ISSN 1940-204X
Costs for Decision Making: An Instructional Case of Relevant
Costs and Differential Analysis of Cost Reduction Alternatives
Scott McGregor, DPS, CMA, CPA
Assistant Professor of Accounting
Fairleigh Dickinson University
INTRODUCTION
IMPACT ON SHORT-TERM PROFITS
This case is based on a real-life project and takes place in
2010 at the New York City headquarters for the United
States operations of AC Global, Inc. (The real name has
been changed.) AC Global is a multinational insurance
company with its headquarters in France and annual
revenue ranking in the top 10 companies globally. The
company has significant operations in the United States,
Europe, Japan, and Australia, and the operations in each
country are separate insurance companies and operate with
a large degree of autonomy. Recently, AC Global established
insurance operations and a servicing center in India. The
servicing center in India primarily provides some information
technology (IT) support for the insurance operations in the
United Kingdom (U.K.), Belgium, and France. The ongoing
global recession has significantly decreased the profitability
of AC Global, increasing the importance of reducing costs.
AC Global’s operations in the U.S. (AC-US) sell life and
annuity products and represent approximately 20% of the
group’s life and annuity revenues. AC-US has approximately
3,000 employees, with about 1,000 employees based in the
New York City headquarters. The remaining employees
are located at the company’s service centers in New Jersey,
Pennsylvania, and North Carolina.
For an insurance company, there are four key line items
on the income statement: premium revenue, investment
income, benefits/claims expense, and operating expenses.
Operating expenses provide the greatest opportunity for
short-term improvement in earnings since the other line
items are less controllable or the impacts of changes emerge
over a long period of time. Investment income is primarily
composed of interest and dividends on bonds and common
stock investments and is not changed through operating
actions. Premium revenue is composed of fees collected
for providing insurance coverage and is only modestly
impacted by current sales. Benefits and claims are paid to
policyholders and their beneficiaries and are also difficult to
impact in the short-term.
The global economic downturn that began in late 2008
put intense pressure on the financial services industry.
During 2009, U.S. sales of annuity products decreased
by 30% while life insurance sales fell by 15%.1 Like the
industry, AC Global has been negatively impacted by
the economic downturn. AC-US premium revenue fell
8% cumulatively between 2007 and 2009. In 2010, the
company’s operations remained stable, but revenue was
expected to be similar to 2009.
AC Global’s operating earnings decreased over 80% from
2007 to 2008, and AC-US suffered an operating loss in 2008.
IM A ED U C ATIO NA L C A S E JOURNAL
1
VOL. 9, N O. 3, ART. 3, SEPTEMBER 2016
©2 0 1 6 I MA
Although operating earnings recovered somewhat in 2009
(shown in Figure 1), the earnings for AC Global consolidated
and AC-US are still 36% and 40%, respectively, below those
in 2007. As a result, the company’s stock price is down nearly
50% since the beginning of the crisis in 2008.
AC-US measures operating efficiency based on the
expense ratio, which is operating expenses divided
by premium revenue. In 2004, AC-US went through
a restructuring that reduced personnel overlap and
inefficiency. Through the restructuring, AC-US reduced the
workforce by 4%, reduced operating expenses by 5%, and
improved the expense ratio from 12.7% in 2004 to 10.1%
by 2007, 14% better than the expense ratio of 11.7% for AC
Global. While operating expenses have grown modestly at
2% since 2007, the expense ratio for AC-US increased from
10.1% in 2007 to over 12.5% in 2009, worse than the 12.1%
for AC Global. AC-US has underperformed AC Global in
earnings and cost efficiency during 2009, which is concerning
for the management of AC-US (see Figure 2).
functions in the service center in India and gave George the
contact information for Sanjay Delphi, the project manager
for the company’s India facility.
George believes that in addition to outsourcing
(offshoring), increasing the use of electronic payments
in accounts payable and relocating some of accounting
functions to the service center in N.J. are two other viable
ways to reduce costs. George made notes on information
regarding expenses relevant for the analysis, including the
severance policy (see Table 7, section F).
George also pulled up the organization chart to list all of the
various accounting functions as well as their annual expense
budgets (Table 1). He assembled information on the staff
in each of the accounting functions, including their salaries,
benefits, residence, and possible severance based on the years
of service and prepared a summary by function (see Table 6).
George meets with two of his team members, Samantha
Charleston and Ryan Falkirk, to explain the project. Given
the one-week turnaround time for the analysis, George
suggests that each of them select one option to analyze
over the next four days and then meet to develop their
recommendations. George selects offshoring, Charleston
decides to analyze electronic check processing, and Falkirk
will analyze relocating accounting functions.
COST REDUCTION ANALYSIS PROJECT
Peter George is a vice president responsible for financial
planning and analysis (FP&A) at AC-US in New York.
In his role, George and his team evaluate all significant
projects with financial implications. George led the team that
analyzed and recommended the restructuring six years ago
that significantly improved the expense ratio.
George met with Brian Thomas, the chief financial officer
(CFO). Thomas had reviewed the first quarter preliminary
revenue and earnings and told George that it is imperative
for the company to find ways to reduce expenses to improve
earnings. He set a goal of a 10% reduction in operating
expenses. If AC-US achieved that goal, he estimated that
the company would return the expense ratio to a value below
11% and operating earnings would return to 2007 levels.
