5-47 ABC and TOCDiscuss the similarities and differences between activity-based costing and the theory of constraints, as well as situations in which one approach might be preferable to the other.
5-48 Cycle time efficiency and JITWalker Brothers Company is considering installing a JIT manufacturing system in the hope that it will improve its overall processing cycle efficiency. Data from the traditional system and estimates for the JIT system are presented here for their Nosun Product:
TIME CATEGORYTRADITIONAL SYSTEMJIT SYSTEM
Storage4 hours1 hour
Inspection40 minutes5 minutes
Moving80 minutes20 minutes
Processing2 hours75 minutes
a.Calculate processing cycle efficiency (PCE) under the traditional and JIT systems for the Nosun product.
b.Strictly based on your PCE calculations above, should Walker Brothers implement the JIT system? Explain.
5-50 Relevant Costs: dropping a productMerchant Company manufactures and sells three models of electronic printers. Ken Gail, president of the company, is considering dropping model JT484 from its product line because the company has experienced losses for this product over the past three quarters. The following product-level operating data have been compiled for the most recent quarter:
CATEGORYTOTALJT284JT384JT484
Sales$1,000,000$500,000$200,000$300,000
Variable costs___600,000__300,000__100,000__200,000
Contribution margin$400,000$200,000$100,000$100,000
Fixed costs:
Rent$50,000$25,000$10,000$15,000
Depreciation60,00030,00012,00018,000
Utilities40,00020,0005,00015,000
Supervisors50,00015,0005,00030,000
Maintenance30,00015,0006,0009,000
Administrative__100,000__30,000__20,000__50,000
Total fixed costs_$330,000$135,000_$58,000$137,000
Operating income (loss)$70,000$65,000$42,000($37,000)
In addition, the following information is also available:
•Factory rent and depreciation will not be affected by a decision to drop model JT484.
•Quarterly utility bills will be reduced from $40,000 to $31,000 if JT484 is dropped.
•Supervision costs for JT484 can be eliminated if dropped.
•The maintenance department will be able to reduce quarterly costs by $7,000 if JT484 is dropped.
•Elimination of JT484 will make it possible to eliminate two administrative staff positions with combined salaries of $30,000 per quarter.
a.Should Merchant Company eliminate JT484?
b.Merchant’s sales manager believes that it is important to continue to produce JT484 to maintain a full product line. He expects the elimination of JT484 will reduce sales of the remaining two products by 5% each. Will this information change your answer to (a)? Explain.
5-51 Quality improvement programs and cost savingsGarber Valves Company manufactures brass valves meeting precise specification standards. All finished valves are inspected before packing and shipping to customers. Rejected valves are returned to the initial production stage to be melted and recast. Such rework requires no new materials in casting but requires new materials in finishing. The following unit cost data are available:
COSTSCASTINGFINISHINGINSPECTIONPACKAGINGTOTALS
Direct materials $225$12$0$8$245
Direct labor841212416245
Variable support1221643020336
Fixed support__63___89___16__10__178
$494$386$70$54$1,004
As a result of a quality-improvement program, the reject rate has decreased from 6.4% to 5.1% and the number of rejects has decreased by (6.4%-5.1%) x (10,000) units. Improvements in reject rates have also led to a decrease in work-in-process inventory from $386,000 to $270,000. Inventory carrying costs are estimated to be 15% per year. Estimate the annual cost savings as a result of the quality improvement.
5-56 Facilities layoutOne aspect of facilities layout for McDonald’s is that when customers come into the building, they can line up in one of several lines and wait to be served. In contrast, customers at Wendy’s are asked to stand in one line that snakes around the front of the counter and to wait for a single server.
a.What is the rational for each approach?
b.Which approach do you favor from (1) a customer’s perspective and (2) management’s perspective? Explain.
