Solution manual managerial accounting 8e by hansen mowen ch 5

Driver analysis is concerned with identifying the root causes of activity costs.. Thus, it may be necessary to also identify the optimal level of the cost driver so that only nonvalue

ACTIVITY- BASED MANAGEMENT

QUESTIONS FOR WRITING AND DISCUSSION

1 The two dimensions are the cost dimension

and the process dimension The cost

di-mension is concerned with accurate

as-signment of costs to cost objects, such as

products and customers Activity-based

costing is the focus of this dimension The

second dimension—the process

dimen-sion—provides information about why work

is done and how well it is done It is

con-cerned with cost driver analysis, activity

analysis, and performance measurement

This dimension offers the connection to the

continuous improvement world found in the

advanced manufacturing environment

2 A functional-based responsibility accounting

system is characterized by four elements:

(1) a responsibility center, where

responsi-bility is assigned to an individual in charge

(responsibility is usually defined in financial

terms); (2) the setting of budgets and

stan-dards to serve as benchmarks for

perform-ance measurement; (3) measurement of

performance by comparing actual outcomes

with budgeted outcomes; and (4) individuals

being rewarded or penalized according to

management policies

3 In an activity-based responsibility accounting

system, the focus of control shifts from

re-sponsibility centers to processes and teams

Management is concerned with how work is

done, not with where it is done Process

im-provement and process innovation are

em-phasized Standards tend to be optimal,

dy-namic, and process oriented Performance

measurement focuses on processes and

ac-tivities that define the processes Finally,

there tends to be more emphasis on group

rewards than on individual rewards

4 Driver analysis is concerned with identifying

the root causes of activity costs Knowing

the root causes of activity costs is the key to

improvement and innovation Once a

man-ager understands why costs are being

in-curred, then efforts can be taken to improve

5 Activity inputs are the resources consumed

by an activity in producing its output Activity output is the result or product of an activity Activity output measurement simply means the number of times the activity is per- formed

6 Activity analysis is concerned with

identify-ing activities performed by an organization, assessing their value to the organization, and selecting and keeping only those that are value adding Selecting and keeping value-adding activities brings about cost re- duction and greater operating efficiency, thus providing support for the objective of continuous improvement

7 Value-added activities are necessary

activi-ties Activities are necessary if they are mandated or if they are not mandated and satisfy three conditions: (1) they cause a change of state, (2) the change of state is not achievable by preceding activities, and (3) they enable other activities to be per- formed Value-added costs are costs caused

by activities that are necessary and

efficient-ly executed

8 Nonvalue-added activities are unnecessary

activities or those that are necessary but efficient and improvable An example is moving goods Nonvalue-added costs are those costs caused by nonvalue-added ac- tivities An example is the cost of materials handling

9 (1) Activity elimination—the identification

and elimination of activities that fail to add value (2) Activity selection—the process of choosing among different sets of activities caused by competing strategies (3) Activity reduction—the process of decreasing the time and resources required by an activity (4) Activity sharing—increasing the efficien-

cy of necessary activities using economies

of scale

lute levels are value-added costs Any

dif-ference between the actual costs incurred

and the ideal costs are nonvalue-added

costs

11 Trend reports will reveal the progress made

over time in reducing nonvalue-added costs

12 A kaizen standard is the planned

improve-ment for the coming period The kaizen

sub-cycle implements the improvement, checks

it, and locks it in and then begins a search

for additional improvements The

mainten-ance subcycle sets a standard based on

prior improvements, executes, and checks

the results to make sure that performance

conforms to the new results If not, then

cor-rective action is taken

13 Benchmarking identifies the best practices

of comparable internal and external units

For internal units, information can be

ga-thered that reveals how the best unit

achieves its results; these procedures can

then be adopted by other comparable units

For external units, the performance standard

provides an incentive to find ways to match

the performance (it may sometimes be

poss-ible to determine the ways the performance

is achieved)

14 If individuals are asked to reduce costs and

are told what the activity driver is, they may

decrease the level of the driver below that

which is optimal Thus, it may be necessary

to also identify the optimal level of the cost

driver so that only nonvalue-added costs are

eliminated

15 The activity volume variance is a measure of

the nonvalue-added costs The unused

ca-pacity variance tells how much of the

commit-ted resources are not being used This

in-formation is particularly important because it

helps managers know when they can take

actions to reduce nonvalue-added costs

16 Activity-based customer costing can identify

what it is costing to service different tomers Once known, a firm can then devise

cus-a strcus-ategy to increcus-ase its profitcus-ability by cusing more on profitable customers, con- verting unprofitable customers to profitable ones where possible, and “firing” customers that cannot be made profitable

fo-17 Activity-based supplier costing traces all

supplier-caused activity costs to suppliers This new total cost may prove to be lower than what is signaled simply by purchase price

