EXERCISES

13-28 Target Costing (15 min)

1. The unit cost is currently $548.60 = $13,715,000 25,000
The current profit per item is $610 - $548.60 = $61.40
Thus, the target cost to meet the competitive price is:
$550 - $61.40 = $488.60, a reduction of $60 from the current cost.
2. The target cost can probably be achieved by efforts in two areas:
a. The analysis of budgeted versus actual cost shows an
unfavorable materials variance of $500,000 ($7,000,000 $6,500,000) or $20 per unit, which is a very significant variance.
Efforts to reduce or eliminate this variance will make the firm much
more competitive. Notice that the labor usage variance for indirect
labor is favorable, and the direct labor variance is unfavorable. It may
be that additional work is needed setting the standards.
b. The standard cost shows an unfavorable direct labor
variance of $125,000 ($2,625,000 - $2,500,000), or $5 per unit, an
opportunity for cost savings.
c. The remaining manufacturing costs can be considered nonvalue adding costs, since they do not add to the functionality or
quality of the product. Efforts can be made to reduce the total cost of
these manufacturing costs, which now total a significant $4,090,000
or $163.60 per unit. Note that inspection and return and rework
costs are also over budget; not only are these costs non-value
adding, they are also increasing above the budget, a strong sign that
Kaizen methods should be employed.

13-29. Target Costing; Spreadsheet Application (30 min)

1., 2.

13-29 (continued -1)

3. The solution uses Goal Seek or trials in the Excel sheet. The number of
parts must be reduced to 101 or fewer to get at least $50 margin.

Alternatively, the current activities using parts as a driver are materials

handling and assembly. These costs now total $528.00 ($247.50 +
$280.50) which would need to be reduced, by the additional required
margin of $39.25, to $488.75. Therefore, $2.25x + $2.55x = $488.75 and x
= 101.82 parts.
4. Target costing should be useful to BSI to assist the firm in meeting the
new competition by finding new ways to cut costs without reducing product
quality or functionality.
13-41 Target Cost; Warehousing (20 min)
Current Year Operating Income
Sales ($20 x 100,000) =

$2,000,000

Costs:
Purchase ($10 x 100,000)

$1,000,000

Purchasing order ($150 x 1,000)

Warehousing ($30 x 8,000)
Distributing ($80 x 500)
Fixed operating cost

150,000
240,000
40,000
250,000

Operating income

1,680,000
$320,000

Determination of Target Cost:

Sales ($20.00 x 100,000 x 0.90)
Desired profit (above)
Costs:
Purchase (2% discount)
Purchasing order ($150 x 680)
Distributing ($77 x 500)
Fixed operating cost

$1,800,000
320,000
$980,000
102,000
38,500
250,000

Maximum allowable costs for warehousing

1,370,500
$109,500

Warehousing costs must be reduced from $240,000 to $109,500, a reduction of

$130,500.

13-44 Target Costing: Quality Function Deployment

The QFD analysis shows that BPI should consider spending more time and
money on the planning meeting and less on the photography done the day
of the wedding, to put their costs more in line with the customer criteria.

Criteria
Fast Service
Getting Good Photos
Quality of Photo Finishing
Quality of Photo Books

Customer
Rating
30
120
60
90
300

Percent
10.0%
40.0%
20.0%
30.0%
100.0%

Activities

Target Cost

Planning Meeting
Take Photos
Prepare Proofs
Prepare Photo Book

Activity/Criteria
Planning Meeting
Take Photos
Prepare Proofs
Prepare Photo Book

Activity/Criteria
Criteria Value
Planning Meeting
Take Photos
Prepare Proofs
Prepare Photo Book

