Week 5

Question 1

Relevant costs

Answer 1

Future costs that differ between and among decision alternatives.

Question 2

Sunk costs

Answer 2

Costs that have been incurred in the past or are already committed for the future. As such, they are irrelevant to the decision-making process. A relevant cost can either be variable or fixed.

Question 3

Setup Cost

Answer 3

Batch-level cost that varies depending on the number of batches that need to be set up.

Although the number of setups occurring during a year may stay the same, the time and expertise each setup needs must also be considered when evaluating alternatives.

Question 4

Depreciation expense

Answer 4

Allocation of a cost already incurred. It represents an allocation of a past cost over the life of the asset purchased. Therefore, it is not relevant to the decision-making process.

However, there is an exception. When tax effects are considered, depreciation can have a positive value that reduces taxable income.

Question 5

Opportunity costs

Answer 5

The benefit lost when the chosen option precludes the benefits from an alternative option, as well.

Question 6

Hierarchy of Costs

Answer 6

• Unit-level costs are costs that vary with each volume produced;
• Batch-level costs vary with each batch of products produced, and are partly fixed and partly variable. It can include machine setup, materials handling and inspection;
• Facility-level costs are fixed, and do not change with units or batches produced. This can include machine depreciation and insurance, and other fixed costs.

Question 7

Value Streams

Answer 7

Groups of related products that put together all the activities that are needed to create customer value for the group of products or services.

It’s a useful tool when it comes to lean accounting, and helps in deciding which costs are relevant to the value stream and which are not.

Question 8

A joint production process

Answer 8

Where multiple outputs arise, naturally, from a common resource input.

At the split-off point, products with individual identities emerge. Before this point, joint production costs are incurred, and are not traceable to individual products.

After the split-off point, separable processing costs are incurred.

Question 9

Predatory pricing

Answer 9

Exists when a company has set prices below average variable costs and plans to raise prices later to recover the losses from the lower prices.

Question 10

Replacing Variable Costs with Fixed Costs

Answer 10

Another problem with relevant cost analysis is that managers have an incentive to replace variable costs with fixed costs, if they realize that upper-level management overlooks fixed costs when relying on relevant cost analysis.

Question 11

5 types of judgement bias

Answer 11

1) Availability Bias - relying too heavily on accessible information;
2) Anchoring Bias - being too influenced by the initial data or information;
3) Overconfidence - results in underestimating the technical challenges and costs for the company;
4) Confirmation Bias - looking for information that proves one right;
5) Rush-to-Resolve - failing to gather enough information.

Question 12

The cost life cycle

Answer 12

Sequence of activities that begins with research and development followed by design, manufacturing (or providing the service), marketing and distribution, and customer service.

Question 13

The sales life cycle

Answer 13

Sequence of phases in the product or service life in the market from the introduction to the market, growth in sales, and finally maturity, decline and withdrawal from the market.

Question 14

The sales life cycle

Answer 14

Sequence of phases in the product or service life in the market from the introduction to the market, growth in sales, and finally maturity, decline and withdrawal from the market.

Question 15

Target costing

Answer 15

Technique in which the firm determines the allowable/target cost for a product or service, so that the firm can earn a desired profit.

The firm has two options for managing costs to reach the target level:

1. Integrate new manufacturing technology, using advanced cost management techniques (e.g. activity-based costing) and seeking higher productivity;
2. Redesign the product or service, which is beneficial since it is recognized that design decisions account for a considerable portion of total product life-cycle costs.

These options are not mutually exclusive, so firms may use both methods.

Question 16

Value engineering

Answer 16

Used in target costing to reduce product cost by analyzing the trade-offs between total product cost and the different types of product functionality (i.e. different product features).

To do so, the first step is to perform a consumer analysis during the design stage to identify critical customer preferences, which will define the desired functionality for the product.

Two major groups of products can be identified:
- Products to which functionality can be added or deleted relatively easily (e.g. automobiles, video equipment, etc.). These products have frequent new models or updates, since consumer preferences may change frequently.

• Products in which consumer preferences are relatively stable (e.g. specialized equipment and industrial products), where the functionality must be designed into the product rather than added on.