Before engaging the rest of the organization, the CFO
would like the functions he manages to take a leadership
position in the cost reductions—not just recommending costreduction actions but also providing examples to show they
are effective. Thomas reviewed the accounting function first
and decided he wants it to reduce expenses by 10% overall
to be in line with the company’s overall target. He also would
like to see a payback period of two years or less for any onetime costs.
Thomas asked George to evaluate potential cost-saving
alternatives and provide him with a preliminary analysis
within one week. Thomas then informed George that the
company has recently began performing some accounting
IM A ED U C ATIO NA L C A S E JOURNAL
OFFSHORING
George reviews some general information on offshoring and
finds that global offshoring has grown rapidly. He finds that
accounting processes such as accounts payable, accounts
receivable, sales ledger, general ledger, financial reporting,
and bank processing are increasingly offshored.2
George calls Delphi to discuss the services performed
at the servicing center in India. Delphi informs George that
the service center currently provides some IT support for
the insurance operations in the U.K., Belgium, and France;
performs some customer service functions; and also recently
added a few accounting functions. Delphi emphasized
that the service center is just beginning to add staff with
accounting expertise and has minimal knowledge of U.S.
generally accepted accounting principles (GAAP) state
regulatory accounting requirements, and U.S. tax law (the
U.S. Internal Revenue Code).
George determines that the first step in his analysis is
to identify which accounting functions would be the best
candidates for offshoring and then analyze the financial and
logistical feasibility of doing that. George prepares a matrix
to assist him in analyzing which functions would be the
most appropriate to offshore (see Table 2). His matrix takes
2
VOL. 9, N O. 3, ART. 3, SEPTEMBER 2016
into account required skill levels, local knowledge (of the
U.S. Internal Revenue Code, for example), compliance risk,
technological support, and the need for direct management
oversight—which may be difficult due to distance and
differences in time zones. He rates the functions on each of
the criteria as high, medium, and low.
George concludes that the functions that score low or
medium on all of the criteria would be the best candidates
for outsourcing. Based on the matrix, he believes that the
accounts payable and bank reconciliation functions are the
best candidates for initial consideration.
The accounts payable function has a separate manager
while the bank reconciliation function reports to the manager
of general accounting. The Bank Reconciliation Department
prepares 50 reconciliations per month (600 per year), and
the Accounts Payable Department processes 50,000 checks
per month (600,000 per year). George reviews the annual
expense budgets (provided in Table 3).
George sends Delphi an email and requests information
on the accounts payable and bank reconciliation service
functions. Delphi responds that the charges for outsourced
services for accounts payable and bank reconciliation are a
base monthly fee of $1,250 for each function ($15,000 per
year) plus $0.65 per payment for processing accounts payable
and $200 per bank reconciliation.
Delphi also informs George that the U.S.-based
operations would need to maintain staff to coordinate the
transfer of information. Based on a similar project being
undertaken by the company’s U.K. operations, Delphi
estimates that one staff member within the Accounting
Department should be sufficient to support both accounts
payable and bank reconciliations. Delphi and George discuss
the necessary skills. George believes that retaining the
accounts payable manager, who likely has the necessary
skills, would be a good solution—and he uses that
assumption for his analysis.
The accounts payable manager’s annual salary is $75,000.
The allocated benefits charge is $18,750, but actual benefits
and taxes are $19,488. George estimates that the cost for a
personal computer, supplies, travel, and all other expenses
(excluding postage) would total $15,500. He assumes that
the salary, benefits and other expenses associated with the
manager would be allocated 65% to accounts payable and
35% to bank reconciliations based upon the estimated time
requirements to support each function. George does not
include the allocation of rent, corporate expenses, or 50% of
IT support in his cost-reduction estimate.
Delphi also gives George the data transfer and
connectivity specifications to discuss with the IT
IM A ED U C ATIO NA L C A S E JOURNAL
Department. Josephine Young, of the IT Department,
analyzes the requirements and informs George that they
would need to improve connectivity and alter the time of
the batch processing for accounts payable. She estimates
there would be a one-time cost of $100,000 plus $2,500 per
month for improved connectivity. The change in the batch
processing time will also cause an increase in personnel costs
of $2,500 per month. But there are no additional technology
requirements for offshoring bank reconciliations.
AUTOMATING ELECTRONIC PAYMENTS
Charleston performs some background research on electronic
payments. She finds that the use of electronic payments
has increased substantially as the number of checks used
in business-to-business transactions rose. The use of paper
checks decreased by 5% from 2006 to 2009.3 The estimated
savings from using electronic payment instead of paper
checks ranged from 20% to 90%.4
Since the accounts payable function issues all of its
payments as checks, Charleston believes that there may
be significant savings if the company made greater use of
electronic payments. Charleston contacts the company’s
corporate banking representative to inquire about electronic
payments alternatives. She finds that the bank charges an
average of $0.125 per electronic payment. The bank also
provides Charleston with a contact at a company that recently
adopted electronic payments (identified as Company XYZ).
As a means to estimate the potential impacts, she
contacts Company XYZ’s treasurer to discuss how it
impacted their staffing needs and costs and is informed
that Company XYZ averaged 2 minutes in labor per manual
check and only 1.5 minutes for each electronic payment. For
recurring payments, Company XYZ experienced an 80%
time savings annually. To support her analysis, Charleston
requests and receives a report showing the number of the
company’s checks that are recurring to vendors as well as
those to employees and business partners, which are good
candidates for electronic payments (see Table 4).
