Management accounting 6th edition ch08 SM PDF

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Management accounting 6th edition solution manual for all exercises and problems at the end of each chapter. uploaded by AHM...

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Chapter 8 Measuring Life-Cycle Costs

QUESTIONS 8-1

The total-life-cycle costing approach is a comprehensive way for managers to understand and manage costs through a product’s design, development, manufacturing, marketing, distribution, maintenance, service, and disposal stages. It refers to the process of managing all costs along the value chain. Using this approach can lead to substantial cost savings. By some estimates, 80-85% of a product’s total life costs are committed by decisions made in the RD&E stage, underscoring the importance of managing all costs along the value chain.

8-2

The three major stages of the total-life-cycle costing approach are (1) research, development and engineering (RD&E), (2) manufacturing, and (3) post-sale service and disposal.

8-3

Committed costs are those that the organization agrees must be set aside (or committed) to cover product costs through the three major stages of the life cycle. Costs incurred are the actual costs that the organization has paid out over the three major stages of the product life cycle.

8-4

The three substages of the RD&E stage are (1) using market research to assess emerging customer needs that lead to idea generation for new products, (2) product design, during which scientists and engineers develop the technical aspects of the product, and (3) product development, during which the company creates the features critical to customer satisfaction and designs prototypes, production processes, and any special tooling required.

8-5

During the post-sale service and disposal stage, organizations have to consider both the costs involved in providing service to products as soon as they are in the hands of customers, as well as the costs of ultimately disposing of the product. The following three substages typically occur during this stage: (1) rapid growth from the first time the product is shipped through the growth stage of its sales, (2) transition from the peak of sales to the peak in the service cycle, and (3) maturity – 297 –

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from the peak in the service cycle to the time of the last shipment made to a customer; disposal occurs at the end of a product’s life and lasts until the customer retires the final unit of a product. 8-6

Target costing is a method of profit planning and cost reduction that focuses on reducing costs for products in the research, development and engineering (RD&E) stage of the total life cycle of a product. It also considers all aspects of the value chain and explicitly recognizes total-life-cycle costs.

8-7

The two essential financial elements needed to arrive at a target cost are the target selling price and the target profit margin. The target cost is the difference between the two.

8-8

For product development and target costing purposes, customers’ needs or requirements must be translated into product functions or components for engineering. A quality function deployment matrix relates information about customer requirements (that is, features that customers require) to a product’s functions or components. The matrix may also include a competitive evaluation of the product. In this way, the matrix highlights the relationship among competitive offerings, customer requirements, and a product’s design parameters. The matrix is used to compute functional (component) rankings of how important each component is to customers, and these rankings are in turn used to compute a value index (benefit/cost ratio) for each component. If the value index is less than one, the cost exceeds the benefit, and the component is a likely candidate for cost reduction in efforts to achieve the target cost.

8-9

Value engineering is a process in which each component of a product is scrutinized to determine whether it is possible to reduce costs while maintaining functionality and performance. Stated another way, value engineering is an organized effort directed at analyzing the functions of the various components for the purpose of achieving these functions at the lowest overall cost without reductions in required performance, reliability, maintainability, quality, safety, recyclability, and usability.

8-10 Target costing is most applicable during the research, development and engineering (RD&E) stage of the total life cycle of a product. 8-11 Cross-functional teams guide the target costing process. These teams may include, for example, representatives from the organization’s design engineering, manufacturing, management accounting, and marketing areas, as well as representatives from among suppliers, customers, distributors, and waste disposers. Supply chain management, which involves developing cooperative, mutually beneficial long-term relations between buyers and suppliers, plays a critical role in – 298 –

Chapter 8: Measuring Life-Cycle Costs

target costing when suppliers actively participate in resolving cost reduction problems. 8-12 The break-even time (BET) metric for the product development process measures the length of time from the project’s beginning until the product has been introduced and generated enough profit to pay back the investment originally made in its development. 8-13 The break-even time (BET) metric brings together in a single measure three critical elements in an effective and efficient product development process. First, for the company to break-even on its R&D process, its investment in the product development process must be recovered. So BET requires tracking the entire cost of the design and development process. It provides incentives to make the product development process faster and less costly. Second, BET stresses profitability. It encourages marketing managers, manufacturing personnel, and design engineers to work together to develop a product that meets real customer needs, including offering the product through an effective sales channel at an attractive price, and at a manufacturing cost that enables the company to earn profits that can repay the product development investment cost. And third, BET is denominated in time: it encourages the launch of new products faster than the competition so that higher sales can be earned sooner to repay the product development investment. 8-14 Desirable behavioral consequences that are likely as people focus on improving the break-even time (BET) metric include collaboration and integration across organizational functions. People from different disciplines come together at the start of every product development project to estimate the time and money they require to perform their tasks, and the impact of their efforts on the success of the entire project. The BET metric promotes discussion and facilitates decision-making during the project among people from the multiple functions as more information about the project, customers, and competitors becomes available. 8-15 Using percent of revenues from new products as a performance metric may fail to stimulate highly innovative products because this metric can lead product developers to introduce new products that are small variations of existing products. With this approach, a company’s products run the risk of becoming stale or being copied by competitive offerings, and prices and margins will consequently decline. 8-16 Nonfinancial measures that a company might use in order to motivate achieving the objective of anticipating future customer needs include (1) time spent with key customers at targeted accounts learning about their future opportunities and needs, and (2) the number of new projects launched based on customer input. – 299 –