Rework rate = $600,000/20,000 = $30 per rework hour

= $2,250,000

Unit overhead cost = $2,250,000/100,000 = $22.50

Improving the accuracy reduced the cost by $7.50, which is still less than the

$10 reduction needed What this means is that although accuracy has a tive effect on the price, it is not the only problem It appears that competitors may be more efficient than Timesaver This outcome then signals the need to reduce costs

posi-2 Since testing and rework costs and setup and rework time are both reduced

by 50%, the activity rates remain the same, although the amount of cost signed to the regular microwave will change:

= $1,875,000

Unit cost = $1,875,000/100,000 = $18.75

This cost now is $11.25 less than the original allows management to reduce the price by $10, increasing the competitive position of the regular model ABC is concerned with how costs are assigned, whereas ABM is not only concerned with how they are assigned but also with how costs can be re- duced Cost accuracy and cost reduction are the dual themes of ABM

of a team looking for ways to improve procurement

Situation 2: In a functional-based responsibility system, individuals in charge of responsibility centers are rewarded based on their ability to achieve the financial goals of the responsibility center Thus, meeting budget promises the “fat” bo- nus In a continuous improvement environment, process improvement is depen- dent on team performance, so rewards tend to be group based, and gainsharing

is often used Furthermore, there are many facets to process performance other than cost, so the performance measures tend to be multidimensional (e.g., quality and delivery time)

Situation 3: In a functional-based system, efforts are made to encourage uals to maximize the performance of the subunit over which they have responsi- bility The concern of activity-based responsibility accounting is overall organiza- tional performance The focus is systemwide It recognizes that maximizing individual performance may not produce firmwide efficiency

individ-Situation 4: In a functional-based system, performance of subunits is usually financial-based and is measured by comparing actual with budgeted outcomes In

an activity-based system, process performance is emphasized The objective is to provide low-cost, high-quality products, delivered on a timely basis Thus, both financial and nonfinancial measures are needed

Situation 5: In a functional-based system, budgets and standards are used to control costs In an activity-based responsibility system, the focus is on activities because activities are the cause of costs Driver analysis and activity analysis are fundamental to the control process Driver analysis recognizes that controlling costs requires managers to understand the root causes Activity analysis is the effort expended to identify, classify, and assess the value content of all activities Once the value content is known, then costs can be controlled through such means as activity reduction, activity elimination, activity sharing, and activity se- lection

Situation 6: A functional-based system uses currently attainable standards that allow for a certain amount of inefficiency Achieving the standard is the empha- sis, and there is no effort to improve on the standards themselves An activity- based approach strives for the ideal, and so the standard is the ideal Progress is measured over time with the expectation that performance should be continually improving Efforts are made to find new ways of doing things and, thus, to find new optimal standards The objective is to always provide incentives for positive changes

Situation 7: The functional-based system tends to ignore a firm’s activities and the linkages of those activities with suppliers and customers It is internally fo- cused An activity-based system builds in explicit recognition of those linkages and emphasizes the importance of the value chain Furthermore, the assessment

of the value content of activities is explicitly related to customers What goes on outside the firm cannot be ignored

5–3

The ABM implementation is taking too long and is not producing the expected sults It also appears to not be integrated with the division’s official accounting system, thus encouraging managers to continue relying on the old system (as evidenced by the continued reliance on traditional materials and labor efficiency variances) The fact that the ABC product costs are not significantly different in many cases could be due to a lack of product diversity or perhaps due to poor choices of pools and drivers The lack of a competitive cost state suggests the presence of significant nonvalue-added costs The emphasis on the absence of product cost differences, lack of cost reductions, and the attitude about activity detail and the value content of inspection all reveal that plant managers have a very limited understanding about ABM and what it can do There clearly needs to

re-be a major effort to train managers to understand and use activity data At this point, there is no organizational culture that emphasizes the need for continuous improvement This need and the role ABM plays in continuous improvement needs to be taught The new ABM system also needs to be integrated to maximize its chances for success

