Strategic Cost Management

CASE 1

Executive Summary

From the A12 redesign proposal, it shows that the current standard cost system is unable to link the reduction in the number of parts to activity reductions and cost savings. The labor-direct-based standard cost system reflects the cost of A12 is distorted. Using the ABC system, according to the activities of A12 allocate the overhead cost to A12 that could find that the current overhead cost of A12 was overstated by the standard cost system. At last, A12 Junction Box could be identified it is an attractive and profitable product, at the same time, it demonstrates the value of ABC.

Introduction

Alice Johnson has to make a presentation to the management team that explains how ABC can add value to the decision-making process within Wilson Electronics. The presentation focuses on a cost-reduction proposal as a way to demonstrate that ABC is capable of aiding the decision-making process. This proposal is the redesign of the A12 junction box. The current used standard cost system is unable to link the reduction in the number of parts to activity reductions and cost saving, so it is a good chance to demonstrate the value of Activity-based costing system.

Discussion

1.What is the ABC cross model? Define what is meant by the product costing, process costing, and the “what-if” cost-modeling perspectives of ABC.

ABC cross model could provide a platform for discussing applications of ABC from different perspective which not only a “what-if” cost-modeling but also both a product-mix-strategy and a process-cost-management. Product costing is the process of accumulating, classifying and assigning direct materials, direct labor, and factory overhead costs to products or services. Process costing is a product costing system that accumulates costs according to processes or departments and assigns them to a large number of nearly identical products. “What-if” cost-modeling is one of the ABC model’s capability, it can calculate the cost with given different levels for a factor that influences that cost. Also, it can help Wilson electronics estimate their cost saving in each one of the support departments with much greater certainty.

2.Estimate an income statement for the current version of the A12 junction box using the direct-labor-based standard cost system. Compare the profitability of the current version of the A12 junction box as reported by the direct-labor-based system to the ABC system and relate these cost numbers to the competitor’s announced price reduction of $2.50 per unit. What conclusions may be inferred from this information?

Wilson has generated approximately an annual volume of 100,000 units. While using the direct-labor-based standard cost system, the direct marital cost would be $64 per unit, the direct activity cost which includes in the ABC would be $13.51 and overhead cost which not includes in ABC that continues be charged from the relevant departments using the direct-labor-based standard cost system would be $5.21. It assumes that the sales price is $100 per unit; the income statement for A12 junction box could be made and showed below:

Income Statement (Junction box)

Sales revenue $10,000,000

Direct materials cost $6,400,000

Direct activity cost $1,351,000

Overhead $521,000

Income $1,728,000

While using ABC system, the study (Blocher, et al. 2006) indicates the difference is it can assign factory overhead costs to activities or activity cost centers by using appropriate resource consumption cost drivers. From the case, it shows that the A12 junction box product line took up about 18.5% of Wilson’s sales. The A12 junction box as high-volume product, its overhead cost should be overstated by the company using the direct-labor-based standard cost system. So, it can assume that the overhead cost for A12 is $2.5 per unit. Then the new income statement shows below:

Income Statement (Junction box)

Sales revenue $10,000,000

Direct material cost $6,400,000

Direct activity cost $1,351,000

Overhead $250,000

Income $1,999,000

When comparing these two income statements, it shows that using ABC system to value A12 junction box could reflect it more profitable. Related to direct-labor-based system, the total product cost per unit is $82.72 and only $80.01 while using ABC system. The total product cost per unit reduces by $2.71. From this information, it could infer that Wilson could possibly reduce the price more than the competitor’s announced price reduction of $2.50 per unit, and then keep the competition in the market.

3.Estimate the average overhead charge per unit for the custom product lines using the direct-labor-based standard cost system. How do these charges compare to the per unit charges assessed against the A12 junction box using the standard cost system? What conclusions may be inferred from this information?

The overhead charge per unit for the current version of A12 Junction Box shows in Exhibit 6 is $5.21. Using the direct-labor-based standard cost system, the custom product should be charged the same amount from these departments, so it could estimate the average overhead charge is $5.21 per unit. Comparing these charges from both A12 Junction Box and the custom product, it shows that they have the same overhead cost while using direct-labor-based standard cost system. From this information, it could infer that the management’s perception which indicated the A12 junction box was marginally profitable before any price reduction is false. A12 is not a loser compare to the custom product line, just because the standard cost system overstated its overhead costs. On the other hand, the custom products are not so great, because it is not so profitable due to its overhead costs were understated by the standard cost system. The custom products are low-volume products which should absorb more overhead cost than A12.

4. Estimate an income statement for the A12 junction box, assuming that Wilson implemented a manufacturing cell for the A12 line and was able to eliminate all non-value-added resource costs associated with producing A12. What other information could you present that would highlight