Revision

1
Revision
B405F Advanced Management Accounting

• Lecture 11

2
Five-Step Decision Process

• Gathering information
• Making predictions
• Choosing an alternative
• Implementing the decision
• Evaluating performance

3
The Meaning of Relevance

• Relevant costs and relevant revenues are expected
  future costs and revenues that differ among
  alternative courses of action.
• Sunk costs are irrelevant because they are past
  costs.
• Common fixed costs are irrelevant because they
  are non-differential costs.

4
Quantitative and Qualitative Relevant Information

• Quantitative factors are outcomes that are
  measured in numerical terms
• Financial
• Nonfinancial
• Qualitative factors are outcomes that cannot be
  measured in numerical terms
• Nonfinancial

5
One-Time-Only Special Order

• Decision criteria
• Accept the order if the revenue differential
  is greater than the cost differential.

6
Make or Buy Decision

• Opportunity costs are not recorded in formal
  accounting records since they do not generate
  cash outlays.
• These costs also are not ordinarily incorporated
  into formal reports.

7
Product-Mix Decisions Under Capacity Constraints

• Decision criteria Aim for the highest
  contribution margin per unit of the constraining
  factor.
• When multiple constraints exist, optimization
  techniques such as linear programming can be used
  in making decisions.

8
Equipment Replacement

• The book value of existing equipment is
  irrelevant since it is neither a future cost nor
  does it differ among any alternatives (sunk costs
  never differ).

9
Decisions and Performance Evaluation

• Managers often behave consistent with their
  short-run interests and favor the alternative
  that yields best performance measures in the
  short run.
• When conflicting decisions are generated,
  managers tend to favor the performance evaluation
  model.
• Top management faces a challenge that is,
  making sure that the performance-evaluation model
  of subordinate managers is consistent with the
  decision model.

10
Time Horizon of Pricing Decisions

• Two key differences when pricing for the long
  run relative to the short run
• Costs that are often irrelevant for short-run
  pricing decisions (fixed costs) are often
  relevant in the long run.
• Profit margins in long-run pricing decisions are
  often set to earn a reasonable return on
  investment.

11
Alternative Long-Run Pricing Approaches

• Market-based
• Cost-based (also called cost-plus)

12
Target Price is...

• the estimated price for a product (or service)
  that potential customers will be willing to pay.
• The target price, calculated using customer and
  competitors inputs, forms the basis for
  calculating target costs.

13
Target Costs

• Target sales price per unit
• Target operating income per unit
• Target cost per unit

14
Implementing Target Pricing and Target Costing

• Steps in developing target prices and target
  costs
• Develop a product that satisfies the needs of
  potential customers.
• Choose a target price.
• Derive a target cost per unit.
• Perform value engineering to achieve target costs.

15
Value-Added Costs

• A value-added cost is a cost that customers
  perceive as adding value, or utility, to a
  product or service
• Adequate memory
• Pre-loaded software
• Reliability
• Easy-to-use keyboards

16
Nonvalue-Added Costs

• A nonvalue-added cost is a cost that customers do
  not perceive as adding value, or utility, to a
  product or service.
• Cost of expediting
• Rework
• Repair

17
Cost Incurrence and Locked-in Costs
Cumulative Costs per unit
Locked-in Cost Curve
Cost Incurrence Curve
Value Chain Functions
Manufacturing
Mktg., Dist., Cust. Svc.
RD and Design
18
Cost-Plus Pricing

• The general formula for setting a cost-based
  price is to add a markup component to the cost
  base.
• Cost base X
  Markup component
  Y Prospective selling price X
  Y

19
Life-Cycle Budgeting

• The product life-cycle spans the time from
  original research and development, through sales,
  to when customer support is no longer offered for
  that product.
• A life-cycle budget estimates revenues and costs
  of a product over its entire life.

20
Predicted Costs

• Many of the production, marketing, distribution
  and customer service costs are locked in
  the RD and design stage.
• Life-cycle budgeting facilitates value
  engineering at the design stage before
  costs are locked in.

