CHAPTER 5

ACTIVITY- BASED MANAGEMENT

QUESTIONS FOR WRITING AND DISCUSSION

1. The two dimensions are the cost dimension processes and activities that define the
and the process dimension. The cost processes. Finally, there tends to be more
dimension is concerned with accurate emphasis on group rewards than on individual
assignment of costs to cost objects, such as rewards.
products and customers. Activity-based
4. Driver analysis is concerned with identifying
costing is the focus of this dimension. The
the root causes of activity costs. Knowing the
second dimension—the process dimension—
root causes of activity costs is the key to
provides information about why work is done
improvement and innovation. Once a
and how well it is done. It is concerned with
manager understands why costs are being
cost driver analysis, activity analysis, and
incurred, then efforts can be taken to improve
performance measurement. This dimension
cost efficiency.
offers the connection to the continuous
improvement world found in the advanced 5. Activity inputs are the resources consumed by
manufacturing environment. an activity in producing its output. Activity
output is the result or product of an activity.
2. A functional-based responsibility accounting
Activity output measurement simply means
system is characterized by four elements: (1)
the number of times the activity is performed.
a responsibility center, where responsibility is
assigned to an individual in charge 6. Activity analysis is concerned with identify-ing
(responsibility is usually defined in financial activities performed by an organization,
terms); (2) the setting of budgets and assessing their value to the organization, and
standards to serve as benchmarks for selecting and keeping only those that are
performance measurement; (3) measurement value adding. Selecting and keeping value-
of performance by comparing actual adding activities brings about cost reduction
outcomes with budgeted outcomes; and (4) and greater operating efficiency, thus
individuals being rewarded or penalized providing support for the objective of
according to management policies. continuous improvement.
3. In an activity-based responsibility accounting 7. Value-added activities are necessary activi-
system, the focus of control shifts from ties. Activities are necessary if they are
responsibility centers to processes and mandated or if they are not mandated and
teams. Management is concerned with how satisfy three conditions: (1) they cause a
work is done, not with where it is done. change of state, (2) the change of state is not
Process improvement and process innovation achievable by preceding activities, and (3)
are emphasized. Standards tend to be they enable other activities to be performed.
optimal, dynamic, and process oriented. Value-added costs are costs caused by
Performance measurement focuses on
 activities that are necessary and efficiently 15. The activity volume variance is a measure of
executed. the nonvalue-added costs. The unused
capacity variance tells how much of the
8. Nonvalue-added activities are unnecessary
committed resources are not being used. This
activities or those that are necessary but
information is particularly important because it
inefficient and improvable. An example is
helps managers know when they can take
moving goods. Nonvalue-added costs are
actions to reduce nonvalue-added costs.
those costs caused by nonvalue-added
activities. An example is the cost of materials 16. Activity-based customer costing can identify
handling. what it is costing to service different
customers. Once known, a firm can then
9. (1) Activity elimination—the identification and
devise a strategy to increase its profitability by
elimination of activities that fail to add value.
focusing more on profitable customers,
(2) Activity selection—the process of choosing
converting unprofitable customers to
among different sets of activities caused by
profitable ones where possible, and “firing”
competing strategies. (3) Activity reduction—
customers that cannot be made profitable.
the process of decreasing the time and
resources required by an activity. (4) Activity
sharing—increasing the efficiency of
17. Activity-based supplier costing traces all
necessary activities using economies of scale.
supplier-caused activity costs to suppliers.
10. Value-added standards represent the abso- This new total cost may prove to be lower than
lute levels of efficiency for activities. The costs what is signaled simply by purchase price.
that should be incurred for these abso-
lute levels are value-added costs. Any
difference between the actual costs incurred
109
and the ideal costs are nonvalue-added costs.
11. Trend reports will reveal the progress made
over time in reducing nonvalue-added costs.
12. A kaizen standard is the planned improve-
ment for the coming period. The kaizen
subcycle implements the improvement,
checks it, and locks it in and then begins a
search for additional improvements. The
maintenance subcycle sets a standard based
on prior improvements, executes, and checks
the results to make sure that performance
conforms to the new results. If not, then
corrective action is taken.
13. Benchmarking identifies the best practices of
comparable internal and external units. For
internal units, information can be gathered
that reveals how the best unit achieves its
results; these procedures can then be
adopted by other comparable units. For
external units, the performance standard
provides an incentive to find ways to match
the performance (it may sometimes be
possible to determine the ways the
performance is achieved).
14. If individuals are asked to reduce costs and
are told what the activity driver is, they may
decrease the level of the driver below that
which is optimal. Thus, it may be necessary to
also identify the optimal level of the cost driver
so that only nonvalue-added costs are
eliminated.

110
 EXERCISES

5–1
1. Plantwide rate = ($1,200,000 + $1,800,000+ $600,000)/60,000 = $60 per Machine
hour

Unit overhead cost = $60 × 50,000/100,000 = $30

Activity rates:
Machine rate = $1,800,000/60,000 = $30 per machine hour
Testing rate = $1,200,000/40,000 = $30 per testing hour
Rework rate = $600,000/20,000 = $30 per rework hour

Total overhead cost = ($30 × 50,000) + ($30 × 20,000) + ($30 × 5,000)

= $2,250,000

Unit overhead cost = $2,250,000/100,000 = $22.50

Improving the accuracy reduced the cost by $7.50, which is still less than the $10
reduction needed. What this means is that although accuracy has a positive
effect on the price, it is not the only problem. It appears that competitors may be
more efficient than Timesaver. This outcome then signals the need to reduce
costs.

2. Since testing and rework costs and setup and rework time are both reduced by
50%, the activity rates remain the same, although the amount of cost assigned
to the regular microwave will change:

Total overhead cost = ($30 × 50,000) + ($30 × 10,000) + ($30 × 2,500)

= $1,875,000

Unit cost = $1,875,000/100,000 = $18.75

This cost now is $11.25 less than the original allows management to reduce the
price by $10, increasing the competitive position of the regular model. ABC is
concerned with how costs are assigned, whereas ABM is not only concerned
with how they are assigned but also with how costs can be reduced. Cost
accuracy and cost reduction are the dual themes of ABM.
5–2
Classification:

Situation Activity-Based Functional-Based

1 A B
2 A B
3 A B
4 B A
5 B A
6 B A
7 A B

Comments:

Situation 1: In a functional-based system, individuals are held responsible for the

efficiency of organizational units, such as the Grinding Department. In an
activitybased system, processes are the control points because they are the units
of change; they represent the way things are done in an organization. Improvement
and innovation mean changing the way things are done, or in other words, changing
processes. Since processes, such as procurement, cut across functional
boundaries, teams are the natural outcome of process management. It is only natural
that the managers of purchasing, receiving, and accounts payable be part of a team
looking for ways to improve procurement.

