Achieving the Target Cost per Unit for Provalue

Exhibit 14-5 uses an activity-based approach to compare cost-driver quantities and rates for the 150,000 units of Provalue manufactured and sold in 2019 and the 200,000 units of Provalue II budgeted for 2020. Value engineering decreases both value-added costs (by designing Provalue II to reduce direct materials costs, direct manufacturing labor-hours, the number of components and testing-hours) and non-value-added costs (by simplifying Provalue II’s design to reduce rework). Value engineering also reduces the machine-hours required to manufacture Provalue II to 1.5 hours per unit. Astel can now use the 300,000 machine-hours of capacity to make 200,000 units of Provalue II (vs. 150,000 units for Provalue), reducing machining cost per unit. For simplicity, we assume that value engineering will not reduce the $20 cost per direct manufacturing labor-hour, the $80 cost per order, the $2 cost per testing-hour, or the $40 cost per rework-hour. (The Problem for Self-Study in the End of Chapter section explores how value engineering can also reduce these cost-driver rates.)

Exhibit 14-5

Cost-Driver Quantities and Rates for Provalue in 2019 and Provalue II for 2020 Using Activity-Based Costing

Screenshot of a spreadsheet shows the manufacturing cost information for 150,000 units of Provalue for 2019 and 200,000 units of Provalue 2 for 2020 under various categories.

The details of the various cost categories are as follows:

  1. Cost category: Direct Manufacturing Costs: Direct materials

    1. Cost driver: Number of kits

      1. Manufacturing Cost Information for 150,000 Units of Provalue in 2019

        • Details of actual cost driver quantities: 1 kit per unit; 150,000 units

        • Actual total quantity of cost driver: 150,000

        • Actual cost per unit of cost driver: $460

      2. Manufacturing Cost Information for 200,000 Units of Provalue 2 for 2020

        • Details of budgeted cost driver quantities: 1 kit per unit; 200,000 units

        • Budgeted total quantity of cost driver: 200,000

        • Budgeted cost per unit of cost driver as given: $385

  2. Cost category: Direct Manufacturing Costs: Direct manufacturing labor, D M L

    1. Cost driver: D M L hours

      1. Manufacturing Cost Information for 150,000 Units of Provalue in 2019

        • Details of actual cost driver quantities: 3.2 D M L hours per unit; 150,000 units

        • Actual total quantity of cost driver: 480,000

        • Actual cost per unit of cost driver: $20

      2. Manufacturing Cost Information for 200,000 Units of Provalue 2 for 2020

        • Details of budgeted cost driver quantities: 2.65 D M L hours per unit; 200,000 units

        • Budgeted total quantity of cost driver: 530,000

        • Budgeted cost per unit of cost driver as given: $20

  3. Cost category: Direct Manufacturing Costs: Direct machining as fixed

    1. Cost driver: Machine-hours

      1. Manufacturing Cost Information for 150,000 Units of Provalue in 2019

        • Actual total quantity of cost driver: 300,000

        • Actual cost per unit of cost driver: $38

      2. Manufacturing Cost Information for 200,000 Units of Provalue 2 for 2020

        • Budgeted total quantity of cost driver: 300,000

        • Budgeted cost per unit of cost driver as given: $38

  4. Cost category: Manufacturing Overhead Costs: Ordering and receiving

    1. Cost driver: Number of orders

      1. Manufacturing Cost Information for 150,000 Units of Provalue in 2019

        • Details of actual cost driver quantities: 50 orders per component; 450 components

        • Actual total quantity of cost driver: 22,500

        • Actual cost per unit of cost driver: $80

      2. Manufacturing Cost Information for 200,000 Units of Provalue 2 for 2020

        • Details of budgeted cost driver quantities: 50 orders per component; 425 components

        • Budgeted total quantity of cost driver: 21,250

        • Budgeted cost per unit of cost driver as given: $80

  5. Cost category: Manufacturing Overhead Costs: Testing and inspection

    1. Cost driver: Testing-hours

      1. Manufacturing Cost Information for 150,000 Units of Provalue in 2019

        • Details of actual cost driver quantities: 30 testing-hours per unit; 150,000 units

        • Actual total quantity of cost driver: 4,500,000

        • Actual cost per unit of cost driver: $2

      2. Manufacturing Cost Information for 200,000 Units of Provalue 2 for 2020

        • Details of budgeted cost driver quantities: 15 testing-hours per unit; 200,000 units

        • Budgeted total quantity of cost driver: 3,000,000

        • Budgeted cost per unit of cost driver as given: $2

  6. Cost category: Manufacturing Overhead Costs: Rework

    1. Cost driver: Rework-hours

      1. Manufacturing Cost Information for 150,000 Units of Provalue in 2019

        • Details of actual cost driver quantities: 2.5 rework-hours per defective unit; (8% defect rate multiplied by 150,000 units) equals 12,000 defective units

        • Actual total quantity of cost driver: 30,000

        • Actual cost per unit of cost driver: $40

      2. Manufacturing Cost Information for 200,000 Units of Provalue 2 for 2020

        • Details of budgeted cost driver quantities: 2.5 rework-hours per defective unit; (6.5% defect rate multiplied by 200,000 units) equals 13,000 defective units

        • Budgeted total quantity of cost driver: 32,500

        • Budgeted cost per unit of cost driver as given: $40.

Exhibit 14-6 presents the target manufacturing costs of Provalue II, using cost driver and cost-driver rate data from Exhibit 14-5. For comparison, Exhibit 14-6 also shows the actual 2019 manufacturing cost per unit of Provalue from Exhibit 14-2. Astel’s managers expect the new design to reduce total manufacturing cost per unit by $140 (from $680 to $540) and cost per unit in other business functions from $220 (Exhibit 14-3) to $180 (calculations not shown) at the budgeted sales quantity of 200,000 units. The budgeted full unit cost of Provalue II is $720 ($540 + $180), which is the target cost per unit. At the end of 2020, Astel’s managers will compare actual costs and target costs to understand improvements they can make in subsequent target-costing efforts.

