Question & Answer

You have been asked to provide the managing director with an approximate cost function for the entity’s activities, and it must be done by this afternoon. Some members of the board of directors want to understand why performance varies so much across store locations. They have asked for a quick analysis today and want a more detailed analysis next week. Which cost estimation technique(s) should you consider using? Explain.

A motor vehicle assembly plant closes every August to retool for the next year’s model. How should August’s cost data be used in estimating the overhead cost function?

          ‘As volume increases, total cost increases and per-unit cost decreases.’ What type of linear cost function does this describe? Draw a simple graph of this type of cost function.

Value chain in the public sector

Traditionally, government organisations have tended to operate in silos, focusing on their own objectives and managing and protecting their own budgets. Recently, however, faced with seemingly intractable economic, social and environmental problems, many government organisations have sought to develop new ways of working. In particular, they have sought to explore how their objectives overlap and depend on other organisations and how they might share information and resources. One example is provided by attempts to reduce crime and enhance public safety in the criminal justice sector.

In New Zealand the Ministry of Justice is the lead agency in the justice sector. The sector includes the New Zealand Police, the Serious Fraud Office, Child Youth and Family, the Department of Corrections and the Crown Law Office.

The organisations in the criminal justice system can be thought of as being involved in a ‘pipeline’ that begins with crime prevention and the investigation of crime and proceeds all the way through to rehabilitation (see the figure below). Looking at the sector as a pipeline, we can see that policies and actions in any part of the system will affect other parts of the system. By working as a coordinated ‘justice sector’, changes can be made that result in the best outcomes for the sector as a whole.

Within this pipeline, the operations within one agency, Public Prisons, can be further analysed to show the links between its key activities and between the department and other organisations in the sector.

Key activities follow this path:

• offenders are convicted in the courts

• offenders are sentenced and sent to prison

• prisoners undergo an initial assessment

• the serving of the sentence is planned

• the offender’s sentence is managed, including provision of relevant rehabilitation programs

• the offender’s release is planned and managed.

Required

(a) With reference to the information provided, distinguish between the structural and executional cost drivers in this value chain.

(b) Is there an ability for governments to outsource any of these value chain activities?

Using Figure 1.5 as an example, develop an internal value chain for an airline such as Virgin Australia.

            Cost drivers; value chain; strategy; organisational structure

Australian fashion designer Sean Ashby commenced his men’s swimwear and clothing business aussieBum in 2001. A keen swimmer and surfer, he was unable to find a good pair of men’s cossies and used his life savings of $20 000 to make a series of prototypes, buy materials and commence manufacturing in Australia. Despite rejection from local retailers who did not see the potential for aussieBum to compete with international brands, Ashby has proven critics wrong. He had no choice but to take his business online, with instant exposure to the international market. It now takes thousands of orders a day.

Since the company’s inception, Ashby says that aussieBum has ‘taken on its own little cult revolution’, with celebrities such as Ewan McGregor, Billy Connolly and David Beckham fans of the aussieBum brand. Even Kylie Minogue’s male dancers wore aussieBum cossies in the film clip for her song ‘Slow’. The marketing thrust behind Ashby’s aussieBum is to live the dream — ‘the dream to be independent and present our gear in a way that gets noticed. We don’t apologise for pushing the boundaries . . . We have a saying at aussieBum — If you doubt yourself, wear something else’.

The company doubled in size every year in its first five years and continued to grow by 20 per cent every quarter. By 2005, aussieBum earned more than $5 million in sales and carried no debt. The aussieBum brand now takes pride of place in stores such as Selfridges in the UK; Brown Thomas in Ireland; La Maison Stores in Canada; Alpha Male in Melrose Drive, Los Angeles; KaDeWa in Germany; as well as others in Spain, The Netherlands, Sweden, Poland and Russia. As well as direct department store sales, aussieBum’s internet retail orders are booming, with aussieBum being distributed to more than 70 countries. It now has over 200 000 consumers ordering direct via its custom built e-commerce site.

Most of the raw materials are sourced from Italy and China. By manufacturing in Australia, aussieBum hopes to promote Australia’s culture and relaxed lifestyle as well as eliminate restrictions that might come with outsourcing production to other countries. Moreover, producing locally (through independent manufacturers) provides flexibility and a reduced timeframe in getting new products to market. With a heavy emphasis on innovative product design, aussieBum pays close attention to the design phase of the product process.

Two recent examples of aussieBum’s flexibility and innovative approach to product development and marketing are worthy of note. First, it was able to capitalise on the consumer backlash against competitor Bonds when that company transferred more of its manufacturing offshore. Ashby estimates that aussieBum’s sales grew by at least 40 per cent as a result. Second, aussieBum was able to achieve continued growth during the global financial crisis. The company continues to avoid debt and own all its assets outright.

Required

(a) With reference to the information provided, distinguish between structural and executional cost drivers.

(b) Illustrate and describe the industry and organisational value chain in which aussieBum operates.

(c) Classify aussieBum’s likely strategy as low cost or product differentiation. Explain.

(d) Classify aussieBum’s organisational structure as centralised or decentralised. Explain.