Situation 2: In a functional-based responsibility system, individuals in charge of

responsibility centers are rewarded based on their ability to achieve the financial
goals of the responsibility center. Thus, meeting budget promises the “fat” bonus.
In a continuous improvement environment, process improvement is dependent on
team performance, so rewards tend to be group based, and gainsharing is often
used. Furthermore, there are many facets to process performance other than cost,
so the performance measures tend to be multidimensional (e.g., quality and delivery
time).

110
5–2 Concluded
Situation 3: In a functional-based system, efforts are made to encourage individuals
to maximize the performance of the subunit over which they have responsibility. The
concern of activity-based responsibility accounting is overall organizational
performance. The focus is systemwide. It recognizes that maximizing individual
performance may not produce firmwide efficiency.

Situation 4: In a functional-based system, performance of subunits is usually

financial-based and is measured by comparing actual with budgeted outcomes. In
an activity-based system, process performance is emphasized. The objective is to
provide low-cost, high-quality products, delivered on a timely basis. Thus, both
financial and nonfinancial measures are needed.

Situation 5: In a functional-based system, budgets and standards are used to control

costs. In an activity-based responsibility system, the focus is on activities because
activities are the cause of costs. Driver analysis and activity analysis are
fundamental to the control process. Driver analysis recognizes that controlling
costs requires managers to understand the root causes. Activity analysis is the
effort expended to identify, classify, and assess the value content of all activities.
Once the value content is known, then costs can be controlled through such means
as activity reduction, activity elimination, activity sharing, and activity selection.

Situation 6: A functional-based system uses currently attainable standards that

allow for a certain amount of inefficiency. Achieving the standard is the emphasis,
and there is no effort to improve on the standards themselves. An activitybased
approach strives for the ideal, and so the standard is the ideal. Progress is measured
over time with the expectation that performance should be continually improving.
Efforts are made to find new ways of doing things and, thus, to find new optimal
standards. The objective is to always provide incentives for positive changes.

Situation 7: The functional-based system tends to ignore a firm’s activities and the
linkages of those activities with suppliers and customers. It is internally focused. An
activity-based system builds in explicit recognition of those linkages and
emphasizes the importance of the value chain. Furthermore, the assessment of the
value content of activities is explicitly related to customers. What goes on outside
the firm cannot be ignored.
5–3
The ABM implementation is taking too long and is not producing the expected
results. It also appears to not be integrated with the division’s official accounting
system, thus encouraging managers to continue relying on the old system (as

111
evidenced by the continued reliance on traditional materials and labor efficiency
variances). The fact that the ABC product costs are not significantly different in
many cases could be due to a lack of product diversity or perhaps due to poor
choices of pools and drivers. The lack of a competitive cost state suggests the
presence of significant nonvalue-added costs. The emphasis on the absence of
product cost differences, lack of cost reductions, and the attitude about activity
detail and the value content of inspection all reveal that plant managers have a very
limited understanding about ABM and what it can do. There clearly needs to be a
major effort to train managers to understand and use activity data. At this point,
there is no organizational culture that emphasizes the need for continuous
improvement. This need and the role ABM plays in continuous improvement needs
to be taught. The new ABM system also needs to be integrated to maximize its
chances for success.

5–4
1. David was concerned about meeting the schedule and staying within the 5 percent
variance guideline. The first week’s production exceeded the guideline for both
materials and labor, and he expected the same outcome for the second week.
By stopping inspections, no materials waste would be observed and recorded
for the second week, moving the usage variance back within the 5 percent
tolerance level. Accepting all units produced also will reduce the total labor time
reported. Finally, using inspectors as production labor and counting their time
as inspection labor provides some “free” direct labor time, which would also
contribute to the reduction or elimination of an unfavorable labor efficiency
variance. David’s behavior is unethical. David (and perhaps others) is
deliberately subverting the organization’s legitimate and ethical objective of
providing a high-quality product used in the manufacture of an airplane—in
exchange for a favorable performance rating and, presumably, a good salary
increase or bonus. Although no explicit information is provided, the stress test
seems to imply an important safety role for the bolts in the airplane structure. If
true, then David’s actions become even more questionable.
5–4 Concluded
2. There appears to be an overreliance on standards and variances. There also
appears to be a strong internal focus—David did not give much consideration
to the effect of his decision on the company’s customers. The reward structure
seems to be tied to the ability of David to meet or beat standards, and this
provides some incentive to engage in perverse and even unethical behavior. The
system certainly works against the goal of zero defects and total quality. An
activity-based system would tend to mitigate the problem because it encourages

112
 a multidimensional performance measurement. For example, quality measures
are important. Failure to meet measures on one dimension may be offset to
some extent by good performance on other dimensions. A strategic-based
approach would mitigate the behavior even more, as it adopts a customer focus,
and performance measures relating to such things as customer satisfaction are
introduced. Furthermore, more effort is made to link the performance measures
with the company’s mission and strategy.

Finally, by communicating the strategy through the use of performance measures

of various perspectives, a strategic-based approach tends to align individual
goals with those of the organization. However, it should be mentioned that
designing a system with perfect incentives is difficult. Ultimately, the firm must
rely on the character of its employees to carry out its objectives.

3. The first week’s experience indicates a fairly high defect rate—between 7 and 8
percent—which was expected to continue for the second week. Apparently,
item-by-item inspection is the company’s way of ensuring reliable bolt
performance. Abandoning the inspection process for a week simply to meet
internal reporting standards seems like a weak excuse, even if a return to normal
practices is expected. All too often, this sort of rationalization leads to repeated
violations of norms to meet short-term goals, and it becomes part of the
culture—to the point where it doesn’t appear to be wrong anymore.
Fundamentally, the need for inspection and the high reject rate suggests that
the company needs to think about ways of improving its manufacturing process
to reduce the number of defective units. This is why an activity- or
strategicbased approach may be more suitable because they both have a
process focus that emphasizes quality and efficiency. Production of defective
units would not be encouraged.
5–5
The following are possible sets of questions and answers (provided as examples of
what students could suggest):

Cleaning oil:

Question: Why is the oil puddle cleaned daily?

Answer: Because the production equipment leaks oil every day.

Question: Why does the production equipment leak oil?

Answer: Because a seal is damaged (root cause).

