12-29

12-29

Target prices, target costs, value engineering, cost incurrence, locked-in costs, activity based costing.

Cutler Electronics makes a radio-cassette player, CE100, which has 80 components. Cutler sells 7,000 units each month for $70 each. The costs of manufacturing CE100 are $45 per unit, or $315,000 per month. Monthly manufacturing costs incurred are:

Direct material costs$182,000

Direct manufacturing labor costs$28,000

Machining Costs (fixed)$31,500

Testing costs$35,000

Rework Costs$14,000

Ordering Costs$3,360

Engineering Costs (fixed)$21,140

Total manufacturing costs$315,000

Cutlers management identifies the activity cost pools, the cost driver for each activity, and the cost per unit of the cost driver for each overhead cost pool as follows:

Manufacturing

ActivityDescription of

ActivityCost DriverCost per Unit of

Cost Driver

1. Machining CostsMachining componentsMachine-hour capacity$4.50 per machine-hour

2. Testing CostsTesting components and final product (Each unit of CE100 is tested individually.)Testing-hours$2 per testing-hour

3. Rework CostsCorrecting and fixing errors and defectsUnits of CE100 reworked$20 per unit

4. Ordering CostsOrdering of componentsNumber of orders$21 per order

5. Engineering CostsDesigning and managing of products and processesEngineering-hour capacity$35 per engineering-hour

Cutlers management views direct material costs and direct manufacturing labor costs as variable with respect to the units of CE100 manufactured. Over a long-run horizon, each of the overhead costs described in the preceding table varies, as described, with the chosen cost drivers.

The following additional information describes the existing design:

a. Testing and inspection time per unit is 2.5 hours.

b. 10% of the CE100s manufactured are reworked.

c. Cutler places two orders with each component supplier each month. Each component is supplied by a different supplier.

d. It currently takes 1 hour to manufacture each unit of CE100.

In response to competitive pressures, Cutler must reduce its price to $62 per unit and its costs by $8 per unit. No additional sales are anticipated at this lower price. However, Cutler stands to lose significant sales if it does not reduce its price. Manufacturing has been asked to reduce its costs by $6 per unit. Improvements in manufacturing efficiency are expected to yield a net savings of $1.50 per radio-cassette player, but that is not enough. The chief engineer has proposed a new modular design that reduces the number or components to 50 and also simplifies testing. The newly designed radio-cassette player, called New CE100 will replace CE100.

The expected effects of the new design are as follows:

a. Direct material costs for the New CE100 is expected to be lower by $2.20 per unit.

b. Direct manufacturing labor cost for the New CE100 is expected to be lower by $0.50 per unit.

c. Machining time required to manufacture the New CE100 is expected to be 20% less, but machine-hour capacity will not be reduced.

d. Time required for testing New CE100 is expected to be lower by 20%.

e. Rework is expected to decline to 4% of New CE100s manufactured.

f. Engineering-hours capacity will remain the same.

Assume that the cost per unit of each driver for CE100 continues to apply to New CE100.

1. Calculate Cutlers manufacturing costs per unit of New CE100.

2. Will the new design achieve the per-unit costs-reduction targets that have been set for the manufacturing costs of New CE100? Show your calculations.

3. The problem describes two strategies to reduce costs: (a) improving manufacturing efficiency and (b) modifying product design. Which strategy has more impact on Cutlers costs? Why? Explain briefly.

1.

Old CE100Cost ChangeNew CE100

Direct materials costs

Direct manufacturing labor costs

Machining costs

Testing costs Rework costs

Ordering costs

Engineering costs

Total manufacturing costs$182,000

28,000

31,500

35,000

14,000

3,360

21,140$315,000$2.20 7,000 = $15,400 less

$0.50 7,000 = $3,500 less

Unchanged because capacity same

(20% 2.5 7,000) $2 = $7,000

(See Note 1)

(See Note 2)

Unchanged because capacity same$166,600

24,500

31,500

28,000

5,600

2,100

21,140$279,440

Note 1:

10% of old CE100s are reworked. That is, 700 (10% of 7,000) CE100s made are reworked. Rework costs = $20 per unit reworked ( 700 = $14,000. If rework falls to 4% of New CE100s manufactured, 280 (4% of 7,000) New CE100s manufactured will require rework. Rework costs = $20 per unit ( 280 = $5,600.

Note 2 :

Ordering costs for New CE100 = 2 orders/month ( 50 components ( $21/order

= $2,100

Unit manufacturing costs of New CE100 = $279,440 7,000 = $39.92

2.Total manufacturing cost reductions based on new design= $315,000 $279,440

= $35,560

Reduction in unit manufacturing costs based on new design= $35,560 7,000

= $5.08 per unit.

The reduction in unit manufacturing costs based on the new design can also be calculated as

Unit cost of old design, $45 ($315,000 7,000 units) Unit cost of new design, $39.92 = $5.08

Therefore, the target cost reduction of $6 per unit is not achieved by the redesign.

3.Changes in design have a considerably larger impact on costs per unit relative to improvements in manufacturing efficiency ($5.08 versus $1.50). One explanation is that many costs are locked in once the design of the radio-cassette is completed. Improvements in manufacturing efficiency cannot reduce many of these costs. Design choices can influence many direct and overhead cost categories, for example, by reducing direct materials requirements, by reducing defects requiring rework, and by designing in fewer components that translate into fewer orders placed and lower ordering costs.

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