BACKGROUND

Customer Services (CS) is a back-office department which provides key support services at the New Zealand Distribution Company (NZDC). Some years ago NZDC made a significant investment in information systems throughout the company which included the development of a traditional ABC system. The ABC system has since grown in complexity and has become expensive to maintain (in terms of both staff time to maintain the system and IT resources to store and process data). The sales director, Abby Sea, has for some time questioned the accuracy of outputs from the current ABC model. They show a reduction in the profitability of established customers and suggest the need for price increases at a time when the market place is highly competitive. Abby discusses the problem with Robyn Kaplan, the management accountant in charge of the ABC system and Eric Easy, the manager of CS. Abby sets the scene: Our basic operation is quite simple. We supply customers quickly and efficiently at a competitive price. We have no special advantage in relation to the products themselves, anyone can import them, and so all our processes have to be highly efficient if we are going to remain profitable in todays highly competitive market. Abby expresses her frustration: Our margins are being squeezed, so we must control our costs in all areas, including our back-office. Improved supply chain management has produced savings but support costs appear to be out of control, particularly sales order processing and related costs. I dont understand why the costs related to CS are so large; I think there must be mistakes in the costing system. Robyn is a little defensive: We have spent much time and effort developing the ABC system and I think the numbers are reasonably accurate. However, I would have to admit that accuracy could be increased if additional activities and cost drivers are introduced into our system. Abby suggests that reasonably accurate may mean absolutely wrong in respect to the CS costs that are currently allocated to customers. She asks if the model can be updated to increase its accuracy. A lengthy debate follows as Eric is unhappy when he learns that any updating of the current ABC model to make it more accurate will require extensive staff surveys. He exclaims: Just processing customer orders keeps my staff pretty busy. I dont want them to waste time filling in questionnaires or being interviewed about how they spend every minute of the day. As it is they are constantly interrupted by phone calls from complaining customers, but that is important work that has to be performed conscientiously. There must be simpler ways of getting the costing information we need without diverting my staff from essential work to support customers. Robyn also highlights that any increased model complexity, e.g. by adding extra activities and new cost drivers, is likely to place excessive demands on the computer programme used to store and process the ABC data. Abby senses that she might have a battle on her hands as Robyn and Eric seem very reluctant to make any changes. But she is convinced of the need for more accurate information and so she pushes her point: If the current ABC system has become inaccurate we might be making incorrect management decisions. I have to have accurate cost information or the prices I set will be wrong and we will no longer be competitive. We must do something to test whether the CS costs allocated to my customers are accurate or not. The three managers agree that something must be done. Robyn mentions that he has heard about an approach called Time-driven ABC which he thinks may be useful. The three managers agree that they need to get some expert advice in order to find the right solution to their costing problems. You are approached to provide that expert advice. As a consultant, you have been asked to advise whether there would be any benefits to be gained by moving to a time-driven ABC system. You are given information on the key activities and costs of the CS department and asked to use this. DETAILS Inspection of the current ABC model enables you to establish that last quarter the total cost of the CS department was in line with budget at $300,000. This total cost was predominantly made up of staff related costs (staff salaries and the costs of their office space and equipment). The CS department has 5 full time staff, each with a practical capacity of 25,000 minutes per quarter. You establish that, to maximise flexibility and efficiency, the staff in CS are all trained to perform three activities. These activities are described by Eric as follows: Process customer orders: For existing customers: Enter details into sales order system which generates prices and provides a total invoice value. If positive credit status and within credit limit pursue cross-selling opportunities. Send order confirmation and flag order for fulfilment. If negative credit status flag customer as requiring a credit check. For new customers: Set up Customer Account and request credit check. Complete above process when credit status is confirmed. Handle complaints: Respond to customer complaints and pursue to resolution. Perform credit checks: For new customers: Request credit report. Upon receipt decide on credit status and limit, update Customer Account and set as active credit account. If credit request rejected, mark Customer Account as pro-forma/cash only account, and inform customer. For existing customers: Consult with customer and resolve credit problem as appropriate (e.g. request payment or revise credit limit/status based on new information). During the design phase of the traditional ABC system, departmental staff kept diaries to record how much of their total time they spent on each of the three key activities undertaken by the department. This information was collated and used to allocate the total cost of the CS department between activities, as shown in table 1 which also shows the calculation of CS department burden rates, based on budgeted activity levels (number of transactions).