113
Question: How do we repair the damaged seal?
Answer: By replacing it.

Providing sales allowances:

Question: Why are we giving sales allowances?

Answer: Because the product is not working as it should.

Question: Why is the product not working as it should?

Answer: Usually because it has a defective component.

Question: Why does it have a defective component?

Answer: Because our subassembly processes occasionally produce bad
components.

Question: Why do our subassembly processes produce bad components?

Answer: Because our workers are not as well trained as they should be (root
cause).

Question: How do we improve the skills of our workers?

Answer: By ensuring that they all pass a rigorous training course.
5–6
Nonvalue-added:

Comparing documents (state detection) $90,000 (0.15 × $600,000)

Resolving discrepancies (rework) $420,000 (0.70 × $600,000)

Value-added:

Preparing checks $60,000 (0.10 × $600,000)

Mailing checks $30,000 (0.05 × $600,000)

5–7
Questions 2–6 represent a possible sequence for the activity of comparing
documents, and Questions 1 and 3–6 represent a possible sequence for resolving
discrepancies. The two activities have a common root cause.

114
Question 1: Why are we resolving discrepancies?
Answer: Because the purchase order, receiving order, and invoice have been
compared and found to be in disagreement.

Question 2: Why are documents being compared?

Answer: Because they may not agree.

Question 3: Why would the documents not agree?

Answer: Because one or more may be wrong.

Question 4: Why would a document be wrong?

Answer: Because the amount received from the supplier may not correspond to the
amount ordered or because the amount billed may not correspond to
the amount received or both.

Question 5: Why are the amounts different?

Answer: Because of clerical error—either by us or by the supplier.

Question 6: How can we avoid clerical error?

Answer: Training for our clerks will reduce the number of discrepancies; for
suppliers, extra training and care can be suggested where there is
evidence of a problem.
5–8
1. A process is a collection of activities with a common objective. The common
objective of procurement is to supply bought and paid for materials to
operations (e.g., the manufacturing process). The common objective of
purchasing is to produce a request for materials from suppliers; the common
objective of receiving is to process materials from suppliers and move them to
the operations area (e.g., stores or manufacturing); the common objective of
paying bills is to pay for the materials received from suppliers.

2. The effect is to reduce the demand for the activity of resolving discrepancies by
30 percent. By so doing, Whitley will save 21 percent (0.30 × 0.70) of its clerical
time. Thus, about four clerks can be eliminated (21% * 20 clerks = 4 clerks
eliminated) by reassigning them to other areas or simply laying them off. This
will produce savings of about $120,000 per year (4 clerks * $30,000 salary). This
is an example of process improvement—an incremental increase in process
efficiency resulting in a cost reduction.

115
5–9
EDI eliminates the demand for virtually all the activities within the bill-paying
process. Some demand may be left for payment activities relative to the acquisition
of nonproductive supplies. Assuming conservatively that 90 percent of the demand
is gone, then there would be a need for perhaps two clerks (10% * 20 clerks = 2
remaining clerks). This would save the company $540,000 (18 clerks * $30,000 salary)
per year for this subprocess alone. Additional savings would be realized from
reduction of demands for purchasing and receiving activities. Switching to an EDI
procurement structure is an example of process innovation.
5–10
Case Nonvalue-Added Cost Root Cause Cost Reduction

A $9 per unit1 Process design Activity selection

B $300 per setup Product design Activity reduction C $120 per unit3 Plant
2

layout Activity elimination D $400,000 per year4 Multiple* Activity

selection E $250 per unit5 Suppliers Activity elimination F $900,000 per
year6 Product design Activity sharing

1 (0.5)$1
2 – (0.25)$8 +
(8 – 7.5)$10
2 (8 –
2)$50
3 (6 –
0)$20
4 $320,0
00 +
(16,000)$5
5 (6.5 –
6)$500
6
As given

*For example, process design, product design, and quality approach or philosophy.

5–11

116
Fixed activity rate = SP = $252,000/28,800 = $8.75 per order

Cost of unused capacity:

SP × SQ SP × AQ SP × AU
$8.75 × 14,400 $8.75 × 28,800 $8.75 × 27,600
$126,000 U $10,500 F
Activity Volume Variance Unused Capacity Variance

The activity volume variance measures the nonvalue-added cost. The unused
capacity variance is a measure of the potential to reduce the spending on an
activity and, thus, reduce the nonvalue-added costs.
5–11 Concluded

2. Value-added costs = $8.75 × 14,400 = $126,000

Nonvalue-added costs = $8.75 × 14,400 = $126,000

Note: For fixed activity costs, the practical capacity is currently 28,800 orders;
thus, 14,400 orders are unnecessary.

A value-added cost report would be as follows:

Value-Added Nonvalue-Added Actual

Costs Costs Costs
Purchasing $126,000 $126,000 $252,000

Highlighting nonvalue-added costs shows managers where savings are possible

and emphasizes the need for improvement. In this case, reducing orders
processed to 14,400 will create unused capacity of 14,400 orders, allowing the
company to save $126,000 in salaries.

3. First, the value-added standard is nonzero. Second, purchasing enables other

activities to be performed. Third, there is a change of state—from a state of no
materials requested to a state of materials requested. Fourth, the purchase state
could not have been achieved by a prior activity. Fifth, it is a necessary activity—
one essential for the firm to remain in business.

117
Possible reasons for exceeding the value-added standard: suboptimal inventory
management policies, reorders due to bad parts being delivered by suppliers,
extra orders due to rework requirements, and additional orders because the
wrong types and quantities of materials were ordered.

4. By reducing the demand by another 6,000 units, the unused capacity will now
equal 7,200 orders—an amount equivalent to 1.5 purchasing agents. Thus, the
number of purchasing agents can be reduced from 6 to 5, saving $42,000.
5–12
1. Willson Company
Value- and Nonvalue-Added Cost Report For
the Year Ended December 31, 2005

Value-Added Nonvalue-Added Actual

Costs Costs Costs
Purchasing parts $ 450,000 $ 180,000 $ 630,000
Assembling parts 2,160,000 234,000 2,394,000
Administering parts 1,980,000 858,000 2,838,000
Inspecting parts 0 1,125,000 1,125,000
Total $4,590,000 $2,397,000 $6,987,000

2. Inspecting parts is nonvalue-added (SQ = 0 is a

necessary condition for a nonvalue-added activity).
Inspection is nonvalue-added because it is a
statedetection activity, not a state-changing
activity. It also is not essential to enable other
activities to be performed. Value-added activities
can engender nonvalue-added costs if they are not
performed efficiently.