Based on her preliminary analysis, Charleston estimates
that the company could process up to 50% of its current
payments electronically. Using the results for Company XYZ
as a proxy, she estimates that electronic payments would
reduce processing time by 25% for each electronic payment.
Since recurring payments require minimal work after initial
set-up, the potential estimated time savings is 80%. Since 16%
of payments are recurring, labor savings would be possible.
Charleston estimates that electronic payment processing
would reduce staff, with associated reductions in salaries and
3
VOL. 9, N O. 3, ART. 3, SEPTEMBER 2016
benefits as well as other associated costs. To estimate the
impact on staff, she uses 10 employees processing 600,000
checks annually and assumes that 50% of the payments
could become electronic.5 To calculate the potential savings
in salaries and benefits, she assumes that the staff reductions
would involve less-experienced staff and represent 15% of
total salaries and benefits for accounts payable. She estimates
also that there would be savings in personal computer (PC)
costs, IT support, and other costs of $1,775 per employee.
Additionally, there would be a reduction in postage costs in
direct proportion to the reduction of the number of checks.
These savings would be partially offset by an additional cost
of $0.125 for each electronic payment that replaces a check.
Further, she uses the information from Table 6 to estimate
that severance costs would represent 15% of the maximum
eligible severance for accounts payable.
of employees that would be retained and the potential
severance costs if a portion of the accounting functions are
relocated to N.J.
He assumes that department heads and their assistants
would have offices in both the corporate headquarters and
the N.J. location. He estimates that 250 square feet of
office space per position will be needed for each employee
relocated from the New York office and a comparable
amount would be available for subleasing. He assumes
100% of all employees who are N.J. residents would be
retained. Of the residents not in New Jersey, he assumes all
department heads and their assistants would remain while
all other employees not from New Jersey would terminate,
and severance would be paid to any employee not relocating.
Information regarding the company’s severance policy is
provided in Table 7, section F, and summary employee
information by department is in Table 6.
RELOCATION
INTERACTION OF ALTERNATIVES
Falkirk meets with the head of corporate facilities to discuss
the availability of space in the N.J. service center and the
possibility of subleasing any excess space created in the New
York office. The head of facilities states that the company
currently has more than 4,000 square feet of excess space
in N.J. There also is up to an additional 28,500 square feet
of space available in the building that could be leased for
approximately $25 per square foot. But space must be leased
in blocks of 9,500 square feet, which is equivalent to one
floor in the building.
Also, the head of facilities states that the company
currently has approximately 3,500 square feet of excess
space in the New York office and could sublease the space
in blocks of 10,000 square feet (equivalent to one floor). But
if a block or blocks of 10,000 square feet of space cannot
be created, the available space could not be subleased.
Given current real estate prices, he estimated the sublease
rent would be $65 per square foot. Based on past moves,
he estimates the costs to move employees and set up new
workstations average $1,000 per position in the new space
plus $50,000 per floor to build out and wire the new space.
Falkirk prepares a grid (see Table 5) highlighting the
level of management and interdepartment interaction as well
as the number of N.J. resident employees in each function.
He believes that those functions with the lowest level of
interdepartment and management interaction would be best
for possible relocation and selects the departments with low
to medium interdepartment rankings. Additionally, Falkirk
prepares a summary list of employees by function and
their residence (see Table 6) to estimate the likely number
IM A ED U C ATIO NA L C A S E JOURNAL
If the company only outsources bank reconciliations, the
team has assumed that the bank reconciliation department
will need to retain the most experienced employee to
support the process. The most experienced employee in the
department has eight years of service, a salary of $48,000,
health insurance costs of $10,000, 401(k) contributions at
5%, and payroll taxes of 7.65%. In addition to the savings
in salaries and benefits for the positions eliminated in bank
reconciliations, it is also estimated that there would be a
savings of $8,000 in total for expenses other than salaries
and benefits. The one time initial costs would consist of
severance costs for the positions eliminated.
CASE QUESTIONS
Provide responses, displaying all work, to the following
questions:
1. General Questions:
a.
What costs are relevant to each of the three
alternatives: offshoring, relocating functions, and
automating functions?
b. What are some of the nonfinancial considerations
associated with each of these alternatives?
2. Offshoring Analysis:
a.
Based on George’s assumptions that all of the
remaining supervisor’s costs are split 65% to accounts
payable and 35% to bank reconciliation, and all
incremental ongoing technology costs and postage
4
VOL. 9, N O. 3, ART. 3, SEPTEMBER 2016
ENDNOTES
costs are charged to accounts payable, calculate the
annual savings per function through offshoring.
b. What would the impact be on AC-US’s costs for the
next three years if the two accounting functions are
performed in India instead of in the U.S.? (Be sure
to include severance in the one-time costs, using
information from Table 6 and assume zero inflation).
nnual Report on the Insurance Industry, Federal Insurance
A
Office of the U.S. Treasury, June 2013.
1
ora Palugod and Paul A. Palugod, “Global Trends in
N
Offshoring and Outsourcing,” Internal Journal of Business and
Social Science, September 2011.
2
3. Electronic Processing:
“ The 2010 Federal Reserve Payments Study: Noncash
Payment Trends in the United States: 2006 - 2009,” updated
April 5, 2011, Federal Reserve System.
3
a.
