Author Question: Cost estimation, incremental unit-time learning model. Assume the same information for the Blue ... (Read 20 times)

cagreen833 · **on:** Jul 6, 2018

Cost estimation, incremental unit-time learning model.

Assume the same information for the Blue Seas Company as in Problem 10- 35 with one exception. This exception is that Blue Seas uses a 90 incremental unit-time learning model as a basis for predicting direct manufacturing labor-hours in its assembling operations. (A 90 learning curve means b = -0.152004.)

Required:
1. Prepare a prediction of the total costs for producing the six PT109s for the Navy.
2. If you solved requirement 1 of Problem 10- 35, compare your cost prediction there with the one you made here. Why are the predictions different? How should Blue Seas decide which model it should use?

Question 2

Customer profitability, distribution.

Best Drugs is a distributor of pharmaceutical products. Its ABC system has five activities:

Rick Flair, the controller of Best Drugs, wants to use this ABC system to examine individual customer profitability within each distribution market. He focuses first on the Ma and Pa single-store distribution market. Using only two customers helps highlight the insights available with the ABC approach. Data pertaining to these two customers in August 2013 are as follows:

Required:
1. Use the ABC information to compute the operating income of each customer in August 2013. Comment on the results and what, if anything, Flair should do.
2. Flair ranks the individual customers in the Ma and Pa single-store distribution market on the basis of monthly operating income. The cumulative operating income of the top 20 of customers is 58,120. Best Drugs reports operating losses of 23,670 for the bottom 40 of its customers. Make four recommendations that you think Best Drugs should consider in light of this new customer-profitability information.

vish98 · **Reply #1 on:** Jul 6, 2018

Answer to Question 1

1. Cost to produce the second through the seventh boats:
Direct materials, 6 201,000
1,206,000
Direct manufacturing labor (DML), 76,0621 43
3,270,666
Variable manufacturing overhead, 76,062 24
1,825,4888
Other manufacturing overhead, 15 of DML costs 490,600
Total costs 6,792,754

1The direct labor hours to produce the second through the seventh boats can be calculated using a table format, given the assumption of an incremental unit-time learning curve of 90 percent:

90 Learning Curve
Cumulative Number of Units (X) Individual Unit Time for Xth Unit (y): Labor Hours Cumulative Total Time: Labor-Hours
(1) (2) (3)
1 15,700 15,700
2 14,130 = (15,700 0.90)
29,830
3 13,285 43,115
4 12,717 = (13,285 0.90)
55,832
5 12,293 68,125
6 11,957 80,082
7 11,680 91,762

Calculated as y = aXb where a = 15,700, b = 0.152004, and X = 1, 2, 3,. . .7.

The direct manufacturing labor-hours to produce the second through the seventh boat is 91,762 15,700 = 76,062 hours.

2. Difference in total costs to manufacture the second through the seventh boat under the incremental unit-time learning model and the cumulative average-time learning model is 6,792,754 (calculated in requirement 1 of this problem) 6,058,107 (from requirement 1 of Problem 10- 36) = 734,647, i.e., the total costs are higher for the incremental unit-time model.
The incremental unit-time learning curve has a slower rate of decline in the time required to produce successive units than does the cumulative average-time learning curve (see Problem 10- 36, requirement 1). Assuming the same 90 percent factor is used for both curves:

Estimated Cumulative Direct Manufacturing Labor-Hours
Cumulative
Number of Units Cumulative Average-
Time Learning Model Incremental Unit-Time Learning Model
1
2
4
7 15,700
28,260
50,868
81,760 15,700
29,830
55,832
91,762
The reason is that, in the incremental unit-time learning model, as the number of units double, only the last unit produced has a cost of 90 percent of the initial cost. In the cumulative average-time learning model, doubling the number of units causes the average cost of all the units produced (not just the last unit) to be 90 percent of the initial cost.

Blue Seas should examine its own internal records on past jobs and seek information from engineers, plant managers, and workers when deciding which learning curve better describes the behavior of direct manufacturing labor-hours on the production of the PT109 boats.

Answer to Question 2

1. The activity-based costing for each customer is:

Ann Arbor
Pharmacy San Diego
Pharmacy
1. Order processing,
42 13; 42 7 546.00 294.00
2. Line-item ordering,
5 (13 11; 7 19) 715.00 665.00
3. Store deliveries,
47 5; 47 7 235.00 329.00
4. Carton deliveries,
4 (5 21; 7 18) 420.00 504.00
5. Shelf-stocking,
13 (5 0.5; 7 0.75) 32.50 68.25
Operating costs 1,948.50 1,860.25

The operating income of each customer is:
Ann Arbor
Pharmacy San Diego
Pharmacy
Revenues,
2,600 5; 1,900 7 13,000.00 13,300.00
Cost of goods sold,
2,100 5; 1,700 7 10,500.00 11,900.00
Gross margin 2,500.00 1,400.00
Operating costs 1,948.50 1,860.25
Operating income 551.50 (460.25)

San Diego Pharmacy has a lower gross margin percentage than does Ann Arbor 10.5 (1,400 13,300) vs. 19.2 (2,500 13,000) and consumes more resources to obtain this lower margin. Serving San Diego necessitates more deliveries and delivery of more line items in each order, albeit lower-priced ones that don't contribute much to Best Drugs' income. Overall, Ann Arbor is a profitable customer, while San Diego is not.

2. Ways Best Drugs could use this information include:
a. Pay increased attention to the top 20 of the customers. This could entail asking them for ways to improve service. Alternatively, Best Drugs may want to highlight to their own personnel the importance of these customers; e.g., it could entail stressing to delivery people the importance of never missing delivery dates for these customers.
b. Work out ways internally at Best Drugs to reduce the rate per cost driver; e.g., reduce the cost per order by having better order placement linkages with customers. This cost reduction by Best Drugs will improve the profitability of all customers.
c. Work with customers so that their behavior reduces the total system-wide costs. At a minimum, this approach could entail having customers make fewer orders and fewer line items. This latter point is controversial with students; the rationale is that a reduction in the number of line items (diversity of products) carried by Ma and Pa stores may reduce the diversity of products Best Drugs carries.

There are several options here:
Simple verbal persuasion by showing customers cost drivers at Best Drugs.
Explicitly pricing out activities like cartons delivered and shelf-stocking so that customers pay for the costs they cause.
Restricting options available to certain customers, e.g., customers with low revenues could be restricted to one free delivery per week.

An even more extreme example is working with customers so that deliveries are easier to make and shelf-stocking can be done faster.

d. Offer salespeople bonuses based on the operating income of each customer rather than the gross margin of each customer.

Some students will argue that the bottom 40 of the customers should be dropped. This action should be only a last resort after all other avenues have been explored. Moreover, an unprofitable customer today may well be a profitable customer tomorrow, and it is myopic to focus on only a one-month customer-profitability analysis to classify a customer as unprofitable.