ASSIGNMENT

Question:(1) Do a management Comment Letter to the Boardof Directors

(2) Do an analysis on Inventory Valuation and do arecommendation to the management

(3) Do an analysis on the Cost of Goods Sold and do arecommendation to management

DO THE ANALYSIS BASE ON US GAAP REQUIREMENTS ONINVENTORY VALUATION AND COST OF GOODS SOLD.

RECOMMENDATION SHOULD BE BASE ON GAAP ALSO.

Case Narrative

Scenario and Client Background

You are an audit senior at Smith, Brown, and Jones, PLC(SB&J) a public accounting firm. You have been assigned to theaudit of Northwest Technologies, Inc., (NWT) for fiscal year endingDecember 31, 2009. NWT is a publicly traded manufacturer ofcomputer chips.

NWT has been a good audit client of the firm for the prior sixyears (2003 through 2008), paying its fees on time, employingcooperative management, and complying with authoritative accountingpronouncements. During those years, however, NWT has been losingmarket share in an increasingly competitive global marketplace.Although NWTâs unit sales have been increasing each year, theydrastically lag behind industry increases. Currently, stagnation inthe computer chip and router markets is significantly reducing themarket demand for NWTâs chips. The companyâs stock has declined invalue from approximately $95 per share in 2003 to $32 per share in2009. Although some of this reduction can be attributed to thegeneral economic slow down, it is relatively greater than declinesin value of competitorsâ stock.

Despite these downward trends, however, NWT remains a widelyrecognized name in the computer chip market.

Planning Meeting

At the instruction of the engagement partner, Steve Smart, youhold a planning meeting with Samantha Strong, NWTâs CEO, to discusscurrent year events and plan the strategy for the upcoming audit.In your meeting, Samantha indicates that NWT is going to have avery good year, despite some difficulties in the recent past. Thecompanyâs main difficulty involves revocation of its line ofcredit: As a result of lower-than-expected sales volume last year,NWT violated its bad debt covenants, and the bank has refused torenew the line of credit. Samantha indicates, however, that a newdiscount policy which encourages customers to pay on a more timelybasis has increased cash flow, and operations have not beenhampered, despite the lack of credit from the bank.

Samantha further indicates that in May 2009, Jane Smith, CFO,resigned to pursue other opportunities. Jane was replaced as chieffinancial officer by Samanthaâs close personal friend, JonathanWhite. Samantha praises Jonathanâs mastery of accounting andreporting, commending his ability to record financial transactionsin ways that âmore accurately reflect the operations of thebusinessâ than had Janeâs methods. Samantha feels that Jonathanâsphilosophy is more practical than Janeâs âoverly conservativeâapproach to accounting. âJonathanâs logical approach to recordingtransactions and his ability to record results that better reflectour performance is doing wonders for our business. Just knowingthat we were doing things so wrong in the past has bothered metremendously,â Samantha states.

Samantha indicates that one of NWTâs major suppliers was on strikeduring June and July of the current year. During this strike, NWTwas forced to buy parts from another supplier at significantlyhigher costs. Nevertheless, Samantha explains, the companyâs bottomline did not suffer. The new CFO (Jonathan) performed a study ofthe overhead application process and redistributed items that wereincorrectly accounted for in the past. As a result of the loweroverhead cost allocation, Samantha indicates that product cost wassignificantly lower after the month of July than it had been inprior years. She explains: âDespite the increase in product costfor those two months during the strike, we experienced no negativegross profit impact because Jonathan reworked the overhead formulato reflect overhead costs more accurately. In fact, our productsare significantly cheaper than we thought. Now we can reduce salesprices and increase volume because of more competitivepricing.â

Samantha indicates that no other significant events occurred thisyear. She mentions a few âminor items,â such as the purchase of asignificant amount of fixed assets and a growth in the customerbase as a result of a new credit-granting policy.

