QUESTION...

Denim Finishing

Calculate the incremental cash flow The Denim Company would generate by accepting and filling the Guess Who order and producing stonewash jeans when Unit #4 isnt tied up by Guess Who jeans. That is, how much better off is The Denim Finishing Company for operating Unit #4 producing Guess Who jeans and stonewash jeans versus letting Unit #4 sit idle (and the firm producing no jeans)? Assume changeover costs are $100 per changeover (and not $250, as stated in the case).

Activity-Based Costing and Cost Interdependencies among Products: The Denim Finishing Company Dennis Caplan, Nahum D. Melumad, and Amir Ziv ABSTRACT: A fictional carrel ilustrates hon interdependencies among products in the production process, and the costs associated with those interdependencia, chal- lenge the ability of cost accounting systems to generate decision-useful product cost infermatin. The cost interdependency in the current example is a produktion-line change over retthetla incurred to retsel a machine whenever the production process charges from ona product to another Both merginal coating and full cost activity-based covering (ABC) are ontployed in en stormat to provide decision-relevant produchoval information in connection with the decision to add a new pla Keywords: avity-based costing seetriterdiependencies, product profitability analy sis; change-over costs, betup costs INTRODUCTION The Morning Let Down isnc Vicae recently hired Marketing Director for The Denim Finishing Company. the first persever is hold the title, was not good at hiding her emotions. Where she felt angry or embarasseclher face furod red. and this morning, she was both. The hunths ago. She hed belt a mid-kevel holiste position stabige international appel tuulcture to accept a top level position at this anal contractor hundry, which provides laundering and finishing operations to pparel moments. She made the move lece she liked me ide of being a big fish in a pell pond. She was also influenced by the enthusiastod force-ot-personality of the presidex and principal shareholder. Tom Cocorra, who had started the company 15 yens earlier, Diane kraw that Tam expected a lot from her nud sibe had anticipated that her now.cement this morning would be her fast delivery on those expectations. She had proudly outlined in the morning management meeting the details of possible exclusive contract to provide laundering operations for a well-kisovet designer jenis colpar, Guess Who Jends. The designs at C Who Joms had developed and patented a new process to give denen products anovul de Jouk. Tsuks ta Diane hard work peristence previous consectiun. sad one luck. she was alate to convince the product engager 31 Guess Who Jeans that he should outsource the new finishing Dennis Coplan is an Assistant Professor at Oregan State University. Neheim D. Melumd is a Professor at Columbia University, and Amir Ziv is a Profeper at the Interdisciplinary Center, Herzliya. Israel. D operation to Denim Finishing Hogeser Denim Finishing would not be allowed in offer the same finish to any olher cutomer. The company harl never done work for Guess Who jeans. Rathe contract represented an important fact-in-the door." But now Bruce Farrand, tine Openitions Director for Denim Finishing questioning whether the company grea wanted the contract. The price per ingen hat Diane had negotisted with Guess Who Jeans w $7.00. This was more than twice the even thai Derint Finishing receives on any other process. Diane attribued the high price not only to her birgaining skills, but to the fact that Guess Who Jesus w Kown as a compens locused on getting innovatie premiuch products to Mirkou fost end perhaps lees ensed on cost control the some of their competitors. Yet Bruce FRE cupressing doubts about the proposed contact. When the first net. Diese was favorably impressed by Bruce. He was in his early fifties, szemed highly professional, and he had a low-key, friendly demens, and a dry sense of humar. But now Diane was thinking to herself. "Did I misjudge his he one of those people who feels threatened by his co-workers' successes? Or maybe he isn't whitimus cnough to take a more work for more profis." Bruce had altexdy ucphasized that even though profit organy appeared higie farbe new umish, olure would be relatively low. Bruce continued Their juo-in-cime program looks like a good ide for them not for us. They want to drop what we're doing where they send thipat and get the day and omil Lech We don't do the cuveily a bhgest and most o alco We col leven machine that can be realed for Guess Who's specially fish, and that mucline is already cheating et cechy to provide on which reell Loving like holes. The tonling cons and machine datime that we'll incre If we acepte rommet will come our prof. And since the specially finish is printed by Guess Who we