(e) With reference to disruptive innovation, do you consider aussieBum to be a disruptor to the traditional garment industry value chain? Discuss why or why not.

          Relevant information; recommendation

Frank owns a caravan and loves to visit national parks with his family. However, the family only takes two one-week trips in the caravan each year. Frank’s wife would rather stay in motels than the caravan. She presented him with the following itemisation of the cost per trip, hoping that he will sell the caravan and use motels instead.

Required

(a)          What are the relevant costs for deciding whether the family should go on one more camping trip this year?

(b)          What are the relevant costs for deciding whether Frank should sell the caravan? Assume the family will take the same vacations but stay in motels if the caravan is sold.

(c)           What factors other than costs might influence the decision to sell the caravan? List as many as you can.

(d)          Consider your own preferences for this problem. Do you expect Frank’s preferences to be the same as yours? How can you control for your biases and consider this problem from Frank’s point of view?

(e)           Frank asks you to help him decide what to do. Do you think he should sell the caravan? Why?

            (LO1, 2 and 3)

          Relevant information; uncertainties; information for decision-making

Janet Baker is deciding where to live during her second year of university. During her first year, she lived in the university residence college. Recently her friend Rachel asked her to share an off-campus flat for the upcoming school year. Janet likes the idea of living in a flat, but she is concerned about how much it will cost.

To help her decide what to do, Janet collected information about costs. She would pay $400 per month in rent. The minimum lease term on the apartment is six months. Janet estimates that her share of the utility bills will be $75 per month. She also estimates that groceries will cost $200 per month. Janet spent $350 on a new couch over the summer. If she lives in the university residence college, she will put the couch in storage at a cost of $35 per month. Janet expects to spend $7500 on university fees and $450 on books each semester. Room and board on campus would cost Janet $2,900 per semester (four months). This amount includes a food plan of 20 meals per week. This cost is non-refundable if the meals are not eaten.

Required

(a)     Use only the cost information collected by Janet for the following tasks.

(i)    List all of the costs for each option. Note: Some costs may be listed under both options.

(ii)   Review your lists and cross out the costs that are irrelevant to Janet’s decision. Explain why these costs are irrelevant.

(iii)  Calculate and compare the total relevant costs of each option.

(iv)  Given the cost comparison, which living arrangement is the better choice for Janet? Explain.

(b)     Identify uncertainties in the cost information collected by Janet.

(i)    Determine whether each cost is likely to be (1) known for sure, (2) estimated with little uncertainty, or (3) estimated with moderate or high uncertainty.

(ii)   For each cost that is known for sure, explain where Janet would obtain the information.

(iii)  For each cost that must be estimated, explain why the cost cannot be known.

(c)     List additional information that might be relevant to Janet’s decision (list as many items as you can).

(i)    Costs not identified by Janet

(ii)   Factors other than costs

(d)     Explain why conducting a cost comparison is useful to Janet, even if factors other than costs are important to her decision.

(e)     Consider your own preferences for this problem. Do you expect Janet’s preferences to be the same as yours? How can you control for your biases as you give Janet advice?

(f)      Think about what Janet’s priorities might be for choosing a housing arrangement. How might different priorities lead to different choices?

(g)     Describe how information that Janet gains over this next year might affect her future housing arrangements.

Suppose Janet asks for your advice.

(h)     Use the information you learned from the preceding analyses to write a memo to Janet with your recommendation and a discussion of its risks. Refer in your memo to the information that would be useful to Janet.

          Quality of decisions

Maria and Tracey became good friends while working at the same entity. Two years ago, they both decided to increase their savings so that they could eventually purchase homes. Each began by putting a portion of each month's salary into a savings account. At the end of the first year, they had each accumulated $4000. Because their savings accounts paid a very small interest rate, they decided to invest the savings to earn a higher rate of return. Maria and Tracey both hoped to save enough money to buy homes within five years.

Maria decided to take an investment course offered through the entity. The course taught her about different types of investments and strategies for investing. She then purchased and read an investment book to learn more. Maria learned that some investments are riskier than others, and that investors must balance risk against desired return. Higher risk leads to higher returns on average; but, higher risk could also lead to low returns or even loss. She also learned that investment advisers recommend diversifying risky investments. One way to diversify is to invest in mutual funds, which invest in many different organisations. Maria decided that she was willing to assume some risk, but was not comfortable with a high level. She decided to invest her $4,000 in a share market mutual fund. She read consumer reports to learn about different mutual funds, and selected a fund that invests conservatively in fairly stable companies. However, the share market did not do well in the first year. The value of her mutual fund at the end of a year was $4050.

Tracey talked with her boyfriend and other friends about how they invest. Her boyfriend’s cousin recommended investing in a start-up company that sells video games. He told her that the games were very popular with teenagers and that the company would probably be acquired, resulting in big gains for investors. This opportunity sounded good to Tracey, so she decided to invest her entire $4000 in the company’s shares. After 10 months, she was excited to learn that the company was being acquired. She received shares in the acquiring company in exchange for her original shares. At the end of the year, the market value of her shares was $8200.

Required

Evaluate the quality of the investment decisions made by Maria and Tracey. Hint: Refer to figure 1.3 (on page 18).

