CHAPTER 6

Activity-Based Management and Cost

Management Tools
ANSWERS TO REVIEW QUESTIONS
6-1

The two-dimensional activity-based costing model provides one way of picturing the
relationship between ABC and ABM. The vertical dimension of the model depicts the
cost assignment view of an ABC system. From the cost assignment viewpoint, the
ABC system uses two-stage cost allocation to assign the costs of resources to the
firm's cost objects. These cost objects could be products manufactured, services
produced, or customers served.
Depicted in the horizontal dimension of the model that follows is the process
view of an ABC system. The emphasis now is on the activities themselves, the
processes by which work is accomplished in the organization. The left-hand side of
the model depicts activity analysis, which is the detailed identification and
description of the activities conducted in the enterprise. Activity analysis entails the
identification not only of the activities, but also of their root causes, the events that
trigger activities, and the linkages among activities. The right-hand side of the model
depicts the evaluation of activities through performance measures. These processes
of activity analysis and evaluation constitute activity-based management.
The two-dimensional ABC model is depicted in the diagram on the next page.

6-2

Activity analysis is the detailed identification and description of the activities

conducted in an enterprise. Activity analysis entails the identification not only of
activities, but also of their root causes, of the events that trigger them, and of the
linkages among them. Three criteria for determining whether an activity adds value
are as follows:
(a) Is the activity necessary?
(b) Is the activity efficiently performed?
(c) Is the activity sometimes value-added and sometimes non-value-added?

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6-1

Diagram of two-dimensional ABC model (from review question 6-1 on preceding page):
Cost Assignment View
RESOURCE COSTS

Process View
Activity analysis
ROOT
ACTIVITY
CAUSES
TRIGGERS

Assignment of resource costs

to activity cost pools
associated with
significant activities
Activity evaluation

ACTIVITIES

PERFORMANCE
MEASURES

Assignment of activity
costs to cost objects
using second-stage
cost drivers
COST OBJECTS
(products or services
produced; customers)

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6-3

An activity's trigger is the preceding event that indicates that the activity should be
performed. The activity's root cause is the event or activity that, if it had not
occurred, would have prevented the activity in question from happening. For
example, the event that triggers the activity of rework is the identification of a
defective part during inspection. However, the inspection is not the root cause of the
rework activity. The root cause of the defective part, and hence the need for rework,
could lie in erroneous part specifications, in an unreliable vendor, or in faulty
production.

6-4

Four techniques for reducing or eliminating non-value-added costs that result from
non-value-added activities are as follows:
(a) Activity reduction
(b) Activity elimination
(c) Activity selection
(d) Activity sharing

6-5

Examples of activity sharing include the use of common parts in several related
products, and the use of a common service facility (e.g., a photocopying center) by
several departments.

6-6

Customer profitability analysis refers to using the concepts of activity-based costing

to determine how serving particular customers causes activities to be performed and
costs to be incurred. Examples of activities that can be differentially demanded by
customers include order frequency, order size, special packaging or handling,
customized parts or engineering, and special machine setups. Such activities can
make some customers more profitable than others.

6-7

Activity-based costing is used to analyze customer-related costs and determine the

cost drivers for these costs. This ABC data then forms the basis for the customer
profitability analysis by assigning the appropriate amount of customer-related costs
to each customer.

6-8

A customer profitability profile, usually expressed in graphical form, shows the

companys cumulative operating income as a percentage of total operating income.
The customers included in the profile generally are ranked either by operating
income or by sales revenue.

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6-3

6-9

In some cases, companies do eliminate unprofitable customers. However, it is

important for companies to not be too quick in doing so. Companies often develop
customer relationships over long time horizons by offering low prices and a high
level of service up front. As the relationship develops, however, the customer may
not require the same level of service or might be willing to pay a premium for the
service. Customer profitability analysis helps management see the overall financial
picture for each customer, and how management can use this information to help
establish a strategic plan for the coming months, quarters, or years. Management
may decide that it is worth keeping an unprofitable customer now to maintain the
potential for future profitability.

6-10

A trend analysis tracks customer-related costs over time to determine whether they
are increasing, decreasing, remaining relatively stable or behaving in any particularly
unusual manner. Trend analysis can help management decide which customerrelated costs need their attention most urgently, and which customers need the most
attention. Perhaps even better than comparing the customer-related costs to the
companys norms, would be to compare them to industry-wide norms, or the norms
for the industrys best performers. Such information can sometimes be generated
from benchmarking studies, which focus on the best practices of organizations both
within the industry and beyond.

6-11

Continuous improvement may be defined as the constant effort to eliminate waste,

reduce response time, simplify the design of both products and processes, and
improve product quality and customer service.
The price down/cost down concept is the tendency of prices to fall over the life cycle
of a newly introduced product. Moreover, if prices are to fall over time,
manufacturers must continually reduce costs.
Target costing is the process of designing a product, and the processes used to
produce it, in order to achieve a manufacturing cost that will enable the firm to make
a profit when the product is sold at an estimated market-driven price. This estimated
price is called the target price, the desired profit margin is called the target profit,
and the cost at which the product must be manufactured is called the target cost.
Value engineering (or value analysis) is a cost-reduction and process-improvement
technique that utilizes information collected about a product's design and
production processes and then examines attributes of the design and processes to
identify candidates for improvement. The attributes examined include such
characteristics as part diversity and process complexity.
Kaizen costing is the process of cost reduction during the manufacturing phase of
an existing product. The Japanese word kaizen refers to continual and gradual
improvement through small betterment activities, rather than large or radical
improvement made through innovation or large investments in technology.

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6-12

Kaizen costing is most consistent with the old saying "slow and steady wins the
race." Kaizen costing is the process of cost reduction during the manufacturing
phase of an existing product. The Japanese word kaizen refers to continual and
gradual improvement through small betterment activities, rather than large or radical
improvement made through innovation or large investments in technology.

6-13

Employee empowerment is the concept that workers are encouraged to take their
own initiative to improve operations, reduce costs, and improve product quality and
customer service.
Benchmarking is the continual search for the most effective method of
accomplishing a task, by comparing existing methods and performance levels with
those of other organizations, or with other subunits within the same organization. An
example of benchmarking is an airline's determining how many of its competitors'
flights are delayed and comparing the data with its own flight-delay record.
The most effective methods of accomplishing various tasks in a particular industry,
often discovered through benchmarking, are referred to as best practices.
Reengineering is the complete redesign of a process, with an emphasis on finding
creative new ways to accomplish an objective. Reengineering has sometimes been
described as taking a blank piece of paper and starting from scratch to redesign a
business process. Rather than searching continually for minute improvements, reengineering involves a radical shift in thinking about how an objective should be
met.

6-14

The theory of constraints (TOC) is a management approach that seeks to maximize

long-term profit through proper management of organization bottlenecks or
constrained resources. The key idea in TOC is to identify the constraints in a system
that are preventing the organization from achieving a higher level of success. Then
the goal is to relieve or relax those constraints. TOC recommends subordinating all
other management goals to the objective of solving the constraint problem. For
example, if limited capacity in a particular machining operation is increasing cycle
time, reducing throughput, and reducing profits, then management would
concentrate much of its efforts on expanding the capacity of that bottleneck
operation. If efforts are continually made to relax constraints, continuous
improvement in organizational performance is a likely result.

6-15

The elimination of production bottleneck activities is an example of the theory of

constraints. (See the preceding answer.)

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6-5

6-16

The philosophy of a just-in-time (JIT) inventory and production management system

is that no materials are purchased and no products are manufactured until they are
needed. The essence of the JIT philosophy is to reduce all inventories to their
absolute minimum.