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8-17 Nonfinancial measures that a company might use in order to motivate achieving the objective of reducing product development cycle time across an array of products include (1) number of projects delivered on time, (2) average time spent by projects at the development, test, and launch stages of the development process, and (3) total RD&E time from idea to market. 8-18 Activities included in environmental costing include selecting suppliers whose philosophy and practice in dealing with the environment match those of buyers, disposing of waste products during the production process, and incorporating postsale service and disposal issues into management accounting systems. 8-19 Explicit environmental costs include the direct costs of modifying technology and processes, costs of cleanup and disposal, costs of permits to operate a facility, fines levied by government agencies, and litigation fees. Implicit environmental costs often pertain to the infrastructure required to monitor environmental issues. Examples of implicit environmental costs include legal counsel, administration, employee education and awareness, and the loss of goodwill if environmental disasters occur. EXERCISES 8-20 The total-life-cycle costing approach differs from the traditional product costing in that it includes the research, development and engineering (RD&E), manufacturing, and post-sale service and disposal cycles. Traditional product costing is more narrowly focused and is concerned only with costs incurred during the manufacturing stage of the total product life cycle. 8-21 The benefits of using a total-life-cycle costing approach to product costing include providing managers with the “big picture” of managing costs over the research development and engineering; manufacturing; and post-sale service and disposal cycles. Such a perspective allows managers the opportunity to see how decisions made in one stage affect costs throughout the entire product life cycle. This perspective is not possible under the traditional product costing approach. The total-life-cycle costing approach should therefore lead to more cost-effective products and services. 8-22 The traditional accounting focus in managing costs is on the manufacturing stage of the total life cycle of a product. The most significant problem with this focus is that the traditional method ignores product costs before manufacturing (in the research, development and engineering (RD&E) stage) as well as those that occur after manufacturing (in the post-sale and disposal stage). The limited focus is – 300 –

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especially problematic because it is common for 80-85% of a product’s life cycle costs to be committed by decisions made in the RD&E cycle. 8-23 Exhibit 8-2 illustrates the relationship between costs committed and costs incurred over the total life cycle of a product. The top curve, “cost committed,” shows how a very large percentage (80–85%) of product life cycle costs are assigned or committed to by an organization during the pre-manufacturing (research development and engineering) stage of the total product life cycle. Costs continue to be committed up through the end of the life cycle, but these costs level off during the manufacturing and post-sale service and disposal stages. The bottom curve, “costs incurred,” illustrates the actual costs incurred by the organization over the various stages of the life cycle. Note that a small percentage of costs are incurred during the research, development and engineering stage, but these costs increase significantly during the manufacturing and post-sale service and disposal stages. The implications are: (1) managers need to manage costs at the RD&E stage, (2) all stages of the life cycle are important, and (3) the RD&E stage is the critical stage in managing later costs. 8-24 The disposal phase of the post-sale service and disposal stage of a product begins when the first unit of product is retired by the customer and ends when the last unit of product is retired by the customer. Disposal costs are most relevant when an organization has to eliminate any harmful effects associated with the end of a product’s life. 8-25 Target costing differs from traditional cost reduction methods through the process by which costs are determined. Under traditional cost reduction, after market research to determine customer requirements and product specification, engineers and designers determine product design, then the cost to produce the product. If the estimated cost is too high, then it may be necessary to modify the product design. The desired profit margin is found by subtracting the estimated cost from the expected selling price. Target costing begins in approximately the same way with market research to determine customer requirements and product specification. From this point on, procedures are quite different. The next step under target costing is to determine the target selling price and target product volume. Then the target profit margin is determined. The target cost is the difference between the target selling price and target profit margin. Target costing focuses on achieving the target cost. Product cost is not important in product design under traditional cost-reduction methods, which focus on cost reduction at the manufacturing stage. In contrast, target costing focuses on cost reduction at the RD&E stage. Target costing uses the total life cycle costing concept to focus on cost of ownership over the product’s life. In – 301 –