(a)          List the information used by Maria in making her investment decision.

(b)          List the information used by Tracey in making her investment decision.

(c)           Did Maria appear to use high-quality information? Explain.

(d)          Did Tracey appear to use high-quality information? Explain.

(e)           Describe Maria’s decision-making process. What did she do to explore her options? Did she appear to be biased? What were her priorities? How did she reach a conclusion?

(f)           Describe Tracey’s decision-making process. What did she do to explore her options? Did she appear to be biased? What were her priorities? How did she reach a conclusion?

(g)          Did Maria appear to use a high-quality decision-making process? Explain.

(h)          Did Tracey appear to use a high-quality decision-making process? Explain.

(i)            Given your analyses of the information and decision-making processes used by Maria and Tracey, which investor made a higher-quality decision? Explain.

1.15     Cost reduction; value chain analysis

Budget Cupboards produces kitchen and bathroom cupboards that incorporate unusual functions, such as specialty drawers for knives and kitchen tools, and kitchen appliance holders that pop up from under the counter top. Competition in this industry has recently increased. Budget’s management wants to cut costs for its basic cupboard models and then cut prices using the structure of the table as shown.

Required

(a)          The following table lists potential areas for cost reduction. Two potential cost reductions are provided for the first area listed (design phase). For each of the remaining areas, identify two potential ways that Budget Cupboard’s management could reduce costs.

(b)     Budget does not currently use value chain analysis. Describe several advantages of using value chain analysis.

1.15     Uncertainties, degree of uncertainty

Community Children’s Hospital can invest in one of two different projects. The first project is to purchase and operate a hotel that is located two blocks from the hospital. The CEO of the hospital has no experience operating a hotel, but the hospital does provide rooms for in-patients, and so she is familiar with cleaning requirements and managing housekeeping staff. However, the hospital does little advertising and does not have a large public relations staff. In addition, the hospital and hotel are located in a part of town that is deteriorating.

The other investment opportunity is to replace the heart monitors in the neonatal intensive care unit (critical care for newborns and infants). The new monitors would provide a range of functions, including monitoring the body temperature and blood pressure of infants, as well as monitoring heart functions. Each monitor can be used for up to four infants with information about each infant forwarded to one computer that is monitored by a special technician. The current monitors are bedside monitors that need to be read every 10 minutes by nursing staff.

Required

(a)          Prepare a list of uncertainties that the CEO faces if she buys the hotel.

(b)          Prepare a list of uncertainties the CEO faces if she replaces the heart monitors.

(c)           Which scenario appears to have a greater degree of uncertainty? Why?

1.15     Relevant information

Suppose you are responsible for ordering a replacement for your office photocopy machine. Part of your job is to decide whether to buy it or lease it.

Required

(a)          Describe something that could be considered relevant information in this decision and explain why it is relevant.

(b)          Describe something that could be considered irrelevant information in this decision and explain why it is irrelevant.

(c)           Explain why it was important to distinguish between relevant and irrelevant information in this problem.

1.15     Structural cost drivers

(a) With reference to Marino Designs in Self-study problem 2, demonstrate the meaning of the structural cost drivers: scope, technology and experience.

(b) Classify Marino Designs’ likely strategy as low cost or product differentiation. Explain.

          Industry and organisational value chain

With reference to Marino Designs in Self-study problem 2, at the start of this chapter, differentiate between an industry value chain and an organisational value chain.

Types of manager decisions

Suppose that the following are activities conducted by Microsoft Corporation.

A. Comparing the timeliness of development steps of a new release of Windows with the timeline that was laid out to guide development.

B. Developing a timeline for the release of new Windows and Microsoft Office products over the next year.

C. Debugging the next version of Windows.

D. Providing technical support to customers who are having problems with Microsoft Office.

E. Estimating cash expenditures for the next year.

F. Comparing budgeted costs to actual costs and discussing major differences with department managers.

G. Deciding whether to construct a new building on the Microsoft site.

Required

Identify whether each activity is most likely part of:

(a)          organisational strategies

(b)          operating plans

(c)           actual operations

(d)          measuring, monitoring, and motivating.

For each item, explain why.

(LO1)

Management accounting function

Differentiate between the management accounting function and the management accountant.

          Internal and external reports

Classify the following reports as internal or external.

(a)          Operating budget          

(b)          Credit reports                            

(c)           Financial statements                  

(d)          Capital budget                           

(e)           Tax returns                                

(f)           Analysis of product mix

Value-added and non-value-added activities

Some activities add value to an organisation, while others do not.

Required

Determine whether each of the following activities is likely to be value-added or non-value-added and explain your choice.

(a)          Inspection activities

(b)          Moving materials to work stations

(c)           Manufacturing extra inventory to keep employees busy

(d)          Packing to fill a customer order

(e)           Product design initiatives

Identify two key influences on the nature of a management accounting system.

Outline the meaning of structural cost drivers.

          In your own words, explain the path to higher-quality decisions.

What is a cost object?

Explain relevant information in a decision-making context.        

What types of information in addition to cost accounting are needed for management decisions?