5–13
1. Willson Company
Nonvalue-Added Cost Trend Report
For the Year Ended December 31, 2006

2005 2006 Change

118
 Purchasing parts $ 180,000 $ 90,000 $ 90,000 F
Assembling parts 234,000 72,000 162,000 F
Administering parts 858,000 660,000 198,000 F
Inspecting parts 1,125,000 675,000 450,000 F
Total $2,397,000 $1,497,000 $900,000 F

Note: The above amounts were computed for each year, using the following
formula: (AQ – SQ)SP.

2. A trend report allows managers to assess the

effectiveness of activity management. It is a critical
document that reveals the success of continuous
improvement efforts. It also provides some
information about additional opportunity for
improvement. In 2006, activity management
reduced the nonvalue-added costs by $900,000,
signaling that the actions taken were good. It also
shows that additional opportunity for reduction
exists—more effort is needed to reduce the
$1,497,000 of remaining nonvalue-added costs.

119
5–14
1. Activity and driver analysis:

Setting up equipment: This is a value-added activity because (1) it causes a change

in the state of nature: improperly configured equipment to properly configured
equipment, (2) there is no prior activity that could have caused the state change,
and (3) it is necessary to enable other activities to be performed. However,
setting up equipment often takes more time than needed and so this activity has
a nonvalue-added component. Most companies strive for zero setup time. Thus,
the time and associated cost are nonvalue-added because the activity is
performed inefficiently. Means should be explored to reduce the time of this
activity so that it consumes fewer resources. Possible root causes include such
factors as product design, process design, and equipment design. Knowing the
root causes can lead to an improvement in activity efficiency. Moving from a
departmental manufacturing structure to a cellular manufacturing structure in
some cases may eliminate the need for setups, thus eliminating the activity, or
flexible manufacturing equipment might be purchased that provides an almost
instantaneous setup capability (a change in process technology—and certainly
a change in equipment design). In other cases, the activity may be improved by
redesigning the product so that a less complicated setup is required.

Creating scrap: This is generally viewed as a nonvalue-added activity and should

be eliminated. It is nonvalue-added because it causes a nondesired change of
state and because it does not enable other value-added activities to be
performed. Efforts should be made to find ways of producing that eliminate
scrap. Possible root causes include poor vendor quality, quality management
approach, and manufacturing process used. Knowing the root causes may lead
to a supplier valuation program that improves the quality of the parts and
materials purchased externally, adoption of a total quality management
program, and perhaps the use of automated equipment to cut down on material
waste (because of greater precision).

Welding subassemblies: This is a value-added activity. It causes a desired state

change that could not have been done by preceding activities and enables other
activities to be performed. If inefficient, then means should be sought to improve
efficiency. The goal is to optimize value-added activity performance. Possible
root causes include product design, process design, and production
technology. Changing either of the two designs could decrease the demand for
the welding activity while producing the same or more output. A change in

120
5–14
technology—buying more advanced technology, for example— may also
increase the efficiency of the activity.
Continued
Materials handling: This is a nonvalue-added activity. Moving materials and
subassemblies from one point in the plant changes location but not the state.
But it does enable other activities to be performed, and it is not a repeated action.
If you argue that changing location is a change in state, then moving materials
is value-added but with the potential of significant increases in efficiency (as
with setups, the goal is to minimize the amount of activity performance).
Possible root causes include plant layout, manufacturing processes, and vendor
arrangements. Moving from a departmental to a cellular structure, adopting
computer-aided manufacturing, and entering into contracts with suppliers that
require just-in-time delivery to the point of production are examples of how
knowledge of root causes can be exploited to reduce and eliminate
nonvalueadded activities.

Inspecting parts: Inspection is a nonvalue-added activity. It is a statedetection

activity and is not necessary to enable other activities to be performed. This
activity should be reduced and eventually eliminated. A possible root cause of
inspection is the possibility of poor quality of parts and materials. The company
should work with suppliers to ensure high quality (zerodefect parts).

2. Behavioral analysis:

Setting up equipment: Using the number of setups as a driver may cause a buildup
of inventories. Since reducing the number of setups will reduce setup costs,
there will be an incentive to have fewer setups. Reducing the number of setups
will result in larger lots and could create finished goods inventory. This is in
opposition to the goal of zero inventories. On the other hand, if setup time is
used as the driver, managers will have an incentive to reduce setup time.
Reducing setup time allows managers to produce on demand rather than for
inventory.
Concluded
Creating scrap: Using the number of defective units as a driver should encourage
managers to reduce defective units. Assuming that defective units are the
source of scrap, this should reduce scrap costs. Similarly, using pounds of
scrap should encourage managers to find ways to reduce scrap. In both cases,

121
5–14
the behavioral consequences could be two-edged. If the reduction of scrap
(defective units) is achieved by increasing quality/productive efficiency, the
effect is compatible with the objective of creating a competitive advantage. If the
reduction is achieved by allowing defective units to flow through to finished
goods, then the effect will be to alienate customers, not win their favor (customer
realization decreases). Neither driver appears to dominate. One solution is to
report the trend in warranty activity with the trend in scrap activity. This may
discourage any kind of pass-on behavior.

Welding subassemblies: Using welding hours should encourage management to

find ways of reducing the welding hours required per product. This would be
more likely to induce managers to look at possible root causes such as product
design and process design rather than number of welded subassemblies. There
is some value in looking for ways to reduce the number of welded
subassemblies, perhaps redesigning the product to eliminate welding.

Materials handling: Both drivers seem to have positive incentives. Seeking ways to
reduce the number of moves or distance moved should lead managers to look
at root causes. Reorganizing the plant layout, for example, should reduce either
the number of moves or the distance moved. Hopefully, the activity drivers will
lead to the identification of executional drivers that can be managed so that the
activity can be reduced and eventually eliminated.

Inspecting parts: Hours of inspection can be reduced by working with suppliers so

that greater incoming quality is ensured. Similarly, the number of defective parts
can be reduced by working with suppliers so that incoming quality is increased.
Hours of inspection, however, can be reduced without increasing quality. This
is not true for the number of defective parts. Using the number of defective parts
appears to be a better choice.

122
5–15
1. First quarter: Setup time standard = 10 hours (based on the planned
improvement: 15 hours – 5 hours)

Second quarter: Setup time standard = 8 hours (based on the planned improvement:
9 hours – 1 hour)

2. Kaizen subcycle:
• Plan (five-hour reduction from process redesign)
• Do (try out setup with new design)
• Check (time required was nine hours, a six-hour reduction)
• Act (lock in six-hour improvement by setting new standard of nine hours and
using same procedures as used to give the nine-hour outcome; and,
simultaneously, search for new improvement opportunity; in this case, the
suggested changes of the production workers.)

