In A Strang Land, a first edition copy of William Blake's Songs of Innocence and Experience, an al ost complete historic collection of the L. Melissa Walters is an Associate Professor and resa M. Pergola is an Assistant Professor, both at The University of Tampa. 531 The authors thank the anonymous reviewers for Issues in Accou ting Education as well as the participants of the 2007 Academy of Business Disciplines Conference for their ins ghtful comments on improving earlier drafts of this manuscript. 532 Walters and Pergola pulp magazine Weird Tales, several rare manuscripts on ancient folklore, and a handwritten manuscript containing what experts have authenticated to be the writings of Percy Bysshe Shelley. Her effort has, to some extent, compensated for the dwindling library budget and allowed the library to create and maintain an exceptional, albeit unusual, library offering. Moreover, the university library has acquired a unique academic reputation due to some of the rare holdings acquired through the donations department's efforts. Both academics and graduate students from other universities make use of Inglis University's peculiar library resources. Perhaps more importantly, the number of students seeking specialized graduate studies at Inglis (especially in the areas of literature, mathematics, and ancient folklore) has increased significantly. There is some evidence to suggest that this is due, at least in part, to the increased visibility of the university, along with the research potential afforded by the unique resources accumulating at the university'S library (due almost entirely to the success of the donations department's activities). The Inglis University Library donations department is operated by the head librarian, Asenath James, and a graduate assistant, Randolph Carter, a folklore student at Inglis University. The head librarian is a salaried position ($48,000 per year), and since Asenath currently spends approximately one-quarter of her time soliciting and processing book donations, one-fourth of her contracted annual base salary ($12,000) is allocated to the book donations department. The Inglis University Library is also allotted $5,200 per academic year in additional funds to support the library donations function. This meager sum is used to provide a graduate work-study student a stipend to assist Asenath in the donations department during the fall and spring semesters. Work-study students typically work 20 hours per week and are paid on an hourly basis at a rate of $1per hour. A typical semester is 13 weeks long. J Currently, Randolph is working all his allotted hours in the book donations department. If he were not fully utilized by the book donations department, he would work elsewhere in the university, as his work hours and stipend are guaranteed as a part of his financial aid program. In addition, the library has allotted a small space in the basement of its main building for donations activities. The library allocates a portion of the library's general facilities costs ($1,200 per year). General facility costs include depreciation on the building, property taxes, insurance, general maintenance costs, and utilities. Since the library's catalog system is computerized, the only other applicable cost is for the RFID inventory tags, which are relatively minimal and run about $0.50 per book; these RFID tags are purchased by the library as needed. Typically, Asenath and her assistant solicit and process an average of 1,000 books per academic year and can, without too much difficulty, solicit and process up to 1,200 books per academic year. However, each year for the past five years, [he number of books donated and processed for the library has increased noticeably. Unfortunately, Asenath, as head librarian, has library duties other than donations and cannot devote any additional time to the donations department. Randolph's current work-study contract is restricted to only 20 hours per week and only applies to the fall and spring semester. Asenath has no additional help during the summer months, which creates quite a backlog of unprocessed books going into the fall semester. Of late, Asenath and Randolph have begun to experience difficulty processing the increasing number of book donations, and some recent acquisitions are still sitting in boxes on the floor of the donations department's basement space. Consequently, the library has approached the university budget committee with a request to increase the I 13 weeks @ 20 hours per week equals 260 hours per semester at $10 per hour equates to $2,600 each semester for a total of $5,200 per year. Issues in Accounting Education, November 2009 An Instructional Case: Cost Concepts and Managerial Analysis 533 funds allotted to the book donations department by $5,000 per year. These additional funds would be used to employ part-time students to work an additional ten hours per week during the fall and spring semester, and to work 20 hours per week during the summer months? to compensate for the increasing number of donated books. This would increase the department's annual capacity