6-17

The key features of a just-in-time inventory and production management system are
as follows: a smooth production rate; a pull method of coordinating steps in the
production process; purchase of materials and manufacture of subassemblies and
products in small lot sizes; quick and inexpensive setups of production machinery;
high-quality levels of raw material and finished products; effective preventive
maintenance of equipment; an atmosphere of teamwork to improve the production
system; and multiskilled workers and flexible facilities.

6-18

"TQC" stands for total quality control. Since no parts are purchased or manufactured
until they are needed for production in a JIT system, it is crucial that they be just
right for their intended purpose.

6-19

In a just-in-time (JIT) production system, raw materials and parts are purchased or
produced just in time to be used at each stage of the production process. This
approach to inventory and production management brings considerable cost
savings from reduced inventory levels.
The key to the JIT system is the "pull" approach to controlling manufacturing.
The diagram on the next page displays a simple multistage production process. The
flow of manufacturing activity is depicted by the solid arrows running down the
diagram from one stage of production to the next. However, the signal that triggers
more production activity in each stage comes from the next stage of production.
These signals, depicted by the dashed-line arrows, run up the diagram. We begin
with sales at the bottom of the exhibit. When sales activity warrants more production
of finished goods, the goods are "pulled" from production stage III by a signal that
more goods are needed. Similarly, when production employees in stage III need
more inputs, they send a signal back to stage II. This signal triggers production
activity in stage II. Working our way back up to the beginning of the process,
purchases of raw materials and parts are triggered by a signal that they are needed
in stage I.

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The Pull Method in a JIT System

Purchasing

Demand for raw materials and parts is signaled when

there is a need in stage I for more inputs.
Production
Stage I

Demand for production activity in stage I is signaled

when there is a need in stage II for more inputs.
Production
Stage II

Demand for production activity in stage II is signaled

when there is a need in stage III for more inputs.
Production
Stage III

Sales

Demand for finished goods is signaled when sales

activity warrants more finished units. This signal
triggers manufacturing activity in the final stage of
production (stage III).

Denotes flow of materials, parts, partially finished goods, and finished goods.

Denotes a signal that more goods are needed at the next stage of production.

This pull system of production management, which characterizes the JIT

approach, results in a smooth flow of production and significantly reduced inventory
levels.
6-20

Five key features of JIT purchasing are as follows: only a few suppliers; long-term
contracts with suppliers; materials and parts delivered in small lot sizes immediately
before they are needed; only minimal inspection of delivered parts and materials;
and grouped payments to each vendor.

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6-7

SOLUTIONS TO EXERCISES

EXERCISE 6-21 (25 MINUTES)

1.

Airline:
(a)

"Deadheading," the practice of flying a nonworking flight-crew member to

another city to work on a flight departing from that location. The crew member
sometimes displaces a paying customer.

(b)

Preparing excess food for a flight, which is not consumed, because the flight
occupancy was misforecast.

(c)

Returning, repairing, or replacing lost or mishandled luggage.

(d) Canceling a flight because of an aircraft maintenance problem that should have
been prevented by routine maintenance.
2.

3.

Bank:
(a)

Correcting customer account errors due to keypunch errors in the bank.

(b)

Following up on checks or deposit slips lost by the bank.

(c)

Performing banking procedures manually when the computer is down.

(d)

Defaulted loans made to risky borrowers as a result of inadequate credit checks.

(e)

Losses due to employee embezzlement and petty theft.

Hotel:
(a)

Breakage of dishes and glassware; loss of or damage to linens and towels.

(b)

Loss of room keys.

(c)

Overstaffing the front desk during nonpeak hours.

(d)

Preparing excess food.

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EXERCISE 6-22 (40 MINUTES, PLUS TIME AT RESTAURANT)

Several restaurant activities are listed in the following table, along with the required
characteristics for each activity. Many other possibilities could be listed, depending on the
level of detail.

Activity Description

Value-Added
or Non-ValueAdded

Taking reservations

VA

Customer calls on
phone

Customer desires
reservation

Customers waiting
for a table

NVA

Customer arrives, but

no table is ready

An error was made in

reservation; service is slow;
customers are slow;
customers arrive without
reservations

Seating customers

VA

Table becomes
available

Customer's reservation (or

turn in line) comes up; table
becomes ready

Taking orders

VA

Customers indicate
readiness to order

Kitchen staff needs to know

what to prepare

Serving meals to
customers

VA

Meals are ready

Meals are ready; customers

are hungry

Returning meal to
kitchen for revised
preparation

NVA

Customer complains
about meal

An error was made in

explaining the menu; there
is an error in the printed
menu description; meal was
prepared wrong; customer
is picky

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EXERCISE 6-22 (CONTINUED)

Customers eating
meal

VA

Meals are served and

are satisfactory

Customers are hungry

Clearing the table

VA

Customers are
finished

Customers have finished

eating

Delivering check to
table

VA

Customers are
finished ordering and
eating

Customers need to know

amount of bill

Collecting payment

VA

Customers have
produced cash or
credit card

Restaurant needs to collect

payment for services
rendered

EXERCISE 6-23 (30 MINUTES)

Answers will vary, depending on the registration process at a particular university.

EXERCISE 6-24 (15 MINUTES)

Several activities performed (or at least supported) by an airline's ground employees, along
with possible performance measures, are as follows:
Activity

Performance Measure

Making reservations over the phone

Reservations booked per hour

Percentage of reservations with
errors
Number of customer complaints

Tagging luggage

Bags tagged per hour

Percentage of bags incorrectly tagged

Handling luggage

Bags handled per hour, per employee

Number of bags damaged
Percentage of bags sent to wrong
destination

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EXERCISE 6-24 (CONTINUED)

Maintaining aircraft

Maintenance procedures per shift, per

employee (both routine and repair)
Number of repair incidents per month
Number of flight delays due to
maintenance problems

Enplaning passengers

Number of passengers enplaned

Number of customer complaints
Average time required at gate to enplane
passengers

Preparing aircraft for departure

Number of aircraft departures per month

Percentage of flights with delays
Average delay per flight delayed

EXERCISE 6-25 (30 MINUTES)

Memorandum
Date:

Today

To:

President, Big Apple Design Company

From:

I. M. Student, Controller, Big Apple Design Company

Subject:

Customer-Profitability Analysis

The customer-profitability analysis ranks customers on the basis of operating income. As

the graph shows, customers 5 and 6 are not profitable for Big Apple Design Company.
There are several possible courses of action, including the following four:
Drop customers 5 and 6.
Raise the prices for customers 5 and 6.
Cut the costs of serving customers 5 and 6 by cutting back on services.
Try to increase higher-margin services to customers 5 and 6 in order to make these
customer relationships profitable.
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EXERCISE 6-26 (25 MINUTES)

1.

Customers ranked by sales revenue:

(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)

108
114
112
116
110
124
121
127
125
128

(11)
(12)
(13)
(14)
(15)
(16)
(17)
(18)
(19)
(20)

113
135
133
106
111
107
134
119
136
137

Yes, the ranking by sales revenue is different from that based on operating income.
2.

No, the companys least profitable customers are not the ones with the lowest sales
revenue. The least profitable customers are numbers 119 and 134.

3.

Yes, the profile would be different, because the ordering of the customers along the
horizontal axis would match the order in requirement (1) instead of the ordering in
Exhibit 6-7.

4.

A customer characterized by high sales revenue would not necessarily be the most
profitable, because the customer may demand costly services such as special
handling or packaging, frequent small shipments, or unique design features.