5–4

1 David was concerned about meeting the schedule and staying within the 5 percent variance guideline The first week’s production exceeded the guide- line for both materials and labor, and he expected the same outcome for the second week By stopping inspections, no materials waste would be ob- served and recorded for the second week, moving the usage variance back within the 5 percent tolerance level Accepting all units produced also will re- duce the total labor time reported Finally, using inspectors as production la- bor and counting their time as inspection labor provides some “free” direct labor time, which would also contribute to the reduction or elimination of an unfavorable labor efficiency variance David’s behavior is unethical David (and perhaps others) is deliberately subverting the organization’s legitimate and ethical objective of providing a high-quality product used in the manufac- ture of an airplane—in exchange for a favorable performance rating and, pre- sumably, a good salary increase or bonus Although no explicit information is provided, the stress test seems to imply an important safety role for the bolts

in the airplane structure If true, then David’s actions become even more questionable

2 There appears to be an overreliance on standards and variances There also appears to be a strong internal focus—David did not give much consideration

to the effect of his decision on the company’s customers The reward ture seems to be tied to the ability of David to meet or beat standards, and this provides some incentive to engage in perverse and even unethical beha- vior The system certainly works against the goal of zero defects and total quality An activity-based system would tend to mitigate the problem because

struc-it encourages a multidimensional performance measurement For example, quality measures are important Failure to meet measures on one dimension may be offset to some extent by good performance on other dimensions A strategic-based approach would mitigate the behavior even more, as it adopts

a customer focus, and performance measures relating to such things as tomer satisfaction are introduced Furthermore, more effort is made to link the performance measures with the company’s mission and strategy

cus-Finally, by communicating the strategy through the use of performance measures of various perspectives, a strategic-based approach tends to align individual goals with those of the organization However, it should be men- tioned that designing a system with perfect incentives is difficult Ultimately, the firm must rely on the character of its employees to carry out its objec- tives

3 The first week’s experience indicates a fairly high defect rate—between 7 and

8 percent—which was expected to continue for the second week Apparently, item-by-item inspection is the company’s way of ensuring reliable bolt per- formance Abandoning the inspection process for a week simply to meet in- ternal reporting standards seems like a weak excuse, even if a return to nor- mal practices is expected All too often, this sort of rationalization leads to repeated violations of norms to meet short-term goals, and it becomes part of the culture—to the point where it doesn’t appear to be wrong anymore Fun- damentally, the need for inspection and the high reject rate suggests that the company needs to think about ways of improving its manufacturing process

to reduce the number of defective units This is why an activity- or based approach may be more suitable because they both have a process fo- cus that emphasizes quality and efficiency Production of defective units would not be encouraged

strategic-5–5

The following are possible sets of questions and answers (provided as examples

of what students could suggest):

Cleaning oil:

Question: Why is the oil puddle cleaned daily?

Question: Why does the production equipment leak oil?

Question: How do we repair the damaged seal?

Providing sales allowances:

Question: Why are we giving sales allowances?

Question: Why is the product not working as it should?

Question: Why does it have a defective component?

components

Question: Why do our subassembly processes produce bad components?

cause)

Question: How do we improve the skills of our workers?

Nonvalue-added:

doc-Question 1: Why are we resolving discrepancies?

compared and found to be in disagreement

Question 2: Why are documents being compared?

Question 3: Why would the documents not agree?

Question 4: Why would a document be wrong?

to the amount ordered or because the amount billed may not pond to the amount received or both

corres-Question 5: Why are the amounts different?

Question 6: How can we avoid clerical error?

suppliers, extra training and care can be suggested where there is evidence of a problem

5–8

1 A process is a collection of activities with a common objective The common objective of procurement is to supply bought and paid for materials to opera- tions (e.g., the manufacturing process) The common objective of purchasing

is to produce a request for materials from suppliers; the common objective of receiving is to process materials from suppliers and move them to the opera- tions area (e.g., stores or manufacturing); the common objective of paying bills is to pay for the materials received from suppliers

2 The effect is to reduce the demand for the activity of resolving discrepancies

clerical time Thus, about four clerks can be eliminated (21% * 20 clerks = 4 clerks eliminated) by reassigning them to other areas or simply laying them off This will produce savings of about $120,000 per year (4 clerks * $30,000 salary) This is an example of process improvement—an incremental increase

in process efficiency resulting in a cost reduction

5–9

EDI eliminates the demand for virtually all the activities within the bill-paying process Some demand may be left for payment activities relative to the acquisi- tion of nonproductive supplies Assuming conservatively that 90 percent of the demand is gone, then there would be a need for perhaps two clerks (10% * 20 clerks = 2 remaining clerks) This would save the company $540,000 (18 clerks *

