Management Accounting

COST ANALYSIS PRESENTATION

GROUP 5 - CASE 3-38 & CASE 3-40
CASE 3-38
The controller of Throckton Company has been to a seminar on CVP analysis and
wants to use some of the techniques she learned. She gives you the following data
and asks that you analyze each cost into its fixed and variable components. She
plans to use the information for profit planning. You prepare the following schedules
of costs and measures of activity for the previous six months.

Sales Labor Hours Prodn Cost Selling Exp Admin Exp

$12,000 500 $ 9,100 $ 3,250 $ 3,200
10,000 700 11,000 2,980 3,300
21,000 1,200 14,300 4,130 4,100
30,000 1,300 15,300 4,950 4,500
33,000 900 11,980 5,370 4,300
35,000 800 11,200 5,560 4,800

Required: Analyze the cost behavior patterns in accordance with the request of the
controller. Determine the most likely driver for each cost.
CASE 3-38
Required: Analyze the cost behavior patterns in accordance with the request of the
controller.

What are the costs that we need to analyze into its fixed and variable components?

Sales Labor Hours Prodn Cost Selling Exp Admin Exp

$12,000 500 $ 9,100 $ 3,250 $ 3,200
10,000 700 11,000 2,980 3,300
21,000 1,200 14,300 4,130 4,100
30,000 1,300 15,300 4,950 4,500
33,000 900 11,980 5,370 4,300
35,000 800 11,200 5,560 4,800
CASE 3-38
Required: Analyze the cost behavior patterns in accordance with the request of the
controller.

What are the costs that we need to analyze into its fixed and variable components?

Sales Labor Hours Prodn Cost Selling Exp Admin Exp

$12,000 500 $ 9,100 $ 3,250 $ 3,200
10,000 700 11,000 2,980 3,300
21,000 1,200 14,300 4,130 4,100
30,000 1,300 15,300 4,950 4,500
33,000 900 11,980 5,370 4,300
35,000 800 11,200 5,560 4,800
CASE 3-38
Production Cost, Selling Expenses and Administrative Expenses here are mixed
cost. All cost varies as the labor hours changes, therefore we can not say that they
are fixed. When we divide each cost according to each labor hours, they will not
resulted to a constant variable cost per unit, so we cannot say also that they are
variable. So, thats why we said they are mixed cost.

Now, to determine the variable and fixed component of each cost, we need to
separate them accordingly. Group 5 uses HIGH-LOW method to separate the cost
into variable and fixed.

In HIGH-LOW method, we need to define first the cost driver. The cost driver on this
case is the LABOR HOURS. Selection of the highest and the lowest data should be
based on COST DRIVER (on this case the labor hours) and not on the total cost.
CASE 3-38
1. Identify the cost the cost driver?
2. Identify the Highest the Lowest Data to separate the Production cost into VC and FC
3. Identify the Highest the Lowest Data to separate the Selling Expenses into VC and FC.
4. Identify the Highest the Lowest Data to separate the Admin. Expenses into VC and FC.

Sales Labor HoursProdn Cost Selling Exp Admin Exp

$12,000 500 $ 9,100 $ 3,250 $ 3,200
10,000 700 11,000 2,980 3,300
21,000 1,200 14,300 4,130 4,100
30,000 1,300 15,300 4,950 4,500
33,000 900 11,980 5,370 4,300
35,000 800 11,200 5,560 4,800
CASE 3-38
1. Identify the cost the cost driver?
2. Identify the Highest and Lowest Data to separate the Production cost into VC and FC
3. Identify the Highest the Lowest Data to separate the Selling Expenses into VC and FC.
4. Identify the Highest the Lowest Data to separate the Admin. Expenses into VC and FC.

Sales Labor Hours Prodn Cost Selling Exp Admin Exp

$12,000 500 $ 9,100 $ 3,250 $ 3,200
10,000 700 11,000 2,980 3,300
21,000 1,200 14,300 4,130 4,100
30,000 1,300 15,300 4,950 4,500
33,000 900 11,980 5,370 4,300
35,000 800 11,200 5,560 4,800
CASE 3-38
1. Identify the cost the cost driver?
2. Identify the Highest the Lowest Data to separate the Production cost into VC and FC
3. Identify the Highest and Lowest Data to separate the Selling Expenses into VC and FC.
4. Identify the Highest the Lowest Data to separate the Admin. Expenses into VC and FC.