21
Strategy

• Strategy specifies how an organization matches
  its own capabilities with the opportunities in
  the marketplace to accomplish its objectives
• A thorough understanding of the industry is
  critical to implementing a successful strategy

22
The Balanced Scorecard

• The balanced scorecard translates an
  organizations mission and strategy into a
  comprehensive set of performance measures.
• The balanced scorecard does not focus solely on
  achieving financial objectives.
• It highlights the nonfinancial objectives that
  an organization must achieve in order to meet its
  financial objectives.

23
The Balanced Scorecard Flowchart
24
Aligning the Balanced Scorecard to Strategy

• Different strategies call for different
  scorecards.
• What are some of the financial perspective
  measures?
• Operating income
• Revenue growth
• Cost reduction is some areas
• Return on investment

25
Aligning the Balanced Scorecard to Strategy

• What are some of the customer perspective
  measures?
• Market share
• Customer satisfaction
• Customer retention percentage
• Time taken to fulfill customers requests

26
Aligning the Balanced Scorecard to Strategy

• What are some of the internal business process
  perspective measures?
• Innovation Process
• Manufacturing capabilities
• Number of new products or services
• New product development time
• Number of new patents

27
Aligning the Balanced Scorecard to Strategy

• Operations Process
• Yield
• Defect rates
• Time taken to deliver product to customers
• Percentage of on-time delivery
• Setup time
• Manufacturing downtime

28
Aligning the Balanced Scorecard to Strategy

• Post-sales service
• Time taken to replace or repair defective
  products
• Hours of customer training for using the product

29
Aligning the Balanced Scorecard to Strategy

• What are some of the learning and growth
  perspective measures?
• Employee education and skill level
• Employee satisfaction scores
• Employee turnover rates
• Information system availability
• Percentage of processes with advanced controls

30
Features of a Good Balanced Scorecard

• Tells the story of a firms strategy,
  articulating a sequence of cause-and-effect
  relationships the links among the various
  perspectives that describe how strategy will be
  implemented
• Helps communicate the strategy to all members of
  the organization by translating the strategy into
  a coherent and linked set of understandable and
  measurable operational targets

31
Features of a Good Balanced Scorecard

• Must motivate managers to take actions that
  eventually result in improvements in financial
  performance
• Limits the number of measures, identifying only
  the most critical ones
• Highlights less-than-optimal tradeoffs that
  managers may make when they fail to consider
  operational and financial measures together

32
Balanced Scorecard Implementation Pitfalls

• Managers should not assume the cause-and-effect
  linkages are precise they are merely hypotheses
• Managers should not seek improvements across all
  of the measures all of the time
• Managers should not use only objective measures
  subjective measures are important as well

33
Balanced Scorecard Implementation Pitfalls

• Managers must include both costs and benefits of
  initiatives placed in the balanced scorecard
  costs are often overlooked
• Managers should not ignore nonfinancial measures
  when evaluating employees
• Managers should not use too many measures

34
Evaluating Strategy

• Strategic Analysis of Operating Income 3 parts
• Growth Component measures the change in
  operating income attributable solely to the
  change in the quantity of output sold between the
  current and prior periods
• Price-Recovery Component measures the change in
  operating income attributable solely to changes
  in prices of inputs and outputs between the
  current and prior periods
• Productivity Component measures the change in
  costs attributable to a change in the quantity of
  inputs between the current and prior periods

35
Revenue Effect Analysis
P2
Price Recovery Component
Q2
Growth Component
P1
Q1
36
Cost Effect Analysis
Q2
Productivity Component
P2
Price Recovery Component
Q
P1
Growth Component
Q1
37
The Management of Capacity

• Managers can reduce capacity-based fixed costs by
  measuring and managing unused capacity
• Unused Capacity is the amount of productive
  capacity available over and above the productive
  capacity employed to meet consumer demand in the
  current period

38
Analysis of Unused Capacity

• Two Important Features
• Engineered Costs result from a cause-and-effect
  relationship between output and the resources
  used to produce that output
• Discretionary Costs have two parts
• They arise from periodic (annual) decisions
  regarding the maximum amount to be incurred
• They have no measurable cause-and-effect
  relationship between output and resources used

39
Managing Unused Capacity

• Downsizing (Rightsizing) is an integrated
  approach of configuring processes, products, and
  people to match costs to the activities that need
  to be performed to operate effectively and
  efficiently in the present and future
• Because identifying unused capacity for
  discretionary costs is difficult, downsizing,
  or otherwise managing this unused capacity, is
  also difficult.