can't ofler it to her Owners Our Caperience with the new fried, and our efforts to rent the king cumni won benefit welchere. When we finisheilisking all eyes humed to Ton Carceran. Diere was prepared to respond paint- by-pain to Bruce objection, but all of the joy had gule out of her monti. Tom was quiet for a long time. Diane wondered whether this management by dilence" Fingity. Tom loobed to Kew Bowed the company's Controller and round Wews soud accountants sad a good accounting yara. Keleycra you incorporate Bruce's concerns to Dinne'i proposed contact and time to what the feet on our profita wond be if we accept the cootroci? Plese try to bere it cady by the end of the rech"Kelsey nodded.sld the locating mcd on to other business. After the meeting, Diane returned to her office. She gondered whether she should offer to help Kelsey, but she barely knew Kelasy, and she reasoned that her offer might be ieved as inderfering, She decided to let things go and see what Kelsey came up with on her over Background The Denim Finishing Company provides laundering and finishing operations for large apparel netors. The company's specialty tsing Dashed denim jeans and the denim process au fashing them with a stovashed, rinsed, beched, or other specialytiniah. The parents we then shipped back to the manufacturer for Warehousing or distribution to customers. The compeay does not surtecture or sucket gamle but for provides an important service to appel manufacturer aho want to outsource this wit of the manufacturing proceso The company operates a single facility. Loutkering operations are capital-intensive and require a large investment in industrial sized washing machines. The facility has six such machines, some of which differalar; technical specifications. The company aparates three this daily les fully stilia some of this equipped One specialty tinish is the studenthal" look, which is achieved by washing garingits along with pumice atome. Only one of the company szik machines (Unit41) cant be used for this process At the present time demand for store aus by Denim Finishing's customers 1918 le discounting Crication February 2015 Activity Bed Coats and Cor Interwendeteksi on Pet The Denti Posting Company Sa exceed the company's capacity to supply this finish, so the company rung Unit A4 on all three shifci. and same customers source this finishinon oiher lemndries as well. Currently, Denim Finishing provides about a daxen different finishes to four major cusian.ers, and also provides some of these same finishes to other customers that use the cuiny occasionally, Fueraris aga, amit at sdopted an activity-based casting system. Most of the company's cutis are overbead with respect to anyone customer or type of finish, and profit maximivation requires a sound deading of the cost of providing each tinish because prices are sometimes repotable. dentades als cepecity oa de equipment, and variety of limits are offered THE CONTROLLER'S ANALYSTS Keley's Firsi Pens In the afternoon on the canle day at the ting, Kely used Denim Finishing's existing coming dysten to as the profitability of sceptice the dewarder for the proprietary dicted finish. For this analys Kel) dicided to ignore faciliy-sustaining costs and other cogla that learly don't way with respect to the decision et hend. Following is the relevant information, Operational Data for Unit Capacity: the machine can sua approbabel: 7.500 hours sanvally, using the shitta daily ta - hour day shift, a 9-hour second shift, and a 6-hour night shift), six daye per week (the facility clones one day weekly, ong roting schedule and may required machine maintenance is scheduled for the dey) This assumes the machine nu mulyono finish, so there is in downtine retooling the inachine for a differeix Finishing operation. Batch time: thure hours per batch, for both the stones and the proprietary distressed finiskira. This eatinete includes cinecolood and baland Unit=4, but ignores alors handling time that does Lottie up the chine Gurmente per batch: 100 games por batch for both stuneeth and the proprietary distresad finish 1 Don Finishing sepies the order from als Who saticipated dostand would be 100 Shipastats of the proprie distressed finish with 500 garments per shipinent. This implies the five comatcutive betebes of te peoprietary finish would Isc processed on each of 100 days during the year. Dinne told Kelsey that she participates these shipments would be received on schedule such hur ne no shipmenis could be nun el-o-back Demand for slaneough is effectively unlimited. So Denim l'inishing couldlfill it." Unit 4 with stanevash whenever the machine was tot aed for the proprietary process Revenue date: The revenue for stonewash is 52.00 pez gament, and for the proprietary distressed finish is $7.00 per panno Direct costs: Direct costs are electively variable