13 17 target operating income value added costs

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Cornerstones of Cost Management
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Chapter 18 / Exercise 15
Cornerstones of Cost Management
Hansen/Mowen
Expert Verified
13-17 Target operating income, value-added costs, service company. Calvert Associates prepares architectural drawings to conform to local structural-safety codes. Its income statement for 2013 is as follows: Following is the percentage of time spent by professional staff on various activities: Assume administrative and support costs vary with professional-labor costs. Consider each requirement independently. Required: 1. How much of the total costs in 2013 are value-added, non-value-added, or in the gray area between? Explain your answers briefly. What actions can Calvert take to reduce its costs? 2. What are the consequences of misclassifying a non-value-added cost as a value-added cost? When in doubt, would you classify a cost as a value-added or non-value-added cost? Explain briefly. 3. Suppose Calvert could eliminate all errors so that it did not need to spend any time making corrections and, as a result, could proportionately reduce professional-labor costs. Calculate Calvert’s operating income for 2013. 4. Now suppose Calvert could take on as much business as it could complete, but it could not add more professional staff. Assume Calvert could eliminate all errors so that it does not need to spend any time correcting errors. Assume Calvert could use the time saved to increase revenues proportionately. Assume travel costs will remain at $15,000. Calculate Calvert’s operating income for 2013. 13-3
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Cornerstones of Cost Management
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Chapter 18 / Exercise 15
Cornerstones of Cost Management
Hansen/Mowen
Expert Verified
SOLUTION 1. The classification of total costs in 2013 into value-added, nonvalue-added, or in the gray area in between follows: Value Gray Nonvalue- Total Added Area added (4) = (1) (2) (3) (1)+(2)+(3) Doing calculations and preparing drawings 77% × $390,000 $300,300 $300,300 Checking calculations and drawings 3% × $390,000 $11,700 11,700 Correcting errors found in drawings 8% × $390,000 31,200 31,200 Making changes in response to client requests 5% × $390,000 19,500 19,500 Correcting errors to meet government building code, 7% × $390,000 27 ,300 27 ,300 Total professional labor costs 319,800 11,700 58,500 390,000 Administrative and support costs at 44% ($171,600 ÷ $390,000) of professional labor costs 140,712 5,148 25,740 171,600 Travel 15 ,000 15,000 Total $475 ,512 $16 ,848 $84 ,240 $576 ,600 Doing calculations and responding to client requests for changes are value-added costs because customers perceive these costs as necessary for the service of preparing architectural drawings. Costs incurred on correcting errors in drawings and making changes because they were inconsistent with building codes are nonvalue-added costs. Customers do not perceive these costs as necessary and would be unwilling to pay for them. Calvert should seek to eliminate these costs by making sure that all associates are well-informed regarding building code requirements and by training associates to improve the quality of their drawings. Checking calculations and drawings is in the gray area (some, but not all, checking may be needed). There is room for disagreement on these classifications. For example, checking calculations may be regarded as value added. 2. The consequences of classifying a non-value-added cost as a value-added cost is that managers may hesitate to reduce these costs thinking that if they

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