EXERCISE 6-27 (15 MINUTES)

1. Trend analysis (percentages rounded):
Customer-Related Cost Item

Year 1

Year 2

Year 3

Year 4

Year 5

Cost of engineering changes.

1.1%

1.9%

1.1%

1.1%

12.0%

Special packaging.

11.0%

11.5%

13.0%

12.0%

12.0%

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EXERCISE 6-27 (CONTINUED)

2. Conclusions:
The cost of engineering changes for customer number 614, which remained
consistently low for four years, spiked to a very high level in year 5. Something unusual
must have occurred in year 5, and this should be investigated by management.
Special packaging costs, although consistent across the five-year period, are quite high.
This may be necessary, due to the special needs of customer number 614, but this
consistently high cost should be investigated by management. There may be a way to cut
this cost, possibly with the cooperation of the customer.

EXERCISE 6-28 (30 MINUTES)

FedEx could use customer profitability analysis to analyze which customers (particularly
commercial customers) are more expensive to serve and, thus, less profitable. See the
discussion of FedExs use of customer profitability analysis in Chapter 6 of the text.

EXERCISE 6-29 (25 MINUTES)

1.

Process time: steps 3, 5, 6, 7, 8, 10, 11

Inspection time: steps 1, 9
Move time: steps 2, 5, 6, 7, 10, 11
Waiting time: steps 4, 5, 7
Storage time: steps 1, 11

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EXERCISE 6-29 (CONTINUED)

2.

Candidates for non-value-added activities:

(a)

Step 2:

Carrying ingredients on hand carts.

(b)

Step 4:

Storing dough until bagel machine is free. (Could move toward a JIT
system for dough mixing.)

(c)

Step 5:

Keeping cut-out bagels until boiling vat is free. (Could move toward
JIT system.)

(d)

Step 6:

Carrying trays to vat room.

(e)

Step 7:

Carrying bagels to oven room.

(ef

Step 7:

Continual opening and closing of oven door.

(g)

Step 9:

Consumption of misshapen bagels by the staff. (Could these faulty

products be sold at a reduced price?)

(h)

Step 10:

Carrying wire baskets to the packaging room.

(i)

Step 11:

Driving forklift to freezer.

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EXERCISE 6-30 (40 MINUTES)

(1)

Redesigned bagel production process:

(a)

Ingredients, such as flour and raisins, are received and inspected in the morning
or afternoon they are to be used. Then they are placed on a conveyor belt that
transports the ingredients to the mixing room next door.

(b)

Dough is mixed in 40-pound batches in four heavy-duty mixers. The dough is

placed on large boards, which are set on the conveyor. The conveyor transports
the boards of dough into the bagel room next door.

(c)

The board is tipped automatically and the dough slides into the hopper of a
bagel machine. This machine pulls off a piece of dough, rolls it into a cylindrical
shape, and then squeezes it into a doughnut shape. The bagel machines can be
adjusted in a setup procedure to accommodate different sizes and styles of
bagels. Workers remove the uncooked bagels and place them on a tray. The
trays are set on the conveyor, which carries the uncooked bagels into an
adjoining room.

(d)

This room houses three 50-gallon vats of boiling water. The bagels are boiled for
approximately one minute.

(e)

Bagels are removed from the vats with a long-handled strainer and placed on a
wooden board. The boards full of bagels are placed on the conveyor, which
transports them to the oven room.

(f)

The two ovens contain eight racks that rotate but remain upright, much like the
seats on a Ferris wheel. A rack full of bagels is finished baking after one
complete revolution in the oven. When a rack full of bagels is removed from the
oven, a fresh rack replaces it. The oven door automatically opens and closes as
each rack completes a revolution in the oven.

(g)

After the bagels are removed from the oven, they are placed in baskets for
cooling.

(h)

While the bagels are cooling, they are inspected. Misshapen bagels are removed
and set aside for sale at a reduced price.

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EXERCISE 6-30 (CONTINUED)

(2)

(i)

After the bagels are cool, the wire baskets are placed on the conveyor and
transported to the packaging room next door.

(j)

Here the bagels are dumped automatically into the hopper on a bagging
machine. This machine packages a half dozen bagels in each bag and seals the
bag with a twist tie.

(k)

Then the packaged bagels are placed in cardboard boxes, each holding 24 bags.

(l)

The boxes are placed in the freezer, where the bagels are frozen and stored for
shipment. The freezer has a door in the packaging room, and another door in the
shipping/receiving room.

Key features of a JIT system:

The new production process of Better Bagels, Inc. has a smooth, uniform production
rate with each part of the process being initiated by the subsequent operation. Thus,
the bagelry uses a pull method of coordinating production steps. The ingredients are
purchased as needed in small lot sizes, delivered twice daily, and sent immediately to
the mixing room. The bagel machine is designed for quick setups for different bagel
sizes and consistency. Only high-quality ingredients are used in order to eliminate
down time and to follow a total quality control philosophy. The machinery is carefully
maintained. The bagelry's employees are encouraged to suggest improvements in the
product or production process. Employees whose suggestions are adopted receive
cash awards or peer recognition. All of the bagelry's employees are trained in each
phase of the production process. Thus, Better Bagel's multiskilled work force enables
the firm to operate with fewer employees.

(3)

New equipment:
Better Bagels, Inc. would need to purchase a new conveyor system that would
transport partially completed bagels between production steps. The conveyor would
tip the bagels automatically into appropriate production machines at various points in
the process. Also needed would be an efficient oven that would open and close
automatically (and quickly) to minimize heat loss.

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Solutions Manual

EXERCISE 6-31 (25 MINUTES)

1.

Target cost = $125 $25 = $100

2.

Target profit = $25

3.

Target price = $125

4.

Target costing involves designing a product, as well as the process used to

manufacture it, so that ultimately the product can be manufactured at a cost that will
enable the firm to make a profit when the product is sold at an estimated marketdriven price. In the case of the photon gismo, the design engineering team needs to
redesign the gismo and/or the production process so that the gismo can be
manufactured for $100.

5.

Value engineering is a cost-reduction and process-improvement technique that

utilizes information collected about a product's design and production process, and
then examines this information to identify candidates for improvement. An example,
in the context of the photon gismo, is using a machine to assemble several parts,
instead of assembling them manually.

6.

The activity phase of a two-dimensional ABC system could help solve the problem
with the photon gismo. This phase would identify activities in the gismo's production
process, as well as the linkages, triggers, and root causes of those activities. For
example, suppose that part of the photon gismo's cost includes the inspection of a
particular component that is sometimes damaged in the assembly operation.
Furthermore, suppose that the root cause of that damage is subsequently determined
to be excessive tightening of a bolt on the mounting chassis for the photon gismo's
parts. Eliminating the problem of excessive tightening would potentially also eliminate
the need for inspecting the component.

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6-17

EXERCISE 6-32 (25 MINUTES)

A wide range of answers is possible for this exercise.
1.

2.

All colleges and universities have admissions departments, course registration

procedures, and teaching operations. All aspects of these operations could be
benchmarked against similar institutions of higher education. For example, how does
an undergraduate school of business administration with an enrollment of 1,000
students compare with five other similar business schools on the following
dimensions:
a.

Average grade point average (GPA) of students admitted to the business school.

b.

Number of course offerings.

c.

Number of corporate recruiters visiting the campus.

d.

Average number of employment offers received per student.

e.

Percentage of graduates who try for professional certification and are

successful in doing so. (For example, of the school's graduates who take the
CPA or CMA examination, what is the percentage of students who pass the
exam?)