40
Customer-Profitability Profiles

• Customer profitability reports often
  highlight that a small percentage of
  customers contribute a large percentage
  of operating income.
• It is important that companies devote
  sufficient resources to maintaining and expanding
  relationships with these key contributors to
  profitability.

41
Other Factors in Evaluating Customer Profitability

• Likelihood of customer retention
• Potential for sales growth
• Long-run customer profitability
• Increases in overall demand from having
  well-known customers
• Ability to learn from customers

42
Sales Volume Variance
aMi
Sales Mix
aQ
Sales Quantity
bMi
bQ
BCMi
aX
Market Share
aZ
BCM
Market Size
bX
bZ
43
Purposes of Cost Allocation

• There are four essential purposes of cost
  allocation
• To provide information for economic decisions
• To motivate managers and other employees
• To justify costs or compute reimbursement
• To measure income and assets for reporting to
  external parties

44
Cost Allocation Criteria
Cost Allocation by Ability to Bear
How many resources are consumed by the cost
object?
Cost Allocation by Cause and Effect
The ability for the cost object to absorb
additional cost given reasonable profit margin
Cost Object
Cost Allocation by Benefit Received
User
How many benefits are received by the user from
using the cost object?
45
Allocating Costs of a Supporting Department to
Operating Departments

• Supporting (Service) Department provides the
  services that assist other internal departments
  in the company
• Operating (Production) Department directly adds
  value to a product or service

46
Allocation Method Tradeoffs

• Single-rate method is simple to implement, but
  treats fixed costs in a manner similar to
  variable costs
• Dual-rate method treats fixed and variable costs
  more realistically, but is more complex to
  implement

47
Allocation Bases

• Under either method, allocation of support costs
  can be based on one of the three following
  scenarios
• Budgeted overhead rate and budgeted hours
• Budgeted overhead rate and actual hours
• Actual overhead rate and actual hours
• Choosing between actual and budgeted rates
  budgeted is known at the beginning of the period,
  while actual will not be known with certainty
  until the end of the period

48
Budgeted versus Actual Rates

• Budgeted rates let the user department know in
  advance the cost rates they will be charged.
• Users are better equipped to determine the amount
  of the service to request.
• Budgeted rates also help motivate the manager of
  the supplier department to improve efficiency.

49
Budgeted versus Actual Usage Allocation Bases

• When budgeted usage is the allocation base, user
  divisions will know in advance their allocated
  costs.
• This information helps the user divisions with
  both short-run and long-run planning.
• The main justification given for the use of
  budgeted usage to allocate fixed costs relates to
  long-run planning.

50
Allocating Support Departments Costs

• Three methods are widely used to allocate the
  costs of support departments to operating
  departments
• Direct allocation method
• Step-down method
• Reciprocal method

51
Direct Method
52
Step-Down Method
53
Reciprocal Method
54
Allocating Common Costs

• Common Cost the cost of operating a facility,
  activity, or like cost object that is shared by
  two or more users at a lower cost than the
  individual cost of the activity to each user
• Two methods for allocating common cost are
• Stand-alone cost-allocation method
• Incremental cost-allocation method

55
Joint-Cost Basics

• Joint costs are the costs of a single production
  process that yields multiple products
  simultaneously.
• Industries abound in which a single production
  process simultaneously yields two or more
  products.

56
Joint Products and Byproducts
Main Products Joint Products
Byproducts
High
Low
Sales Value
57
Approaches to Allocating Joint Costs

• The two basic approaches to allocating joint
  costs are
• Approach 1 Allocate costs using market-based
  data such as revenues.
• Approach 2 Allocate costs in some physical
  measure-based data such as weight or volume.

58
Allocating Joint Costs

• Approach 1
• The sales value at splitoff method
• The estimated net realizable value (NRV) method
• The constant gross-margin percentage NRV method

59
Constant Gross-Margin Percentage NRV Method

• Step 1 Compute the overall gross-margin
  percentage.
• Step 2 Use the overall gross-margin
  percentage and deduct the gross margin
  from the final sales values to obtain the
  total costs that each product should
  bear.
• Step 3 Deduct the expected separable costs
  from the total costs to obtain the joint-
  cost allocation.

