Problem Three

NON-VALUE-ADDED COSTS, ACTIVITY COSTS, ACTIVITY COST REDUCTION (LO 4)

John Thomas, vice president of Mallett Company (a producer of a variety of plastic products), has been supervising the implementation of an ABC management system. One of John's objectives is to improve process efficiency by improving the activities that define the processes. To illustrate the potential of the new system to the president, John has decided to focus on two processes: production and customer service.

Within each process, one activity will be selected for improvement: materials usage for production and sustaining engineering for customer service (sustaining engineers are responsible for redesigning products based on customer needs and feedback). Value- added standards are identified for each activity (the level of efficiency so that no waste exists). For materials usage, the value-added standard calls for six kilograms per unit of output (although the plastic products differ in shape and function, their sizeas measured by weightis uniform). The value-added standard is based on the elimination of all waste due to defective moulds. The standard price of materials is $5 per kilogram.

For sustaining engineering, the standard is 58 percent of current practical activity capacity. This standard is based on the fact that about 42 percent of the complaints have to do with design features that could have been avoided or anticipated by the company.

Current practical capacity (at the end of 2009) is defined by the following requirements: 6,000 engineering hours for each product group that has been on the market or in development for five years or less and 2,400 hours per product group of more than five years. Four product groups have less than five years' experience, and 10 product groups have more. Each of the 24 engineers is paid a salary of $60,000. Each engineer can provide 2,000 hours of service per year. No other significant costs are incurred for the engineering activity.

Actual materials usage for 2010 was 25 percent above the level called for by the Value-added standard; engineering usage was 46,000 hours. A total of 80,000 units of output were produced. John and the operational managers have selected some improvement measures that promise to reduce non-value-added activity usage by 40 percent in 2011. Selected actual results achieved for 2011 are as follows:

Units produced 80,000

Materials used 584,800

Engineering hours 35,400

The actual prices paid for materials and engineering hours are identical to the standard or budgeted prices.

Required:

For 2010, calculate the non-value-added usage and costs for materials usage and sustaining engineering.

2. Using the budgeted improvements, calculate the expected activity usage levels for 2011. Now, calculate the 2011 usage variances (the difference between the expected and actual values), expressed in both physical and financial measures, for materials and engineering. Comment on the company's ability to achieve its targeted reductions. In particular, discuss what measures the company must take to capture any realized reductions in resource usage