Repeat kaizen subcycle:

• Plan (one-hour reduction from setup procedure changes)
• Do (train and then implement procedures)
• Check (actual time required was 6.5 hours, a 2.5-hour reduction)
• Act (lock in improvement by setting standard of 6.5 hours and begin search
for new improvement)

3. Maintenance subcycle:

First quarter (end of):

• Establish standard (nine hours based on improved process design)
• Do (implement repetitively the improved standard)
• Check (see if the nine-hour time is maintained)
• Act (if the nine-hour time deteriorates, find out why and take corrective action
to restore to seven hours.)

Second quarter: Same cycle using 6.5 hours as the new standard to maintain

Note: The maintenance cycle described begins after observing the actual
improvement. The actual improvement is locked in. The maintenance standard
at the beginning of the first quarter is 15 hours.
5–15 Concluded

4. Nonvalue-added cost saved (eliminated): $100 × 8.5 = $850 per setup.

123
5. Standard costing basically uses only a maintenance subcycle. Standards are set
and maintained. The principal difference is the emphasis on constantly
searching for improvements with the standard changing with each
improvement. This search involves all employees (e.g., engineers and
production workers). Thus, kaizen costing is dynamic, whereas traditional
(functionalbased) standard costing is static.

5–16
1. JIT Non-JIT
a
Sales $25,000,000 $25,000,000
Allocationb 1,500,000 1,500,000

a
$125 × 200,000, where $125 = $100 cost + ($100 × 0.25) markup on cost, and
200,000 is the average order size times the number of orders
JIT : 400 orders * 500 average order size = 200,000
Non-JIT: 40 orders * 5,000 average order size = 200,000
b 0.50 ×
$3,000,000

2. Activity rates:

Ordering rate = $1,760,000/440= $4,000 per sales order

Selling rate = $640,000/80 = $8,000 per sales call
Service rate = $600,000/300 = $2,000 per service call
5–16 Concluded
JIT Non-JIT
Ordering costs:
$4,000 × 400 $ 1,600,000

$4,000 × 40 $ 160,000

Selling costs:
$8,000 × 40 320,000

$8,000 × 40 320,000

Service costs:
$2,000 × 200 400,000

124
 $2,000 × 100 200,000
Total $ 2,320,000 $ 680,000

For the non-JIT customers, the customer costs amount to $1,500,000/40 = $37,500
per order under the original allocation. Using activity assignments, this drops to
$680,000/40 = $17,000 per order, a difference of $20,500 per order. For an order
of 5,000 units, the order price can be decreased by $4.10 per unit without
affecting customer profitability. Overall profitability will decrease, however,
unless the price for orders is increased to JIT customers.

3. It sounds like the JIT buyers are switching their inventory carrying costs to Carbon
without any significant benefit to Carbon. Carbon needs to increase prices to
reflect the additional demands on customer-support activities. Furthermore,
additional price increases may be needed to reflect the increased number of
setups, purchases, and so on, that are likely occurring inside the plant. Carbon
should also immediately initiate discussions with its JIT customers to begin
negotiations for achieving some of the benefits that a JIT supplier should have,
such as long-term contracts. The benefits of long-term contracting may offset
most or all of the increased costs from the additional demands made on other
activities.
5–17
1. Supplier cost:

First, calculate the activity rates for assigning costs to suppliers:

Inspecting components: $240,000/2,000 = $120 per sampling hour
Reworking products: $760,500/1,500 = $507 per rework hour
Warranty work: $4,800,000/8,000 = $600 per warranty hour

Next, calculate the cost per component by supplier:

Supplier cost:
Vance Foy
Purchase cost:
$23.50 × 400,000 $ 9,400,000

$21.50 × 1,600,000 $ 34,400,000

Inspecting components:
$120 × 40 4,800

125
 $120 × 1,960 235,200

Reworking products:
$507 × 90 45,630

$507 × 1,410 714,870

Warranty work:
$600 × 400 240,000

$600 × 7,600 4,560,000

Total supplier cost $ 9,690,430 $ 39,910,070
Units supplied ÷ 400,000 ÷ 1,600,000
Unit cost $ 24.23* $ 24.94*

*Rounded

The difference is in favor of Vance; however, when the price concession is

considered, the cost of Vance is $23.23, which is less than Foy’s component.
Lumus should accept the contractual offer made by Vance.

5–17 Concluded
2. Warranty hours would act as the best driver of the three choices. Using this driver,
the rate is $1,000,000/8,000 = $125 per warranty hour. The cost assigned to each
component would be:

Vance Foy
Lost sales:
$125 × 400 $ 50,000

$125 × 7,600 $ 950,000

$ 50,000 $ 950,000
Units supplied ÷ 400,000 ÷ 1,600,000
Increase in unit cost $ 0.13* $ 0.59*

126
*Rounded

127
 PROBLEMS

5–18
1. An activity driver measures the amount of an activity consumed by a cost object.
It is a measure of activity output. Activity drivers are used to assign activity
costs to cost objects. On the other hand, a cost driver is the root cause of the
activity and explains why the activity is performed. Cost drivers are useful for
identifying how costs can be reduced (rather than assigned).

2. Value content and driver analysis:

Setting up equipment: At first glance, this appears to be a value-added activity

because: (1) it causes a change in the state of nature: improperly configured
equipment to properly configured equipment, (2) there is no prior activity that
should have caused the state change, and (3) it is necessary to enable other
activities to be performed. However, setting up equipment often takes more time
than needed and so has a nonvalue-added component. Most companies strive
for zero setup time, suggesting that the time and associated cost are nonvalue-
added because the activity is performed inefficiently. (A zero setup time
suggests a nonvalue-added activity.) Means should be explored to reduce the
time of this activity so that it consumes fewer resources. Possible root causes
include such factors as product design, process design, and equipment design.
Knowing the root causes can lead to an improvement in activity efficiency.
Moving from a departmental manufacturing structure to a cellular manufacturing
structure in some cases may eliminate the need for setups, thus eliminating the
activity. Or flexible manufacturing equipment might be purchased that provides
an almost instantaneous setup capability (a change in process technology—and
certainly a change in equipment design). In other cases, the activity may be
improved by redesigning the product so that a less complicated setup is
required.