60
Comparison of Methods

• Why is the sales value at splitoff method widely
  used?
• It is objective.
• It does not anticipate subsequent management
  decisions on further processing.
• It uses a meaningful common denominator.
• It is simple.

61
Irrelevance of Joint Costs for Decision
Making

• No techniques for allocating joint-product costs
  should guide decisions about whether a product
  should be sold at the splitoff point or processed
  beyond splitoff.

62
Accounting for Byproducts

• Although byproducts have much lower sales value
  than do joint or main products, the presence of
  byproducts can affect the allocation of joint
  costs.
• Byproduct accounting methods differ on whether
  byproducts are recognized in the financial
  statements at the time of production or the time
  of sale.

63
Production Method
Sales Method
Revenue MP Only MP BP
COGS
Total Cost BP NRV
Total Cost
EI (MP)
COGS
EI
COGS
Total EI EI (MP) EI (BP)
64
Operation Costing
Process-costing Systems
Job-costing Systems
Operation Costing System

• A hybrid costing system of customized
  manufacturing (job-order) and mass production
  (process) systems
• Produce batches of similar products with each
  batch being a variation of one design.

65
Operation Costing

• The production system is a sequence of operations
  or processes that a product must go through.
• All products may not go through all of the
  processes

Batch A
Operation 1
Materials
Finished Goods Inventory
Operation 3
Batch B
Operation 2
Batch C
66
Accounting for Operation Costing

• Separate WIP for each operation (or process).
• As the product moves between operations, debit
  receiving operation's WIP, credit sending
  operation's WIP.
• Direct materials are traced directly to each
  batch (or order).
• Conversion costs are accumulated by operation. A
  single average conversion cost is then applied to
  units that go through the operation, regardless
  of which batch they belong to.

67
Spoilage, Rework and Scrap Terminology

• There are three types of costs that arise as a
  result of defects
• Spoilage (???)
• Rework (???)
• Scrap (????)
• Some amount of spoilage, rework, or scrap appears
  to be an inherent part of many production
  processes.

68
Abnormal Spoilage

• Abnormal spoilage costs are written off as losses
  of the accounting period in which detection of
  the spoiled units occurs.
• Companies record the units of abnormal spoilage
  and keep a separate Loss from Abnormal Spoilage
  account.

69
FIFO Spoilage

• The FIFO method of process costing keeps costs in
  the beginning inventory separate from the costs
  in the current period when determining the costs
  of good units (which includes a normal spoilage
  amount) and the costs of abnormal spoilage.

70
Job Costing Spoilage or Rework

• Normal spoilage or rework can be assigned to a
  specific job or, if common to all jobs, as part
  of manufacturing overhead.
• Abnormal spoilage or rework is written off as a
  cost of the period.

71
Recognizing Scrap

• Scrap, if material in dollar amount, is
  recognized in the accounting records either at
  the time of its sale or at the time of its
  production.
• Scrap, if immaterial, is often recognized as
  other revenues at time of sale.

72
Recognizing Material Scrap at Time of Sale

• Recognizing sale of scrap specific to Job 10
• Cash or Accounts Receivable 300
  Work-in-Process (Job 10) 300
• Recognizing sale of scrap common to all jobs
• Cash or Accounts Receivable 300
  Manufacturing Overhead Control 300

73
Recognizing Material Scrap at Time of Production

• Recognizing scrap specific to Job 10 is
  returned to the storeroom
• Materials Control 300
  Work-in-Process (Job 10)
  300
• Recognizing scrap common to all jobs is returned
  to the storeroom
• Materials Control 300
  Manufacturing Overhead Control 300

74
Quality and Failure
75
The Financial Perspective Costs of Quality

• The costs of quality (COQ) refer to costs
  incurred to prevent, or costs arising as a result
  of, the production of a low-quality product.
• These costs focus on conformance quality and are
  incurred in all business functions of the value
  chain.

76
The Financial Perspective Costs of Quality

• Prevention costs--costs incurred in precluding
  the production of products that do not conform
  to specifications.
• Appraisal costs--costs incurred in detecting
  which of the individual units of products do not
  conform to specifications.

77
The Financial Perspective Costs of Quality

• Internal failure costs--costs incurred by a
  nonconforming product detected before it is
  shipped to customers.
• External failure costs--costs incurred by a
  nonconforming product detected after it is
  shipped to customers.