Using the information that Charleston gathered
on electronic payment processing, determine the
potential staff reduction and calculate the potential
annual cost savings from electronic processing of 50%
of the accounts payable checks.
b. If AC-US outsources bank reconciliations and/
or accounts payable, what would be the maximum
combined savings of electronic payments and
outsourcing over the next three years, including the
one-time costs? (Be sure to include severance costs,
using information from Table 6, in the one-time costs).
atthew Heller, “Electronic Payments 10 Times Cheaper
M
Than Checks,” CFO.com, October 12, 2015.
4
stimated staff reduction based on 600,000 checks supported
E
by 10 full-time employees (FTEs). Estimate 300,000 checks,
or 50%, with similar level of FTE support per check. The
necessary FTEs to support electronic payments (34% of
payments) assume 25% time savings for electronic payments.
The remaining 16% of payments are recurring electronic
payments and estimate an 80% time savings.
5
4. Relocation:
a.
Using the information that Falkirk gathered on
potential real estate savings through relocation,
estimate the annual cost savings available through
relocating some or all of the accounting functions to
New Jersey.
b. What are the impacts on AC-US’s costs over the next
three years, including the one-time costs? (Be sure to
include severance costs, using information from Table
6, in the one-time costs).
ABOUT IMA®
IMA, the association of accountants and financial professionals
in business, is one of the largest and most respected associations
focused exclusively on advancing the management accounting
profession. Globally, IMA supports the profession through
research, the CMA® (Certified Management Accountant)
program, continuing education, networking, and advocacy of the
highest ethical business practices. IMA has a global network of
more than 80,000 members in 140 countries and 300 professional
and student chapters. Headquartered in Montvale, N.J., USA,
IMA provides localized services through its four global regions:
The Americas, Asia/Pacific, Europe, and Middle East/Africa.
For more information about IMA, please visit www.imanet.org.
5. Recommendation:
Based on your analysis, recommend a course of action
for AC-US. Remember Thomas’s goal of 10% reduction
in the expenses for the accounting function. Your
alternatives include retaining operations as they are,
adopting electronic payments for accounts payable,
relocating accounting functions, and/or offshoring
functions. You may recommend a combination of any of
the alternative cost savings approaches.
IM A ED U C ATIO NA L C A S E JOURNAL
5
VOL. 9, N O. 3, ART. 3, SEPTEMBER 2016
Figure 1: Operating Earnings ($ in millions)
9,000
8,000
7,000
6,000
5,000
4,000
3,000
2,000
1,000
(1,000)
AC Global
AC-US
2004
2005
2006
2007
2008
2009
Figure 2: Operating Expense Ratio for AC Global vs. AC-US
14.0%
13.0%
AC Global
12.0%
AC-US
11.0%
10.0%
2004
2005
2006
2007
2008
IM A ED U C ATIO NA L C A S E JOURNAL
2009
6
VOL. 9, N O. 3, ART. 3, SEPTEMBER 2016
Table 1: Accounting Department Expense Budget Summary
Annual Salaries
Annual Benefits Load
All Other
Total Budgeted
Expenses
8
$802,000
$200,500
$176,500
$1,179,000
12
812,000
203,000
170,000
1,185,000
Tax management
2
250,000
62,500
72,500
385,000
Controller
2
285,000
71,250
68,750
425,000
SEC reporting
7
525,000
131,250
158,750
815,000
U.S. GAAP reporting
7
575,000
143,750
126,250
845,000
Regulatory financial reporting
6
525,000
131,250
118,750
775,000
Management reporting
6
455,000
113,750
106,250
675,000
Cost accounting
6
385,000
96,250
98,750
580,000
General accounting
10
628,000
157,000
100,000
885,000
Accounts payable
10
470,000
117,500
393,750
981,250
Bank reconciliations
5
215,000
53,750
61,750
330,500
Planning and budgeting
4
325,000
81,250
88,750
495,000
Financial analysis
8
685,000
171,250
108,750
965,000
93
$6,937,000
$1,734,250
$1,849,500
$10,520,750
Function
Number of
Employees
Federal tax preparation
State tax preparation
Totals
Table 2: Matrix of Potential Accounting Functions for Outsourcing
Skill Level
Required
Local Knowleged
Required
Mgmt. Support/
Interaction
Technology
Support Required
Compliance Risk
Federal tax preparation
Medium
High
Low
Low
High
State tax preparation
Medium
High
Low
Low
High
High
High
High
Low
Medium
SEC reporting
High
High
Medium
Medium
High
U.S. GAAP reporting
High
High
Medium
Medium
High
Regulatory reporting
Medium
High
Medium
Medium
High
Management reporting
Medium
Medium
High
Medium
Low
Cost accounting
Medium
Low
Medium
Medium
Medium
General accounting
Medium
Medium
Medium
Medium
Medium
Accounts payable
Low
Low
Low
Medium
Low
Bank reconciliations
Low
Low
Low
Low
Low
Planning and budgeting
Medium
Medium
High
Medium
Low
Financial analysis
Medium
Medium
High
Low
Low
Function
Tax Department
Tax planning
Controller’s Department
Financial Planning and Analysis
IM A ED U C ATIO NA L C A S E JOURNAL
7
VOL. 9, N O. 3, ART. 3, SEPTEMBER 2016
Table 3: 2010 Detailed Expense Budget for Accounts Payable
and Bank Reconciliations
Expense
Accounts
Payable
Bank
Reconciliations
Salaries
$470,000
$215,000
Benefits load
117,500
53,750
Rent and related
64,000
42,000
Supplies
16,750
1,750
PCs
12,000
6,000
IT support
11,500
6,000
270,000
–
11,500
3,000
8,000
3,000
$981,250
$330,500
Postage
Travel and entertainment
Corporate expenses
Total
Table 4: Summary of Checks Processed per Month
Recurring
Business Partners/
Employees
(probably electronic)
Checks (monthly)
8,000
17,000
25,000
50,000
Percentage
16%
34%
50%
100%
All Others
Total
Table 5: Matrix for Evaluating Relocation Prospects
Function
Number of
Employees
Management
Interaction
Interdepartment
Interaction
Employee(s)
in N.J.
