Problem 7-61 Nonvalue-Added Costs, Activity Costs, Activity Cost Reduction

John Thomas, vice president of Mallett Company (a producer of a variety of plastic products), has been supervising the implementation of an ABC management system. John  wants  to improve process efficiency by improving the activities that define the processes. To illustrate the potential of the new system to the president, John has decided to focus on two processes: pro- duction and customer service.

Within each process, one activity will be selected for improvement: materials usage for pro- duction and sustaining engineering for customer service (sustaining engineers are responsible for redesigning products based on customer needs and feedback). Value-added standards are identi- fied for each activity. For materials usage, the value-added standard calls for six pounds per unit of output (the products differ in shape and function, but their weight is uniform). The value- added standard is based on the elimination of all waste due to defective molds. The standard price of materials is $5 per pound. For sustaining engineering, the standard is 58% of current practical activity capacity. This standard is based on the fact that about 42% of the complaints have to do with design features that could have been avoided or anticipated by the  company.

Current practical capacity (at the end of 2013) is defined by the following requirements: 6,000 engineering hours for each product group that has been on the market or in development

for 5 years or less and 2,400 hours per product group of more than 5 years. Four product groups have less than 5 years’ experience, and 10 product groups have more. Each of the 24 engineers is paid a salary of $60,000. Each engineer can provide 2,000 hours of service per year. No other significant costs are incurred for the engineering activity.

Actual materials usage for 2013 was 25% above the level called for by the value-added stand- ard; engineering usage was 46,000 hours. A total of 80,000 units of output were produced. John and the operational managers have selected some improvement measures that promise to reduce nonvalue-added activity usage by 40% in 2014. Selected actual results achieved for 2014 are as follows:

 

Units produced	80,000
Materials used	584,800
Engineering hours	35,400

The actual prices paid for materials and engineering hours are identical to the standard or budgeted prices.

Required:

1.       For 2013, calculate the nonvalue-added usage and costs for materials usage and sustaining engineering.

2.       CONCEPTUAL CONNECTION Using the budgeted improvements, calculate the expected activity usage levels for 2014. Now, compute the 2014 usage variances (the difference between the expected and actual values), expressed in both physical and financial measures, for materials and engineering. Comment on the company’s ability to achieve its targeted reductions. In particular, discuss what measures the company must take to capture any real- ized reductions in resource usage.