Percent

800
2,400
600
1,200

16.0%
48.0%
12.0%
24.0%

$ 5,000

100.0%

Fast Service

Good Photos

Finishing

Book Quality

30%
5%
35%
30%

40%
60%
0%
0%

0%
0%
50%
50%

35%
15%
0%
50%

100%

100%

100%

100%

Fast Service
10%
3%
0.5%
3.5%
3%

Good Photos
40%
16%
24%
0%
0%

Finishing
20%
0%
0%
10%
10%

Book Quality
30%
10.5%
4.5%
0%
15%

Importance
Index

Cost Index

Value Index
Ratio

29.50%
29.00%
13.50%
28.00%

16.00%
48.00%
12.00%
24.00%

1.84
0.60
1.13
1.17

100.00%

100.00%

Importance
Index
100%
29.50%
29.00%
13.50%
28.00%
100.00%

Comparison of Cost and Value

Planning Meeting
Take Photos
Prepare Proofs
Prepare Photo Book

Spend More
Spend Less
No clear action
No clear action

1. A limitation of the above analysis is that there are certain costs of taking
the photos on the day of the wedding (additional lighting, backup
cameras, and equipment, etc.) which may make it difficult to reduce the
cost of this activity. The principal take-away from the analysis is to put
careful attention to the planning meeting; when carefully done it can
contribute a great deal to the couples satisfaction with the photos and
therefore ultimately of the quality of the wedding photo book.
13-46 Theory of Constraints (30 min)
With the information available Don can complete the first two steps of TOC
as shown below. The analysis shows that the reactor process is the
constraint, and that in the short run, Polymer 1 is the most profitable
product. The most profitable product mix is 60 units of Polymer 1 and 35
units Polymer 2. Until the production delays can be dealt with (TOC steps
3-5), Don should advise CPC to meet all the sales demand of Polymer 1
and to advise customers of Polymer 2 there would be some delays in the

shortterm. Then, CPC should work quickly to relieve the constraint,

reactor time, by applying the third, fourth and fifth TOC steps. Without
specialized technical knowledge of the manufacturing processes in this
industry, one can only speculate about what these steps might be.
First: Identify the Constraint
Total Time Required for Each activity for Given Demand
Time Required for
Total
Time Slack
Polymer 1
Polymer 2
Time
Available Time
Filtering
602= 120
Stripper 60(1+1) 120
=
Reactor
603= 180
Final Filter 602= 120
Mixing
603= 180

40(2+2)= 160
40(2+1)= 120

280
240

320
320

40
80

405 = 200
40 1 = 40
403 = 120

380
160
300

320
160
320

(60)
0
20

The reactor is the constraint, since there is a demand of 380 hours but
only 320 hours available.

13-46 (continued)
Second: Identify the most profitable product
Polymer 1
$
145
45
$
100
3
$
33

Price
Materials Cost
Throughput Margin
Constraint time(reactor)
Throughput/hour

$
$
$

Polymer 2
185
60
125
5
25

Third: Identify the most profitable product mix

Since Polymer 1 is the most profitable product, its total demand of 60 is
filled first. The remaining time on the reactor is used to complete as many
units of Polymer 2 as possible:
Capacity of reactor available for Polymer 2 = 320 (60 3) = 140
1405 = 28 units of Polymer 2

Units
Throughput/unit

Polymer 1
60
$
100

Polymer 2
28
$
125

Total throughput

6,000

3,500

Total

$9,500

13-48 Life-Cycle Costing; Ethics (25 min)

1. Kate Stephen's analysis based on the prepared report fails to
consider the very significant amount of research and development
and selling costs. It is unlikely that the two products consumed equal
shares of these costs. As the calculations in part 2 below illustrate,
the determination of profitability can be significantly affected by the
tracing of these non-manufacturing costs to each product. The idea is
that life-cycle costing, including upstream and downstream costs
(research and development, and selling costs, respectively) as well
as the manufacturing costs, is necessary to get an accurate picture of
each products overall profitability.
2.
Sales
Cost of goods sold
Gross profit
Research and development
Selling expenses
Profit before taxes

Xderm
$2,900,000
$2,000,000
$900,000
$600,000
$75,000
$225,000

Yderm
$2,000,000
$1,500,000
$500,000
$200,000
$25,000
$275,000

Total
$4,900,000
$3,500,000
$1,400,000
$800,000
$100,000
$500,000

The life-cycle product line profitability analysis shows a much different

result.
Now, Xderm has the lower total profit and Yderm has the higher profit
percentage. This illustrates that including the upstream and
downstream costs can be very important in getting a useful analysis of
product profitability. Failing to include these non-manufacturing costs,
as Kate Stephens did at first, may lead to incorrect marketing and
management decision making, as the firm may have a biased and
incorrect idea of the most profitable product(s).
Pre-tax margin

$225,000
$2,900,000
=
7.76%

$ 275,000
$2,000,000
= 13.75%

$ 500,000
$ 4,900,000
=10.2%

13-48 (continued)
3. Kate Stephens should recognize, as the results in part 2 show, that
Xderm is not as profitable on a life cycle basis as it is on a gross
margin basis. In fact, it has a lower return on sales as the existing
product Yderm when life cycle costs are included. She should
present the data shown in part 2 and explain that Xderm has been a
successful product, but perhaps has not achieved the very high level
of success she may have promised. To present the gross margin data
only would be misleading and therefore in conflict with his
responsibility for integrity under the management accountants code of
ethics (chapter 1).