While discussing your planning meeting with the audit partner, younote the following concerns and areas of risk:

Managements integrity (specifically concerns about the new CFO)â the drastic improvement in current year results.

Inventory valuation â the new overhead application formula

Propriety of cost of goods sold â the new overhead applicationformula

Possibility of a going concern issue â lack of bank funding

Valuation of reserves and liabilities

Potential risk of loss â new credit-granting policy

Audit Fieldwork

1. Salesand Cost of Goods Sold

In performing your regression analysis of sales and cost ofgoods sold, you note that, according to prior year work-papers,gross profit rates have averaged between 38% and 41% over the pastsix years (2003-2008). The client has provided the followingcurrent-year data for your analysis:

Month	Sales	COGS	Gross Profit Rate
January	$14,534,672	$8,867,134	38.99%
February	15,068,010	9,063,465	39.85%
March	14,835,456	8,968,979	39.54%
April	14,236,726	8,613,564	39.50%
May	15,255,664	8,974,685	41.17%
June	15,365,790	8,313,646	42.13%
July	15.489.454	9.016,465	41.79%
August	14,964,889	8,065,646	46.10%
September	15,032,469	8,074,656	46.29%
October	17,028,646	8,765,646	48.52%
November	18,900,644	9,564,698	49.39%
December	19,365,471	9,679,879	50.01%
TOTAL	$189,077,891	$105,968,463

In reviewing the data provided by the client, you note that salesincreased significantly in the last three months of the year.Additionally, you note that gross profit margins increasedbeginning in August and further increased beginning in October.Discussions with Richard Jones, accounting manager, indicate thefollowing:

Profit margins would have increased more beginning in June, butthe strike affected the cost of direct materials used inproduction.

The cost of goods sold formula was altered to exclude insurance,depreciation, and sales salaries. Jones indicated that such itemswere excluded from overhead because they are paid for and utilizedby non-production departments.

Overtime paid to production workers is now charged to the HumanResources Department as a fringe benefit. Such cost hashistorically been tracked in the production department and includedas a component of cost of goods sold. Jonathan White, the CFO,changed this policy under the rationale that this overtime premiumis given by the Human Resources Department as part of the newcontract it negotiated with the production workers, and should,therefore, be a Human Resourceâs expense and included as anadministration expense item on the income statement rather thanbeing included as a component of cost of goods sold. This policywent into effect in October.

In October, NWT initiated a special sales promotion in which thecompany shipped bulk quantities of computer chips to a significantnumber of customers. This is part of a campaign in which NWT istrying to promote the use of its products by making them readilyavailable in bulk to customers. NWT shipped these additionalquantities to customers âin good faith,â along with the customersâregular orders. In a letter to customers, NWT stated, âWe want tobe your supplier of choice for computer chips. Please accept thesechips for use in your production needs. If you do not need or usethem, you may return them within three months with no obligation.âNWT recorded a sale of goods and related account receivable uponshipment of these additional bulk quantities.

2. Fixed Asset Additions andDisposals

Remembering Samantha Strongâs statement that considerable fixedassets were purchased during the year, you ask Joseph Danna, fixedasset clerk in the accounting department, about the nature of thesefixed assets. Dana indicates that a significant portion of thefixed asset additions represents labor of company mechanics. Suchlabor was incurred during a routine, two-week plant shutdown inwhich each machine was thoroughly cleaned and inspected by themaintenance department. Additionally, plant walkways and work areaswere resurfaced. Joseph tells you that these costs were capitalizedbecause they enhance the useful lives of the machinery andequipment. Furthermore, all replacement parts bought during theyear for the machines (nuts, bolts, compressors, etc.) werecapitalized because they become part of the fixed asset.

When you ask Dana why these labor and replacement costs weretreated as fixed assets, he replies that Jonathan, the CFO, orderedthe change to the previous capitalization policy. Dana states thathe believes the new policy is correct because these items and laborcosts are ârelated to fixed assets and should be capitalized.â Whenyou contact Mr. White for confirmation of this new policy, hemaintains that capitalization treatment is correct for all theadditions.