A college or university could also benefit from benchmarking "outside the box." All
colleges and universities have grounds and maintenance departments, food service
operations, and housing operations. So do hospitals and hotels. These types of
college operations could be benchmarked against similar operations in hospitals or
hotels.
Colleges have course scheduling procedures. Scheduling is also an important activity
in airlines, bus lines, railroads, hospitals, and landscaping firms, to name a few.
Public service is an important component of the mission of many colleges and
universities. Effectiveness in this area could be benchmarked against a service
organization such as the American Red Cross.
Academic advising and counseling for students in a college or university could be
benchmarked against similar operations in employment search firms and human
resources departments in for-profit businesses.
In short, the sky's the limit on the kinds of organizations against which a college or
university might effectively benchmark its operations.

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Solutions Manual

SOLUTIONS TO PROBLEMS
PROBLEM 6-33 (30 MINUTES)
1.

If Kelifo Electric Vehicle Company (KEVCO) implements a "demand pull" production

philosophy, both its planning and operating processes could experience the following
effects.
Planning

Production planning will change from a centralized batch function process to a

more decentralized activity. In some cases, production teams will be responsible

for the entire production process of a product.

The method and timing of how the company prepares its production schedule

(including capacity requirements) will change to parallel the "demand pull"

approach as opposed to the "production push" approach.

The Purchasing Department will need to plan to have high-quality, reliable, and
flexible suppliers who can quickly deliver orders of varying sizes as needed.

Operations

Change-over time (set-up time) will reduce lead times significantly.

A kanban-like system will have to be implemented. A triggering device such as a
kanban card is necessary so that the department or cell knows when to begin
production.

Greater employee participation will result from cell production team arrangements.

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6-19

PROBLEM 6-33 (CONTINUED)

2.

Five benefits to KEVCO in changing to a "demand pull" production operating

philosophy are as follows:

Less rework and fewer defective units because of cell-level accountability and
control and product problem solving at the cell level.

A lower cash investment in inventory and plant space. Handling, storage,

insurance, breakage, and obsolescence all will be lower.

More satisfied customers should result because of shorter lead times and higher
quality.

Improved labor productivity as a result of rearranging the production process and

the creation of manufacturing cell teams.

A reduction of the number of suppliers, leading to improved relationships and

communication.

3.

Some of the behavioral effects of the proposed change at KEVCO on team

participation in planning and production include the following:

Higher team morale and motivation, since each cell team is responsible for all cell

production and will, therefore, have more control over their work and an increased
sense of ownership.

Higher individual satisfaction, development, and motivation, as management will

encourage participation, training, and input on how to improve the product and
production process.

A possible resistance to change by those employees who may feel insecure or

threatened by the change.

A sense of partnership with management in achieving the goals and objectives of

the organization.

McGraw-Hill/Irwin
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2008 The McGraw-Hill Companies, Inc.

Solutions Manual

PROBLEM 6-34 (25 MINUTES)

1.

Annual financial impact:

Return on released funds
[($3,600,000 - $600,000) x 12%] $360,000
Savings in insurance and property taxes
27,000
Lease revenue (30,000 square feet x 75% x $2).
45,000
Depreciation on remodeled facilities
(60,000)
($600,000 10 years)..
Savings in warranty and repair costs...
25,000
Salary savings*...
30,000
Added stockout costs...
(70,000)
Savings from JIT system... $357,000
* Note: The cost of the two transferred employees is excluded
because Alliance will continue to have these individuals on
the payroll.

2.

With a just-in-time purchasing system, companies avoid costly build-ups of rawmaterial inventories because materials and parts are ordered only when needed. The
suppliers under such a system are highly reliable and deliver quality goods on time.
Thus, despite the absence of inventories that firms can rely on if needed, the
likelihood of excessive stockouts is fairly low.

3.

Long-term contracts under a JIT purchasing system set tight standards with respect
to the quality of materials purchased. The quality is high, which reduces the need
for incoming inspections.

4.

Under a traditional purchasing system, goods are purchased (frequently in large

lots) and then placed in inventory until used. In contrast, with JIT, costly inventories
are avoided by having the materials arrive just-in-time to be issued to production.
Materials are therefore purchased only when needed, which often translates into
numerous small acquisitions throughout the period.

PROBLEM 6-35 (30 MINUTES)

1.

Activity-based management refers to the use of activity-based costing to improve

operations and eliminate non-value-added costs. These costs arise from non-valueadded activitiesoperations that are either (a) unnecessary and dispensable or (b)
necessary but inefficient and improvable. Put simply, such activities can be
eliminated without harming overall quality, performance, or perceived value.

McGraw-Hill/Irwin
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2008 The McGraw-Hill Companies, Inc.

6-21

PROBLEM 6-35 (CONTINUED)

2.

Cost of non-value-added activities:

Warehousing: 550 moves x $40a. $22,000
Outgoing shipments: 250 shipments x $15b
3,750
Total $25,750
$360,000 9,000 inventory moves = $40 per move
shipments: $225,000 15,000 shipments = $15 per shipment

aWarehousing:
bOutgoing

3.

Extra inventory moves in the warehouse may be caused by books being shelved (i.e.,
stocked) incorrectly, poor planning for the arrival and subsequent
placement/stocking of new titles, and other similar situations. Extra shipments
would likely be the result of errors in order entry and order filling, goods lost in
transit, or damaged merchandise being sent to customers.

4.

As the following figures show, the elimination of non-value-added activities allows

BookNet.Com to achieve the target-cost percentage for software only.

Activity
Incoming
receipts.
Warehousing.
Outgoing
shipments

Cost-Driver
Quantity

%
Books

%
Software

Cost-Driver
Quantity:
Books

Cost-Driver
Quantity:
Software

2,000
9,000

70%
80%

30%
20%

1,400
6,650*

600
1,800

15,000

25%

75%

3,750

11,000**

* (9,000 moves x 80%) 550

** (15,000 shipments x 75%) 250

McGraw-Hill/Irwin
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2008 The McGraw-Hill Companies, Inc.

Solutions Manual

PROBLEM 6-35 (CONTINUED)

Books
Incoming receipts:
1,400 purchase orders x $150* ...........
600 purchase orders x $150.
Warehousing:
6,650 moves x $40...
1,800 moves x $40...
Outgoing shipments:
3,750 shipments x $15
11,000 shipments x $15.
Total cost.
Cost as a percentage of sales:
$532,250 $3,900,000
$327,000 $2,600,000

Software

$210,000
$ 90,000
266,000
72,000
56,250
$532,250

165,000
$327,000

13.65%
12.58%

Incoming receipts:
$300,000 2,000 purchase orders = $150 per purchase order
5.

Additional cost cutting of $25,250 is needed for books to achieve the 13% target of
$507,000 ($3,900,000 x 13%). Tools that the company might use include customerprofitability analysis, target costing, value engineering, kaizen costing,
benchmarking, and reengineering.

McGraw-Hill/Irwin
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2008 The McGraw-Hill Companies, Inc.

6-23

PROBLEM 6-36 (50 MINUTES, PLUS TIME SPENT AT GROCERY STORE AND BANK)
This is a chance to think carefully about how detailed and precise an activity analysis can
be. It's also an opportunity to invoke your sense of humor and air your pet peeves about a
couple of errands we all have to do routinely.
There is clearly no single correct answer. Reasonable answers will vary widely.
1.