with respect to the weber of sankalis proceso Disposabk supplies for stoneshongist of punice sont, and for the proprietary disureaded finish. consist of derenyent and also an abrasive natural rock product Shipping refers to the car to ship the geed back to the souliches Sated on a per-pem cubois, these direst posts are as follane Proprietary Stonewash Finish Distressed Finish Direct costs Dispoyebke Supplies $0.00 $0.90 Shipping $0.10 $0.20 lol 30.19 $1.10 Overhead costs: The Denim Finishing Company classifies overhead costs into four cost pools, based on the cost hierarchy of output unit-level costs, batch-level costs, product-sustaining costs, and facility-sustaining costs Batch-Level and Output Unit-Level Cosis Botch-level costs consist of utility expense and batch set-up costs for both washing and drying operations. Output unit-level overhead costs consist of wages for matcrials-handlers. These materi- als-handlers receive shipments of garments and batch them for processing. After the garments have been processed through the washing and drying operations, the materials-handlers prepare finished garments for shipment back to the customer. All batch-level and output unit-level costs have the same resource requirements, stated on a per garment basis, for the proprietary distressed finish as for the stonewash finish. This is partly due to the fact that batch sizes and machine cycle times are the same for both processes. Batch-level and output unit-level cost information is as follows: Overhead Cost Cast Driver Overhead Rate per Garment Batch-level coste Utility expense machine hours $7.50 per hour S0.45 Set-up costs number of batches $25 per batch $0.25 Output it-level costs Materials handling number of garments 50.10 per garment $0.10 The per-utit utility expense is based on six soachine hours per batch: three for washing and three for drying. Hence, $7.50 per hour * 6 machine hours + 100 garments per batch - $0.45 per germent. Product Sustaining Costs Product-sustaining costs can be ignored for all processes other than stonewash and the proprio etary finish (the two processes that utilize Unit #4). Product-sustaining costs for these two processes are fixed costs that are incurred if that particulur finish is run, and are avoidable if the finish is not run. If the finish is run, then these costs are fixed, and do not vary with respect to the number of batches or the number of garments per batch. Hence, the per-gamont product-sustaining cost is an allocation of fixed costs, and varies for stonewash depending on the number of units run. Product-sustaining costs for stonewash are $140,000 annually. These costs consist of rental payments on equipment to store and handle the pumice stone, and payments to a consultant who has considerable expertise with the stonewash finish. The consultant supervises the quality assurance process for stonewash, as well as sourcing of the pusnice stone. The product-sustaining per-unit cost depends on the volume of stonewash product, as shown in Exhibit Product-sustaining costs for the proprietary distressed finish are $37,500 annually, or $0.75 per garment. These costs consist principally of monthly case payments on equipment required to treat the wastewater discharged from Unit #4 when the proprietary distressed finish is nu on that machine, before the wastewater can be released into the local sewer system. There are also annual fixed costs for this finish that relate to regulatory permits for the wastewater discharge. Facilit-Sustaining Costs These costs can be ignored, because they are expected to remain constant regardless of hon Unit #4 is used. Hence, they are not incremental costs with respect to the decision at hand. For background information on the role of cost hicrarchis in aeth ity-based coating, af to a comprehensive naanage- into accounting textbook such as Cost Accounting: A Sigoris Experis by Homgien et al. (2003), or Alanagerial Accounting by Carrison and Noreen (2003). issues in Accounting Education, Mebruary 2005 Activity-Based Costing and Cost Interdependencies among Products: The Demina Finishing Company 55 Machine Change-Over Costs There are additional costs that Kelsey was unsure how to classify. These are costs associated with converting Unit #4 between stonewash and the proprietary distressed finish, and they are in addition to the usual batch-level set-up costs. The change-over costs include shop-floor labor to clean and retool the machine. Bruce told Kelsey that he would need two hourly workers for four hours each to perfon these activities, although the machine would only be down for three of the four hours. When Kelsey shared this information with Diane. Diane thought it sounded very reasonable. Kelsey estimated the wage rate for these two employees at $25 per hour. The change-over costs also include disposable supplies (such