91Ó°ÊÓ

Target prices, target costs, value engineering, cost incurrence, locked-in costs, activity-based costing. Cutler Electronics makes an MP3 player, CE100, which has 80 components. Cutler sells 7,000 units each month for \(\$ 70\) each. The costs of manufacturing \(\mathrm{CE} 100\) are \(\$ 45\) per unit, or \(\$ 315,000\) per month. Monthly manufacturing costs are as follows. Cutler's 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: $$\begin{array}{lccc} \begin{array}{l} \text { Manufacturing } \\ \text { Activity } \end{array} & \text { Description of Activity } & \text { cost Driver } & \begin{array}{c} \text { cost per Unit } \\ \text { of cost Driver } \end{array} \\ \hline \text { 1. Machining costs } & \text { Machining components } & \text { Machine-hour } & \text { \$4.50 per machine-hour } \\ & \text { capacity } & & \text { \$2 per testing-hour } \\ \text { 2. Testing costs } & \text { Testing components and final } & \text { Testing-hours } & \text { (inder } \\ & \text { product (Each unit of CE100 } & & \\ \text { 3. Rework costs } & \text { Correcting and fixing errors } & \text { Units of CE100 } & \text { \$20 per unit } \\ & \text { is tested individually.) } & \text { reworked } & \\ \text { 4. Ordering costs } & \text { Ordering of components } & \text { Number of orders } & \text { \$21 per order } \\ \text { 5. Engineering costs } & \text { Designing and managing of } & \text { Engineering-hour } & \text { \$35 per engineering-hour } \\ & \text { products and processes } & \text { capacity } & \end{array}$$ Cutler's 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 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. It currently takes one 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 MP3 player, but that is not enough. The chief engineer has proposed a new modular design that reduces the number of components to 50 and also simplifies testing. The newly designed MP3 player, called "New CE100" will replace CE100. The expected effects of the new design are as follows: a. Direct material cost 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. time required for testing the 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 cost driver for CE100 continues to apply to New CE100. 1\. Calculate Cutler's manufacturing cost per unit of New CE100. 2\. Will the new design achieve the per-unit cost-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 Cutler's costs? Why? Explain briefly.

Step by step solution

01

Calculate current costs per unit

First, determine the current cost structure for producing CE100. The monthly manufacturing cost is $315,000 for 7,000 units, resulting in a manufacturing cost of $45 per unit.

02

Calculate cost components for current design

Determine individual cost components such as machining, testing, rework, ordering, and engineering based on the activities described. Calculate these per unit for the current CE100 design: - **Machining**: 1 hour per unit at $4.50 per hour = $4.50 per unit - **Testing**: 2.5 hours per unit at $2 per hour = $5.00 per unit - **Rework**: 10% of units at $20 per unit = $2.00 per unit - **Ordering**: 2 orders for 80 components per month at $21 per order = $0.48 per unit - **Engineering**: Assume 1 hour per unit at $35 per hour = $5.00 per unit assuming full capacity used. Add direct materials and labor to achieve the $45 per unit cost (Direct Material and Labor fill the remaining balance).

03

Calculate new costs with design improvements

Apply changes due to the new design to determine costs for New CE100. - **Direct Material Cost Reduction**: $2.20 less; - **Direct Labor Reduction**: $0.50 less; - **Machining**: Reduce by 20%, thus $4.50 - 0.9 = $3.60 per unit; - **Testing**: Time reduced by 20%, 2.5 hours becomes 2 hours at $2 per hour = $4.00 per unit; - **Rework**: 4% of units at $20 per unit = $0.80 per unit; Costs for ordering and engineering remain unchanged: - **Ordering** still $0.48 per unit - **Engineering** remains $5.00 per unit.

04

Calculate total cost per unit for New CE100

Add all of the new CE100 costs per unit: - New Direct Material: Original remaining balance - $2.20 - New Direct Labor: Original remaining balance - $0.50 - **Revised Cost Components**: Machining $3.60 + Testing $4.00 + Rework $0.80 + Ordering $0.48 + Engineering $5.00. Deduce final cost per unit based on changes.

05

Evaluate cost reduction against targets

Compare the calculated manufacturing cost per unit for New CE100 against the target cost reduction per unit ($6 per unit reduction). Check savings: - Calculate the total reduction on material, labor, and component activities to find total cost reduction, target achieved if total reduction is ≥ $6 per unit.

06

Compare strategies: efficiency vs design modification

Assess the impact of efficiency improvement and design modification: - Efficiency improvement targeted $1.50 reduction, - Design modification reduced cost by $2.20 in materials, 50 cents in labor, along with reductions in activity costs (testing), greater impact due to larger-scale changes in base and variable costs.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Value Engineering

Value engineering is a strategic approach focused on increasing the value of products by either optimizing their functions or reducing their costs. This practice is vital in industries like electronics, where every cent saved can impact competitiveness.
At the heart of value engineering lies the idea of making products more efficient without sacrificing quality or functionality. When applied to manufacturing, it usually involves:

• Identifying components or processes that don't contribute significantly to the product's value.
• Streamlining production methods to eliminate waste.
• Substituting materials or methods with more cost-effective alternatives.

The case of the new design for the CE100 illustrates value engineering in action.
The engineering team proposed a modular design which simplifies the product, reducing component count from 80 to 50. This simplification not only cuts manufacturing costs but also reduces testing and rework needs, thus boosting the product's overall efficiency and cost-effectiveness. By maintaining product quality while significantly dropping production expenses, the company can keep competitive pricing, all thanks to effective value engineering.

Activity-Based Costing

Activity-Based Costing (ABC) is an approach to cost analysis that identifies activities in an organization and assigns the cost of each activity to the products and services according to the actual consumption. This method of accounting provides a more accurate snapshot of where resources are being allocated.

In the case of Cutler Electronics, ABC helps us clearly see how much each activity, like machining or testing, contributes to total product costs. For example, if testing takes 2.5 hours per unit at $2 per hour, understanding this component of cost can help in decision-making about areas for efficiency gains.

Implementing ABC provides several benefits:

• Improves the accuracy of product and service costing.
• Uncovers high overhead costs per product, which might be overlooked in traditional costing systems.
• Identifies inefficient processes, leading to operational improvements and cost savings.

In this textbook scenario, ABC aided Cutler in calculating cost per unit precisely aligned with real consumption, influencing decisions like deciding to adopt a new product design, given the accurate reflection of cost savings per activity.

Cost Reduction Strategies

For companies like Cutler Electronics, reducing production costs is crucial to maintaining market competitiveness, especially when facing pressure to lower product prices without losing quality. The exercise demonstrates two major cost reduction strategies: improving manufacturing efficiency and product design modification.
First, improving manufacturing efficiency focuses on optimizing existing processes to save costs. It includes reducing wasted time and resources, refining operation workflows, and making labor more productive. In the CE100's case, minor gains through efficiency improvements contributed a $1.50 reduction in cost per unit.
Secondly, product design modification tends to have a larger impact, as it addresses the core structure of the product itself. By redesigning the CE100 to a simpler form, Cutler saves directly on materials and indirectly on activities like testing and rework. This strategy hit the target more significantly due to large-scale changes across multiple cost drivers.
Cost reduction strategies like these ensure the company can continue operating profitably while still offering competitive pricing, making them essential tools in a firm's strategic arsenal for market survival.