Performing warranty work: This is generally viewed as a nonvalue-added activity

and should be eliminated. It is nonvalue-added because it represents a type of
rework—repairs on products that are caused by faulty production. Possible root
causes include poor vendor quality, poor product design, quality management
approach, and manufacturing process used. Knowing the root causes may lead
to a supplier valuation program that improves the quality of the parts and
materials purchased externally, adoption of a total quality management
program, product redesign, process redesign, and perhaps the use of automated
equipment to cut down on faulty products.

128
5–18 Continued
Welding subassemblies: This is a value-added activity. It causes a desired state
change that could not have been done by preceding activities and enables other
activities to be performed. If inefficient, then means should be sought to improve
efficiency. The goal is to optimize value-added activity performance. Possible
root causes of inefficiency include product design, process design, and
production technology. Changing either product or process design could
decrease the demand for the welding activity while producing the same or more
output. A change in technology—buying more advanced technology, for
example—may also increase the efficiency of the activity.

Moving materials: This is usually viewed as a nonvalue-added activity. Moving

materials and subassemblies from one point in the plant changes location but
not the state. But it does enable other activities to be performed, and it is not a
repeated action. If it is argued that changing location is a change in state, then
you could respond by noting that it is an unnecessary change of state. Possible
root causes include plant layout, manufacturing processes, and vendor
arrangements. Moving from a departmental to a cellular structure, adopting
computer-aided manufacturing, and entering into contracts with suppliers that
require just-in-time delivery to the point of production are examples of how
knowledge of root causes can be exploited to reduce and eliminate material
handling cost.

Inspecting components: Inspection is a nonvalue-added activity. It is a

statedetection activity and is not necessary to enable other activities to be
performed. This activity should be reduced and eventually eliminated. A
possible root cause of inspection is the possibility of poor quality of parts and
materials. The company should work with suppliers to ensure high quality
(zerodefect parts).
5–18 Concluded
3. Behavioral analysis:

Setting up equipment: Using the number of setups as a driver may cause a buildup
of inventories. Since reducing the number of setups will reduce setup costs,
there will be an incentive to have fewer setups. Reducing the number of setups
will result in larger lots and could create finished goods inventory. This is in
opposition to the goal of zero inventories. On the other hand, if setup time is
used as the driver, managers will have an incentive to reduce setup time.
Reducing setup time allows managers to produce on demand rather than for
inventory.

129
Performing warranty work: Using the number of defective units as a driver should
encourage managers to reduce defective units. Assuming that defective units
are the source of warranty work, this should reduce warranty costs. Similarly,
using warranty hours could encourage managers to find ways to reduce
warranty work by decreasing its causes. Alternatively, it may cause them to look
for more efficient means of performing warranty work. Increasing the efficiency
of a nonvalue-added activity has some short-run merit but it should not be the
focus. Of the two drivers, defective units is the most compatible with eventual
elimination of the nonvalue-added activity.

Welding subassemblies: Using welding hours should encourage management to

find ways of reducing the welding hours required per product. This would more
likely induce managers to look at possible root causes such as product design
and process design than would number of welded subassemblies. There is some
value in looking for ways to reduce the number of welded subassemblies,
perhaps redesigning the product to eliminate welding.

Moving materials: Both drivers seem to have positive incentives. Seeking ways to
reduce the number of moves or distance moved should lead managers to look
at root causes. Reorganizing the plant layout, for example, should reduce either
the number of moves or the distance moved. Hopefully, the activity drivers will
lead to the identification of executional drivers that can be managed so that the
activity can be reduced and eventually eliminated.

Inspecting components: Hours of inspection can be reduced by working with

suppliers so that greater incoming quality is ensured. Similarly, the number of
defective parts can be reduced by working with suppliers so that incoming
quality is increased. Hours of inspection, however, can be reduced without
increasing quality. This is not true for the number of defective parts. Using the
number of defective parts appears to be a better choice.
5–19
1. Activity-based management is a systemwide, integrated approach that focuses
management’s attention on activities. It involves two dimensions: a cost
dimension and a process dimension. A key element in activity management is
identifying activities, assessing their value, and retaining only value-adding
activities. The consultant identified the activities but did not formally classify the
activities as value-added or nonvalue-added. Nor did the consultant offer any
suggestions for increasing efficiency—at least not formally. The consultant
apparently had tentatively identified savings possible by eliminating nonvalue-
added activities. Management must still decide how to reduce, eliminate, share,
and select activities to achieve cost reductions.

2. Setup $125,000

130
 Materials handling 180,000
Inspection 122,000
Customer complaints 100,000
Warranties 170,000
Storing 80,000
Expediting 75,000
Total $852,000

Units produced and sold ÷120,000*

Potential unit cost reduction $ 7.10

*$1,920,000/$16 (total cost divided by unit cost)

The consultant’s estimate of cost reduction was on target. Per-unit costs can be
reduced by at least $7, and further reductions may be possible if improvements
in value-added activities are possible.

3. Total potential reduction:

$ 852,000 (from Requirement 2)
150,000 (by automating)
$1,002,000
Units ÷ 120,000
Unit savings $ 8.35

Costs can be reduced by at least $7, enabling the company to maintain current
market share. Further, if all the nonvalue-added costs are eliminated, then the
cost reduction needed to increase market share is also possible. Activity
selection is the form of activity management used here.

4. Current:

Sales $ 2,160,000 ($18 × 120,000 units)

Costs (1,920,000) Income $ 240,000

$14 price (assumes that current market share is maintained):

Sales $1,680,000 ($14 × 120,000 units)

131
 Costs (918,000) ($7.65* × 120,000 units) Income
$ 762,000

$12 price:

Sales $ 2,160,000 ($12 × 180,000 units)

Costs (1,377,000) ($7.65* × 180,000 units) Income
$ 783,000

*$16 – $8.35 = $7.65

The $12 price produces the greatest benefit.

132
5–20
1. Nonvalue-added usage and costs, 2008:

Nonvalue-AddedNonvalue-Added
Usage Cost
AQ* SQ** AQ – SQ (AQ – SQ)SP
Materials 600,000 480,000 120,000 $ 600,000
Engineering 48,000 27,840 20,160 604,800
$1,204,800

*1.25 × 6 × 80,000; (4 × 6,000) + (10 × 2,400) (AQ for engineering represents the
actual practical capacity acquired.)
**6 × 80,000; (0.58 × 24,000) + (0.58 × 24,000)

Note: SP for materials is $5; SP for engineering is $30 ($1,440,000/48,000). There are
no price variances because SP = AP.

