Example: Cost Management in the Procurement System
During the procurement process, Company 200 believes it is incurring extra costs because its bicycle bags come from both domestic and non-domestic suppliers. The company has observed that some materials are delivered directly to the shop floor while others go through receiving, sorting, and quality inspection prior to being placed in inventory. Therefore, the company wants to use activity-based costing techniques to analyze the extra costs of procuring bicycle bags and determine how much of the cost can be attributed to whether it uses a domestic supplier.
This activity-based costing scenario is designed to analyze the cost of the procurement process for two different suppliers. Transactions originate from the following sources:
Expenditures - Procurement.
Quality - Procurement.
Inventory carry costs - General Ledger.
Miscellaneous, such as time to receive and sort bags - Cost Analyzer.
The company procures bicycle bags from two different suppliers. One is a domestic supplier; the other is not. The company has a special contract with the non-domestic supplier. This supplier can provide the bags at a lower cost (including duty fees) than the domestic supplier, and it imprints a logo onto the bags at no extra charge. The company places electronic orders with this supplier for both plain and imprinted bags. However, the company must process additional paperwork for customs and other regulatory requirements. The supplier requires a three month lead time. Therefore, the bags are shipped in very large quantities four times a year.
When the company receives the bags, it must inspect the merchandise quality for possible problems such as ink bleed from printing the logo. The inspection department averages a 90 percent pass rate. All rejected bags are scrapped because it is too costly to return them to the supplier. Next, the plain and logo-imprinted bags are separated from each other.
Upon completion of the inspection, the bags are placed into inventory and pulled out of stock on an as-needed basis. To assure sufficient inventory is available, the company carries a small safety stock of the bags.
The company also uses a domestic bicycle bag supplier for plain black bags. If the customer requests custom logo imprints on the bags, the company can pay the supplier a nominal fee for its imprinting service and then charge the customer for the printing.
The company uses a Kanban replenishments method. When the Kanban is empty, it is replenished with stock from the stockroom. When the stockroom Kanban is empty, an electronic purchase order is created to request that the supplier automatically replenish bicycle bags when the stock is needed. The supplier delivers small quantities of bags within a two day lead time directly to the storeroom. Due to the quality of bags, they average a 98 percent pass rate. If the shop floor rejects a bag, a credit request is submitted to accounting and the bag is scrapped.
As a result of analyzing the procurement process, the company identifies extra steps that incur hidden costs for receiving, sorting, inspecting, and carrying inventory for the non-domestic supplier. Therefore, they would like to analyze the extra costs that are related to these steps to determine how much can be attributed to each supplier.