Exercise 5-36
Make or buy, relevant costs, opportunity cost. Kentucky Motors has manufactured compressor parts at its plant in Pitcairn, Indiana , for the past 18 years . An outside suppliers, Superior Compressor Company, has offered to supply compressor model A238 are as follows:
Direct materials $80
Direct labor 60
Unit-related support 26
Batch-related support 22
Product-sustaining support 8
Facility-sustaining support 17
Total costs $213
a. Should Superior Compressor's offer be accepted if the plant is presently operating below capacity?
The offer by Superior Compressor should not be accepted if facility-sustaining support costs are unavoidable.
Cost per unit / Make / BuyCost of purchase / $200
Variable cost:
Direct material / $ 80
Direct labor / 60
Unit-related support / 26
Batch-related support / 22
Product-sustaining support / 8
Relevant cost per unit / $196 / $200
b. What is the maximum acceptable purchase price if the plant facilities are fully utilized a present and if any additional available capacity can be deployed for the production of other compressor?
The maximum acceptable purchase price is $213 per unit if the plant
facilities are fully utilized at present and the incremental cost of adding more
capacity is approximated well by the $17 per unit facility-sustaining support
cost.
Exercise 5-37
Bogden Company introduced JIT manufacturing last year and has prepared the following data to assess the benefits from the change.
Category Before the Change After the Change
Production cycle time 68 days 30 days
Inventories $160,00 $40,000
Total sales $1,260,000 $1,700,000
Cost as percent of sales:
Direct materials 30% 20%
Direct Labor 22% 15%
Variable support 28% 10%
Fixed support 12% 5%
Inventory financing cost are 15% per year. Estimate the total financial benefits that resulted from the switch to JIT manufacturing operations.
Benefits from cellular manufacturing operations are estimated to be $767,200 as shown below:
Change / After the Change / Difference
Sales / $1,260,000 / $1,700,000 / $440,000
Costs:
Direct material / (378,000) / (340,000) / 38,000
Direct labor / (277,200) / (255,000) / 22,200
Variable support / (352,800) / (170,000) / 182,800
Fixed support / (151,200) / (85,000) / 66,200
Inventory carrying costs / (24,000) / (6,000) / 18,000
Profit / $76,800 / $844,000 / $767,200
Exercise 5-43
Make or buy Tanner Appliance Company manufacturers 12,000 units of part M-4 annually. The part is used in the production of one of its prinicpal products. The following unit cost information is available on part M4:
Direct material $11
Direct Labor 9
Unit-related support 4
Batch-related support 5
Product-sustaining 2
Facility-sustaining support 2
Allocated corporate support 5
Total costs $38
A potential supplier has offered to manufacture this part for Tanner Appliance for $30 per unit. If Tanner Appliance outsources the production of part M4, 50% of batch related and 80% of product-sustaining activity resources can be eliminated. Furthermore, the production facility now being used to produce this part can be used for a fast-growing new product line that would otherwise require the use of a neighboring facility at a rental cost of $20,000 per year.
a. Should Tanner Appliance purchase part M4 from the outside supplier?
Cost of purchase: $30 ´ 12,000 / $360,000
Manufacturing cost:
Direct material / $132,000
Direct labor / 108,000
Unit-related support / 48,000
Batch-related support / 60,000 / 30,000a
Product-sustaining support / 24,000 / 4,800b
Facility-sustaining support / 24,000 / 24,000
Allocated corporate support / 60,000 / 60,000
Savings in rental costs / 0 / (20,000)
Total costs / $456,000 / $458,800
a 50% ´ 60,000 = 30,000
b 20% ´ 24,000 = 4,800
Based on the cost analysis above, Tanner Appliance Company should make
part M4 in-house.
b. What costs are relevant for the decision?
The costs (and cost savings) that differ between the two alternatives are relevant for this decision. That is, direct material, direct labor, unit-related support, differential batch-related support, differential product-sustaining support, and savings in rental costs are relevant for this decision.
c. What additional factors should Tanner consider?
In deciding whether to purchase part M4 from the outside supplier, Tanner should consider factors such as the supplier’s reliability in maintaining quality and on-time delivery, and permanence of the offered price.
Exercise 5-47
ABC and TOC Discuss the similarities and difference between activity-based costing and the theory of constraints as well as situations in which one approach might be preferable to the other.
Both 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.
Exercise 5-48
Cycle time efficiency and JIT Walker Brother Company is considering installing a JIT manufacturing system in the hope that it will improve its over all processing cycle efficiency. Data from the traditional system and estimates for the JIT system are presented here for their Nosun Product.
Time Category Traditional System JIT System
Storage 4hours 1 hours
Inspection 40 minutes 5 minutes
Moving 80 minutes 20 minutes
Processing 2 hours 75 minutes
a. Calculator processing cycle efficiency (PCE) under the traditional and JIT systems for the Nosun Product.
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. Strictly based on your PCE calculation above, should Walker Brothers implement the JIT system? Explain.
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).
Exercise 5-50
Relevant costs: dropping a product Merchant Company manufacturers 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 quarters:
Category Total JT284 JT384 JT484
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
Depreciation 60,000 30,000 12,000 18,000
Utilities 40,000 20,000 5,000 15,000
Supervision 50,000 15,000 5,000 30,000
Maintenance 30,000 15,000 6,000 9,000
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 eliminated two administrative staff positions with combined salaries of $30,000 per quarter.
a. Should Merchant Company eliminate JT484.
Cost 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. 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.
No, the decision to retain JT484 will only be reinforced by the sales manager’s comments.
Exercise 5-51
Quality improvement programs and cost saving. Garber 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 initals production stage to be melted and recast. Such rework requires no new materials in casting but requires new materials in finishings. The following unit cost data are available:
Costs Casting Finishing Inspection Packing Total
Direct Material $225 $12 $0 $ 8 $245
Direct labor 84 121 24 16 245
Variable support 122 164 30 20 336
Fixed support 63 89 16 10 178
$494 $386 $70 $54 $1004
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 I 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. Estimated the annual cost savings as a result of the quality improvement.
Estimated 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
Exercise 5-56
Facilities layout. One 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, customer's 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 rationale for each approach ?
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. Which approach do you favor from (1) a customer's perspective and (2) management's perspective? Explain.
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.
Exercise 5-59
Preparing a cost of quality report. The following information shows last year's quality-related costs for the Renewal Company:
Item Amount
Quality engineering $500,000
Warranty claims 2,345,000
Product liability lawsuits 4,500,000
Research of customer needs 75,000
Maintenance of test equipment 350,000
Returned products 1,200,000
Rework costs 1,200,000
Quality training 125,000
Process control monitoring 1,000,000
Inspection of and testing of incoming materials 400,000
Repair costs in the field 850,000
Statistical process control 250,000
Product recalls 2,000,000
Waste 700,000
Net cost of scrap 635,000
Product quality 475,000
Downtime due to defects 125,000
Supplier certification 90,000
Total sales for the year were $100,000,000
a. Prepare a cost of quality report grouping costs into prevention, appraisal, internal failure, and external failure. Also show costs as a percent of sales.
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%
b. Interpret the data and make recommendations to Renwal's management.