Unused capacity for engineering:

SP × AQ SP × AU
$30 × 48,000 $30 × 46,000
$60,000 F
Unused Capacity Variance

2. Kaizen standards for the coming year (2009):

Materials: SQ = 480,000 + 0.6(120,000) = 552,000 pounds

Engineering: SQ = 27,840 + 0.6(20,160) = 39,936 engineering hours
5–20 Concluded
3. AQ* SQ AQ – SQ SP(AQ – SQ)
Materials 584,800 552,000 32,800 $164,000 U
Engineering 35,400 39,936 (4,536) 136,080 F

*For engineering, the kaizen standard is a measure of how much resource usage
is needed (this year), and so progress is measured by comparing SQ with actual

133
 usage, AU, not AQ, activity availability. The formula AQ – AU, on the other hand,
will measure the unused capacity, a useful number, as is discussed below.

The company failed to meet the materials kaizen standard but beat the engineering
standard. The engineering outcome is of particular interest. The actual usage of
the engineering resource is 35,400 hours, and activity availability is 48,000.
Thus, the company has created 12,600 hours of unused engineering capacity.
Each engineer brings a capacity of 2,000 hours. Since engineers come in whole
units, the company now has six too many! Thus, to realize the savings for the
engineering activity, the company must decide how to best use these available
resources. One possibility is to simply lay off six engineers, thereby increasing
total profits by the salaries saved ($360,000). Other possibilities include
reassignment to activities that have insufficient resources (assuming they could
use engineers, e.g., perhaps new product development could use six engineers).
The critical point is that resource usage reductions must be converted into
reductions in resource spending, or the efforts have been in vain.

134
5–21
1. Nonvalue-added costs:

Materials (400,000 – 380,000)$21 $ 420,000

Labor (96,000 – 91,200)$12.50 60,000
Setups (6,400 – 0)$75 480,000
Materials handling (16,000 – 0)$70 1,120,000
Warranties (16,000 – 0)$100 1,600,000
Total $ 3,680,000
Units produced and sold ÷ 20,000
Unit nonvalue-added cost $ 184

Current cost less nonvalue-added cost:

$640 – $184 = $456

This is much less than the Santa Clara plant’s cost of $560. Thus, matching the
Santa Clara cost is possible and so is the target cost for expanding market share.
How quickly the cost reductions can be achieved is another matter. Since the
Santa Clara plant has experience in achieving reductions, it may be possible to
achieve at least a cost of $560 within a reasonably short time. As plant manager,
I would borrow heavily from the Santa Clara plant experience and attempt to
reduce the nonvalue-added costs quickly. I would also lower the price to $624
and seek to take advantage of the increased market share— even if it meant a
short-term reduction in profits.

2. Benchmarking played a major role. The Santa Clara plant set the standard and
offered to share information on how it achieved the cost reductions that enabled
it to lower its selling price. The Lincoln plant responded by accepting the offer
of help and taking actions to achieve the same or greater cost reductions.
5–22
1. First quarter: Setup time standard = 8 hours (based on the planned
improvement: 12 hours – 4 hours of reduced time)
Second quarter: Setup time standard = 4 hours (based on the planned improvement:
9 hours – 5 hours)

2. Kaizen subcycle:

• Plan (4-hour reduction from process redesign.)

• Do (Try out setup with new design.)
• Check (Time required was 9 hours, a 3-hour reduction.)

135
 • Act (Lock in 3-hour improvement by setting new standard of 9 hours and
using same procedures as used to give the 9-hour outcome; simultaneously,
search for new improvement opportunity—in this case, the suggested
changes of the production workers.)

Repeat Kaizen subcycle:

• Plan (5-hours reduction from setup procedure changes.)

• Do (Train and then implement procedures.)
• Check (Actual time required was 3 hours, a 6-hour reduction.)
• Act (Lock in improvement by setting standard of 3 hours and begin search
for new improvement.)

3. Maintenance subcycle:

First quarter:

• Establish standard (9 hours based on improved process design.)

• Do (Implement repetitively the improved standard.)
• Check (See if the 9-hour time is maintained.)
• Act (If the 9-hour time deteriorates, find out why and take corrective action
to restore to 9 hours.)

Second quarter: Same cycle using 3 hours as the new standard to maintain.

Note: The maintenance cycle begins after observing the actual improvement. The
actual improvement is locked in.

5–22 Concluded

4. Nonvalue-added cost saved (eliminated): $300 × 6 hours savings = $1,800 per

setup. Kaizen costing is concerned with improving activity performance and
uses root causes to help identify initiatives for improvement. Thus, kaizen is a
tool or means for implementing ABM concepts.

5. Kaizen costing emphasizes constantly searching for process improvements

with the standard changing with each improvement. This search involves all
employees (e.g., engineers and production workers). Thus, kaizen costing
focuses on processes and uses dynamic standards, which are characteristics
of activity-based responsibility accounting. Standard costing uses only the
maintenance subcycle. Standards are set and maintained—they are static in

136
 nature and thus consistent with the financial-based responsibility accounting
model.

5–23
1. Cost per account = $4,070,000/50,000 = $81.40
Average fee per month = $81.40/12 = $6.78*

*Rounded

2. Activity rates:

Opening and closing accounts: $200,000/20,000 = $10 per account

Issuing monthly statements: $300,000/600,000 = $0.50 per statement

Processing transactions: $2,050,000/20,500,000 = $0.10 per transaction

Customer inquiries: $400,000/2,000,000 = $0.20 per minute

Providing ATM services: $1,120,000/1,600,000 = $0.70 per transaction

5–23 Continued
3. Costs assigned:
Low Medium High
Opening and closing:

$10 × 15,000 $ 150,000

$10 × 3,000 $ 30,000

$10 × 2,000 $ 20,000

Issuing monthly statements:

$0.50 × 450,000 225,000

$0.50 × 100,000 50,000

$0.50 × 50,000 25,000

Processing transactions:

137
 $0.10 × 18,000,000 1,800,000

$0.10 × 2,000,000 200,000

$0.10 × 500,000 50,000

Customer inquiries:
$0.20 × 1,000,000 200,000

$0.20 × 600,000 120,000

$0.20 × 400,000 80,000

Providing ATM services:

$0.70 × 1,350,000 945,000

$0.70 × 200,000 140,000

$0.70 × 50,000 35,000

Total cost $ 3,320,000 $540,000 $210,000
Number of accounts ÷ 38,000 ÷ 8,000 ÷ 4,000
Cost per account $ 87.37 $ 67.50 $ 52.50

Average profit per account: $90.00 – $81.40 = $8.60

ABC profit measure:

Low-balance customers: $80 – $87.37 = $(7.37)
Medium-balance customers: $100 – $67.50 = $32.50
High-balance customers: $165 – $52.50 = $112.50

5–23 Concluded
4. First, calculate the profits from loans, credit cards, and other products by
customer category (using ABC data). Next, compare 50 percent of the cross
sales profits from low-balance customers with the total loss from the lowbalance
checking accounts. If the cross sales profits are greater than the loss, the
president’s argument has merit.