to approximately 1,900 books. Asenath can handle the workload between semesters and during the holiday breaks herself with no additional help. Using the cost information provided by the library, the budget committee computed a unit cost per book of $18.90, calculated as follows: Librarian salary allocation Graduate assistant stipend Facility cost allocation Total costs Per book (based on 1,000 books) RFID tag per book Total unit cost $]2,000 $5,200 $1,200 $18,400 $18.40 $.50 $18.90 The committee has since denied the request for additional funds and expressed the following sentiments. "First, the unit cost of $18.90 per donated book is already too high; an additional $5,000 per year would bring the cost per book to $23.90 per book, an entirely unacceptable cost for the processing of an old used book. Librarian salary allocation Graduate assistant stipend Facility cost allocation Part-time student help Total costs Per book (based on 1,000 books) RFID tag per book Total unit cost $12,000 $5,200 $1,200 $5,000 $23,400 $23.40 $.50 $23.90 "Second, at the already-high cost of $18.90 per book, the library can hardly afford to accept more than 1,000 books per year; if, for instance, the library were to accept 2,000 books, it would cost the university $37,800. Finally, we have serious doubts as to the value of the donations department; if it were eliminated entirely, the university could save, at the very least $23,900 per year. These savings could be used to support some other, more worthwhile function within the library." Librarian salary allocation Graduate assistant stipend Facility cost allocation Part-time student help RFID tags ($.50 x 1,000 books) Total savings $12,000 $5,200 $1,200 $5,000 $500 $23,900 2 Ten hours per week x J3 weeks = 130 hours per semester for the fall and spring semesters; 20 hours per week for 12 weeks in the summer = 240 hours; total additional hours are 130 + 130 + 240 = 500 hours times $10 per hour for a total of $5,000. Issues in Accounting Education, November 2009 534 Walters and Pergola Case Requirements 1. Explain what is meant by an activity measure. Identify an appropriate activity measure for analyzing the cost structure of the book donations department within the university's library. Justify your answer. Is the activity measure you identified a true cost driver? Explain. 2. Explain what is meant by relevant range. Based on your chosen activity measure above, identify the current relevant range of activity for the book donations department. Justify your answer. Explain why the consideration of relevant range is significant to the analysis here. 3. Cost Analysis:" a. Identify each cost associated with the library's book donations department. b. Classify each cost associated with the library's book donations department asfixed or variable within the relevant range of activity you identified above. Justify your classifications. Would your classifications change if the book donations department's activity moved outside the relevant range of activity you identified above? Explain. c. Classify each cost associated with the library's book donations department as direct or indirect, assuming that the cost object of interest is the book donations department as a whole. Justify your classifications. Would your classifications change if you were to assume that the cost object of interest were an individual book processed? Explain. d. Classify each cost associated with the library's book donations department as committed orflexible. Justify your classifications. Would your classification of the graduate student's stipend change if you were told that the stipend was guaranteed only for the current academic year? Explain. Would your classification of the RFID tag cost change if you were told that the library is contracted to purchase the inventory tags in lots of a hundred tags at a time? Explain. e. Explain how the analysis of cost behavior, cost traceability, and cost flexibility is relevant to the analysis of the book donations department's request for additional funds. 4. Explain what is meant by a unit cost. Is the initial unit cost used by the budget committee computationally appropriate? Explain. Does the inclusion of fixed costs as a component of the unit costs make it problematic for managerial analysis purposes? Explain. 5. Examine and discuss the use of cost data in each of the three statements made by the budget committee justifying their decision to deny the request for additional funds. In your discussion, address the following for each statement: Are their cost computations correct? What assumptions did they make? What errors in logic did they make? Prepare a revised cost computation. 6. In a professional memo (use proper headings and formatting) directed to the Chair of the Budget Committee: (1) summarize (do not reiterate all of the details) your evaluation of the budget committee's analysis (in Part 5), and (2) based on your analysis, present a succinct, logical argument in support of the library's request for additional funds for the book donations department. Limit your logical argument to three or four key points