as cleaning supplies) of $50 per change-over. Hence the total out-of-pocket change-over costs would be $250 ($25 per hour * 4 hours * 2 employees, plus 550 in supplies). These costs would be avoided if Unit #4 were used for either finish exclusively. Activity-Based Costing and Cost Interdependencies among Products: The Denim Finishing Company Dennis Caplan, Nahum D. Melumad, and Amir Ziv ABSTRACT: A fictional carrel ilustrates hon interdependencies among products in the production process, and the costs associated with those interdependencia, chal- lenge the ability of cost accounting systems to generate decision-useful product cost infermatin. The cost interdependency in the current example is a produktion-line change over retthetla incurred to retsel a machine whenever the production process charges from ona product to another Both merginal coating and full cost activity-based covering (ABC) are ontployed in en stormat to provide decision-relevant produchoval information in connection with the decision to add a new pla Keywords: avity-based costing seetriterdiependencies, product profitability analy sis; change-over costs, betup costs INTRODUCTION The Morning Let Down isnc Vicae recently hired Marketing Director for The Denim Finishing Company. the first persever is hold the title, was not good at hiding her emotions. Where she felt angry or embarasseclher face furod red. and this morning, she was both. The hunths ago. She hed belt a mid-kevel holiste position stabige international appel tuulcture to accept a top level position at this anal contractor hundry, which provides laundering and finishing operations to pparel moments. She made the move lece she liked me ide of being a big fish in a pell pond. She was also influenced by the enthusiastod force-ot-personality of the presidex and principal shareholder. Tom Cocorra, who had started the company 15 yens earlier, Diane kraw that Tam expected a lot from her nud sibe had anticipated that her now.cement this morning would be her fast delivery on those expectations. She had proudly outlined in the morning management meeting the details of possible exclusive contract to provide laundering operations for a well-kisovet designer jenis colpar, Guess Who Jends. The designs at C Who Joms had developed and patented a new process to give denen products anovul de Jouk. Tsuks ta Diane hard work peristence previous consectiun. sad one luck. she was alate to convince the product engager 31 Guess Who Jeans that he should outsource the new finishing Dennis Coplan is an Assistant Professor at Oregan State University. Neheim D. Melumd is a Professor at Columbia University, and Amir Ziv is a Profeper at the Interdisciplinary Center, Herzliya. Israel. D operation to Denim Finishing Hogeser Denim Finishing would not be allowed in offer the same finish to any olher cutomer. The company harl never done work for Guess Who jeans. Rathe contract represented an important fact-in-the door." But now Bruce Farrand, tine Openitions Director for Denim Finishing questioning whether the company grea wanted the contract. The price per ingen hat Diane had negotisted with Guess Who Jeans w $7.00. This was more than twice the even thai Derint Finishing receives on any other process. Diane attribued the high price not only to her birgaining skills, but to the fact that Guess Who Jesus w Kown as a compens locused on getting innovatie premiuch products to Mirkou fost end perhaps lees ensed on cost control the some of their competitors. Yet Bruce FRE cupressing doubts about the proposed contact. When the first net. Diese was favorably impressed by Bruce. He was in his early fifties, szemed highly professional, and he had a low-key, friendly demens, and a dry sense of humar. But now Diane was thinking to herself. "Did I misjudge his he one of those people who feels threatened by his co-workers' successes? Or maybe he isn't whitimus cnough to take a more work for more profis." Bruce had altexdy ucphasized that even though profit organy appeared higie farbe new umish, olure would be relatively low. Bruce continued Their juo-in-cime program looks like a good ide for them not for us. They want to drop what we're doing where they send thipat and get the day and omil Lech We don't do the cuveily a bhgest and most o alco We col leven machine that can be realed for Guess Who's specially fish, and that mucline is already cheating et cechy to provide on which reell Loving like holes. The tonling cons and machine datime that we'll incre If we acepte rommet will come our prof. And since the specially finish is printed by Guess Who we can't ofler it to her Owners Our Caperience with the new fried, and our efforts to rent the king cumni won benefit welchere. When we finisheilisking all eyes humed to Ton Carceran. Diere was prepared to respond paint- by-pain to Bruce objection, but