5-59 Preparing a cost-of-quality reportThe following information shows last year’s quality-related costs for the Renwal Company:
ITEMAMOUNT
Quality engineering$500,000
Warranty claims2,345,000
Product liability lawsuits4,500,000
Research of customer needs75,000
Maintenance of test equipment350,000
Returned products1,200,000
Rework costs1,200,000
Quality training125,000
Process control monitoring1,000,000
Inspection of and testing of incoming materials400,000
Repair costs in the field850,000
Statistical process control250,000
Product recalls2,000,000
Waste700,000
Net cost of scrap635,000
Product quality audits475,000
Downtime due to defects125,000
Supplier certification90,000
Total sales for the year was $100,000,000
a.Prepare a cost-of-quality report grouping costs into prevention, appraisals, internal failure, and external failure. Also show costs as a percent of sales.
b.Interpret the data and make recommendations to Renwal’s management.
5-47Both the theory of constraints and activity-based costing support aspects of process improvement and improved profitability, but differ in many other respects. The theory of constraints emphasizes the short-run optimization of throughput contribution, and downplays operating costs (except direct materials) because they are viewed as difficult to alter in the short-run. Consequently, analyses of activities and cost drivers are not conducted as they are in activity-based costing. Proponents of activity-based costing take a long-term perspective in which managers can alter capacity resources. Therefore, it is viewed as beneficial to produce accurate cost information by tying actual resources consumed to cost objects, such as products, services, channels, and customers. The theory of constraints and activity-based costing might conceivably be used together.
5-48(a)PCE in minutes under the traditional system equals [120/(120 + 80 + 240 + 40)] = [120/480] = 0.25. PCE under the JIT system equals [75/(75 + 20 + 60 + 5)] = [75/160] = 0.47.
(b)Based on the calculations above, Walker Brothers should implement the JIT system since the processing cycle efficiency is almost double that of the traditional system (0.47 vs. 0.25).
5-50(a)Impact of dropping JT484 on operating income:
Reduction in contribution margin / $100,000Cost savings:
Utilities / (9,000)
Supervision / (30,000)
Maintenance / (7,000)
Administrative / (30,000)
Decrease in operating income / $24,000
Therefore, JT484 should not be eliminated.
(b)No, the decision to retain JT484 will only be reinforced by the sales manager’s comments.
5-51Estimated cost savings as a result of the quality improvement:
Savings from decrease in reject rate(0.064 – 0.051) [(494 – 63 – 225) + (386 – 89) + (70 – 16)] 10,000 / $72,410
Savings from reduction in inventory carrying cost
($386,000 – $270,000) 0.15 / $17,400
Total annual savings / $89,810
5-56(a)The approach used at McDonalds in which customers wait in several lines is consistent with the push or conventional manufacturing approach. As one comes into McDonalds it is clear that they have been, and are building inventory in each of the specific bins that they use for, let’s say, Big Macs, fish sandwiches, regular hamburgers, etc. Having inventory at predefined levels keeps the production process going. The motivation to use the traditional production method is to sustain a certain level of inventory to reduce the time the customer has to wait for an order. Notice in McDonalds that hot lights are used to keep the sandwiches warm. One goal of this approach is that customers perceive that they can get their sandwich very quickly due to the inventory of sandwiches always on hand. On the other hand, Wendy’s uses more of a pull or JIT system. As you enter into Wendy’s, notice that you cannot really observe any sandwich inventory building up. The idea in forming one line is that each person has the perception (and often the reality) that each sandwich is made on the spot. This procedure is designed to show customers how fresh the sandwiches are. The motivation to use a just-in-time approach is to improve the quality of the food and to reduce waste by eliminating the need to throw out food that has been sitting too long. As processing time and setup costs drop, the organization can move closer to just-in-time, reducing the waste and quality problems that arise with batch production.