Tax Department
Federal tax preparation
State tax preparation
Tax planning and management
8
Low
Low
4
12
Low
Low
9
2
High
Medium
0
Controller’s Department
Controller
2
High
High
1
SEC reporting
7
Medium
Low
5
U.S. GAAP reporting
7
Medium
Low
5
Regulatory financial reporting
6
Medium
Low
4
Management reporting
6
Medium
High
4
Cost accounting
6
Medium
Low
5
General accounting
10
Medium
Low
9
Accounts payable
10
Low
Medium
7
5
Low
Low
3
Planning and budgeting
4
Medium
High
2
Financial analysis
8
High
High
6
Bank reconciliations
Financial Planning and Analysis
93
IM A ED U C ATIO NA L C A S E JOURNAL
64
8
VOL. 9, N O. 3, ART. 3, SEPTEMBER 2016
Table 6: Summary Employee Information for Severance Calculations
Actual Costs
Number of
Employees
Weeks of Eligible
Severance
Total Annual
Salaries
Benefits
Load
2
32
$250,000
$62,500
$17,200
$12,500
$19,125
N.J. residents
4
76
445,000
111,250
32,200
22,250
34,043
Non-N.J. residents
4
66
357,000
89,250
27,200
17,850
27,311
8
142
802,000
200,500
59,400
40,100
61,354
N.J. residents
9
140
627,000
156,750
76,600
31,350
47,966
Non-N.J. residents
3
52
185,000
46,250
20,000
9,250
14,153
12
192
812,000
203,000
96,600
40,600
62,119
2
28
285,000
71,250
15,000
14,250
21,803
N.J. residents
5
96
379,000
94,750
34,400
18,950
28,994
Non-N.J. residents
2
36
146,000
36,500
17,200
7,300
11,169
7
132
525,000
131,250
51,600
26,250
40,163
N.J. residents
5
74
413,500
103,375
37,200
20,675
31,633
Non-N.J. residents
2
30
161,500
40,375
12,200
8,075
12,355
7
104
575,000
143,750
49,400
28,750
43,988
N.J. residents
4
52
351,000
87,750
27,200
17,550
26,852
Non-N.J. residents
2
30
174,000
43,500
17,200
8,700
13,311
6
82
525,000
131,250
44,400
26,250
40,163
N.J. residents
4
52
303,000
75,750
27,200
15,150
23,180
Non-N.J. residents
2
30
152,000
38,000
17,200
7,600
11,628
6
82
455,000
113,750
44,400
22,750
34,808
N.J. residents
5
70
322,000
80,500
34,400
16,100
24,633
Non-N.J. residents
1
12
63,000
15,750
10,000
3,150
4,820
6
82
385,000
96,250
44,400
19,250
29,453
N.J. residents
9
128
559,000
139,750
69,400
27,950
42,764
Non-N.J. residents
1
18
69,000
17,250
7,200
3,450
5,279
10
146
628,000
157,000
76,600
31,400
48,042
Health
401(k)
Payroll Taxes
Tax Department:
Department head and assistant
Federal Tax
Total
State Taxes
Total
Controller’s Department:
Department head and assistant
SEC Reporting
Total
U.S. GAAP Reporting
Total
Regulatory Reporting
Total
Management Reporting
Total
Cost Accounting
Total
General Accounting
Total
IM A ED U C ATIO NA L C A S E JOURNAL
9
VOL. 9, N O. 3, ART. 3, SEPTEMBER 2016
Table 6: Summary Employee Information for Severance Calculations (continued)
Actual Costs
Number of
Employees
Weeks of Eligible
Severance
Total Annual
Salaries
Benefits
Load
N.J. residents
7
106
333,000
83,250
46,600
16,650
25,475
Non-N.J. residents
3
60
137,000
34,250
25,000
6,850
10,481
10
166
470,000
117,500
71,600
23,500
35,956
N.J. residents
3
42
137,000
34,250
30,000
6,850
10,481
Non-N.J. residents
2
24
78,000
19,500
12,200
3,900
5,967
5
66
215,000
53,750
42,200
10,750
16,448
Health
401(k)
Payroll Taxes
Accounts Payable
Total
a
Bank Reconciliation
Total
a
Financial Reporting & Analysis Department:
Budgeting
N.J. residents
2
28
177,000
44,250
12,200
8,850
13,541
Non-N.J. residents
2
26
148,000
37,000
15,000
7,400
11,322
4
54
325,000
81,250
27,200
16,250
24,863
N.J. residents
6
72
526,000
131,500
39,400
26,300
40,239
Non-N.J. residents
2
30
159,000
39,750
17,200
7,950
12,164
8
102
685,000
171,250
56,600
34,250
52,403
Total
Financial Analysis
Total
a
The severance and continuing benefits for the accounts payable manager total $29,073, and the severance and continuing benefits for the most experienced staff member in bank reconciliations is $19,714.