$30,000 salary) per year for this subprocess alone Additional savings would be realized from reduction of demands for purchasing and receiving activities Switching to an EDI procurement structure is an example of process innovation

Case Nonvalue-Added Cost Root Cause Cost Reduction

Fixed activity rate = SP = $252,000/28,800 = $8.75 per order

Cost of unused capacity:

The activity volume variance measures the nonvalue-added cost The unused

capacity variance is a measure of the potential to reduce the spending on an

activity and, thus, reduce the nonvalue-added costs

A value-added cost report would be as follows:

Highlighting nonvalue-added costs shows managers where savings are ible and emphasizes the need for improvement In this case, reducing orders processed to 14,400 will create unused capacity of 14,400 orders, allowing the company to save $126,000 in salaries

poss-3 First, the value-added standard is nonzero Second, purchasing enables other activities to be performed Third, there is a change of state—from a state of

no materials requested to a state of materials requested Fourth, the purchase state could not have been achieved by a prior activity Fifth, it is a necessary activity—one essential for the firm to remain in business

Possible reasons for exceeding the value-added standard: suboptimal tory management policies, reorders due to bad parts being delivered by sup- pliers, extra orders due to rework requirements, and additional orders be- cause the wrong types and quantities of materials were ordered

inven-4 By reducing the demand by another 6,000 units, the unused capacity will now equal 7,200 orders—an amount equivalent to 1.5 purchasing agents Thus, the number of purchasing agents can be reduced from 6 to 5, saving $42,000

1 Willson Company

For the Year Ended December 31, 2005

5–13

For the Year Ended December 31, 2006

man-5–14

1 Activity and driver analysis:

Setting up equipment: This is a value-added activity because (1) it causes a change in the state of nature: improperly configured equipment to properly configured equipment, (2) there is no prior activity that could have caused the state change, and (3) it is necessary to enable other activities to be per- formed However, setting up equipment often takes more time than needed and so this activity has a nonvalue-added component Most companies strive for zero setup time Thus, the time and associated cost are nonvalue-added because the activity is performed inefficiently Means should be explored to reduce the time of this activity so that it consumes fewer resources Possible root causes include such factors as product design, process design, and equipment design Knowing the root causes can lead to an improvement in activity efficiency Moving from a departmental manufacturing structure to a cellular manufacturing structure in some cases may eliminate the need for se- tups, thus eliminating the activity, or flexible manufacturing equipment might

be purchased that provides an almost instantaneous setup capability (a change in process technology—and certainly a change in equipment design)

In other cases, the activity may be improved by redesigning the product so that a less complicated setup is required

Creating scrap: This is generally viewed as a nonvalue-added activity and should be eliminated It is nonvalue-added because it causes a nondesired change of state and because it does not enable other value-added activities to

be performed Efforts should be made to find ways of producing that nate scrap Possible root causes include poor vendor quality, quality man- agement approach, and manufacturing process used Knowing the root caus-

elimi-es may lead to a supplier valuation program that improvelimi-es the quality of the parts and materials purchased externally, adoption of a total quality manage- ment program, and perhaps the use of automated equipment to cut down on material waste (because of greater precision)

Welding subassemblies: This is a value-added activity It causes a desired state change that could not have been done by preceding activities and enables other activities to be performed If inefficient, then means should be sought to improve efficiency The goal is to optimize value-added activity per- formance Possible root causes include product design, process design, and production technology Changing either of the two designs could decrease the demand for the welding activity while producing the same or more output

A change in technology—buying more advanced technology, for example— may also increase the efficiency of the activity

Materials handling: This is a nonvalue-added activity Moving materials and subassemblies from one point in the plant changes location but not the state But it does enable other activities to be performed, and it is not a repeated ac- tion If you argue that changing location is a change in state, then moving ma- terials is value-added but with the potential of significant increases in efficien-

cy (as with setups, the goal is to minimize the amount of activity performance) Possible root causes include plant layout, manufacturing processes, and ven- dor arrangements Moving from a departmental to a cellular structure, adopting computer-aided manufacturing, and entering into contracts with suppliers that require just-in-time delivery to the point of production are examples of how knowledge of root causes can be exploited to reduce and eliminate nonvalue- added activities

