Value- and Nonvalue-Added Costs
Waterfun Technology produces engines for recreational boats. Because of competitive pressures, the company was making an effort to reduce costs. As part of this effort, management implemented an activity-based management system and began focusing its attention on processes and activities. Purchasing was among the processes (activities) that were carefully studied. The study revealed that the number of purchase orders was a good driver for purchasing costs. During the last year, the company incurred fixed receiving costs of $630,000 (salaries of 15 employees). These fixed costs provide a capacity of processing 72,000 receiving orders (7,200 per employee at practical capacity). Management decided that the efficient level for purchasing should use 36,000 receiving orders.
1. Conceptual Connection: Explain why receiving would be viewed as a value-added activity. List all possible reasons. Also, list some possible reasons that explain why the demand for purchasing is more than the efficient level of 36,000 orders.
2. Break the cost of receiving into its value-added and nonvalue-added components.
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