Note: When calculating severance using the total salaries, you must first find the average weekly salary (salaries/number of employees/52 weeks) and multiply by the number of weeks of severance. Follow a similar process for
health benefits. For 401(k) and payroll taxes, you may either follow the same process or apply the rate.
Table 7: Supplemental Information on Relevant Expenses
A. The benefits load of 25% of salaries is designed to represent the costs to provide health, dental and vision insurance, the employer contribution to the 401(k)
plan, and employer payroll taxes.
1. The company’s share of health benefits (including dental and vision insurance) is $10,000 per year for family (F), $7,200 for parent/children or employee/
spouse (P/C), and $5,000 for single (S) employees.
2. The employer portion of payroll taxes is 7.65% of salaries.
3. The company contribution to the 401(k) plan is 5% of salaries.
B. The company has eight years remaining on its lease and is unlikely to be able to reduce space unless it can create 10,000 square feet (one floor) of available
space for sublease. Based on an average of 250 square feet per employee, staff in the New York office would need to be reduced by 40 or more.
1. The company pays $65 in rent per square foot in New York. The standard workstation is approximately 250 square feet per employee, and office space of
a department head and assistant are 500 square feet in total.
2. The rent per square foot is $25 in the service center in N.J., located just across the Hudson River from the New York headquarters.
C. The corporate expense allocation is for the company cafeteria and an on-site gym; the company’s costs are unlikely to fall if staff in the Accounting Department
is reduced.
D. PCs are leased, and the company can return them with no penalty; 50% of the IT support costs are variable and can be saved when the PCs are eliminated.
E. The postage costs in accounts payable would not change by offshoring or relocation as the checks would be printed and mailed from the company’s office in
the U.S.
F. The company severance policy calls for two weeks of salary for each year of service with minimum payment of 12 weeks. Health benefits and retirement
plan contributions continue to be provided during the severance period. Payroll taxes would also apply.
IM A ED U C ATIO NA L C A S E JOURNAL
10
VOL. 9, N O. 3, ART. 3, SEPTEMBER 2016
Keep Accounts
Payable
Costs for Decision Making Case
Offshoring Decision
Quantitative Costs:
Accounts Payable Function
Annual Savings:
Function Performance by current employees
Less: Cost by Accounts Payable Manager
Other Department Costs
$
$
Checks Processed
Bank Reconcilation Function
$
Bank Reconciliations
Retain Accounts Payable Manager
Salary
Allocated Benefits
Actual Benefits
Other Costs (Compuer, Travel)
$
$
Allocation of Manager Expenses
IT Department Connectivity Upgrade
IT Personnel Batch Processing Costs
1,250.00 per month
0.65 per transaction processed
600,000 per year
1,250.00 per month
200 per bank reconciliation
600 per year
75,000
18,750
19,488
15,500
109,988
$
587,500.00
(71,012.50)
46,000.00
Outsourced Processing
Connectivity Upgrade
IT Personnel Batch Processing
562,487.50
Annual Accounts Payable Savings
$
1,687,462.50
$
1,687,462.50
Three year Accounts Payable Savings
65% Accounts Payable
35% Bank Reconciliation
100,000.00 one time charge
2,500.00 per month
2,500.00 per month
Table 3: Budgeted Costs
Salaries
Benefits load
Rent and related
Supplies
PCs
IT Support
Postage
Travel and Entertainment
Corporate expenses
Total
Accounts Payable
Bank Reconciliations
$
470,000 $
215,000
117,500
53,750
64,000
42,000
16,750
1,750
12,000
6,000
11,500
6,000
270,000
11,500
3,000
8,000
3,000
$
981,250 $
330,500
Qualitative (Nonfinancial) Costs:
Not all of the services are performed - only some IT, some customer service and some accounting
Delphi Outsourcing only has minimal knowlede of GAAP and IRC
Some tasks and skills require management oversight
George uses his own subjectivity to determine low, medium and high functions
Why are allocated benefits not the same as actual benefits? Is this a common problem throughout AC-US? Are situations bleaker than managers think?
How many weeks of severance does the Accounts Payable Manager have? Would have to deduct from Table 6. Can use average but probably higher than that.
Culture and reputation in community damaged by off-shoring
How would Trump view this now as he is trying to keep jobs in the U.S.?
In my analysis, I'm using budgeted salaries and benefits but actual salaries and benefits for severance. There is a mismatch here but actual seems to be correct given the decisions.
Keep Bank
Rec
Drop Bank Rec
$ 268,750.00
(38,237.50)
13,750.00
$
$
Annual Costs over Three Year Period
One Time Severance Costs
One Time IT Connectivity Upgrade
Drop Accounts
Payable
$
405,000.00
30,000.00
30,000.00
465,000.00
$
97,487.50
$ 1,395,000.00
172,688.01
100,000.00
$ 1,667,688.01
$
19,774.49
135,000.00
$ 244,262.50
$
135,000.00
$
109,262.50
$ 732,787.50
$
405,000.00
72,193.34
$ 732,787.50
$
477,193.34
$
255,594.16
Costs for Decision Making Case
Automating Electronic Payments Decision
Requirement 1: Samantha Charleston identified relevant costs but didn't complete the analysis.
