STRATEGIC COST MANAGEMENT, TARGET COSTING
Assume that a firm has the following activities and associated cost behaviors:
|
Activities |
Cost Behavior |
|
Assembling components |
$10 per direct labor hour |
|
Setting up equipment |
Variable: $100 per setup |
|
|
Step fixed: $30,000 per step, 1 step = 10 setups |
|
Receiving goods |
Step fixed: $40,000 per step, 1 step = 2,000 hours |
Activities with step cost behavior are being fully utilized by existing products. Thus, any new product demands will increase resource spending on these activities.
Two designs are being considered for a new product: Design I and Design II. The following information is provided about each design (1,000 units of the product will be produced):
|
Activity Driver |
Design I |
Design II |
|
Direct labor hours |
3,000 |
2,000 |
|
Number of setups |
10 |
20 |
|
Receiving hours |
2,000 |
4,000 |
The company has recently developed a cost equation for manufacturing costs using direct labor hours as the driver. The equation has R2 = 0.60 and is as follows:
Y = $150,000 + $20X
Required:
1. Suppose that Design Engineering is told that only direct labor hours drive manufacturing costs (based on the direct labor cost equation). Compute the cost of each design. Which design would be chosen based on this unit based cost assumption?
2. Now compute the cost of each design using all driver and activity information. Which design will now be chosen? Are there any other implications associated with the use of the more complete activity information set?
3. Consider the following statement: “Strategic cost analysis should exploit internal linkages.” What does this mean? Explain, using the results of Requirements 1 and 2.
4. An outside consultant indicated that target costing ought to be used in the design stage. Explain what target costing is, and describe how it requires an understanding of both supplier and customer linkages.
5. What other information would be useful to have concerning the two designs? Explain.