Continuing your discussion of fixed assets, you ask whether anydisposals occurred during the year. Dana is not aware of any;however, he does tell you that such disposals occur at thediscretion of individual plant managers and are not brought to theattention of the accounting department.

3. Credit-Granting Policy

While talking to Richard Jones, accounting manager, you learn thatNWT is relaxing its credit-granting guidelines. In the past, onlythe credit manager could approve credit. Now, however, thecredit-approval procedure has been decentralized. Each credit clerkis responsible for a region of the market and is authorized togrant credit for that region without obtaining approval from thecredit manager. Furthermore, the clerks are also now responsiblefor determining bad-debts write-offs and recoveries for their ownregion based on whether or not, in their professional judgment,they feel that collection will be made. Jones tells you that thispolicy change was initiated âto empower the employees and create agreater sense of participation in management.â

Conclusion

When you complete the audit fieldwork, you report the progress tothe engagement partner, Steve Smart. Although NTâs net income hasincreased significantly in the current year and outpaced theindustry average, Steve is uneasy with this increase. He isconcerned that the companyâs sales policy is too aggressive andthat the accounting for certain sales is possibly not in accordancewith GAAP. Additionally, Steve is not sure whether the companyâsoverhead policies follow procedures recommended under GAAP. Steveis uncertain about the companyâs ability to continue as a goingconcern and about Smith, Brown, and Jonesâs ability to issue anunqualified opinion without significant adjustment to the financialstatements.

The following assignments are based on the information in thiscase narrative:

[1] This comprehensive audit engagement exercise set is adaptedfrom a case prepared by Ryan R. Fox of Deloitte and Touche,L.L.P.

emeraldgiraffe77

8-47 Target costing Mercedes-Benz All-Activity Vehicle(AAV)

Introduction

During the recession beginning in the early 1990s, Mercedes-Benz(MB) struggled with product development, cost efficiency, materialpurchasing, and problems in adapting to changing markets.

In 1993, these problems caused the worst sales slump in decades,and the luxury car maker lost money for the first time in itshistory. Since then, MB has streamlined the core business, reducedparts and system complexity, and established simultaneousengineering programs with suppliers.

In their search for additional market share, new segments, andnew niches, MB started developing a range of new products. Newproduct introductions included the C-Class in 1993, the E-Class in1995, the new sportster SLK in 1996, and the A-Class and M-ClassAll-Activity Vehicle (AAV) in

1997. Perhaps the largest and most radical of MB's new projectswas the AAV. In April 1993, MB announced it would build its firstpassenger vehicle-manufacturing facility in the United States.

The decision emphasized the company's globalization strategy anddesire to move closer to its customers and markets.

Mercedes-Benz United States International used function groupswith representatives from every area of the company (marketing,development, engineering, purchasing, production, and controlling)to design the vehicle and production systems. A modularconstruction process was used to produce the AAV. First-tiersuppliers provided systems rather than individual parts orcomponents for production of approximately 65,000 vehiclesannually.

The AAV Project Phases

The AAV moved from concept to production in a relatively shortperiod of time. The first phase, the concept phase, was initiatedin 1992. The concept phase resulted in a feasibility study that wasapproved by the board. Following board approval, the projectrealization phase began in 1993, with production commencing in1997. Key elements of the various phases are described next.