Sales Labor Hours Prodn Cost Selling Exp Admin Exp

$12,000 500 $ 9,100 $ 3,250 $ 3,200
10,000 700 11,000 2,980 3,300
21,000 1,200 14,300 4,130 4,100
30,000 1,300 15,300 4,950 4,500
33,000 900 11,980 5,370 4,300
35,000 800 11,200 5,560 4,800
CASE 3-38
1. Identify the cost the cost driver?
2. Identify the Highest the Lowest Data to separate the Production cost into VC and FC
3. Identify the Highest the Lowest Data to separate the Selling Expenses into VC and FC.
4. Identify the Highest and Lowest Data to separate the Admin. Expenses into VC and FC.

Sales Labor Hours Prodn Cost Selling Exp Admin Exp

$12,000 500 $ 9,100 $ 3,250 $ 3,200
10,000 700 11,000 2,980 3,300
21,000 1,200 14,300 4,130 4,100
30,000 1,300 15,300 4,950 4,500
33,000 900 11,980 5,370 4,300
35,000 800 11,200 5,560 4,800
CASE 3-38
After we identify the cost driver, the highest and lowest data per cost, we are now ready
to separate each cost into its variable and fixed component using the following formula:
y= a + bx y = total cost, a = fixed cost, b = variable cost, x = cost driver

b= Y Y = Change in Total Cost

x x = Change in Activity Level

a= y - bx

a. production cost H L

b= Y 15,300 9,100 6,200 7.75

x 1,300 500 800

y- (b x)

a= 15,300 7.75 1,300 5,225.00

CASE 3-38
After we separate the cost into variable and fixed cost, the controller is now ready to
analyze the transactions using CVP for the previous six months.

500 700 1,200 1,300 900 800

Sales 12,000.00 10,000.00 21,000.00 30,000.00 33,000.00 35,000.00
VC PC 7.75 3,875.00 5,425.00 9,300.00 10,075.00 6,975.00 6,200.00
SE 2.13 1,062.50 1,487.50 2,550.00 2,762.50 1,912.50 1,700.00
AE 1.63 812.50 1,137.50 1,950.00 2,112.50 1,462.50 1,300.00
Total VC 5,750.00 8,050.00 13,800.00 14,950.00 10,350.00 9,200.00
CM 6,250.00 1,950.00 7,200.00 15,050.00 22,650.00 25,800.00
FC PC 5,225.00 5,225.00 5,225.00 5,225.00 5,225.00 5,225.00
SE 2,187.50 2,187.50 2,187.50 2,187.50 2,187.50 2,187.50
AE 2,387.50 2,387.50 2,387.50 2,387.50 2,387.50 2,387.50
Total FC 9,800.00 9,800.00 9,800.00 9,800.00 9,800.00 9,800.00
NP -3,550.00 -7,850.00 -2,600.00 5,250.00 12,850.00 16,000.00
 CASE 3-40
MUL Company manufactures six types of products. The products are relatively standard, not made-to-order. MUL takes orders
from customers, then fills the orders from stock or manufactures the required units. The company keeps finished units in a
warehouse that is also uses for materials and components. The QC Division inspects all shipments of materials and
components, a well as all finished products before they are shipped.
The Company holds a two-to-three-month supply of parts and components that it uses to make a high-volume products. MULs
purchasing manager is responsible for obtaining materials and components at the lowest possible cost and so scours the
country looking for the best deals. MUL therefore uses a good many vendors.
Production begins by withdrawing the necessary materials and components from the warehouse, inspecting them for possible
deterioration during storage, and transporting them to the first station that works on the product. Each station does one function,
such as drilling, plating, welding, and various assembly operations.
Each station has an area to store materials and components for jobs that is has not yet started. The materials wait in the area
until the station is ready to begin the job. Setup time in going from one product to another is often substantial at some stations.
After the workers at the station have finished with their part of the job, they send the semi-completed units along with the
materials and components not yet installed to the next station. There the same process is repeated and so on until all work is
completed. In some cases, a job will go to the same station more than once because it requires the same operation at different
stages of production.
At the conclusion of production, units go to the QC Division to await testing and inspection. They then go to the warehouse for
shipment. The company usually makes 10% more units than needed for an order to allow for defects. Any spare good units are
held in the warehouse until another order arrives. Defective units are sometime reworked and sometimes sold as scrap.
Reworked units are stored in the warehouse. If it is possible to determine which work station caused the defect, its manager is
held responsible. (Bonus fro station managers are based largely on total good output.) In cases where it is not possible to
determine the source of the defect, no one is held responsible.
The factory manager has said, It gets pretty hectic at the end of each month when were trying to finish up jobs and get the stuff
out to the warehouse.
The cycle time varies among types of products, but runs from 10days to 45days depending on various factors.