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addition, target costing involves cross-functional teams and close relationships with suppliers. Market research is not a single event as it is under traditional cost methods. Under target costing, market research is customer driven, with customer input obtained continually throughout the process. 8-26 The relationship between value engineering and target costing is as follows: Once a target cost has been set, the organization must determine target costs for each component in a product. Value engineering is used to examine the design of each component of a product to determine whether it is possible to reduce costs while maintaining functionality and performance. 8-27 Return on sales (net income ÷ sales) is the most widely used profitability measure to develop the target profit margin under target costing. 8-28 Some of the potential problems in implementing a target costing system from a behavioral point of view are: (a) conflicts that arise between parties involved in the target costing process, (e.g., the conflict that arises between suppliers and the target costing organization when too much pressure is placed on suppliers to cut their costs), (b) burnout among employees, and (c) some employees (such as senior executives) reject the idea and do not understand its value. 8-29 A manager asked to benchmark another organization’s target costing system would want information pertaining to the method by which target prices and target margins (and consequently, target costs) are set, supplier relations, how the organization uses value engineering to reduce costs, and the organizational structure and culture needed to manage the target costing process. While these are critical variables on which to gather information, target costing always has to be studied and understood in relation to the specific organization involved. 8-30 The target costing relationship is expressed in the following equation form: , where C is the target cost, S is the target selling price, and P is the target profit margin. This equation differs from the other two types of traditional equations relating to cost reduction in the following ways. The first traditional cost reduction method is expressed as follows: . The desired profit margin, P, is found by subtracting the estimated cost, C, from the expected selling price, S. The second traditional approach, known as the cost-plus method, expresses the relationship among variables as . Under cost-plus, an expected profit margin is added to the expected product cost. Price is simply the result of the sum of these two variables. Unlike the traditional approaches, target costing focuses on achieving a particular cost target.

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Chapter 8: Measuring Life-Cycle Costs

8-31 (a) Percent Contribution of Each Component to Customer Requirements

Customer Requirements

Brew Basket

Tastes/smells like expresso

0.7 × 20% = 14% 0.5 × 16% = 8%

Easy to clean

Looks nice

Has 6+ cup capacity Starts automatically on time Has multiple grinder settings Keeps the coffee warm

Carafe

Component Coffee Body/ Warmer Water Well

Heating Display Element Panel 0.3 × 20% = 6%

0.1 × 16% = 1.6% 0.1 × 8% = 0.8% 0.5 × 12% = 6%

0.4 × 16% = 6.4% 0.5 × 8% = 4% 0.5 × 12% = 6%

16%

0.4 × 8% = 3.2%

0.1 × 4% = 0.4%

22.4%

10.8%

9.6%

16%

4%

12%

0.8 × 12% = 9.6%

Automatic shutoff Converted component ranking

8%

12%

1× 16% = 16% 0.9 × 4% = 3.6% 0.2 × 12% = 2.4%

Relative Feature Ranking 20%

16.4%

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6.0%

1× 12% = 12% 34.8%

12%

100%

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(b) Value Index for Kitchenhelp’s Coffeemaker

Component or Function Brew Basket Carafe Coffee Warmer Body/ Water Well Heating Element Display Panel

(2) Component Cost

(3) Relative Importance

18.0% 4.0% 6.0% 18.0% 8.0% 46.0%

22.4% 10.8% 9.6% 16.4% 6.0% 34.8%

(3) ÷ (2) Value Index 1.24 2.70 1.60 0.91 0.75 0.76

Action Implied Enhance Enhance Enhance Reduce cost Reduce cost Reduce cost

The body/ water well, heating element, and display panel are candidates for cost reduction because their value indexes are less than 1.

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8-32 As shown below, Greyson’s new break-even time occurs during Quarter 3 of Year 4, approximately 15 months later than the initial 30 months (Year 3, Quarter 2). (000)

Y1, Y1, Y1, Q1 Q2 Q3 $(100) $(50)

Y1, Q4

Y2, Q1

Y2, Q2

Y2, Q3

Y2, Q4

Market Research Product (80) (150) (150) (150) (150) (150) (150) Development Selling Price Cost per unit Margin/unit Sales quantity Contribution MSDA expenses Product profit $(100) $(130) $(150) $(150) $(150) $(150) $(150) $(150) Quarterly Profit/Loss Cumulative $(100) $(230) $(380) $(530) $(680) $(830) $(980) $(1,130) Profit/Loss

(000)a

Y3, Q1

Y3, Q2

Y3, Q3

Y3, Q4

Y4, Q1

Y4, Q2

Y4, Q3

Y4, Q4

Market Research Product Development $(60) Selling Price $19 $18 $18 $17 $17 $16 $15 $15 Cost per unit 10 10 10 10 10 10 10 10 Margin/unit $9 $8 $8 $7 $7 $6 $5 $5 Sales quantity 25 35 45 50 50 50 40 30 Contribution $225 $280 $360 $350 $350 $300 $200 $150 MSDA expenses 120 120 120 120 120 120 120 120 Product profit $105 $160 $240 $230 $230 $180 $80 $30 Quarterly Profit/Loss $45 $160 $240 $230 $230 $180 $80 $30 Cumulative $(1,085) $(925) $(685) $(455) $(225) $(45) $35 $65 Profit/Loss a All amounts except selling price, cost per unit, and margin per unit are in 1,000s.

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8-33 As shown below, Greyson will now never reach a break-even time. Beginning with Y4, Q4, Greyson will incur quarterly losses of $20,000 and will never show a positive cumulative profit. (000)

Y1, Y1, Y1, Q1 Q2 Q3 $(100) $(50)

Y1, Q4

Y2, Q1

Y2, Q2

Y2, Q3

Y2, Q4

Market Research (80) (150) (150) (150) (150) (150) (150) Product Development Selling Price Cost per unit Margin/unit Sales quantity Contribution MSDA expenses Product profit Quarterly $(100) $(130) $(150) $(150) $(150) $(15...