Exhibit 14-6

Target Manufacturing Costs of Provalue II for 2020

<p>Screenshot of a spreadsheet shows the target manufacturing costs of Provalue 2 for 2020 using cost driver and cost-driver rate data under various categories.</p>

The details of the various categories are as follows:

1. Direct manufacturing costs

a. Direct material costs of 200,000 kits multiplied by $385 per kit

&bull; Provalue 2: Budgeted manufacturing costs for 200,000 Units: $77,000,000

&bull; Provalue 2: Budgeted manufacturing cost per unit: $385.00

It is a result of budgeted manufacturing costs for 200,000 Units divided by 200,000

&bull; Provalue: Actual manufacturing cost per unit: $460.00

b. Direct manufacturing labor costs of 530,000 D M L-hours multiplied by $20 per hour

&bull; Provalue 2: Budgeted manufacturing costs for 200,000 Units: $10,600,000

&bull; Provalue 2: Budgeted manufacturing cost per unit: $53.00

It is a result of budgeted manufacturing costs for 200,000 Units divided by 200,000

&bull; Provalue: Actual manufacturing cost per unit: $64.00

c. Direct machining costs of 300,000 machine-hours multiplied by $38 per machine-hour

&bull; Provalue 2: Budgeted manufacturing costs for 200,000 Units: $11,400,000

&bull; Provalue 2: Budgeted manufacturing cost per unit: $57.00

It is a result of budgeted manufacturing costs for 200,000 Units divided by 200,000

&bull; Provalue: Actual manufacturing cost per unit: $76.00

d. Direct manufacturing costs

&bull; Provalue 2: Budgeted manufacturing costs for 200,000 Units: $99,000,000

&bull; Provalue 2: Budgeted manufacturing cost per unit: $495.00

It is a result of budgeted manufacturing costs for 200,000 Units divided by 200,000

&bull; Provalue: Actual manufacturing cost per unit: $600.00

2. Manufacturing overhead costs

a. Ordering and receiving costs of 21,250 orders multiplied by $80 per order

&bull; Provalue 2: Budgeted manufacturing costs for 200,000 Units: $1,700,000

&bull; Provalue 2: Budgeted manufacturing cost per unit: $8.50

It is a result of budgeted manufacturing costs for 200,000 Units divided by 200,000

&bull; Provalue: Actual manufacturing cost per unit: $12.00

b. Testing and inspection costs of 3,000,000 testing-hours multiplied by $2 per hour

&bull; Provalue 2: Budgeted manufacturing costs for 200,000 Units: $6,000,000

&bull; Provalue 2: Budgeted manufacturing cost per unit: $30.00

It is a result of budgeted manufacturing costs for 200,000 Units divided by 200,000

&bull; Provalue: Actual manufacturing cost per unit: $60.00

c. Rework costs of 32,500 rework- hours multiplied by $40 per hour

&bull; Provalue 2: Budgeted manufacturing costs for 200,000 Units: $1,300,000

&bull; Provalue 2: Budgeted manufacturing cost per unit: $6.50

It is a result of budgeted manufacturing costs for 200,000 Units divided by 200,000

&bull; Provalue: Actual manufacturing cost per unit: $8.00

d. Manufacturing overhead costs

&bull; Provalue 2: Budgeted manufacturing costs for 200,000 Units: $9,000,000

&bull; Provalue 2: Budgeted manufacturing cost per unit: $45.00

It is a result of budgeted manufacturing costs for 200,000 Units divided by 200,000

&bull; Provalue: Actual manufacturing cost per unit: $80.00

e. Total manufacturing costs

&bull; Provalue 2: Budgeted manufacturing costs for 200,000 Units: $108,000,000

&bull; Provalue 2: Budgeted manufacturing cost per unit: $540.00

It is a result of budgeted manufacturing costs for 200,000 Units divided by 200,000

&bull; Provalue: Actual manufacturing cost per unit: $680.00.

Unless managed properly, value engineering and target costing can have undesirable effects:

To avoid these pitfalls, target-costing efforts should always (1) encourage employee participation and celebrate small improvements toward achieving the target cost, (2) focus on the customer, (3) pay attention to schedules, and (4) set cost-cutting targets for all value-chain functions to encourage a culture of teamwork and cooperation.

The target-pricing approach is another illustration of the five-step decision-making process introduced in Chapter 1.

  1. IDENTIFY THE PROBLEM AND UNCERTAINTIES. The problem is the price to charge for Provalue in 2020. The uncertainties are identifying what customers want, how competitors will respond, and how to manage costs.
  2. OBTAIN INFORMATION. Astel’s managers do market research to identify customer needs, the prices that competitors are likely to charge, and the opportunities to reduce costs.
  3. MAKE PREDICTIONS ABOUT THE FUTURE. Managers make predictions about the effect of different prices on sales volumes and how much they can reduce costs through value engineering and product redesign.
  4. MAKE DECISIONS BY CHOOSING AMONG ALTERNATIVES. Managers decide to reduce Provalue’s price from $1,000 to $800, anticipating sales to increase from 150,000 units to 200,000 units in 2020.
  5. IMPLEMENT THE DECISION, EVALUATE PERFORMANCE, AND LEARN. Cross-functional value-­engineering teams redesign Provalue to achieve a target cost of $720 per unit, considerably lower than the current cost of $900. At the end of 2020, managers will compare actual and target costs to evaluate performance and to identify ways to reduce costs even further.

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