all of the joy had gule out of her monti. Tom was quiet for a long time. Diane wondered whether this management by dilence" Fingity. Tom loobed to Kew Bowed the company's Controller and round Wews soud accountants sad a good accounting yara. Keleycra you incorporate Bruce's concerns to Dinne'i proposed contact and time to what the feet on our profita wond be if we accept the cootroci? Plese try to bere it cady by the end of the rech"Kelsey nodded.sld the locating mcd on to other business. After the meeting, Diane returned to her office. She gondered whether she should offer to help Kelsey, but she barely knew Kelasy, and she reasoned that her offer might be ieved as inderfering, She decided to let things go and see what Kelsey came up with on her over Background The Denim Finishing Company provides laundering and finishing operations for large apparel netors. The company's specialty tsing Dashed denim jeans and the denim process au fashing them with a stovashed, rinsed, beched, or other specialytiniah. The parents we then shipped back to the manufacturer for Warehousing or distribution to customers. The compeay does not surtecture or sucket gamle but for provides an important service to appel manufacturer aho want to outsource this wit of the manufacturing proceso The company operates a single facility. Loutkering operations are capital-intensive and require a large investment in industrial sized washing machines. The facility has six such machines, some of which differalar; technical specifications. The company aparates three this daily les fully stilia some of this equipped One specialty tinish is the studenthal" look, which is achieved by washing garingits along with pumice atome. Only one of the company szik machines (Unit41) cant be used for this process At the present time demand for store aus by Denim Finishing's customers 1918 le discounting Crication February 2015 Activity Bed Coats and Cor Interwendeteksi on Pet The Denti Posting Company Sa exceed the company's capacity to supply this finish, so the company rung Unit A4 on all three shifci. and same customers source this finishinon oiher lemndries as well. Currently, Denim Finishing provides about a daxen different finishes to four major cusian.ers, and also provides some of these same finishes to other customers that use the cuiny occasionally, Fueraris aga, amit at sdopted an activity-based casting system. Most of the company's cutis are overbead with respect to anyone customer or type of finish, and profit maximivation requires a sound deading of the cost of providing each tinish because prices are sometimes repotable. dentades als cepecity oa de equipment, and variety of limits are offered THE CONTROLLER'S ANALYSTS Keley's Firsi Pens In the afternoon on the canle day at the ting, Kely used Denim Finishing's existing coming dysten to as the profitability of sceptice the dewarder for the proprietary dicted finish. For this analys Kel) dicided to ignore faciliy-sustaining costs and other cogla that learly don't way with respect to the decision et hend. Following is the relevant information, Operational Data for Unit Capacity: the machine can sua approbabel: 7.500 hours sanvally, using the shitta daily ta - hour day shift, a 9-hour second shift, and a 6-hour night shift), six daye per week (the facility clones one day weekly, ong roting schedule and may required machine maintenance is scheduled for the dey) This assumes the machine nu mulyono finish, so there is in downtine retooling the inachine for a differeix Finishing operation. Batch time: thure hours per batch, for both the stones and the proprietary distressed finiskira. This eatinete includes cinecolood and baland Unit=4, but ignores alors handling time that does Lottie up the chine Gurmente per batch: 100 games por batch for both stuneeth and the proprietary distresad finish 1 Don Finishing sepies the order from als Who saticipated dostand would be 100 Shipastats of the proprie distressed finish with 500 garments per shipinent. This implies the five comatcutive betebes of te peoprietary finish would Isc processed on each of 100 days during the year. Dinne told Kelsey that she participates these shipments would be received on schedule such hur ne no shipmenis could be nun el-o-back Demand for slaneough is effectively unlimited. So Denim l'inishing couldlfill it." Unit 4 with stanevash whenever the machine was tot aed for the proprietary process Revenue date: The revenue for stonewash is 52.00 pez gament, and for the proprietary distressed finish is $7.00 per panno Direct costs: Direct costs are electively variable with respect to the weber of sankalis proceso Disposabk supplies for stoneshongist of punice sont, and for the proprietary disureaded finish. consist of derenyent and also an abrasive natural rock product Shipping refers to the car to ship the geed back