ConceptPhase,1992-1993

Team members compared the existing production line with variousmarket segments to discover opportunities for new vehicleintroductions. The analysis revealed opportunities in the rapidlyexpanding sports utility vehicle market that was dominated by Jeep,Ford, and GM. Market research was conducted to estimate potentialworldwide sales opportunities for a high-end AAV with thecharacteristics of a Mercedes-Benz. A rough cost estimate wasdeveloped that included materials, labor, overhead, and one-timedevelopment and project costs. Projected cash flows were analyzedover a 10-year period using net present value (NPV) analysis toacquire project approval from the board of directors. Thesensitivity of the NPV was analyzed by calculating "what-if"scenarios involving risks and opportunities. For example, riskfactors included monetary exchange rate fluctuations, differentsales levels due to consumer substitution of the AAV for another MBproduct, and -product and manufacturing costs that differed fromprojections. On the basis of the economic feasibility study of theconcept phase, the board approved the project and initiated asearch for potential manufacturing locations. Sites located inGermany, other European countries, and the United States wereevaluated. Consistent with the company's globalization strategy,the decisive factor that brought the plant to the United States wasthe desire to be close to the major market for sports utilityvehicles.

Project Realization Phase,1993-1996

Regular customer clinics were held to view the prototype and toexplain the new vehicle concept. These clinics produced importantinformation about how the proposed vehicle would be received bypotential customers and the press. Customers were asked to rank theimportance of various characteristics, including safety, comfort,economy, and styling. Engineers organized in function groupsdesigned systems to deliver these essential characteristics.However, MB would not lower its internal standards for components,even if initial customer expectations might be lower than the MBstandard. For example, many automotive experts believed that thesuperior handling of MB products resulted from manufacturing thebest automobile chassis in the world. Thus, each class within theMB line met strict standards for handling, even though thesestandards might exceed customer expectations for some classes. MBdid not use target costing to produce the lowest price vehicle inan automotive class. The company's strategic objective was todeliver products that were slightly more expensive than competitivemodels. However, the additional cost would have to translate intogreater perceived value on the part of the customer.

Throughout the project realization phase, the vehicle (andvehicle target cost) remained alive because of changing dynamics.For example, the market moved toward the luxury end of the spectrumwhile the AAV was under development. In addition, crash testresults were incorporated into the evolving AAV design. For thesereasons, MB found it beneficial to place the design and testingteam members in close physical proximity to other functions withinthe project to promote fast communication and decision making.Sometimes new technical features, such as side air bags, weredeveloped by MB. The decision to include the new feature on all MBlines was made at the corporate

level because experience had shown that customers' reactions toa vehicle class can affect the entire brand.

ProductionPhase,1997

The project was monitored by annual updates of the NPV analysis.In addition, a three-year plan (including income statements) wasprepared annually and reported to the headquarters in Germany.

Monthly departmental meetings were held to discuss actual costperformance compared with standards developed during the costestimation process. Thus, the accounting system served as a controlmechanism to ensure that actual production costs would conform totarget (or standard) costs.

Target Costing and the AAV

The process of achieving target cost for the AAV began with anestimate of the existing cost for each function group. Next,components of each function group were identified with theirassociated costs. Cost reduction targets were set by comparing theestimated existing cost with the target cost for each functiongroup. These function groups included the following: doors,sidewall and roof, electrical system, bumpers, power train, seats,heating system, cockpit, and front end. Next, cost reductiontargets were established for each component. As part of thecompetitive benchmark process, MB bought and tore down competitors'vehicles to help understand their costs and manufacturingprocesses.

The AAV manufacturing process relied on high-value-added systemssuppliers. For example, the entire cockpit was purchased as a unitfrom a systems supplier. Thus, systems suppliers were part of thedevelopment process from the beginning of the project. MB expectedsuppliers to meet established cost targets. To enhance functiongroup effectiveness, suppliers were brought into the discussion atan early stage in the process. Decisions had to be made quickly inthe early stages of development. The target costing process was ledby cost planners who were engineers, not accountants.

Because the cost planners were engineers with manufacturing anddesign experience, they could make reasonable estimates of coststhat suppliers would incur in providing various systems. Also, MBowned much of the tooling, such as dies to form sheet metal, usedby suppliers to produce components. Tooling costs are a substantialpart of the one-time costs in the project phase.