5–24
1. GAAP mandates that all nonmanufacturing costs be expensed during the period
in which they are incurred. GAAP are the most likely cause of the practice. The
limitations of GAAP-produced information for cost management should be
emphasized.

138
2. The total product consists of all benefits, both tangible and intangible, that a
customer receives. One of the benefits is the order-filling service provided by
Sorensen. Thus, it can be argued that these costs should be product costs and
not assigning them to products undercosts all products. From the information
given, there are more small orders than large (50,000 orders averaging 600 units
per order); thus, these small orders consume more of the orderfilling resources.
They should, therefore, receive more of the order-filling costs.

The average order-filling cost per unit produced is computed as follows:

$4,500,000/90,000,0001 units = $0.05 per unit

1 (50,000 orders * 600 units per order) + (30,000 orders * 1,000 units per order) +
(20,000 orders * 1,500 units per order) = 90,000,000 units

Thus, order-filling costs are about 6 to 10 percent of the selling price, clearly not a
trivial amount.

Furthermore, the per-unit cost for individual product families can be computed
using the number of orders as the activity driver:

Activity rate = $4,500,000/100,000 orders

= $45 per order

The per-unit ordering cost for each product family can now be calculated:
Category I: $45/600 = $0.075 per unit
Category II: $45/1,000 = $0.045 per unit
Category III: $45/1,500 = $0.03 per unit

Category I, which has the smallest batches, is the most undercosted of the three
categories. Furthermore, the unit ordering cost is quite high relative to

5-24 Concluded

Category I’s selling price (9 to 15 percent of the selling price). This suggests that
something should be done to reduce the order-filling costs.

3. With the pricing incentive feature, the average order size has been increased to
2,000 units for all three product families. The number of orders now processed
can be calculated as follows:

139
 Orders = [(600 × 50,000) + (1,000 × 30,000) + (1,500 × 20,000)]/2,000
= 45,000

Reduction in orders = 100,000 – 45,000 = 55,000

Steps that can be reduced = 55,000/2,000 = 27 (rounding down to nearest whole

number)

There were initially 50 steps: 100,000/2,000

Reduction in resource spending:

Step-fixed costs: $50,000 × 27 = $1,350,000

Variable activity costs: $20 × 55,000 = 1,100,000
$2,450,000

Customers were placing smaller and more frequent orders than necessary. They
were receiving a benefit without being charged for it. By charging for the benefit
and allowing customers to decide whether the benefit is worth the cost of
providing it, Sorensen was able to reduce its costs (potentially by shifting the
cost of the service to the customers). The customers, however, apparently did
not feel that the benefit was worth paying for and so increased order size. By
increasing order size, the number of orders decreased, decreasing the demand
for the order-filling activity, allowing Sorensen to reduce its order-filling costs.
Other benefits may also be realized. The order size affects activities such as
scheduling, setups, and material handling. Larger orders should also decrease
the demand for these activities, and costs can be reduced even more.

Competitive advantage is created by providing the same customer value for less
cost or better value for the same or less cost. By reducing the cost, Sorensen
can increase customer value by providing a lower price (decreasing customer
sacrifice) or by providing some extra product features without increasing the
price (increasing customer realization, holding customer sacrifice constant).
This is made possible by the decreased cost of producing and selling the bolts.
5–25
1. Supplier cost:

First, calculate the activity rates for assigning costs to suppliers:

Replacing engines: $3,200,000/4,000 = $800 per engine

140
 Expediting orders: $4,000,000/400 = $10,000 per late shipment Repairing
engines: $7,200,000/5,000 = $1,440 per engine

Next, calculate the cost per engine by supplier:

Supplier cost:
Watson Johnson
Purchase cost:
$900 × 72,000 $64,800,000
$1,000 × 16,000 $16,000,000

Replacing engines:
$800 × 3,960 3,168,000

$800 × 40 32,000

Expediting orders:
$10,000 × 396 3,960,000

$10,000 × 4 40,000

Repairing engines:
$1,440 × 4,880 7,027,200

$1,440 × 120 172,800

Total supplier cost $ 78,955,200 $16,244,800
Units supplied ÷ 72,000 ÷ 16,000
Unit cost $ 1,096.60 $ 1,015.30

The Johnson engine costs less when the full supplier effects are considered. This
is a better assessment of cost because it considers the costs that are caused by
the supplier due to poor quality, poor reliability, and poor delivery performance.

2. In the short run, buy 40,000 from Johnson and 48,000 from Watson. In the long
run, one possibility is to encourage Johnson to expand its capacity; another
possibility is to encourage Watson to increase its quality and maintain
purchases from both sources.

MANAGERIAL DECISION CASE

141
5–26
1. Tim and Jimmy have been friends for a long time. The one-time nature of the
request and the alleged effect a redesign would have on Jimmy’s career
opportunity both create strong pressure for Tim to provide the requested
cooperation. Of course, even without any specific ethical standards, it is fairly
easy to see that falsification of reports to help ensure a promotion is not the
right thing to do. Tim should turn down the request and make every effort to help
Jimmy find a solution that will benefit him and the company. For example, Tim
might be able to use his influence to obtain extra development capital, including
a sufficient amount to expedite the development so that the production dates
can still be met.

2. If Tim cooperates, he will violate (at least) the following ethical standards (see
Chapter 1): competence standard I-3 (Provide decision support information and
recommendations that are accurate, clear, concise, and timely); integrity
standards III-1 and III-2: and credibility standards IV-1 and IV-2.

3. Tim should follow any relevant organizational policies bearing on matters such
as these. If these policies do not apply, then he should discuss the problem with
his supervisor (the divisional manager). If satisfactory resolution is not obtained
here, then the issues should be submitted to the next higher management level.
Certainly, the actions described here would place Tim in an awkward position.
Even though he has not willingly cooperated, a passive reaction could later be
construed as implicit involvement. Thus, some action such as that outlined is
strongly recommended.

RESEARCH ASSIGNMENT

5–27
Answers will vary.

142