EXERCISE 8-21 (CONTINUED)

3. At first glance, it appears that the company is losing money on local

commercials. However, the action analysis report indicates that if this

market segment were dropped, most of the costs are likely to continue

being incurred. The nature of the technical staff salaries is clearly critical

since it makes up the bulk of the costs. Management has suggested that

the technical staff are the company’s most valuable asset and that they

would be the last to go in case of financial difficulties. Nevertheless,

there are at least two situations in which these costs would be relevant.

First, dropping the local commercial market segment may reduce future

hiring of new technical staff. This would have the effect of reducing fu-

ture spending and therefore would reduce the company’s costs. Second,

if technical staff time is a constraint, dropping the local commercial mar-

ket segment would allow managers to shift technical staff time to other,

presumably more profitable, work. However, if this is the case, there are

better ways to determine which projects should get technical staff atten-

tion. This subject will be covered in Chapter 13 in the section on utiliza-

tion of scarce resources.

Finally, the cost of the animation concept at the proposal stage is a ma-

jor drag on the profitability of the local commercial market. The activity-

based costing system, as currently designed, assumes that all project

proposals require the same effort. This may not be the case. Proposals

for local commercials may be far less elaborate than proposals for major

special effects animation sequences for motion pictures. If management

has been putting about the same amount of effort into every proposal,

the above activity-based costing analysis suggests that this may be a

mistake. Management may want to consider cutting back on the effort

going into animation concepts for local commercials at the project pro-

posal stage. Of course, this may lead to an even lower success rate on

bids for local commercials.

Problem 8-30 (45 minutes)