Index Development toSupportTarget Costing Activities

During the concept development phase, MB team members usedvarious indexes to help them determine critical performance,design, and cost relationships for the AAV.To construct theindexes, various forms of information were gathered from customers,suppliers, and their own design team.Although the actual number ofcategories used by MB was much greater, Table 1 illustrates thecalculations used to quantify customer responses to the AAVconcept. For example, values shown in the "Importance" columnresulted from asking a sample of potential customers whether theyconsider each category extremely important when considering thepurchase of a new MB product. Respondents could respondaffirmatively to all categories that applied.

To gain a better understanding of the various sources of costs,function groups were identified together with target costestimates. (MB also organizes teams called function groups whoserole is to develop specifications and cost projections.) As shownin Table 2, the relative target cost percentage of each functiongroup was computed.

Table 3 summarizes how each function group contributes to theconsumer requirements identified in Table 1. For example, safetywas identified by potential customers as an importantcharacteristic of the AAV; some function groups contributed more tothe safety category than others. MB engineers determined thatchassis quality was an important element of safety (50% of thetotal function group contribution).

Table 4 combines the category weighting percentages from Table 1with the function group contribution from Table 3. The result is animportance index that measures the relative importance of eachfunction group across all categories. For example, potentialcustomers weighted the categories of safety, comfort, economy, andstyling as 0.41, 0.32, 0.18, and 0.09, respectively. The rows inTable 4 represent the contribution of each function group to thevarious categories. The importance index for the chassis iscalculated by multiplying each row value by its correspondingcategory value and summing the results: (0.50 X 0.41) + (0.30 X0.32) + (0.10 >< 0.18) + (0.10 X 0.09) = 0.33.

As shown in Table 5, the target cost index is calculated bydividing the importance index by the target cost percentage byfunction group. Managers at MB used indexes suchas these during the concept design phase to understand therelationship of the importance of a function group to the targetcost of a function group. Indexes less than 1 may indicate a costin excess of the perceived value of the function group. Thus,opportunities for cost reduction consistent with customer demands,may be identified and managed during the early stages of productdevelopment.

Choices made during the project realization phase were largelyirreversible during the production phase because approximately 80%of the production cost of the AAV was for materials and systemsprovided by external suppliers.

The AAV project used a streamlined management structure tofacilitate efficient and rapid development. The streamlined MBorganization produced an entirely new vehicle from concept toproduction in four years. Using the target costing process as a keymanagement element, MB manufactured the first production AAV in1997.

Required

(a) What is the competitive environment faced by MB as itconsiders launching the AAV?

(b) How has MB reacted to the changing world for luxuryautomobiles?

(c) Using Cooper's cost, quality, and functionality chart, 15discuss the factors on which MB would have to compete with otherautomobile producers, such as Jeep, Ford, and GM.

(d) How does the AAV project link with MB's strategy in terms ofmarket coverage?

(e) Explain the process of developing an importance index for afunction group or component.

How can such an index guide managers in making cost reductiondecisions?

(f) How does MB approach cost reduction to achieve targetcosts?

(g) How do suppliers factor into the target costing process? Whyare they so critically important to the success of the MB AAV?

(h) What role does the accounting department play in the targetcosting process?

blackoyster4

8-47 Target costing Mercedes-Benz All-Activity Vehicle(AAV)

Introduction

During the recession beginning in the early 1990s, Mercedes-Benz(MB) struggled with product development, cost efficiency, materialpurchasing, and problems in adapting to changing markets.

In 1993, these problems caused the worst sales slump in decades,and the luxury car maker lost money for the first time in itshistory. Since then, MB has streamlined the core business, reducedparts and system complexity, and established simultaneousengineering programs with suppliers.

In their search for additional market share, new segments, andnew niches, MB started developing a range of new products. Newproduct introductions included the C-Class in 1993, the E-Class in1995, the new sportster SLK in 1996, and the A-Class and M-ClassAll-Activity Vehicle (AAV) in

1997. Perhaps the largest and most radical of MB's new projectswas the AAV. In April 1993, MB announced it would build its firstpassenger vehicle-manufacturing facility in the United States.