(b)From a customer’s perspective, it does depend on what one favors. If a customer goes to a fast food restaurant, his or her goal is to get food quickly. On any particular day, the customer may be in a great hurry and wish to run in and run out of a fast food establishment. Having multiple lines at a place like McDonalds may be very appealing as far as the perception of the speed with which one can get a meal (compared to a single line at Wendy’s). On another day, perhaps having a meal made freshly on the spot, without any “warming” time under hot lights is more appealing than the speed of getting the food. Of course, one may simply like the taste of one company’s hamburgers over another’s.
From management’s perspective, apart from taste, competing in selling hamburgers may depend on other variables such as the speed with which an order is filled versus tailoring the production process to individual taste. The traditional push production process can lead to a lot more waste than the JIT system, because if a batch of hamburgers is made and demand drops, the quality of the food deteriorates and often has to be thrown out. However, if the line at Wendy’s is very long and customers begin to get impatient, the freshness of the food may begin to lose its appeal.
5-59
/(a)
/Quality Cost Report for Renwal Company
Quality Cost Category /Annual
Cost /Percent of
Sales*Prevention Costs:
Quality training / $125,000 / 0.125%
Quality engineering / 500,000 / 0.500%
Statistical process control / 250,000 / 0.250%
Supplier certification / 90,000 / 0.090%
Research of customer needs / 75,000 / 0.075%
Total / $1,040,000 / 1.040%
Appraisal Costs:
Inspection of and testing of in-coming
materials / $400,000 / 0.400%
Maintenance of test equipment / 350,000 / 0.350%
Process-control monitoring / 1,000,000 / 1.000%
Product-quality audits / 475,000 / 0.475%
Total / $2,225,000 / 2.225%
Internal Failure Costs:
Waste / $700,000 / 0.700%
Net cost of scrap / 635,000 / 0.635%
Rework costs / 1,200,000 / 1.200%
Downtime due to defectives / 125,000 / 0.125%
Total / $2,660,000 / 2.660%
External Failure Costs:
Product-liability lawsuits / $4,500,000 / 4.500%
Repair costs in the field / 850,000 / 0.850%
Warranty claims / 2,345,000 / 2.345%
Returned products / 1,200,000 / 1.200%
Product recalls / 2,000,000 / 2.000%
Total / $10,895,000 / 10.895%
Total Quality Costs: / $16,820,000 / 16.820%
*Total sales were $100,000,000.
(b)The most obvious problem at Renwal is the extremely high external-failure costs of almost 11%. Since as a norm many companies would like to keep their quality costs below 4% to 5% of sales, Renwal Company’s quality costs are out of line. Note in particular that product-liability lawsuits, warranty claims, and product recalls are the biggest external-failure costs. Renwal must find out why its products seem to be failing in the field.
Renwal should first turn to an analysis of its other quality costs. Quality costs are incurred throughout the total life cycle of a product. If Renwal does not control quality costs early in the research, development, and engineering stage by ensuring good product design, then design problems will lead to increased quality costs later on.
At Renwal both prevention and appraisal costs are a relatively small percent of total quality costs (1.04% and 2.225% respectively). Renwal should consider putting more effort into quality training, quality engineering, and statistical process control. The company should also determine whether to spend more money on appraisal. There could be a problem with Renwal’s test equipment that would require the company to incur higher maintenance costs.
With regard to internal-failure costs, Renwal also apparently incurs a great deal of rework costs. The product seems to require many additional costs that need not be incurred if the company could produce it correctly the first time. Perhaps the production process is at fault, or maybe Renwal’s workers are not well trained.
Note that Renwal’s quality-related costs are very low at the prevention stage. They increase for the appraisal and internal-failure cost categories. The external failure costs are extremely high. This pattern of quality costs is what most organizations hope to avoid because the highest category of quality costs corresponds to poor quality recognized only after products are in customers’ hands.
The more desirable quality-costtrend is the reverse of Renwal’s pattern. That is, organizations desire to have the greatest proportion of quality costs incurred in the prevention stage. By increasing quality training and quality engineering costs during this stage, a company can reduce other quality costs. With the company’s products failing less frequently in the customers’ hands, customer satisfaction should increase and the company’s reputation should improve.