Complete the analysis and determine total savings (if any) each year and for the three-year period.
Make sure to use formulas and calculations in the cells to arrive at your answer.
Process Checks As-Is
Quantitative Costs:
Decrease in use of paper checks from 2006-2009
Savings from use of electronic payments - Low end
Savings from use of electronic payments - high end
Bank charges for electronic payments
5%
20%
90%
$
Time to process paper check
Time to process electronic payment
Time savings on recurring payments
0.125 per electronic payment
2 minutes
1.5 minutes
80% annually
Table 3: Budgeted Costs
Salaries
117,500
Rent and related
Supplies
PCs
IT Support
Postage
64,000
16,750
12,000
11,500
270,000
Travel and Entertainment
Corporate expenses
Total
11,500
8,000
981,250
$
Table 4: Summary of Checks Processed per Month
Checks - Recurring
Percentage of total checks
Annual Costs over Three Year Period:
Severance Payments for Staff Reduction
Total Savings over Three Year Period
Requirement 2: Determine two qualitative (nonfinancial) costs relating to the automation of the
electronic payments decision.
Requirement 3: Would you automate the check processing? Why or why not?
8,000 monthly
16%
Business Parnters/Employees - Potential Electronic Payments
Percentage of total checks
17,000 monthly
34%
All other checks
Percentage of total checks
25,000
50%
Estimate of processing of current payments electronically
Reduction in processing time from electronic payments
Potential time savings from setting up recurring payments
50%
25%
80%
Labor Savings from Processing Payments:
Current Employees processing payments
Checks processed by employees
10
600,000 annually
$
Percentage of checks estimated to be processed electronically
Percentage of Staff Reductions of Accounts Payable
Savings in PC, IT support, other costs
Annual Cost (Savings):
Bank Charges of Processing Recurring Payments
Bank Charges of Processing other Electronic Payments
Savings in Salary Reductions
Savings in PC, IT support, other costs
Savings in postage costs
Accounts Payable
$
470,000
Benefits load
Calculated current costs related to time to process payment
Automate Check
Processing
1.02 per check
50%
$
15%
1,775.00 per employee
Reduction in postage costs by moving to electronic payments
50% direct proportion to reduction of checks
Percentage of Severance from Accounts Payable
15% of maximum Accounts Payable coverage
Department
Tax Department:
Department head and assistant
Federal Tax:
NJ residents
Non-NJ residents
State Taxes:
NJ residents
Non-NJ residents
Controller's Department:
Department head and assistant
SEC Reporting
NJ residents
Non-NJ residents
U.S. GAAP Reporting
NJ residents
Non-NJ residents
Regulatory Reporting
NJ residents
Non-NJ residents
Management Reporting
NJ residents
Non-NJ residents
Cost Accounting
NJ residents
Non-NJ residents
# of
Weeks of Eligible
Employees
Severance
Total Annual
Salaries
2
32 $
250,000
4
4
8
76 $
66
142 $
445,000
357,000
802,000
9
3
12
140 $
52
192 $
627,000
185,000
812,000
2
28 $
285,000
5
2
7
96 $
36
132 $
379,000
146,000
525,000
5
2
7
74 $
30
104 $
413,500
161,500
575,000
4
2
6
52 $
30
82 $
351,000
174,000
525,000
4
2
6
52 $
30
82 $
303,000
152,000
455,000
5
1
6
70 $
12
82 $
322,000
63,000
385,000
General Accounting
NJ residents
Non-NJ residents
Accounts Payable
NJ residents
Non-NJ residents
Bank Reconciliation
NJ residents
Non-NJ residents
Financial Reporting & Analysis Department
Budgeting
NJ residents
Non-NJ residents
Financial Analysis
NJ residents
Non-NJ residents
9
1
10
128 $
18
146 $
559,000
69,000
628,000
7
3
10
106 $
60
166 $
333,000
137,000
470,000
3
2
5
42 $
24
66 $
137,000
78,000
215,000
2
2
4
28 $
26
54 $
177,000
148,000
325,000
6
2
8
72 $
30
102 $
526,000
159,000
685,000
Actual Health Actual 401(k) Actual Payroll Total Actual
Benefits Load
Costs
Costs
Taxes
Payroll Costs
Average Salary
Cost per Week
$
62,500 $
17,200 $
12,500 $
19,125 $
48,825 $
2,403.85
$
115,250 $
89,250
204,500 $
32,200 $
27,200
59,400 $
22,250 $
17,850
40,100 $
34,043 $
27,311
61,354 $
88,493 $
72,361
160,854 $
2,139.42
1,716.35
1,927.88
$
156,750 $
46,250
203,000 $
76,600 $
20,000
96,600 $
31,350 $
9,250
40,600 $
47,966 $
14,153
62,119 $
155,916 $
43,403
199,319 $
1,339.74
1,185.90
1,301.28
$
71,250 $
15,000 $
15,250 $
21,803 $
52,053 $
2,740.38
$
94,750 $
36,500
131,250 $
34,400 $
17,200
51,600 $
18,950 $
7,300
26,250 $
28,994 $
