1. A percentage analysis of the company s quality cost report is presented below:

Transcription

1 Problem 2-23 (45 minutes) 1. A percentage analysis of the company s quality cost report is presented below: Year 2 Year 1 Amount Percentage* Amount Percentage* evention costs: Machine maintenance... $ % 27.1 % $ % 22.3 % Training suppliers Design reviews otal ppraisal costs: Incoming inspection Final testing otal ternal failure costs: Rework Scrap otal xternal failure costs: Warranty repairs Customer returns otal otal quality cost... $ % % $ % % otal production cost... $4,510 $4,120 *Percentage figures may not add down due to rounding.

2 Problem 2-23 (continued) From the above analysis it would appear that Bergen, Inc. s program has been successful, since: total quality costs as a percentage of total production have declined from 23.4% to 13.1%. external failure costs, those costs signaling customer dissatisfaction, have declined from 8% of total production to 2.3%. These declines in warranty repairs and customer returns should translate into increased sales in the future. internal failure costs have been reduced from 4.6% to 2.3% of production costs, which represents a 50% drop. appraisal costs have decreased from 5.0% to 2.6% of total production a drop of 48%. Higher quality is reducing the demand for final testing. quality costs have shifted to the area of prevention where problems are solved before the customer becomes involved. Maintenance, training, and design reviews have increased from 5.8% of total production cost to 6% and from 24.9% of total quality costs to 45.7%. The $30,000 increase is more than offset by decreases in other quality costs. 2. Tony Reese s current reaction to the quality improvement program is more favourable as he is seeing the benefits of having the quality problems investigated and solved before they reach the production floor. Because of improved designs, quality training, and additional preproduction inspections, scrap and rework costs have declined. Fewer resources are now required for customer service. Throughput has increased and throughput time has decreased; work is now moving faster through the department. 3. To measure the opportunity cost of not implementing the quality program, Bergen Inc. could assume that: sales and market share would continue to decline and then calculate the revenue and income lost. the company would have to compete on price rather than quality and calculate the impact of having to lower product prices.

3 Problem 3-23 (60 minutes) 1. The overhead applied to the Slug Fest job would be computed as follows: Estimated studio overhead cost (a)... $90,000 $90,000 Estimated hours of studio service (b) ,000 Predetermined overhead rate (a) (b)... $120 $90 Slug Fest job s studio hours... _ 30 _ 30 Overhead applied to the Slug Fest job... $3,600 $2,700 Overhead is underapplied for both years as computed below: Predetermined overhead rate (see above) (a)... $120 $90 Actual hours of studio service provided (b) Overhead applied (a) _ (b)... $72,000 $81,000 Actual studio cost incurred... 90,000 90,000 Underapplied overhead... $18,000 $ 9, If the predetermined overhead rate is based on the hours of studio service at capacity, the computations would be: Estimated studio overhead cost (a)... $90,000 $90,000 Hours of studio service at capacity (b)... 1,800 1,800 Predetermined overhead rate (a) (b)... $50 $50 Slug Fest job s studio hours... _ 30 _ 30 Overhead applied to the Slug Fest job... $1,500 $1,500

4 Problem 3-23 (continued) Overhead is underapplied for both years under this method as well: Predetermined overhead rate (see above) (a)... $50 $50 Actual hours of studio service provided (b) Overhead applied (a) _ (b)... $30,000 $45,000 Actual studio cost incurred... 90,000 90,000 Underapplied overhead... $60,000 $45, When the predetermined overhead rate is based on capacity, the underapplied overhead is interpreted as the cost of idle capacity. Indeed, proponents of this method suggest that the underapplied overhead be treated as a period expense that would be separately disclosed on the income statement as Cost of Unused Capacity. 4. Skid Road Recording s fundamental problem is the competition that is drawing customers away. The competition is able to offer the latest equipment, excellent service, and attractive prices. The company must do something to counter this threat or it will ultimately face failure. Under the conventional approach in which the predetermined overhead rate is based on the estimated studio hours, the apparent cost of the Slug Fest job has increased between 2001 and That happens because the company is losing business to competitors and therefore the company s fixed overhead costs are being spread over a smaller base. This results in costs that seem to increase as the volume declines. Under this method, Skid Road Recording s managers may be misled into thinking that the problem is rising costs and they may be tempted to raise prices to recover their apparently increasing costs. This would almost surely accelerate the company s decline.

5 Problem 3-23 (continued) Under the alternative approach, the overhead cost of the Slug Fest job is stable at $1,500 and lower than the costs reported under the conventional method. Under the conventional method, managers may be misled into thinking that they are actually losing money on the Slug Fest job and they might refuse such jobs in the future another sure road to disaster. This is much less likely to happen if the lower cost of $1,500 is reported. It is true that the underapplied overhead under the alternative approach is much larger than under the conventional approach and is growing. However, if it is properly labeled as the cost of idle capacity, management is much more likely to draw the appropriate conclusion that the real problem is the loss of business (and therefore more idle capacity) rather than an increase in costs. While basing the predetermined rate on capacity rather than on estimated activity will not solve the company s basic problems, at least this method will be less likely to send managers misleading signals.