The decision emphasized the company's globalization strategy anddesire to move closer to its customers and markets.

Mercedes-Benz United States International used function groupswith representatives from every area of the company (marketing,development, engineering, purchasing, production, and controlling)to design the vehicle and production systems. A modularconstruction process was used to produce the AAV. First-tiersuppliers provided systems rather than individual parts orcomponents for production of approximately 65,000 vehiclesannually.

The AAV Project Phases

The AAV moved from concept to production in a relatively shortperiod of time. The first phase, the concept phase, was initiatedin 1992. The concept phase resulted in a feasibility study that wasapproved by the board. Following board approval, the projectrealization phase began in 1993, with production commencing in1997. Key elements of the various phases are described next.

ConceptPhase,1992-1993

Team members compared the existing production line with variousmarket segments to discover opportunities for new vehicleintroductions. The analysis revealed opportunities in the rapidlyexpanding sports utility vehicle market that was dominated by Jeep,Ford, and GM. Market research was conducted to estimate potentialworldwide sales opportunities for a high-end AAV with thecharacteristics of a Mercedes-Benz. A rough cost estimate wasdeveloped that included materials, labor, overhead, and one-timedevelopment and project costs. Projected cash flows were analyzedover a 10-year period using net present value (NPV) analysis toacquire project approval from the board of directors. Thesensitivity of the NPV was analyzed by calculating "what-if"scenarios involving risks and opportunities. For example, riskfactors included monetary exchange rate fluctuations, differentsales levels due to consumer substitution of the AAV for another MBproduct, and -product and manufacturing costs that differed fromprojections. On the basis of the economic feasibility study of theconcept phase, the board approved the project and initiated asearch for potential manufacturing locations. Sites located inGermany, other European countries, and the United States wereevaluated. Consistent with the company's globalization strategy,the decisive factor that brought the plant to the United States wasthe desire to be close to the major market for sports utilityvehicles.

Project Realization Phase,1993-1996

Regular customer clinics were held to view the prototype and toexplain the new vehicle concept. These clinics produced importantinformation about how the proposed vehicle would be received bypotential customers and the press. Customers were asked to rank theimportance of various characteristics, including safety, comfort,economy, and styling. Engineers organized in function groupsdesigned systems to deliver these essential characteristics.However, MB would not lower its internal standards for components,even if initial customer expectations might be lower than the MBstandard. For example, many automotive experts believed that thesuperior handling of MB products resulted from manufacturing thebest automobile chassis in the world. Thus, each class within theMB line met strict standards for handling, even though thesestandards might exceed customer expectations for some classes. MBdid not use target costing to produce the lowest price vehicle inan automotive class. The company's strategic objective was todeliver products that were slightly more expensive than competitivemodels. However, the additional cost would have to translate intogreater perceived value on the part of the customer.

Throughout the project realization phase, the vehicle (andvehicle target cost) remained alive because of changing dynamics.For example, the market moved toward the luxury end of the spectrumwhile the AAV was under development. In addition, crash testresults were incorporated into the evolving AAV design. For thesereasons, MB found it beneficial to place the design and testingteam members in close physical proximity to other functions withinthe project to promote fast communication and decision making.Sometimes new technical features, such as side air bags, weredeveloped by MB. The decision to include the new feature on all MBlines was made at the corporate

level because experience had shown that customers' reactions toa vehicle class can affect the entire brand.

ProductionPhase,1997

The project was monitored by annual updates of the NPV analysis.In addition, a three-year plan (including income statements) wasprepared annually and reported to the headquarters in Germany.

Monthly departmental meetings were held to discuss actual costperformance compared with standards developed during the costestimation process. Thus, the accounting system served as a controlmechanism to ensure that actual production costs would conform totarget (or standard) costs.