Inspecting parts: Inspection is a nonvalue-added activity It is a detection activity and is not necessary to enable other activities to be per- formed This activity should be reduced and eventually eliminated A possible root cause of inspection is the possibility of poor quality of parts and mate- rials The company should work with suppliers to ensure high quality (zero- defect parts)

Setting up equipment: Using the number of setups as a driver may cause a buildup of inventories Since reducing the number of setups will reduce setup costs, there will be an incentive to have fewer setups Reducing the number

of setups will result in larger lots and could create finished goods inventory This is in opposition to the goal of zero inventories On the other hand, if se- tup time is used as the driver, managers will have an incentive to reduce se- tup time Reducing setup time allows managers to produce on demand rather than for inventory

5–14 Concluded

Creating scrap: Using the number of defective units as a driver should courage managers to reduce defective units Assuming that defective units are the source of scrap, this should reduce scrap costs Similarly, using pounds of scrap should encourage managers to find ways to reduce scrap In both cases, the behavioral consequences could be two-edged If the reduc- tion of scrap (defective units) is achieved by increasing quality/productive ef- ficiency, the effect is compatible with the objective of creating a competitive advantage If the reduction is achieved by allowing defective units to flow through to finished goods, then the effect will be to alienate customers, not win their favor (customer realization decreases) Neither driver appears to dominate One solution is to report the trend in warranty activity with the trend in scrap activity This may discourage any kind of pass-on behavior

Welding subassemblies: Using welding hours should encourage management

to find ways of reducing the welding hours required per product This would

be more likely to induce managers to look at possible root causes such as product design and process design rather than number of welded subassem- blies There is some value in looking for ways to reduce the number of welded subassemblies, perhaps redesigning the product to eliminate welding

Materials handling: Both drivers seem to have positive incentives Seeking ways to reduce the number of moves or distance moved should lead manag- ers to look at root causes Reorganizing the plant layout, for example, should reduce either the number of moves or the distance moved Hopefully, the ac- tivity drivers will lead to the identification of executional drivers that can be managed so that the activity can be reduced and eventually eliminated

Inspecting parts: Hours of inspection can be reduced by working with

suppli-ers so that greater incoming quality is ensured Similarly, the number of fective parts can be reduced by working with suppliers so that incoming qual- ity is increased Hours of inspection, however, can be reduced without increasing quality This is not true for the number of defective parts Using the number of defective parts appears to be a better choice

de-1 First quarter: Setup time standard = 10 hours (based on the planned provement: 15 hours – 5 hours)

Second quarter: Setup time standard = 8 hours (based on the planned provement: 9 hours – 1 hour)

• Plan (five-hour reduction from process redesign)

• Do (try out setup with new design)

• Check (time required was nine hours, a six-hour reduction)

• Act (lock in six-hour improvement by setting new standard of nine hours

and using same procedures as used to give the nine-hour outcome; and, simultaneously, search for new improvement opportunity; in this case, the suggested changes of the production workers.)

Repeat kaizen subcycle:

• Plan (one-hour reduction from setup procedure changes)

• Do (train and then implement procedures)

• Check (actual time required was 6.5 hours, a 2.5-hour reduction)

• Act (lock in improvement by setting standard of 6.5 hours and begin search

for new improvement)

First quarter (end of):

• Establish standard (nine hours based on improved process design)

• Do (implement repetitively the improved standard)

• Check (see if the nine-hour time is maintained)

• Act (if the nine-hour time deteriorates, find out why and take corrective

ac-tion to restore to seven hours.)

Second quarter: Same cycle using 6.5 hours as the new standard to maintain

Note: The maintenance cycle described begins after observing the actual

im-provement The actual improvement is locked in The maintenance standard

at the beginning of the first quarter is 15 hours

5–15 Concluded

5 Standard costing basically uses only a maintenance subcycle Standards are set and maintained The principal difference is the emphasis on constantly searching for improvements with the standard changing with each improve- ment This search involves all employees (e.g., engineers and production

workers) Thus, kaizen costing is dynamic, whereas traditional

(functional-based) standard costing is static

5–16

200,000 is the average order size times the number of orders

Ordering rate = $1,760,000/440= $4,000 per sales order

Selling rate = $640,000/80 = $8,000 per sales call

Service rate = $600,000/300 = $2,000 per service call