Rugters Case Analysis About Decision Making Model First, read the following case on differential analysis. ?PDF?Then, review the following files on this to

Rugters Case Analysis About Decision Making Model First, read the following case on differential analysis. ?PDF?Then, review the following files on this topic.?PPT?Finally, complete the following assignment.?excel?Samantha Charleston (responsible for the analysis on the electronic check processing) became ill and asked you to complete her analysis. She has identified relevant costs and benefits. However, you need to complete Steps 4, 5 and 6 of the Decision Making model. Charleston asks that you finish her spreadsheet above. Provide your answers in the second tab of the spreadsheet, making sure to include calculations and explanations where appropriate. 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.
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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
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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
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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
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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
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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).
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