Proper manufacturing cost for BMA 3C4.

Based on the information provided in the case, briefly discuss how would the use of  activity-based costing help Tim Lahn determine proper manufacturing cost for BMA 3C4.

PLESE DONT REPET THE ANSWER OVER AND OVER AND I NEED EXPLANATION.

IMA The Association of EDUCATIONAL Case Case Journal Study ima Accountants and Financial Professionals in Business ISSN 1940-204X Target Costing Decisions at BMA AG’ Marc Wouters, Ph.D. Professor of Management Accounting Karlsruhe Institute of Technology (KIT) University of Amsterdam INTRODUCTION elements of the car to be changed as well, with complex implications for production processes and suppliers. Tim Lahn is a young management accountant at the German After presenting more information about BMA, Part I of car company BMA AG. He works in a large management the case offers details about BMA’s current 3C4 project, which accounting department in product development. His specific is the focus of the next meeting of the 3C4 project team. Tim role is to help project teams manage costs when developing needs to prepare for that meeting. Part II of the case takes a new car model and to ensure that the finished design place about two years later and includes information about a will allow BMA to make its target profit. To fulfill his role, newly formed task force for changing BMA’s target-costing Tim and his colleagues rely heavily on target costing. They system, which Tim is heading. Tim needs to prepare for develop a business case for a new car model, which includes the first meeting of this task force. The discussions in class targets for the sales price, sales volumes, and costs. The emulate these meetings of the 3C4 project team and the task business case also specifies attributes for the functionality force. The case is rather long because it provides a realistic and performance of the car. Tim and the entire project team description of target costing in practice. review the design of the new car as it progresses. Does it meet the targets, not only regarding costs, but also for all BMA’S MARKET, VALUE CHAIN, AND COST the other important attributes? Which actions need to be STRUCTURE taken? For this case, you will fill the role of Tim or another member of the project team to help ensure the success of BMA AG offers car models in a range of sizes, from mini- BMA’s 3C4 project. You will also be involved in a task force compact to large cars and SUVs, or in the European for improving BMA’s target-costing method. In this case, classification, cars in the A-F, S, and J segments. Most of you will be focused on decision-making and target-costing BMA’s car models come in various vehicle types, such as concepts, and you will not be preparing detailed target- four-door sedan, five-door station wagon, two-door coupe, costing calculations. SUV, and convertible. The company’s head office is located The importance of target costing for BMA during product in Southern Germany, with production facilities located in development is easy to see. Early in the product lifecycle, Germany and all over the world. The network of suppliers BMA has many more degrees of freedom to make decisions is crucial, as more than 75% of the manufacturing costs that significantly affect costs. Once a new car model has been consisted of purchased parts. launched, much less can be changed to reduce costs. For Sales market. BMA’s sales market was global. Sales prices and example, cost reduction through materials substitution would car specifications depended on consumer preferences and be much more difficult, as this would require other design The case has been developed solely for class discussion and is based on interviews and other information obtained from various car companies. While the case realistically highlights the intricacies of target costing at car companies, specific examples and numbers have been disguised and are partly fictitious. IMA EDUCATIONAL CASE JOURNAL 1 VOL. 13, NO. 1, ART. 3, MARCH 2020 @2020 IMA

competition in a local market. For example. competition is very tough in the United States. and prices are considerably lower in the United States than in Europe. Another difference is that in Europe. customers usually specify the car they want and then wait weeks or months before it is delivered after being assembled to order. In the United States. customers buy a fully loaded car that the dealer has in inventory. In China. customers usually buy the car from the dealer’s inventory; models with extra—long wheelbases. as well as softer upholstery and suspension. are popular. Clearly. markets have their own characteristics. Sales prices. Sales prices of all the cars of one model vary enormously. As mentioned previously. a car model usually comes in various vehicle types. which could be equipped with various types of engines. such as diesel. gasoline. or hybrid. A customer could choose from many more options. such as those for communication. navigation. entertainment. seat materials. headlights. all—wheel drive. manual or automatic transmission. types of suspension. glass roofs. rims. and paint. Furthermore. a car model could be sold in many different countries. where market prices differ considerably. Moreover. sales prices are dynamic. and the price in the first year after a new model has been launched differs from the price after. for example. three years. As a car model gets older. more special offers are needed in the form of lower prices and/or extra options for the same price. Value chain. BMA’S value chain is rather complex. Dealers operate in more than 100 countries. and manufacturers have more than 20 factories in more than 15 countries. The importing companies are sometimes owned by BMA. but others are independently owned. Cars are transported to the sales countries by trucks. trains. and ships. Some of the manufacturing factories are joint ventures with local companies. and others conduct only the simpler assembly activities based on “completely knocked down’1 kits. Dozens offirst—tier suppliers deliver parts to BI-IA’s factories. and these suppliers coordinate operations with thousands of seconds and thirditier suppliers all over the world. Cost structure. The cost structure of the value chain is quite intricate for target costing. BMA needs to consider local costs in each of its markets: the margins of importers and dealers. warranty. sales. marketing. distribution. import duties. and local value—added sales taxes. Some countries have considerable additional taxes beyond the normal value—added sales tax. which applies specifically to cars and depends on the price and technical characteristics of the car. For example. the final consumer price in Denmark could be more than twice the price before taxes. Furthermore. exchange rates entered into the equation. because many importing companies pay RNA in a currency other than the euro; likewise. BMA pays suppliers in various currencies. All these factors have an impact on the net revenues of the car—the sales price that RNA receives in Germany is typically about 60% to 70% of the average final sales price of a car. depending on the model. Because sales prices decrease over time. most costs have to be reduced as well during the lifecycle ofa car model. Initial investments. BMA’s initial investments for developing a new car model could easily amount to €l billion. These consisted of research and development (R&D) expenses such as for engineers and other staff. laboratories. equipment. tests. prototypes. externally hired engineers and other staff. and payments to suppliers for their R&D efforts. BMA also incurs significant development costs for conducting a product upgrade about halfway into a model’s lifecycle. Furthermore. BMA makes model—specific investments in tools (such as pressing tools. tools in the body shop. contaiiierslcartridges in assembly) and other manufacturing equipment specifically required for a particular car model. Most investments are made before the start of production but are also made later for the product upgrade. Some investments in manufacturing assets are paid for and owned by BMA but are actually placed at suppliers’ sites. Nonmanulacturing costs. BMA incurs many nonmanufacturing costs for a particular car model. Besides the costs for product development. costs for marketing. distribution. sales. and warranty are relevant. Marketing costs encompass BIN-[A’s marketing activities for a new model or model upgrade. such as producing and airing expensive commercials. producing brochures in many different languages. and creating the websites for the new model. Although most sales costs are incurred by the importers (BMA fully or partially owns some ofthese). BIN-IA also has a host of different arrangements for contributing to local sales costs. such as product advertising and incentives and rebates for customers and dealers. Warranty costs depend on the local conditions for how cars are used and how much they wear. as well as customer expectations about leniency of dealers when it comes to warranty issues. Overall. these direct nonmanufacturing costs tend to range from 20% to 35% of the total costs. depending on the market segment for a car model. I-‘lanufacturing costs could be direct or indirect in relation to a particular car model. IMA EDUCATIONAL CASE JOURNAL VOL 13, NO. ‘I, ART. 3, MARCH 2020