78
Cost of Quality Exclusions

• Opportunity Costs resulting from poor quality
• Contribution Margin and Income forgone from lost
  sales
• Lower Prices
• Excluded due to estimation difficulties and being
  unrecorded as to the financial accounting records

79
Nonfinancial Measures

• Nonfinancial measures of customer-satisfaction
• Nonfinancial measures of internal performance
• Measures of learning and growth

80
Evaluating Quality Performance

• Advantages of Financial COQ measures
• Financial measures are helpful to evaluate
  tradeoffs among prevention costs, appraisal
  costs, and failure costs.
• Financial COQ measures assist in problem solving
  by comparing different quality-improvement
  programs and setting priorities for achieving
  maximum cost reduction.
• COQ provides a single, summary measure of quality
  performance.

81
Evaluating Quality Performance

• Advantages of nonfinancial measures of quality
• Nonfinancial measures of quality are often easy
  to quantify and understand.
• Nonfinancial measures direct attention to
  physical processes and hence focus attention on
  the precise problem areas that need improvement.

82
Control Charts
Production Line B
m 2s
m s
Defect Rate
m
m - s
m - 2s
1 2 3 4 5 6 7 8 9 10
Days
83
Pareto Diagram
700
Number of Times Defect Observed
500
Copies are fuzzy and unclear
Copies are too light/dark
200
Paper gets jammed
84
Cause-and-Effect Diagrams
Methods and Design Factors
Human Factors
Flawed part design Incorrect manufacturing sequenc
e
Inadequate supervision Poor training New operator
Multiple suppliers Incorrect specification Variati
on in purchased components
Inadequate tools Incorrect speed Poor maintenance
Machine-related Factors
Materials and Components Factors
85
Time as a Competitive Weapon

• Companies need to measure time in order to manage
  it properly.
• Two common operational measures of time are
• Customer-response time
• On-time performance

86
Customer-Response Time
Order is placed
Order is received
Order is set up
Order is manufactured
Order is delivered
Waiting Time
Mfg. Time
Receipt Time
Manufacturing Lead Time
Delivery Time
Customer-Response Time
87
Theory of Constraints

• The objective of TOC is to increase throughput
  contribution while decreasing investments and
  operating costs.
• TOC considers a short-run time horizon and
  assumes operating costs to be fixed costs.

88
Theory of Constraints

• The theory of constraints emphasizes the
  management of bottlenecks as the key to improving
  the performance of the production system as a
  whole.

89
Methods to Relieve Bottlenecks

• Eliminate idle time at the bottleneck operation
• Process only those parts or products that
  increase throughput contribution, not parts or
  products that will remain in finished goods or
  spare parts inventories
• Shift products that do not have to be made on the
  bottleneck operation to nonbottleneck processes,
  or to outside processing facilities

90
Methods to Relieve Bottlenecks

• Reduce setup time and processing time at
  bottleneck operations
• Improve the quality of parts or products
  manufactured at the bottleneck operation

91
Costs Associated with Goods for
Sale

• Five categories of costs associated with goods
  for sale are
• Purchasing costs
• Ordering costs
• Carrying costs
• Stockout costs
• Quality costs

92
Economic-Order-Quantity Decision Model

• The formula for the EOQ model is
• EOQ
• D Demand in units for a specified time period
• P Relevant ordering costs per purchase order
• C Relevant carrying costs of one unit in
• stock for the time period used for D

93
Considerations in Obtaining Estimates of Relevant
Costs

• Obtaining accurate estimates of the cost
  parameters used in the EOQ decision model is a
  challenging task.
• What are the relevant incremental costs of
  carrying inventory?
• Only those costs of the purchasing company that
  change with the quantity of inventory held

94
Considerations in Obtaining Estimates of Relevant
Costs

• What is the relevant opportunity cost of capital?
• It is the return forgone by investing capital in
  inventory rather than elsewhere.
• It is calculated as the required rate of return
  multiplied by those costs per unit that vary with
  the number of units purchased and that are
  incurred at the time the units are received.

95
Economic-Order-Quantity Decision Model

• What are the relevant total costs?
• The formula for relevant total costs (RTC) is
  RTC Annual relevant ordering costs Annual
  relevant carrying costs
  
  RTC ( ) P ( ) C
  
  
  
  
• Q can be any order quantity, not just EOQ.