Activity sequences and linkages:

Grocery Store
(1) Strategically choose time of day,
keeping in mind (a) how urgent need
is, (b) likely crowding, and (c) how
well stocked the shelves will be

Bank
(1) Strategically choose time of day
and branch location

(2) Drive or walk to store

(2) Choose among inside teller

window, drive-up lane, or ATM

(3) Park car

(3) Park car

(4) Walk to front door

(4) Walk to front door

(5) Get cart; search parking lot if

necessary

(5) Prepare banking documents

(6) Walk aisles to find items

(6) Wait in line

(7) Read product labels

(7) Explain banking needs to teller

(or operate ATM)

(8) Compare prices

(8) Wait while transaction is

completed

(9) Select items

(9) Check teller's (or ATM's) work

(10) Strategically choose checkout line

(Express line? Cash only? Which one
is shortest? Which one is fastest?
Which clerk is fastest? etc.)

McGraw-Hill/Irwin
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(10) Leave bank

2008 The McGraw-Hill Companies, Inc.

Solutions Manual

PROBLEM 6-36 (CONTINUED)

(11) Wait in line; jockey for position if new
checkout lane opens

(11) Leave parking lot

(12) Unpack cart

(13) Items are checked out
(14) Items are bagged (paper or plastic?)
(15) Carry out bags (or have bags carried
out)
(16) Load car
(17) Leave parking lot

McGraw-Hill/Irwin
Managerial Accounting, 7/e

2008 The McGraw-Hill Companies, Inc.

6-25

PROBLEM 6-36 (CONTINUED)

2.

Specifying whether an activity is value-added or non-value added often depends on

how well the business is organized for the activity. For example, some grocery stores
make it easier to park close to the entrance than do others. Thus, getting from your
car to the front door could be value-added or non-value-added, depending on how
convenient the store's parking lot is. The designations of VA or NVA will vary widely,
depending on individual experiences.
Grocery Store
Activity
VA or NVA
(1)
VA
(2)
VA
(3)a
VA, NVA
(4)a
VA, NVA
b
(5)
VA, NVA
c
(6)
VA, NVA
(7)d
VA, NVA
d
(8)
VA, NVA
(9)
VA
(10)e
NVA
(11)e
NVA
(12)
VA
(13)
VA
(14)f
NVA
(15)g
NVA
g
(16)
NVA
h
(17)
VA, NVA

Bank
Activity
(1)
(2)
(3)a
(4)a
(5)i
(6)j
(7)k
(8)l
(9)m
(10)
(11)h

VA or NVA
VA
VA
VA, NVA
VA, NVA
VA, NVA
NVA
VA, NVA
NVA
NVA
VA
VA, NVA

aDepends

on the configuration of the parking lot in relation to the design of the

building and the location of the front door.
bGetting a cart in the store or by the front door, VA; searching the parking lot, NVA.
cDepends on the store layout. The author is inclined to say NVA, since it would be an
improvement if grocery stores would adopt a standard layout (e.g., the soda always in
aisle 4, or the dairy-case pizza always in aisle 6 on the end near the registers).
dDepends on how convenient the store makes these tasks. Interestingly, this is one
area where the law has helped the consumer. Stores now must display unit pricing
information, and food companies must include nutritional information on the labels of
many items.

McGraw-Hill/Irwin
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2008 The McGraw-Hill Companies, Inc.

Solutions Manual

PROBLEM 6-36 (CONTINUED)

eThis

part of grocery shopping drives the author up the wall. Why not have all nonexpress-lane customers wait in one line and then feed into the next available checkout
lane? This configuration is typical of banks, but the author has seen it done in only
one grocery store.
fBagging can be simultaneous with checking out, especially if bar code scanners are
in use.
gThe store could adopt the technology of an automated material-handling system
(AMHS) here. Bags of groceries would be placed in bins with the customer's number
indicated. Then the bins would be transported by conveyor to a location by the front
door. When the customer drove up, a store employee would load the groceries into
the car. The author has seen this system in operation, but rarely.
hDepends on the configuration of the parking lot.
iDepends on how user-friendly the documents are.
jNVA, but a lot better than in a typical grocery store. See note (e) above.
kDepends on the bank's operating procedures and level of teller training.
lElectronic operating systems process transactions much faster than do manual
systems.
mNVA, because we wouldn't have to check if errors were extremely rare or
nonexistent.
3.

Two striking examples of successful reengineering are the widespread introduction of

bar code scanners by grocery stores (and other retailers) and ATMs (automatic teller
machines) by banks. The introduction of electronic banking (from the home) is
another emerging example of reengineering in the banking industry. Similarly, the
introduction of shopping services and telephone ordering by grocery stores
continues the re-engineering process in this industry. Also, many retail companies
are dramatically reengineering their sales and billing procedures due to the everincreasing use of buying via the Internet.

McGraw-Hill/Irwin
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2008 The McGraw-Hill Companies, Inc.

6-27

PROBLEM 6-37 (30 MINUTES)

1.

Contribution margin of lost sales (20,000) units:

Revenue .................................................................................
Variable costs:
Costs of goods sold.....................................................
Selling and administrative ...........................................
Total variable costs......................................................
Unit contribution margin ......................................................
Volume of lost sales..............................................................
Total contribution margin of lost sales ......................
Overtime premiums...............................................................
Rental savings .......................................................................
Rental income from owned warehouse
(12,000 sq. ft. .75 $1.50) ............................................
Elimination of insurance .......................................................
Opportunity cost of funds released from inventory
investment:
Investment in inventory ..............................................
Interest before taxes....................................................
Estimated before-tax dollar savings ....................................

$12.00*
$ 4.50*
1.00*
$ 5.50
$ 6.50
20,000
$(130,000)
(40,000)
60,000
13,500
14,000
$600,000

.20

120,000
$ 37,500

*Total amount on the income statement 900,000 units

The

cost of overtime premiums, $40,000, is less than the additional forgone contribution
margin if the overtime is not used (15,000 units $6.50 = $97,500). Therefore, the overtime
should be used.

McGraw-Hill/Irwin
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2008 The McGraw-Hill Companies, Inc.

Solutions Manual

PROBLEM 6-37 (CONTINUED)

2.

Conditions that should exist in order for a company to install just-in-time inventory
methods successfully include the following:

Top management must be committed and provide the necessary leadership

support in order to ensure a companywide coordinated effort.

A detailed system for integrating the sequential operations of the manufacturing

process needs to be developed and implemented. Raw materials must arrive when
needed for each subassembly so that the production process functions smoothly.

Accurate sales forecasts are needed for effective finished-goods planning and
production scheduling.

Products should be designed to use standardized parts to reduce manufacturing

time and decrease costs.

Reliable vendors who can deliver quality raw materials on time with minimum lead
time must be identified.

McGraw-Hill/Irwin
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2008 The McGraw-Hill Companies, Inc.

6-29

PROBLEM 6-38 (45 MINUTES)

1.

Two dimensional ABC:

Cost Assignment View
RESOURCE COSTS
Assignment of resource costs
to activity cost pools
associated with
significant activities

Process View
Activity analysis

1
7
11

2
8

3
9

12
13

ROOT
CAUSES
(see req. (3)
for examples)

4
10

14

15
16

ACTIVITY
TRIGGERS

Activity evaluation

ACTIVITIES

PERFORMANCE
MEASURES
(see req. (4) for examples)

(see req. (2) for

examples)

Assignment of activity
costs to cost objects
using second-stage
cost drivers
COST OBJECTS
(Product lines: cooking
utensils, tableware,
flatware)

McGraw-Hill/Irwin
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2008 The McGraw-Hill Companies, Inc.

Solutions Manual

PROBLEM 6-38 (CONTINUED)

2.

Triggers for selected activities:

Activity
Number
Trigger
(2)
Realization by purchasing personnel that they do not fully understand the
part specifications

3.