Indirect manufacturing costs. Almost all of BMA’s production sites product: multiple car models. which share assets such as manufacturing equipment (for example, the presses for producing the metal parts of a car body). assembly lines (a mix of different car models could be assembled on one line). and buildings. Support departments such as inbound logistics and quality management also work for several car models. Direct manufacturing costs. Modelispecific manufacturing assets cause direct, fixed manufacturing costs. but most direct manufacturing costs are variable. The variable manufacturing costs consist mainly of parts purchased from suppliers and direct manufacturing labor. As a car entails thousands of different components. parts. and materials. many detailed target costs provide the starting point for price negotiations with suppliers. BMA buys some major components. such as transmissions. as complete units from specialized suppliers. In other cases. BMA buys smaller parts and puts together a component itself For example. BMA produces its own engines. and the same types of engines are used for various car models. BMA also produces some parts from raw materials. such as many of the pressed metal parts for the car body. Corporate overhead. Finally. BMA’s cost structure includes corporate overhead. such as financing costs and costs for central departments such as basic RSCD. corporate communication. finance. and legal. PART 1: TARGET COSTING THE NEW 304 MODEL RNA is currently in the middle of developing a new generation ofits model 304. which accounts for its largest sales volume. Tim Lahn is part of the 3C4 development project. The main vehicle types of the 3C4 family are the fouridoor sedan and the fiveidoor station wagon. Besides offering various types of conventional diesel and gasoline engines. BMA also introduces a plug—in hybrid and a 100% electric drive for the new generation ofthe 304 model. Development ofa new car takes around four years. and BMA applies target costing to manage the cost of the new 3C4 model during product development. Development consists of two phases: the concept phase for product definition and the realization phase for product development. Details of BMA’s product development process are in Appendix A. The 304 project was now halfway into the realization phase. close to the procurement release milestone. The next meeting of the 304 project team is taking place in two days. and Tim needs to prepare for this meeting. He recollects what had happened so far in the concept phase and the realization phase of the new 304 model. TARGET COSTING IN THE 384 CONCEPT PHASE Tim believed that the concept phase had been the crucial time for target costing. when several decisions with a major impact on costs had been made. That early. it was not yet possible for him to model the full complexity of all the different countries. customer—specific configurations. price erosion. supply chain costs. and so on. as described previously. In the concept phase. cost modeling was still approximate but. at the same time. was central to guiding key technical decisions. Tim had started target costing for the 3C4 by defining three so—called “reporting models" for Germany. the United States. and China (see Table l for an example). For each model. specifications were defined. sales prices and volumes were set. and the required profit margin was determined. Other assumptions were also made. such as for production locations and exchange rates. Target costing during concept design was based on in—depth analyses of these three reporting models. Applying the Target Costing Logic and Finding Cost Reductions The logic of target costing during the concept phase is shown in Exhibit 1. The requirements for the new 3C4 model were described by the marketing function in a product profile document. The document defined properties of the car for which customers had certain expectation levels. such as acceleration. maximum speed. fuel economy. connectivity. C02 and NOx emissions. types of transmissions. engines. and drive systems (two—wheel. all—wheel). interior noise. upholstery. and safety. Some properties were qualitatively described. such as for the driving experience (“agile handling”) or the design ("dynamic light"). Some requirements were based on regulation (existing or anticipated). The inputs for determining the requirements were diverse. such as analysis of the strengths and weaknesses of the current 3C4 model. research about competitors’ future cars in the same market segment as the 3C4. as well as feedback and ideas from customers. dealers. importers. and BMA employees.I Guided by these requirements for the new 304 model. simultaneous engineering (SE) teams made technical proposals for the design of the car. and cost engineers made cost estimates. These activities involved the specialized knowledge and experience of dozens of experts. In many cases. the initial proposals had been too expensive and exceeded the target cost. so other technical solutions had to be found (see examples in Appendix B). Cheaper solutions. however. still need to result in a car that satisfied all the requirements for the new 304 model and enabled IMA EDUCATIONAL CASE JOURNAL a VOL 13, NO. ‘I, ART. 3, MARCH 2020

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