Target Costing and the AAV

The process of achieving target cost for the AAV began with anestimate of the existing cost for each function group. Next,components of each function group were identified with theirassociated costs. Cost reduction targets were set by comparing theestimated existing cost with the target cost for each functiongroup. These function groups included the following: doors,sidewall and roof, electrical system, bumpers, power train, seats,heating system, cockpit, and front end. Next, cost reductiontargets were established for each component. As part of thecompetitive benchmark process, MB bought and tore down competitors'vehicles to help understand their costs and manufacturingprocesses.

The AAV manufacturing process relied on high-value-added systemssuppliers. For example, the entire cockpit was purchased as a unitfrom a systems supplier. Thus, systems suppliers were part of thedevelopment process from the beginning of the project. MB expectedsuppliers to meet established cost targets. To enhance functiongroup effectiveness, suppliers were brought into the discussion atan early stage in the process. Decisions had to be made quickly inthe early stages of development. The target costing process was ledby cost planners who were engineers, not accountants.

Because the cost planners were engineers with manufacturing anddesign experience, they could make reasonable estimates of coststhat suppliers would incur in providing various systems. Also, MBowned much of the tooling, such as dies to form sheet metal, usedby suppliers to produce components. Tooling costs are a substantialpart of the one-time costs in the project phase.

Index Development toSupportTarget Costing Activities

During the concept development phase, MB team members usedvarious indexes to help them determine critical performance,design, and cost relationships for the AAV.To construct theindexes, various forms of information were gathered from customers,suppliers, and their own design team.Although the actual number ofcategories used by MB was much greater, Table 1 illustrates thecalculations used to quantify customer responses to the AAVconcept. For example, values shown in the "Importance" columnresulted from asking a sample of potential customers whether theyconsider each category extremely important when considering thepurchase of a new MB product. Respondents could respondaffirmatively to all categories that applied.

To gain a better understanding of the various sources of costs,function groupswere identified together with target costestimates. (MB also organizes teams called function groups whoserole is to develop specifications and cost projections.) As shownin Table 2, the relative target cost percentage of each functiongroup was computed.

Table 3 summarizes how each function group contributes to theconsumer requirements identified in Table 1. For example, safetywas identified by potential customers as an importantcharacteristic of the AAV; some function groups contributed more tothe safety category than others. MB engineers determined thatchassis quality was an important element of safety (50% of thetotal function group contribution).

Table 4 combines the category weighting percentages from Table 1with the function group contribution from Table 3. The result is animportance index that measures the relative importance of eachfunction group across all categories. For example, potentialcustomers weighted the categories of safety, comfort, economy, andstyling as 0.41, 0.32, 0.18, and 0.09, respectively. The rows inTable 4 represent the contribution of each function group to thevarious categories. The importance index for the chassis iscalculated by multiplying each row value by its correspondingcategory value and summing the results: (0.50 X 0.41) + (0.30 X0.32) + (0.10 >< 0.18) + (0.10 X 0.09) = 0.33.

As shown in Table 5, the target cost index is calculated bydividing the importance index by the target cost percentage byfunction group. Managers at MB usedindexes suchas these during the concept design phase to understand therelationship of the importance of a function group to the targetcost of a function group. Indexes less than 1 may indicate a costin excess of the perceived value of the function group. Thus,opportunities for cost reduction consistent with customer demands,may be identified and managed during the early stages of productdevelopment.

Choices made during the project realization phase were largelyirreversible during the production phase because approximately 80%of the production cost of the AAV was for materials and systemsprovided by external suppliers.

The AAV project used a streamlined management structure tofacilitate efficient and rapid development. The streamlined MBorganization produced an entirely new vehicle from concept toproduction in four years. Using the target costing process as a keymanagement element, MB manufactured the first production AAV in1997.

https://drive.google.com/file/d/0B7DlLcOZwfeKXzdfbVQwMlVteUE/view?usp=sharinglink to required tables