(9)

Realization by purchasing personnel that the ordered part will be (or may
be) late in arriving

(11)

Receipt of order

(12)

Discovery during inspection that parts do not meet specifications

(13)

Discovery that parts do not satisfy intended purpose

Possible root causes:

Activity
Number
Possible Root Causes*
(2)
Unclear specifications
Incomplete specifications
Clear, but apparently wrong, specifications
Undertrained purchasing personnel
(9)

Vendor delay
Delay in placing order
Failure by purchasing personnel to make deadline clear

(11)

Use of vendor that has not been fully certified as a reliable supplier
Critical importance of parts

(12)

Misspecification of parts
Error by purchasing personnel in placing order
Vendor error
Inspector error

(13)

Misspecification of parts
Incomplete specifications
Poor product design
Error by purchasing personnel in placing order
Vendor error

*This list is not necessarily complete. Other root causes may exist.

McGraw-Hill/Irwin
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2008 The McGraw-Hill Companies, Inc.

6-31

PROBLEM 6-38 (CONTINUED)

4.

Suggested performance measures:

Activity
Number
(5)
Average price paid

Performance Measures

(6)

Number of vendors
Number of vendors that are precertified as dependable

(10)

Percentage of orders received on time

Average delay for delinquent orders

(12)

Number of orders returned

Percentage of orders returned

(16)

Average dollar value tied up in parts inventory

McGraw-Hill/Irwin
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2008 The McGraw-Hill Companies, Inc.

Solutions Manual

PROBLEM 6-39 (40 MINUTES)

1.

The net cash savings realized by AgriCos Service Division as a result of the just-intime inventory program is $43,000, computed as follows:
Cash
Savings
(loss)
Funds released from inventory investment .......................
Interest ..................................................................................
Insurance savings ($80,000 .60) .....................................
Warehouse rental revenue
[(8,000 sq. ft. .75) $2.50 per sq. ft.] ...........................
Warehouse rental cost: no effect ........................................
Transferred employees: no effect .......................................
Contribution of lost sales (3,800 units at $10.00)* .............
Overtime premium (7,500 units at $5.60) ..........................
Net cash savings ..................................................................

$400,000

.15

*Calculation of unit contribution margin:

Revenue ($6,160,000 280,000 units) ................................
Less variable costs:
Cost of goods sold ($2,660,000 280,000 units) .....................
Selling and administrative expenses ($700,000 280,000 units)
Contribution margin .......................................................................

$60,000
48,000
15,000

(38,000)
(42,000)
$43,000

$22.00
$9.50
2.50

12.00
$10.00

The

incremental cost of $5.60 per unit for overtime is less than the additional $10.00
per unit contribution for the 7,500 units that would have been lost sales. Therefore,
the overtime hours should be used.

McGraw-Hill/Irwin
Managerial Accounting, 7/e

2008 The McGraw-Hill Companies, Inc.

6-33

PROBLEM 6-39 CONTINUED)

2.

Factors, other than financial, that should be considered before a company implements
a JIT inventory program include:

Customer dissatisfaction: Stockouts of finished goods or spare parts could result

in customers' downtime, which may be costly.

Distributor relations: Stockouts of spare parts or finished goods can impair the

manufacturer's image with its distributors, who represent the direct contacts with
the ultimate customers.

Supplier dissatisfactions: Placement of smaller and more frequent orders can

result in higher material and delivery costs from suppliers. Additionally, with
changes in their production and procurement processes, suppliers may choose to
discontinue supplying to a just-in-time customer.

Competition: The marketplace will determine the impact of service degradation

due to stockouts. Brand loyalty can deteriorate when service standards are
lowered. Therefore, it is crucial that before adopting JIT, management think
through all the implications. It is important to maintain the company's prior service
standards and if possible to improve on them.

3. Spreadsheet is shown on this chapters solutions manual opening screen.

McGraw-Hill/Irwin
6-34

2008 The McGraw-Hill Companies, Inc.

Solutions Manual

PROBLEM 6-40 (50 MINUTES)

1.

Predetermined overhead rate

budgetedmanufacturing overhead
budgeteddirect-labor hours

$1,496,000
20,000 hr

= $74.80 per hr.

2.

There is no single correct response to this requirement. One reasonable response is

shown in the following table. Overhead costs are categorized into nine cost pools
designated (a) through (i). Cost drivers are identified as follows:
(a)

Production (in units)

(b)

Raw-material cost

(c)

Factory space

(d)

Machine hours

(e)

Production runs

(f)

Shipments of finished goods

(g)

Shipments of raw materials

(h)

Number of different raw materials and parts used in a product

(i)

Engineering specifications and change orders

3.

See the following table.

4.

See the following table.

McGraw-Hill/Irwin
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2008 The McGraw-Hill Companies, Inc.

6-35

PROBLEM 6-40 (CONTINUED)

Overhead Item
Supervision .................................................
Machine maintenancelabor ....................
Machine maintenancematerials .............
Electrical power ..........................................
Natural gas (for heating) ............................
Factory supplies .........................................
Setup labor ..................................................
Lubricants ...................................................
Property taxes .............................................
Insurance .....................................................
Depreciation on manufacturing
equipment ...............................................
Depreciation on trucks and forklifts ..........
Depreciation on material conveyors .........
Building depreciation .................................
Grinding wheels ..........................................
Drill bits .......................................................
Purchasing ..................................................
Waste collection .........................................
Custodial labor ............................................
Telephone service.......................................
Engineering design.....................................
Inspection of raw materials ........................
Receiving .....................................................
Inspection of finished goods .....................
Packaging ....................................................
Shipping ......................................................
Wages of parts clerks (find parts for
production departments) .......................
Wages of material handlers .......................
Fuel for trucks and forklifts........................
Depreciation on raw-material
warehouse ..............................................
Depreciation on finished-goods
warehouse ..............................................

McGraw-Hill/Irwin
6-36

Req. (2)
Cost Pool
and
Cost Driver

Req. (3)

Req. (4)
Candidate
for
Elimination

Production
Activity

h
d
d
d
c
a
e
d
c
c

process
process
process
process
process
process
process
process
process
process

d
b
b
c
a
a
b
a
c
h
i
g
g
a
a
f

process
move
move
process
process
process
process
process
process
process
process
inspection
process
inspection
process
move

h
b
b

storage
move
move

X
X
X

storage

storage

2008 The McGraw-Hill Companies, Inc.

Solutions Manual

PROBLEM 6-40 (CONTINUED)

5.

Activity accounting identifies the costs and other performance measures that pertain
to significant activities in the firm. Identification of activities and their costs helps
management to identify and examine non-value-added costs. For example,
management may be able to eliminate (or significantly reduce) the cost of fuel and
depreciation for the trucks and forklifts and the wages of material handlers by
installing an automated material-handling system. Similarly, adoption of a JIT
approach to production could enable management to eliminate or reduce the wages of
parts clerks and the depreciation on the two warehouses.

6.

Computation of pool rate:

Receiving ......................................................................................................
Inspection of raw material ...........................................................................
Total ..............................................................................................................
Pool rate =

budgetedcost
budgetedlevel of cost driver

$20,000
20,000
$40,000

$40,000
400

= $100 per shipment

PROBLEM 6-41 (40 MINUTES)
1.

Customer-profitability analysis:
Trace
Telecom

Sales revenue ......................................................................

