Target prices, target costs, value engineering, cost incurrence, locked-in costs, activity based costing.
Cutler Electronics makes a radio-cassette player, CE100, which has 80 components. Cutler sells 7,000 units each month for $70 each. The costs of manufacturing CE100 are $45 per unit, or $315,000 per month. Monthly manufacturing costs incurred are:
Direct material costs $182,000
Direct manufacturing labor costs $28,000
Machining Costs (fixed) $31,500
Testing costs $35,000
Rework Costs $14,000
Ordering Costs $3,360
Engineering Costs (fixed) $21,140
Total manufacturing costs $315,000
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:
Activity Description of
Activity Cost Driver Cost per Unit of
1. Machining Costs Machining components Machine-hour capacity $4.50 per machine-hour
2. Testing Costs Testing components and final product (Each unit of CE100 is tested individually.) Testing-hours $2 per testing-hour
3. Rework Costs Correcting and fixing errors and defects Units of CE100 reworked $20 per unit
4. Ordering Costs Ordering of components Number of orders $21 per order
5. Engineering Costs Designing and managing of products and processes Engineering-hour capacity $35 per engineering-hour
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 and inspection time per unit is 2.5 hours.
b. 10% of the CE100’s manufactured are reworked.
c. Cutler places two orders with each component supplier each month. Each component is supplied by a different supplier.
d. It currently takes 1 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 radio-cassette player, but that is not enough. The chief engineer has proposed a new modular design that reduces the number or components to 50 and also simplifies testing. The newly designed radio-cassette player, called “New CE100” will replace CE100.
The expected effects of the new design are as follows:
a. Direct material costs 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.
d. Time required for testing 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 driver for CE100 continues to apply to New CE100.
1. Calculate Cutler’s manufacturing costs per unit of New CE100.
2. Will the new design achieve the per-unit costs-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.