Required: What activities previously describe do not add value to products? What changes in operations can you recommend?
 CASE 3-40
Before we answer the requirements on the case, we recommend to have a review
first on the concepts of Value-Added Cost and Non-Value-Added Cost.

A. Value-Added Activities - The value you add to your products that

convinces your customers to buy them. These are the activities that make
money for your business. Examples:
a. Raw Materials
b. Direct Labor
c. Equipment and Machinery Used in production
d. Cost of holding goods in work in process and storing finished goods
e. Merchandising Business Cost of Merchandise Inventory and
Transporting the merchandise
B. Non-value-added activities The costs to your product without
enhancing the value. Keeping your non-value-added activities to a
minimum improves your profit margin by cutting unnecessary expenses.
 CASE 3-40
Some of the non-value-adding activities we observed on Problem 3-40 are the following:

1. Storing of Excessive Raw Materials

This happens when you have more inventory than is needed for a job. It is important to
tackle excess inventory as it has a huge impact on cash flow. Based on the problem,
the company holds a two-to-three month supply of parts and components. The costs of
storing and warehousing raw materials are non-value added activities. Keeping
inventory in storage for too long may reduce its value through obsolescence.

2. Raw Material Canvassing

Though canvassing plays a great role to minimize cost, but it should be done bearing in
mind the cost-benefit concept of canvassing also. In the case of MUL Company, the
purchasing manager, in his/her advocacy to find lowest possible cost, he/she searching all
over the country for the best deals. If such canvassing were done through phone, there will
be no problem, but if the canvassing were done through travelling all over the country,
the cost incurred will be considered a non-value-added activities.

3. Inspections and Quality Control Activities

Inspection and quality control are non-valued-added activities. Inspecting the work in
process or finished items do not add value to them. Based on the case, the quality control
jobs are: a). during shipments of materials and components to the different stations,
and b). at the conclusion of production, for testing and inspection.
 CASE 3-40
Some of the non-value-adding activities we observed on Problem 3-40 are the following:

4. Cost due to Excess motion

This refers to any movement of people or machines that does not add value to the product or
service.Common causes are poor plant or office layout, double handling, inconsistent work
methods and poor workplace organization. For the MUL Company, we observed that there are lots of
unnecessary movements of materials before they finally converted into finished goods. These
movements incur time and added to the cost of labor and are non-value- added activities. For
instance, all materials and components to be used in the production, after withdrawing from the
warehouse, are all transported on each station (Drilling, planing, welding, and various assembly
station). The materials that are not to be used in the station wait in the storage area until such
station is ready to begin the job. After the workers at the station have finished with their part of the
job, they send the semi-completed units ALONG with the materials and components not yet
installed to the next station. There the same process is repeated and so on until all work is completed.
In some case, a job will go to the same station more than once because it requires the same operation
at different stages of production.

5. Storing of Over-production
Excess production increases your inventory costs and the costs of warehousing and storing your
products. Having too much inventory on hand may indicate a problem with estimating customer
demand, and keeping inventory in storage for too long may reduce its value through obsolescence.
Your customers may view your older inventory as inferior compared to what your competitor offers.
Based on the problem, the company usually makes 10% more units than needed for an order to
allow for defects. Any spare goods units are held in the warehouse until another order arrives.

 CASE 3-40
Some of the non-value-adding activities we observed on Problem 3-40 are the
following:

6. Reworking of defective Products

Reworking defective products, product inspections and quality control are non-
value-added costs. Defective productions are non-value-added costs, as is production
time lost from idle employees or machines.

7. Bonuses
Bonuses are non-value-added costs.
 CASE 3-40
Recommendations:

1. Review materials purchasing strategy. Canvass through phones, websites,

referrals or through other means with a reasonable cost. Buy materials at a
cheaper price, in smaller amounts and have them delivered to you more frequently.

2. Order just enough inventory items to satisfy your production or retail demands
while avoiding excess inventory. Excess production increases your inventory costs
and the costs of warehousing and storing your products.

3. Group together the inventory items you need to complete a job to eliminate
time wasted looking for items.

4. Eliminate or reduce unnecessary movements through proper layout planning

and effective job planning process.

5. Produce output based on order or with reasonable margin for defects.