Cost of goods sold .............................................................
Gross margin ......................................................................
Selling and administrative costs:
General selling costs ....................................................
General administrative costs .......................................
Customer-related costs:
Sales activity ...........................................................
Order taking ............................................................
Special handling .....................................................
Special shipping .....................................................
Total selling and administrative costs ..............................
Operating income ...............................................................
McGraw-Hill/Irwin
Managerial Accounting, 7/e

Caltex
Computer

$190,000
80,000
$110,000

$123,800
62,000
$ 61,800

$ 24,000
19,000

$ 18,000
16,000

8,000
3,000
40,000
9,000
$103,000
$ 7,000

6,000
4,000
30,000
10,000
$ 84,000
$ (22,200)

2008 The McGraw-Hill Companies, Inc.

6-37

PROBLEM 6-41 (CONTINUED)

2.

Customer-profitability graph:

Customer Operating Income (in dollars)

25,000
20,000
15,000
10,000

$7,000

5,000
0

Customer

-5,000
-10,000
-15,000
-20,000
$(22,200)

-25,000
Trace
Telecom

McGraw-Hill/Irwin
6-38

Caltex
Computer

2008 The McGraw-Hill Companies, Inc.

Solutions Manual

PROBLEM 6-41 (CONTINUED)

3.

Spreadsheet is shown on this chapters solutions manual opening screen.

PROBLEM 6-42 (45 MINUTES)

1.

Customer-profitability profile (supporting details in the table following the profile):

Cumulative Operating Income as a

Percentage of Total Operating Income
120%
110%
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%

Customers*

0%
1

*Customers ranked by operating income.

McGraw-Hill/Irwin
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2008 The McGraw-Hill Companies, Inc.

6-39

PROBLEM 6-42 (CONTINUED)

Supporting details for customer-profitability profile:

Customer
Numbera
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)

Customer
Network-All, Inc.
Golden Gate Service Associates
Graydon Computer Company
Mid-State Computing Company
Trace Telecomb
The California Group
Tele-Install, Inc.
Caltex Computerc

Operating
Profit

Cumulative
Operating
Profit

Cumulative
Operating
Profit as a
Percentage of
Operating
Income

$93,000
71,000
60,000
42,000
7,000
6,000
(18,000)
(22,200)

$ 93,000
164,000
224,000
266,000
273,000
279,000
261,000
238,800

39%
69%
94%
111%
114%
117%
109%
100%

aCustomer

numbers are ranked by operating income.

solution to preceding problem.
cFrom solution to preceding problem.
bFrom

2.

Memorandum

Date:

Today

To:

I. Sellit, Vice President for Marketing

From:

I. M. Student

Subject:

Customer-profitability profile

The attached customer-profitability profile shows that two of our customer relationships are
unprofitable (Tele-Install, Inc. and Caltex Computer). As the profile shows, over half of our
operating income is generated by our two most profitable customers, and 94 percent of our
operating profit is generated by our three most profitable customers. Without our two
unprofitable customers, our operating income would be 17% higher.
An activity-based costing analysis of customer-related costs provided the data for the
customer-profitability analysis portrayed in the profile.

McGraw-Hill/Irwin
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2008 The McGraw-Hill Companies, Inc.

Solutions Manual

PROBLEM 6-43 (40 MINUTES)

1.

Referring to the specific ethical standards for management accountants of

competence, confidentiality, integrity, and credibility, Marie Waters violated the
following standards of ethical conduct when she asked Andrew Fulton to suppress
pertinent information.
Competence.: Marie Waters, controller, has a responsibility to:

Provide decision support information and recommendations that are accurate,

clear, concise, and timely.

In this instance, Waters' request to Fulton, the assistant controller, to suppress

information about the component failures is unethical. This action keeps both Waters
and Fulton from performing their duties in accordance with technical standards and
has a favorable impact on earnings as requested by Jack March, vice president of
manufacturing. The reported financial information, with the omission, lacks relevance
and reliability for decision making. Management does not have a clear solution to
overcome the component failure problem.
Confidentiality: Does not apply.
Integrity: Waters has a responsibility to:

Refrain from engaging in any conduct that would prejudice carrying out duties
ethically.

Abstain from engaging in or supporting any activity that might discredit the
profession.

Waters' request is unethical since she has responsibilities to report all information of
use to decision makers in the company. She should protect the overall interests and
goal attainment of Resolute Electronics Corporation by encouraging further study of
the problem by her staff, informing her superiors of this matter, and working with
others to find solutions.

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PROBLEM 6-43 (CONTINUED)

Credibility: Waters has a responsibility to:

Disclose all relevant information that could reasonably be expected to influence

intended users' understanding of the reports, analyses, and recommendations.

Waters' request is unethical because it would suppress information that could

influence an understanding of the results of operations. Waters is also not
communicating information objectively by withholding information about the
contingent liability.
2.

The steps that Andrew Fulton, assistant controller, could follow to resolve this
situation are as follows:

Follow the established policy on ethical conduct at REC, if a policy exists.

Fulton has discussed the matter with Waters. If a satisfactory solution is not found

and losses continue to mount, Fulton should discuss it again with Waters and may
write a report detailing the probable economic effects of the situation and
mentioning Waters' request to suppress the component failures.

Fulton should advise Waters that he intends to take the matter further and discuss

the issue with her superior. If the matter is not resolved satisfactorily, Fulton
should continue up through higher levels in the organization (eventually to the
board of directors) until the matter is resolved.

Fulton should clarify the relevant concepts with a confidential and objective
advisor to obtain an understanding of possible courses of action.

If, after exhausting all internal review levels, the ethical conflict still exists, Fulton

may have no recourse but to resign and write an informative memorandum to the
appropriate organizational representative.

Except where legally prescribed, communication of such problems to authorities

or individuals not employed or engaged by the organization is not considered
appropriate.

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2008 The McGraw-Hill Companies, Inc.

Solutions Manual

PROBLEM 6-44 (45 MINUTES)

1.

See the graph on the following page.

2.

See the graph on the following page.

3.

See the graph on the following page.

4.

See the graph on the following page.

5.

See the graph on the following page.

6.

Kaizen costing seeks to lower costs during the manufacturing phase through
continuous improvement in the production process. Costs are lowered through
constant small betterment activities, which every employee in the company is trying
to achieve.
By lowering its costs and improving quality through continuous improvement
efforts, the company will be in a better position to compete in the global market on
both price and quality.

McGraw-Hill/Irwin
Managerial Accounting, 7/e

2008 The McGraw-Hill Companies, Inc.

6-43

PROBLEM 6-44 (CONTINUED)

Cost per TV set

Cost base
for current year
$500

$400

Actual cost
performance
at end of
last year

Kaizen goal:
cost-reduction amount

Kaizen goal:
cost-reduction rate

Actual cost
reduction
achieved

Actual cost
performance
of current year
Cost base
for next year

$300

$200

$100

Jan Feb Mar Apr May Jun Jul Aug Sept Oct Nov Dec
12/31/x0
12/31/x1

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Time

2008 The McGraw-Hill Companies, Inc.

Solutions Manual

PROBLEM 6-45 (60 MINUTES)

1. Pickwick Paper Company: Current production process.
Harvested trees
Rail
Woodyard
(logs stored)

Shipping

Flume
Plant
Building 1

Loading Dock

Debarker
Chipping
machines

Labeled
rolls
stored

Labeling

Bins
(chips stored)

Labeling
Building

Forklifts

Small trucks
Plant
Building 2

Digester

Winding
machines

Fibers
stored

Calenders
(polishing)
Conveyor

McGraw-Hill/Irwin
Managerial Accounting, 7/e

Paper
machines

Refining
area
(treatment
of
fibers)

Depressurized
blow tank
Pallets
(separated fibers
stored)

Pallets
(rolls stored)

Forklifts

2008 The McGraw-Hill Companies, Inc.

6-45

PROBLEM 6-45 (CONTINUED)

2.