11,169
40,163 $
82,344 $
35,669
118,013 $
1,457.69
1,403.85
1,442.31
103,375 $
40,375
143,750 $
37,200 $
12,200
49,400 $
20,675 $
8,075
28,750 $
31,633 $
12,355
43,988 $
89,508 $
32,630
122,138 $
1,590.38
1,552.88
1,579.67
87,750 $
43,500
131,250 $
27,200 $
17,200
44,400 $
17,550 $
8,700
26,250 $
26,852 $
13,311
40,163 $
71,602 $
39,211
110,813 $
1,687.50
1,673.08
1,682.69
75,750 $
38,000
113,750 $
27,200 $
17,200
44,400 $
15,150 $
7,600
22,750 $
23,180 $
11,628
34,808 $
65,530 $
36,428
101,958 $
1,456.73
1,461.54
1,458.33
80,500 $
15,750
96,250 $
34,400 $
10,000
44,400 $
16,100 $
3,150
19,250 $
24,633 $
4,820
29,453 $
75,133 $
17,970
93,103 $
1,238.46
1,211.54
1,233.97
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
139,750 $
17,250
157,000 $
69,400 $
7,200
76,600 $
27,950 $
3,450
31,400 $
42,764 $
5,279
48,043 $
140,114 $
15,929
156,043 $
1,194.44
1,326.92
1,207.69
83,250 $
34,250
117,500 $
46,600 $
25,000
71,600 $
16,650 $
6,850
23,500 $
25,475 $
10,481
35,956 $
88,725 $
42,331
131,056 $
914.84
878.21
903.85
34,250 $
19,500
53,750 $
30,000 $
12,200
42,200 $
6,850 $
3,900
10,750 $
10,481 $
5,967
16,448 $
47,331 $
22,067
69,398 $
878.21
750.00
826.92
44,250 $
37,000
81,250 $
12,200 $
15,000
27,200 $
8,850 $
7,400
16,250 $
13,541
11,322
24,863
$
1,701.92
1,423.08
1,562.50
131,500 $
39,750
171,250 $
39,400 $
17,200
56,600 $
26,300 $
7,950
34,250 $
40,239
12,164
52,403
$
$
$
1,685.90
1,528.85
1,646.63
Average Benefits
Load per week
$
Average Actual
Benefits Cost
Difference btw
Benefits Load and
Actual Benefits
Cost of Severance
600.96 $
469.47 $
131.49 $
91,946.15
554.09
429.09
491.59
425.45
347.89
386.67
128.64
81.20
104.92
194,930.13
136,239.55
328,666.51
334.94
296.47
325.32
333.15
278.22
319.42
1.78
18.25
5.90
234,205.64
76,134.33
311,175.08
685.10
500.51
184.59
90,745.04
364.42
350.96
360.58
316.71
342.97
324.21
47.72
7.99
36.37
170,342.40
62,885.42
233,180.54
397.60
388.22
394.92
344.26
313.75
335.54
53.33
74.47
59.37
143,163.82
55,999.04
199,182.29
421.88
418.27
420.67
344.24
377.03
355.17
77.63
41.24
65.50
105,650.50
61,503.17
167,104.70
364.18
365.38
364.58
315.05
350.27
326.79
49.13
15.12
37.79
92,132.50
54,354.23
146,379.99
309.62
302.88
308.49
288.97
345.58
298.41
20.64
(42.69)
10.09
106,920.42
18,685.38
125,655.28
298.61
331.73
301.92
299.39
306.33
300.08
(0.78)
25.40
1.84
191,210.67
29,398.50
220,135.15
228.71
219.55
225.96
243.75
271.35
252.03
(15.04)
(51.80)
(26.07)
122,810.03
68,973.46
191,875.57
219.55
187.50
206.73
303.40
212.18
266.92
(83.85)
(24.68)
(60.18)
49,627.58
23,092.38
72,193.34
425.48
355.77
390.63
332.61
324.25
328.43
92.88
31.52
62.20
421.47
382.21
411.66
339.55
358.79
344.36
81.93
23.42
67.30
COSTS FOR DECISION MAKING:
AN INSTRUCTIONAL CASE OF
RELEVANT COSTS AND
DIFFERENTIAL ANALYSIS OF
COST REDUCTION
ALTERNATIVES
© 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Relevant Costs Defined
▪ The decision-making approach just described
emphasizes the importance of identifying and
using relevant costs.
▪ Relevant costs possess two characteristics:
▪ they are future costs AND
▪ they differ across alternatives.
▪ All pending decisions relate to the future.
▪ Accordingly, only future costs can be relevant to
decisions.
LO-1
© 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
The Decision-Making Model
▪ Step 1. Recognize and define the problem.
▪ Step 2. Identify alternatives as possible solutions to the
problem. Eliminate alternatives that clearly are not feasible.
▪ Step 3. Identify the costs and benefits associated with each
feasible alternative. Classify costs and benefits as relevant
or irrelevant, and eliminate irrelevant ones from
consideration.
▪ Step 4. Estimate the relevant costs and benefits for each
feasible alternative.
▪ Step 5. Assess qualitative factors.
▪ Step 6. Make the decision by selecting the alternative with
LO-1
the greatest overall net benefit.
© 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Keep-or-Drop Decisions
▪ A manager needs to determine whether a
segment, such as a product line, should be kept
or dropped.
▪ Segmented reports prepared on a variablecosting basis provide valuable information for
these keep-or-drop decisions.
▪ Both the segment’s contribution margin and its
segment margin are useful in evaluating the
performance of segments.
LO-2
© 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Purchase answer to see full
attachment