Problem 19 - Accounting

Question

Laser Cast, Inc., manufactures color laser printers. Model A200 presently sells for \(\$ 400\) and has a total product cost of \(\$ 320\), as follows: \begin{tabular}{lrr} & Direct materials & \(\$ 230\) \\ & Direct labor & 60 \\ & Factory overhead & \(\frac{30}{\$ 320}\) \\ \hline \end{tabular} It is estimated that the competitive selling price for color laser printers of this type will drop to \(\$ 380\) next year. Laser Cast has established a target cost to maintain its historical markup percentage on product cost. Engineers have provided the following cost reduction ideas: 1\. Purchase a plastic printer cover with snap-on assembly. This will reduce the amount of direct labor by nine minutes per unit. 2\. Add an inspection step that will add six minutes per unit of direct labor but reduce the materials cost by \(\$ 8\) per unit. 3\. Decrease the cycle time of the injection molding machine from four minutes to three minutes per part. Thirty percent of the direct labor and \(42 \%\) of the factory overhead is related to running injection molding machines. The direct labor rate is \(\$ 25\) per hour. a. Determine the target cost for Model A200 assuming that the historical markup on product cost is maintained. b. Determine the required cost reduction. c. Evaluate the three engineering improvements to determine if the required cost reduction (drift) can be achieved.

Step-by-Step Solution

Answer

Target cost is $304; required cost reduction is $16. Implementing all proposed changes achieves $16.90 reduction.

Step 1: Calculate the Historical Markup Percentage

The historical markup on product cost is found by using the current selling price and the total product cost. Calculate it as follows:\[ \text{Markup Percentage} = \frac{\text{Selling Price} - \text{Total Product Cost}}{\text{Total Product Cost}} = \frac{400 - 320}{320} = \frac{80}{320} = 0.25 \text{ or } 25\% \]

Step 2: Determine Target Cost

To determine the target cost maintaining the historical markup percentage while reducing the selling price to $380:\[ (1 + 0.25) \times \text{Target Product Cost} = 380 \] Thus:\[ \text{Target Product Cost} = \frac{380}{1.25} = 304 \]

Step 3: Calculate Required Cost Reduction

Subtract the target product cost from the current total cost to find the required cost reduction:\[ \text{Required Cost Reduction} = 320 - 304 = 16 \]

Step 4: Analyze Engineering Improvement 1

Reduction in direct labor due to less assembly time:- Change in Direct Labor Time = -9 minutes - \[\frac{-9}{60} \text{ hours} \times 25 \text{ per hour} = -3.75 \text{ reduction in Direct Labor Cost}\]Next, update direct labor cost:- New Direct Labor = 60 - 3.75 = 56.25

Step 5: Analyze Engineering Improvement 2

Add an inspection step that results in:- Change in Direct Labor Time = +6 minutes - \[\frac{6}{60} \text{ hours} \times 25 \text{ per hour} = +2.5 \text{ addition in Direct Labor Cost}\]- Reduction in Material Cost = -8New values:- Direct Labor = 56.25 + 2.5 = 58.75 - Materials = 230 - 8 = 222

Step 6: Analyze Engineering Improvement 3

Decrease cycle time in injection molding which impacts 30% of labor and 42% of overhead:- Original labor cost related to molding: \(0.30 \times 60 = 18\)- New cycle time = 0.75 factor reduction- New labor cost: \(18 \times 0.75 = 13.5\)- Labor cost change: \(18 - 13.5 = 4.5 \text{ reduction}\)New values:- Direct Labor = 58.75 - 4.5 = 54.25For Overhead:- Original overhead related to molding = \(0.42 \times 30 = 12.6\)- New overhead: \(12.6 \times 0.75 = 9.45\)- Overhead cost change: \(12.6 - 9.45 = 3.15 \text{ reduction}\) New Overhead = 30 - 3.15 = 26.85

Step 7: Calculate Total New Cost and Savings

Recalculate the total cost with improvements: - Total New Cost = Materials (222) + Direct Labor (54.25) + Overhead (26.85) = 303.10 - Cost Reduction Achieved = 320 - 303.10 = 16.90

Step 8: Compare Cost Reduction Achieved to Required Reduction

The required cost reduction was $16. The achieved reduction with the proposed engineering improvements is $16.90, which meets and slightly exceeds the requirement.

Key Concepts

Product Cost Reduction

Reducing product cost is a critical element in maintaining competitiveness, especially when market prices fall. In manufacturing, this often means examining each component of the product's cost structure for potential savings.
To effectively reduce costs, companies should:

• Analyze each material's cost to explore less expensive alternatives or negotiate better supplier rates.
• Assess labor costs to identify areas where production efficiency can be improved, thereby reducing the time—and cost—required to manufacture each unit.
• Re-evaluate factory overhead costs to find savings, such as through energy efficiency improvements or optimizing production schedules.

For instance, in Laser Cast's case, they target labor efficiencies and material costs while also reducing overhead associated with specific machinery to lower product costs.

Manufacturing Process Optimization

Optimizing the manufacturing process involves refining operations to enhance efficiency and reduce inefficiencies.
A proactive approach includes:

• Streamlining assembly processes to reduce manual labor and time, as seen with Laser Cast’s strategy of using snap-on components.
• Incorporating quality control steps that prevent defects and waste, which, although they might initially add cost, contribute to reducing overall production errors and rework.
• Employing advanced technology or machinery that speeds up production cycles without compromising product quality.

By adopting a holistic view of the production process, companies can identify bottlenecks and create a smoother, more cost-effective manufacturing process.

Target Costing

Target costing is a strategic approach where a company determines the cost to produce a product after the selling price and desired profit margins have been set.
This backward method encourages manufacturers to control costs tightly to meet margin goals. Steps include:

• Identifying the predicted market price for the product and determining acceptable profit margins.
• Calculating the target cost by subtracting the profit margin from the expected selling price.
• Implementing cost-reduction strategies to meet this target, ensuring that production can proceed profitably.

For Laser Cast, the need to lower their cost to reach a target set by reduced market price underscores the importance of target costing in sustaining profitability amid competitive pressures.

Engineering Improvements in Production

Engineering improvements focus on modifying production techniques and equipment to enhance performance and cost-effectiveness. By analyzing production tasks, engineers can develop new methods that lead to substantial savings.
Examples of engineering improvements include:

• Innovating new assembly techniques that reduce labor time, as with the snap-on printer cover used by Laser Cast.
• Enhancing machines to operate more efficiently, decreasing cycle times and minimizing energy use, which can significantly cut down labor and overhead costs.
• Incorporating additional inspection processes to reduce material waste, leading to fewer defective products and less financial loss.

Such enhancements not only ensure that production meets the required cost reductions but also stabilize quality, supporting the company’s goals for operational excellence.