Costs for Decision Making: An Instructional Case of Relevant Costs and Differential Analysis of Cost Reduction Alternatives

Abstract

Textbook questions and cases often ask students to use differential analysis to evaluate one independent cost reduction action. But businesses often have multiple cost reduction alternatives to evaluate simultaneously. Furthermore, companies may consider these options independently or through combinations of alternatives. The case is based on an actual project to evaluate alternative cost reduction actions at a large insurance company. For educational purposes, the scope of the project has been significantly reduced to one function, the accounting department, to provide students with a realistic situation in a manageable format. Students are presented with three alternative cost reduction approaches and must identify the relevant costs and calculate the estimated potential impacts of each alternative. The cost reduction actions evaluated are outsourcing (“offshoring”), greater automation, and an office relocation. Additionally, the students must identify the risks and other nonfinancial considerations associated with the potential cost reduction actions and make a recommendation.

This case was prepared for inclusion in Sage Business Cases primarily as a basis for classroom discussion or self-study, and is not meant to illustrate either effective or ineffective management styles. Nothing herein shall be deemed to be an endorsement of any kind. This case is for scholarly, educational, or personal use only within your university, and cannot be forwarded outside the university or used for other commercial purposes.

2024 Sage Publications, Inc. All Rights Reserved

You are not authorized to view Teaching Notes. Please contact your librarian for instructor access or sign in to your existing instructor profile.

Resources

Figure 1: Operating Earnings ($ in millions)

Figure

Figure 2: Operating Expense Ratio for AC Global vs. AC-US

Figure

Table 1: Accounting Department Expense Budget Summary

Function

Number of Employees

Annual Salaries

Annual Benefits Load

All Other

Total Budgeted Expenses

Federal tax preparation

8

$802,000

$200,500

$176,500

$1,179,000

State tax preparation

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

Totals

93

$6,937,000

$1,734,250

$1,849,500

$10,520,750

Table 2: Matrix of Potential Accounting Functions for Outsourcing

Function

Skill Level Required

Local Knowleged Required

Mgmt. Support/Interaction

Technology Support Required

Compliance Risk

Tax Department

Federal tax preparation

Medium

High

Low

Low

High

State tax preparation

Medium

High

Low

Low

High

Tax planning

High

High

High

Low

Medium

Controller’s Department

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

Financial Planning and Analysis

Planning and budgeting

Medium

Medium

High

Medium

Low

Financial analysis

Medium

Medium

High

Low

Low

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

Postage

270,000

Travel and entertainment

11,500

3,000

Corporate expenses

8,000

3,000

Total

$981,250

$330,500

Table 4: Summary of Checks Processed per Month

Recurring

Business Partners/Employees (probably electronic)

All Others

Total

Checks (monthly)

8,000

17,000

25,000

50,000

Percentage

16%

34%

50%

100%

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

8

Low

Low

4

State tax preparation

12

Low

Low

9

Tax planning and management

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

Bank reconciliations

5

Low

Low

3

Financial Planning and Analysis

Planning and budgeting

4

Medium

High

2

Financial analysis

8

High

High

6

93

64

Table 6: Summary Employee Information for Severance Calculations

Actual Costs

Number of Employees

Weeks of Eligible Severance

Total Annual Salaries

Benefits Load

Health

401(k)

Payroll Taxes

Tax Department:

Department head and assistant

2

32

$250,000

$62,500

$17,200

$12,500

$19,125

Federal Tax

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

Total

8

142

802,000

200,500

59,400

40,100

61,354

State Taxes

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

Total

12

192

812,000

203,000

96,600

40,600

62,119

Controller’s Department:

Department head and assistant

2

28

285,000

71,250

15,000

14,250

21,803

SEC Reporting

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

Total

7

132

525,000

131,250

51,600

26,250

40,163

U.S. GAAP Reporting

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

Total

7

104

575,000

143,750

49,400

28,750

43,988

Regulatory Reporting

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

Total

6

82

525,000

131,250

44,400

26,250

40,163

Management Reporting

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

Total

6

82

455,000

113,750

44,400

22,750

34,808

Cost Accounting

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

Total

6

82

385,000

96,250

44,400

19,250

29,453

General Accounting

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

Total

10

146

628,000

157,000

76,600

31,400

48,042

Accounts Payable

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

Total a

10

166

470,000

117,500

71,600

23,500

35,956

Bank Reconciliation

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

Total a

5

66

215,000

53,750

42,200

10,750

16,448

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

Total

4

54

325,000

81,250

27,200

16,250

24,863

Financial Analysis

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

Total

8

102

685,000

171,250

56,600

34,250

52,403

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
  • 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.
    • 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.
    • The employer portion of payroll taxes is 7.65% of salaries.
    • The company contribution to the 401(k) plan is 5% of salaries.
  • 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.
    • 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.
    • 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.
  • 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.
  • 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.
  • 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.
  • 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.

This case was prepared for inclusion in Sage Business Cases primarily as a basis for classroom discussion or self-study, and is not meant to illustrate either effective or ineffective management styles. Nothing herein shall be deemed to be an endorsement of any kind. This case is for scholarly, educational, or personal use only within your university, and cannot be forwarded outside the university or used for other commercial purposes.

2024 Sage Publications, Inc. All Rights Reserved

locked icon

Sign in to access this content

Get a 30 day FREE TRIAL

  • Watch videos from a variety of sources bringing classroom topics to life
  • Read modern, diverse business cases
  • Explore hundreds of books and reference titles