QC 2
D Q
Q 2
DP Q
96
Economic-Order-Quantity Decision Model
10,000
8,000
Annual relevant total costs
Relevant Total Costs (Dollars)
6,000
5,434
Annual relevant ordering costs
4,000
Annual relevant carrying costs
2,000
600
1,200
1,800
2,400
988 EOQ
Order Quantity (Units)
97
Reorder Point
988
Reorder Point
Reorder Point
494
Weeks
1
2
3
4
5
6
7
8
Lead Time 2 weeks
98
Safety Stock

• Safety stock is inventory held at all times
  regardless of the quantity of inventory ordered
  using the EOQ model.
• Safety stock is used as a buffer against
  unexpected increases in demand or lead time and
  unavailability of stock from suppliers.

99
Evaluating Managers and Goal-Congruence Issues

• Goal-congruence issues can arise when there is an
  inconsistency between the EOQ decision model and
  the model used to evaluate the performance of the
  manager implementing the inventory management
  decisions.

100
Materials Requirement Planning (MRP)

• Materials requirements planning (MRP) systems
  take a push-through approach that manufactures
  finished goods for inventory on the basis of
  demand forecasts.
• MRP predetermines the necessary outputs at each
  stage of production.
• Inventory management is a key challenge in an MRP
  system.

101
Just-In-Time Production Systems

• Just-in-time (JIT) production systems take a
  demand pull approach in which goods are only
  manufactured to satisfy customer orders.
• Demand triggers each step of the production
  process, starting with customer demand for a
  finished product at the end of the process, to
  the demand for direct materials at the beginning
  of the process.

102
Major Features of a JIT System

• The five major features of a JIT system are
• Organizing production in manufacturing cells
• Hiring and retaining multi-skilled workers
• Emphasizing total quality management
• Reducing manufacturing lead time and setup time
• Building strong supplier relationships

103
Benefits of JIT Systems

• Benefits of JIT production
• Lower carrying costs of inventory
• Eliminating the root causes of rework, scrap,
  waste, and manufacturing lead time.

104
Performance Measures and Control in JIT Production

• To manage and reduce inventories, the management
  accountant must design performance measures to
  control and evaluate JIT production.
• What information may management accountants use?
• Personal observation by production line workers
  and managers
• Financial performance measures, such as inventory
  turnover ratios

105
Performance Measures and Control in JIT Production

• What are nonfinancial performance measures of
  time, inventory, and quality?
• Manufacturing lead time
• Units produced per hour
• Days inventory on hand
• Total setup time for machines/Total manufacturing
  time
• Number of units requiring rework or scrap/Total
  number of units started and completed

106
Backflush Costing

• A unique production system such as JIT often
  leads to its own unique costing system.
• Organizing manufacturing in cells, reducing
  defects and manufacturing lead time, and ensuring
  timely delivery of materials enables purchasing,
  production, and sales to occur in quick
  succession with minimal inventories.

107
Backflush Costing

• Where journal entries for one or more stages in
  the cycle are omitted, the journal entries for a
  subsequent stage use normal or standard costs to
  work backward to flush out the costs in the cycle
  for which journal entries were not made.

108
Trigger Points

• Stage A Purchase of direct materials
• Stage B Production resulting in work in
  process
• Stage C Completion of a good finished unit or
  product
• Stage D Sale of finished goods

109
Trigger Points

• Assume trigger points A, C, and D.
• This company would have two inventory accounts
• Type
  Account Title 1. Combined
  materials Inventory Material and materials
  in work-in- and In-Process process
  inventory Control
• 2. Finished goods Finished Goods Control

110
Trigger Points

• Assume trigger points A and D.
• This company would have one inventory account
• Type
  Account Title Combines direct materials
  Inventory inventory
  and any direct Control
  materials in work-in-process
  and finished goods inventories

111
Special Considerations in Backflush Costing

• Backflush costing does not necessarily comply
  with GAAP
• However, inventory levels may be immaterial,
  negating the necessity for compliance
• Backflush costing does not leave a good audit
  trail the ability of the accounting system to
  pinpoint the uses of resources at each step of
  the production process