to the souliches Sated on a per-pem cubois, these direst posts are as follane Proprietary Stonewash Finish Distressed Finish Direct costs Dispoyebke Supplies $0.00 $0.90 Shipping $0.10 $0.20 lol 30.19 $1.10 Overhead costs: The Denim Finishing Company classifies overhead costs into four cost pools, based on the cost hierarchy of output unit-level costs, batch-level costs, product-sustaining costs, and facility-sustaining costs Batch-Level and Output Unit-Level Cosis Botch-level costs consist of utility expense and batch set-up costs for both washing and drying operations. Output unit-level overhead costs consist of wages for matcrials-handlers. These materi- als-handlers receive shipments of garments and batch them for processing. After the garments have been processed through the washing and drying operations, the materials-handlers prepare finished garments for shipment back to the customer. All batch-level and output unit-level costs have the same resource requirements, stated on a per garment basis, for the proprietary distressed finish as for the stonewash finish. This is partly due to the fact that batch sizes and machine cycle times are the same for both processes. Batch-level and output unit-level cost information is as follows: Overhead Cost Cast Driver Overhead Rate per Garment Batch-level coste Utility expense machine hours $7.50 per hour S0.45 Set-up costs number of batches $25 per batch $0.25 Output it-level costs Materials handling number of garments 50.10 per garment $0.10 The per-utit utility expense is based on six soachine hours per batch: three for washing and three for drying. Hence, $7.50 per hour * 6 machine hours + 100 garments per batch - $0.45 per germent. Product Sustaining Costs Product-sustaining costs can be ignored for all processes other than stonewash and the proprio etary finish (the two processes that utilize Unit #4). Product-sustaining costs for these two processes are fixed costs that are incurred if that particulur finish is run, and are avoidable if the finish is not run. If the finish is run, then these costs are fixed, and do not vary with respect to the number of batches or the number of garments per batch. Hence, the per-gamont product-sustaining cost is an allocation of fixed costs, and varies for stonewash depending on the number of units run. Product-sustaining costs for stonewash are $140,000 annually. These costs consist of rental payments on equipment to store and handle the pumice stone, and payments to a consultant who has considerable expertise with the stonewash finish. The consultant supervises the quality assurance process for stonewash, as well as sourcing of the pusnice stone. The product-sustaining per-unit cost depends on the volume of stonewash product, as shown in Exhibit Product-sustaining costs for the proprietary distressed finish are $37,500 annually, or $0.75 per garment. These costs consist principally of monthly case payments on equipment required to treat the wastewater discharged from Unit #4 when the proprietary distressed finish is nu on that machine, before the wastewater can be released into the local sewer system. There are also annual fixed costs for this finish that relate to regulatory permits for the wastewater discharge. Facilit-Sustaining Costs These costs can be ignored, because they are expected to remain constant regardless of hon Unit #4 is used. Hence, they are not incremental costs with respect to the decision at hand. For background information on the role of cost hicrarchis in aeth ity-based coating, af to a comprehensive naanage- into accounting textbook such as Cost Accounting: A Sigoris Experis by Homgien et al. (2003), or Alanagerial Accounting by Carrison and Noreen (2003). issues in Accounting Education, Mebruary 2005 Activity-Based Costing and Cost Interdependencies among Products: The Demina Finishing Company 55 Machine Change-Over Costs There are additional costs that Kelsey was unsure how to classify. These are costs associated with converting Unit #4 between stonewash and the proprietary distressed finish, and they are in addition to the usual batch-level set-up costs. The change-over costs include shop-floor labor to clean and retool the machine. Bruce told Kelsey that he would need two hourly workers for four hours each to perfon these activities, although the machine would only be down for three of the four hours. When Kelsey shared this information with Diane. Diane thought it sounded very reasonable. Kelsey estimated the wage rate for these two employees at $25 per hour. The change-over costs also include disposable supplies (such as cleaning supplies) of $50 per change-over. Hence the total out-of-pocket change-over costs would be $250 ($25 per hour * 4 hours * 2 employees, plus 550 in supplies). These costs would be avoided if Unit #4 were used for either finish exclusively