Table 1 - The Customer Services Department - ABC burden rates:
Activity	% of time spent	Allocated cost	Budgeted no. of Transactions	Burden Rates
Process customer orders	75%	$225,000	10,000	$22.50 per order
Handle complaints	10%	$30,000	800	$37.50 per enquiry
Perform credit checks	15%	$45,000	600	$75.00 per credit check
Totals	100%	$300,000

The actual number of transactions required during the last quarter was reported as follows: 9,500 customer orders were processed, 820 customer complaints were handled and 580 credit checks were performed. If the actual number of transactions processed by the CS department had been in line with budget, the traditional ABC system would have allocated all CS costs to customers. However, as the actual number of transactions was below budget overall (particularly customer orders processed below budget by 5%) the cost of resources consumed and allocated to customers was $12,000 (4%) less than budgeted. See table 2

For the purposed of developing the TDABC model, Eric has observed his staff and estimated the

average unit times for performing the three main CS department activities as follows:

Activity	Unit time (minutes)
Process customer orders	8
Handle complaints	12
Perform credit checks	30

Eric explains that the order processing time of 8 minutes includes a time allowance for staff to pursue opportunities for up-selling and cross-selling (e.g. by phoning existing customers and offering them discounts for larger quantities or related merchandise at special prices).

REQUIRED

Your consultants report to the management team of NZDC.

a) An analysis of the information in Table 2 produced using the Traditional ABC system. Explain why spare capacity costing $12,000 has arisen and advise how NZDC can identify responsibility for this spare capacity. Should the cost of spare capacity be charged to customers? Should NZDCs selling departments be held accountable for the cost of spare capacity?

b) Using TDABC principles; compute the cost per time unit and derive revised cost driver rates for the three activities of the CS department. Compare these new burden rates to the cost driver rates derived under traditional ABC (table 1 above) and explain why they differ.

c) Using the TDABC cost driver rates; determine the costs assigned to each activity and the capacity used (in minutes). Calculate the estimated minutes of unused capacity and the associated cost. Explain how the accuracy of this information may be verified and evaluate the new information and suggest management action.

d) At a cost of $20,000 per quarter an online, automated, order processing system, will reduce the number of orders needing to be processed manually to 8,000 per quarter. However, these remaining orders will be the more complex ones and are expected to take 8.5 minutes each to process. Estimate what effect this will have on the assignment of CS department costs and the capacity used (in minutes). Recalculate the minutes of unused capacity and its cost and advise management on whether to implement the online, automated, order processing system.

e) Summarise the main advantages of converting to the proposed TDABC system for CS costings and recharges to customers. Identify any possible disadvantages of the system as currently proposed, make suggestions for improvements and overall recommendations with respect to moving to a TDABC system.

Please answer all questions (clear explain and calculation)

Table 2 - Customer Services Department - Traditional ABC cost assignment Actual no. of Allocated Activity Transactions Burden Rate Cost Process customer orders 9,500 $22.50 per order $213,750 Handle complaints 820 $37.50 per complaint $30,750 Perform Credit Checks 580 $75.00 per credit check $43,500 Total cost of resources consumed $288,000 Cost of resources supplied $300,000 Cost of spare capacity $12,000 As percentage of resources supplied 4.0% Table 2 - Customer Services Department - Traditional ABC cost assignment Actual no. of Allocated Activity Transactions Burden Rate Cost Process customer orders 9,500 $22.50 per order $213,750 Handle complaints 820 $37.50 per complaint $30,750 Perform Credit Checks 580 $75.00 per credit check $43,500 Total cost of resources consumed $288,000 Cost of resources supplied $300,000 Cost of spare capacity $12,000 As percentage of resources supplied 4.0%