Week 6 assignment

13-16Value-added, non-value-added costs.The Magill Repair Shop repairs and services machine tools.

A summary of its costs (by activity) for 2013 is as follows:

a.Materials and labor for servicing machine tools $1,100,000

b.Rework costs 90,000

c.Expediting costs caused by work delays 65,000

d.Materials-handling costs 80,000

e.Materials-procurement and inspection costs 45,000

f.Preventive maintenance of equipment 55,000

g.Breakdown maintenance of equipment 75,000

1. Classify each cost as value-added, non-value-added, or in the gray area between.

2. For any cost classified in the gray area, assume 60% is value-added and 40% is non-value-added. How much of the total of all seven costs is value-added and how much is non-value-added?

3. Magill is considering the following changes: (a) introducing quality-improvement programs whose net effect will be to reduce rework and expediting costs by 40% and materials and labor costs for servicing machine tools by 5%; (b) working with suppliers to reduce materials-procurement and inspection costs by 20% and materials-handling costs by 30%; and (c) increasing preventive-maintenance costs by 70% to reduce breakdown-maintenance costs by 50%. Calculate the effect of programs (a), (b), and (c) on value-added costs, non-value-added costs, and total costs. Comment briefly.

13-17Target operating income, value-added costs, service company.Calvert Associates prepares architectural drawings to conform to local structural-safety codes. Its income statement for 2013 is as follows:

Revenues $701,250

Salaries of professional staff (7,500 hours*$52 per hour) 390,000

Travel 15,000

Administrative and support costs 171,600

Total costs 576,600

Operating income $124,650

Following is the percentage of time spent by professional staff on various activities:

Making calculations and preparing drawings for clients 77%

Checking calculations and drawings 3

Correcting errors found in drawings (not billed to clients) 8

Making changes in response to client requests (billed to clients) 5

Correcting own errors regarding building codes (not billed to clients) 7

Total 100%

Assume administrative and support costs vary with professional-labor costs. Consider each requirement independently.

1.How much of the total costs in 2013 are value-added, non-value-added, or in the gray area between?

Explain your answers briefly. What actions can Calvert take to reduce its costs?

2.What are the consequences of misclassifying a non-value-added cost as a value-added cost? When in doubt, would you classify a cost as a value-added or non-value-added cost? Explain briefly.

3. Suppose Calvert could eliminate all errors so that it did not need to spend any time making corrections and, as a result, could proportionately reduce professional-labor costs. Calculate Calvert’s operating income for 2013.

4. Now suppose Calvert could take on as much business as it could complete, but it could not add more professional staff. Assume Calvert could eliminate all errors so that it does not need to spend any time correcting errors. Assume Calvert could use the time saved to increase revenues proportionately. Assume travel costs will remain at $15,000. Calculate Calvert’s operating income for 2013.

13-28Cost-plus, target return on investment pricing.Zoom-o-licious makes candy bars for vending machines and sells them to vendors in cases of 30 bars. Although Zoom-o-licious makes a variety of candy, the cost differences are insignificant, and the cases all sell for the same price. Zoom-o-licious has a total capital investment of $15,000,000. It expects to produce and sell 300,000 cases of candy next year. Zoom-o-licious requires a 10% target return on investment.

Expected costs for next year are:

Variable production costs $4.00 per case

Variable marketing and distribution costs $1.00 per case

Fixed production costs $300,000

Fixed marketing and distribution costs $400,000

Other fixed costs $200,000

Zoom-o-licious prices the cases of candy at full cost plus markup to generate profits equal to the target return on capital.

1. What is the target operating income?

2. What is the selling price Zoom-o-licious needs to charge to earn the target operating income? Calculate the markup percentage on full cost.

3. Zoom-o-licious’s closest competitor has just increased its candy case price to $16, although it sells 36 candy bars per case. Zoom-o-licious is considering increasing its selling price to $15 per case. Assuming production and sales decrease by 4%, calculate Zoom-o-licious’ return on investment. Is increasing the selling price a good idea?

13-30Cost-plus and market-based pricing.Georgia Temps, a large labor contractor, supplies contract labor to building-construction companies. For 2014, Georgia Temps has budgeted to supply 84,000 hours of contract labor. Its variable costs are $13 per hour, and its fixed costs are $168,000. Roger Mason, the general manager, has proposed a cost-plus approach for pricing labor at full cost plus 20%.

1. Calculate the price per hour that Georgia Temps should charge based on Mason’s proposal.

2.The marketing manager supplies the following information on demand levels at different prices:

Price per Hour Demand (Hours)

$16 124,000

17 104,000

18 84,000

19 74,000

20 61,000

Georgia Temps can meet any of these demand levels. Fixed costs will remain unchanged for all the demand levels. On the basis of this additional information, calculate the price per hour that Georgia Temps should charge to maximize operating income.

3.Comment on your answers to requirements 1 and 2. Why are they the same or different?