Managing Resource Capacity through Activity-Based Costing (ABC) This assignment deals with the application of a traditional ABC system to the problem of measuring and managing the cost of capacity. As controller for Zen Company, you've been asked to provide input regarding the appropri- ate level of resource capacity needed to support the strategic initiatives of the company, as indenti- fied in the company's strategic planning system.
Because of the focus of the company on exceptional customer service, you've decided to run a pilot test by focusing on a single activity: handling customer orders. During the most recent year, total resource costs of this activity were $500,000. You've determined that, during the year, 7,000 customer orders were handled by the company. Observations of the process and your own inter- views with knowledgeable personnel indicate that the current level of resource spending in this area provides the capacity to efficiently process approximately 10,000 customer orders. (That is, the practical capacity of resources supplied is 10,000 customer orders.) An analysis of past accounting data and the application of the cost-estimation techniques covered in Chapter 8 suggest that resource spending for this activity in the coming year will be approximately $560,000. The company expects to handle 8,000 customer orders during the coming year. Your basic task is to determine how the use of ABC data can facilitate decisions regarding the appropriate level of spending to support the customer-ordering process.
Required
1. Distinguish between short-term variable costs and short-term fixed (i.e., capacity-related) costs. For many organizations today, including the Zen Company, which type of costs characterize support costs, such as the cost of handling customer orders?
2. ABC fundamentally deals with the issue of assigning costs to activities, then activity-based costs to out- puts such as products, services, or customers. From the start, however, you are a bit bewildered: which data at your disposal should be used to calculate the cost of handling a customer order? Show calculations. Include in your answer an explanation of the term practical capacity and a short discussion of what is referred to as the death-spiral effect.
3. How can the use of ABC data assist managers in managing spending on resource capacity? (Hint: be sure to address the issue of the cost of unused capacity.) Why is the management of resource capacity costs of strategic importance to companies such as Zen?
4. Assume that Zen, in an effort to improve the process of handling customer orders, implements a TQM or other initiative, the effect of which is to increase the number of orders that can be handled effi- ciently. As a result, the practical capacity of the process increases to approximately 14,000 orders per year. Has the cost of handling a customer order changed in response to the TQM initiative? (Assume a total cost, as before, of $560,000.) Assume, as before, that the company in the coming year expects to process 8,000 customer orders. After the TQM implementation, what is the estimated cost of unused capacity?
5. What strategies are available to managers for reducing or eliminating unused capacity?
6. What recommendation would you make to management regarding how the cost of unused capacity should be assigned?