3.

Candidates for non-value-added costs:

(a)

Storage time. Logs in the woodyard and finished rolls of paperboard in the
labeling building are stored for a long time.

(b)

Move time: A lot of effort and employee time is devoted to moving work in
process. Logs are unloaded from the railroad cars and subsequently reloaded
into the flume. Small trucks are used to transport chips to the digester in plant
building 2. Forklifts are used to transport separated fibers to the refining area.
Finally, forklifts are used to transport rolls of paperboard to the labeling
building.

(c)

Wait time: Work-in-process inventory waits at several points in the production

process until the next operation is ready to receive it. First, logs are stored in
the wood yard. Second, chips are stored in bins near the chipping machines.
Third, fibers are stored near the digester. Fourth, separated fibers are stored on
pallets near the depressurized blow tank. Fifth, unlabeled rolls of paperboard
are stored on pallets near the winding machines. As the problem states, the
partially processed product sometimes waits for two to three days between
production operations.

(d)

Labor force: The labor force is probably larger than necessary. Much of this
excess labor is involved in material-handling operations.

Plan for revised production process:

The plan for a new production process involves the following key changes:
(a)

Direct transfer of harvested trees from railroad cars to the flume.

(b)

Installation of an automated material-handling system (AMHS) to move all work

in process after it enters plant building 1.

(c)

No storage of work in process between production stages. Implementation of a

pull method for production scheduling.

(d)

New construction to house the AMHS between buildings.

(e)

Movement of the labeling machines to the other end of the labeling building,
closer to the winding machines.

(f)

Reduction of finished-goods inventory.

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2008 The McGraw-Hill Companies, Inc.

Solutions Manual

PROBLEM 6-45 (CONTINUED)

A diagram of the new process is shown on the next page. The steps in the new
process are as follows:
(1)

Harvested trees arrive as needed for production by rail in the woodyard and are
transferred to the flume.

(2)

Logs are moved by a flume into the plant where they pass through a debarker
and are cut up into chips.

(3)

The chips are transported by the AMHS to the digester.

(4)

The chips then are placed in a digester, a large pressure cooker where heat,
steam, and chemicals convert the chips into moist fibers.

(5)

The fibers are loaded onto the AMHS, which carries the fibers to a
depressurized blow tank. This operation separates the fibers.

(6)

The AMHS is used to carry the separated fibers to the refining area, where the
fibers are washed, refined, and treated with chemicals and caustic substances
until they become pulp.

(7)

The wood pulp then enters the paper machines through a headbox, which
distributes pulp evenly across a porous belt of forming fabric.

(8)

Water is removed from the pulp by passing the pulp over a wire screen.

(9)

Additional water is removed from the pulp in a series of presses.

(10) Driers then remove any remaining water from the pulp.
(11) The AMHS carries the sheets of pulp to the calenders. The thin, dry sheets of
pulp are then smoothed and polished by the calendars.
(12) The paperboard is wound into large rolls and placed on the AMHS.
(13) The rolls are labeled and stored for shipment in the labeling building. Inventory
is minimized.
(14) The rolls of paperboard are shipped to customers from the new loading dock in
the labeling building.

McGraw-Hill/Irwin
Managerial Accounting, 7/e

2008 The McGraw-Hill Companies, Inc.

6-47

PROBLEM 6-45 (CONTINUED)

Pickwick Paper Company: New production process.
Harvested trees
Rail
Logs transferred from
railroad car to flume
Flume

Shipping

New Loading Dock Loading Dock

Plant
Building 1

Debarker

Chipping
machines

Automated
Material
Handling
System
(AMHS)

Labeling
Building
Small quantities of
labeled rolls
stored
Labeling
machines
(new location)
New
construction
to connect
buildings

New construction to
connect buildings
Plant
Building 2

Digester

Winding
machines
Calenders
(polishing)

Depressurized
blow tank

McGraw-Hill/Irwin
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Refining
area
(treatment
of
fibers)

Paper
machines

2008 The McGraw-Hill Companies, Inc.

Solutions Manual

SOLUTION TO CASE
CASE 6-46 (45 MINUTES)
1.

A proliferation of part numbers means that the company may be ordering and
stocking many more types of unique parts than it needs to. Overordering and
overstocking entail more costs in purchasing, receiving, inspecting, storing, and
material handling than might otherwise be necessary.

2.

Long production cycles may indicate that the production process is inefficient.
Inefficiencies, in turn, imply non-value-added costs.

3.

An ABC system can be used to help reduce costs by focusing attention on the
problem of part number proliferation.
a.

The division's strategy is to be a product differentiator. It used to be a price

leader, but now it must meet the market price, since new competitors have
entered the market.

b.

Prices are currently being set by the market.

c.

Management's primary need is cost reduction so that the division can meet the
market-driven price. More accurate product costs, while always desirable, are
not the primary need here. The division will not be able to use cost-based
pricing anyway.

d.

Cost reduction is the current goal of management.

e.

Part number proliferation is (at least partially) to blame for high production
costs.

f.

The design engineers, who strive for "engineering elegance" in their product
designs are largely to blame for part number proliferation. By designing
products "from scratch," engineers often specify new partsthat is, parts that
the division does not already use in its other products.

g.

An ABC system can help solve the problem of part number proliferation by
focusing attention on it. One method of directing attention to this problem is to
choose a cost driver that makes the design engineers aware of the implicit costs
from specifying new unique parts in a product design.

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CASE 6-46 (CONTINUED)

4.

The objective is to find a cost driver that charges to a product the costs associated
with purchasing, receiving, inspecting, storing, and handling the parts used in the
product. Possible candidates for such a driver include (1) direct-material cost, (2)
number of parts, and (3) number of part numbers.
Driver number (3), the number of part numbers (i.e., the number of different
parts in a product), would probably work the best. It focuses most directly on the
problem at hand: part number proliferation. By charging a product for all the myriad
support costs that go along with using many different types of parts, the design
engineers will see more clearly the adverse cost effect of using new parts in a product
design. They will be encouraged, when it is possible, to use parts that the division
already stocks. The hope is that the design engineers will begin to make cost-effective
trade-offs between engineering elegance and product cost.

5.

The answer to this question is similar in spirit to the answer to requirement (4). The
ABC system could use cycle time as a cost driver in assigning production-line costs
to products. Thus, the longer a product's cycle time, the longer its assigned product
cost. In this manner, the costing system focuses attention on a problem that
management feels is unnecessarily inflating production costs.

6.

In the illustration used in Chapters 5 and 6, the fundamental role of the ABC system
was to achieve more accurate product costs by eliminating (or minimizing) the
problem of cost distortion that is so common in traditional, volume-based productcosting systems. The role of the ABC system here is fundamentally different. The
objective of the ABC system is to modify behavior. By choosing cost drivers that
focus attention on the implicit costs of part number proliferation and long production
cycles, the system encourages employees to change the way they do their work. The
design engineers, for example, are encouraged to use common parts in product
designs whenever possible rather than always designing from scratch to achieve
engineering elegance.

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Solutions Manual

FOCUS ON ETHICS (See page 239 in the text.)

These scenarios explore ethical issues surrounding customer profitability analysis,
when it is used to support differential treatment for preferred and nonpreferred
customers.
Students usually differ in their opinion about whether there are any ethical issues
involved. Ethics aside, however, many students question whether these scenarios
describe sound business practices. Many students, for example, argue that a student
may be an undesirable banking customer during his or her student days, but what
about later on? Would a bank not be wise to avoid alienating its future preferred
customers during their years as students?

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