Question 17

2 types of value engineering

Answer 17

• Functional analysis is a type of value engineering in which the performance and cost of each major function or feature of the product is examined. The objective is to determine a desired balance of functionality and cost. Benchmarking is often used to determine which features give the firm a competitive advantage.
• Design analysis is a form of value engineering in which the design team prepares several possible designs of the product, each having similar features with different levels of both performance and cost. It mainly applies to the second category of products. In conjunction with the cost management personnel, the design that best meets customer preferences while not exceeding the target cost is then selected.

Question 18

Concurrent engineering, or simultaneous engineering

Answer 18

New way of designing products that rely on integration.

It uses cross-functional teams throughout the cost life cycle, and information is passed around the phases of the value chain to improve design.

Question 19

Quality function deployment (QFD)

Answer 19

Integration of value engineering, marketing analysis and target costing to help determine which components of the product should be targets of redesign or cost reduction. There are four steps to be followed:

1. Determine the customer’s purchasing criteria for this product and how these criteria are ranked;
2. Identify the components of the product and the manufacturing cost of each component;
3. Determine how each component contributes to customer satisfaction;
4. Determine the importance index of each component, by combining information in steps 1 and 3, and then comparing this to the cost information of step 2.

Question 20

The Theory of Constraints

Answer 20

The theory of constraints was developed to help managers reduce cycle times and operating costs.

Previously, managers tried to improve efficiency and speed throughout the manufacturing process, instead of focusing on the constraints (or bottlenecks) in the process.

Question 21

Applying the theory of constraints in practice involves a five-part process:

Answer 21

A constraint is an activity that slows the product’s cycle time.

1. Identify the constraint, and develop a flow diagram with the sequence of activities and time per activity;
2. While considering the production constraint, use the throughput margin, or product price minus materials cost, to specify the most profitable product mix;
3. Simplify the sequence of activities by maximizing flow through the constraint. This may involve reducing takt time, the speed at which units are manufactured to meet demand;
4. Increase the capacity of the constraint;
5. Redesign the manufacturing process for flexibility and fast cycle time.

Question 22

Setting prices in a differentiation strategy

Answer 22

• Skimming: consists of increasing profits by setting an initial high price for those willing to pay, followed by lower prices for the cost-conscious customers.
• Penetration: consists of lowering the prices to increase market share.

Question 23

4 price-setting methods

Answer 23

1. Full Manufacturing Cost plus Markup
2. Life-Cycle Cost plus Markup
3. Full Cost and Desired Gross Margin Percentage
4. Full Cost plus Desired Return on Assets

Strategic pricing also depends on the position of the product in the sales life cycle. As it becomes shorter, the analysis becomes increasingly important.

Question 24

Price-setting methods 1. Full Manufacturing Cost plus Markup

Answer 24

Firm uses the total of variable and fixed manufacturing costs and applies a markup percentage to cover other operating costs plus profits. The markup can be determined by industry practice, judgement or desired level of profit.

Question 25

Price-setting methods 2. Life-Cycle Cost plus Markup

Answer 25

Full life-cycle cost is used instead of the manufacturing cost. The advantage is that all costs are included, hence the markup percentage can be directly tied to a desired level of profit.

Question 26

Price-setting methods 3. Full Cost and Desired Gross Margin Percentage

Answer 26

The price is determined based upon achieving a desired gross margin percentage.

Question 27

4 phases of sales life cycle

Answer 27

1. Introduction
2. Growth
3. Maturity
4. Decline

Question 28

Introduction

Answer 28

There is little competition, with sales rising slowly as customers are exposed to the product.

There is high R&D expenditure (hence high costs) and capital costs. The price is high because of these initial costs, and focus is on design, differentiation and marketing.

Question 29

Growth

Answer 29

Sales begin to increase rapidly, as does product variety. Competition increases and prices start to fall. Focus is on new product development and pricing strategies.

Question 30

Maturity

Answer 30

Sales increase at a decreasing rate. Competitors decline, and prices fall even further. Competition is based on cost given competitive quality and functionality (differentiation is no longer important). Focus is on cost control, quality and service.

Question 31

Decline

Answer 31

Sales and price decline along with the number of competitors. Control of costs is key to continued survival.