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. One of John’s objectives is 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: production and customer service. Within each process, one activity will be selected for improvement: materials usage for production and sustaining engineering for customer service (sustaining engineers are responsible for redesigning products based on customer needs and feedback). Value-added standards are identified for each activity (the level of efficiency so that no waste exists). For materials usage, the value-added standard calls for six pounds per unit of output (although the plastic products differ in shape and function, their size— as measured by 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 percent of current practical activity capacity. This standard is based on the fact that about 42 percent 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 2007) is defined by the following requirements: 6,000 engineering hours for each product group that has been on the market or in development for five years or less and 2,400 hours per product group of more than five years. Four product groups have less than five 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 2008 was 25 percent above the level called for by the value-added standard; 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 percent in 2009. Selected actual results achieved for 2007 are as follows:

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