Management Accounting Information for Activity and Process Decisions

1
Management Accounting Information for Activity
and Process Decisions

• Chapter 6

2
Introduction

• Tobor Toy Companys best-selling toy was a
  mechanical toy robot.
• Lately, however, Tobor experienced a large drop
  in market share.

3
Introduction

• Customers complained that the toy robots failed
  to perform many of their functions.
• Thomas Archer, senior manager of manufacturing,
  and a cross-functional team documented numerous
  shop floor problems.
• Archers report to top management raised a number
  of questions.
• Should many of the existing machines be replaced?

4
Introduction

• What should the company do about a local vendor
  who produced faulty computer chips?
• Would it make sense to implement an entirely new
  production process such as JIT?
• In this chapter we will discuss many issues
  related to how management accounting information
  is used when making decisions.

5
Learning Objectives

• Explain why sunk costs are not relevant costs.
• Analyze make-or-buy decisions.
• Explain the influence of qualitative factors in
  making decisions.

6
Learning Objectives

• Describe the different types of facilities
  layouts.
• Discuss the theory of constraints.
• Explain the purpose of just-in-time manufacturing
  systems.

7
Learning Objectives

• Describe the concept of the cost of quality.
• Describe the cost savings resulting from
  reductions in inventories, reduction in
  production cycle time, production yield
  improvements, and reductions in rework and defect
  rates.

8
Learning Objective 1

• Explain why sunk costs are not relevant costs.

9
Evaluation of Financial Implications

• Many decisions require tradeoffs between the
  costs and the benefits of different alternatives.
• Financial information about the different types
  of costs forms the basis of decisions about the
  organizations activities and processes.

10
Sunk Costs

• What are sunk costs?
• Sunk costs consist of those costs incurred in the
  past.
• They are the costs of resources already committed
  and cannot be changed by any current action.
• These costs are irrelevant in decision making.

11
Relevant Costs and Revenues

• What are relevant revenues and costs?
• They are the revenues and costs that differ
  across the decision alternatives.
• Costs that remain the same regardless of the
  alternative chosen are not considered relevant
  for the decision.

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Relevant Costs and Revenues

• What are some examples of relevant cost increases
  or cost savings?

Down payment on a new machine
Disposal of an old machine
Lease payments on a new machine
Cost savings
13
Relevant Costs and Revenues

• Management of Joe Printers, Inc. is considering
  replacing its current printing machines with
  newer, faster, and more efficient technology.
• The following data have been compiled

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Relevant Costs and Revenues
Existing New
Category Machines Machines
Original cost 100,000 120,000
Annual operating

costs 55,000 20,000 Remaining useful

life 4 years 4 years
Disposal value now 25,000 N/A Salvage value

after 4 years 0 0
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Relevant Costs and Revenues

• Four Years
  Together Keep
  Replace Difference Operating
  
  costs 220,000 80,000 140,000
• Disposal
  value --
  ( 25,000) 25,000
• New machine
  acquisition cost 120,000 (120,000)
• Total costs 220,000 175,000 45,000

16
Relevant Costs and Revenues

• Should Joe Printers, Inc. replace the existing
  machines?
• Yes, because replacing the machines will provide
  the company with cost savings of 45,000 over the
  four years period.

17
Learning Objective 2

• Analyze make-or-buy decisions.

18
Make-Or-Buy Decisions

• What is a make-or-buy decision?
• It is to either make some parts and components
  in-house or subcontract with another
  company to supply them.
• What is outsourcing?
• It is purchasing a product, part, or component
  from an outside supplier instead of
  manufacturing it in-house.

19
Make-Or-Buy Decisions

• Virginia Motors manufactures auto parts.
• An outside supplier has offered to supply 30,000
  parts of model G23 at a price of 180 per unit.
• What costs must the decision maker identify
  before accepting this offer?

20
Make-Or-Buy Decisions

• Decision makers must identify what costs are
  relevant for the decision.
• Avoidable costs are eliminated when a part,
  product line, or a business segment is
  discontinued.
• Unavoidable costs will continue.

21
Make-Or-Buy Decisions

• Unit manufacturing costs for G23 are

Direct material 78 Direct
labor 60 Unit related
support 15 Batch related
support 20 Product sustaining
support 10 Facility sustaining
support 17 Total
cost 200
22
Make-Or-Buy Decisions

• Assume that the avoidable costs are

Direct material 78 Direct
labor 60 Unit related
support 13 Batch related
support 10 Product sustaining
support 6 Total avoidable
cost 167
23
Make-Or-Buy Decisions

• The following costs will continue whether
  Virginia Motors makes the part or
  outsources it

Unit related support 2 Batch
related support 10 Product
sustaining support 4 Facility
sustaining support 17
Total cost 33
24
Make-Or-Buy Decisions

• Should Virginia Motors outsource model G23?
• No, because it will cost the company 390,000
  more to purchase the part from the outside
  supplier.
• (180 167) 30,000 390,000

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Learning Objective 3

• Explain the influence of qualitative factors in
  making decisions.

26
Qualitative Factors

• Are the quantitative estimates of revenues and
  costs the only relevant considerations for
  decision makers?
• No, because qualitative factors also need to be
  considered.
• What are examples of qualitative factors?

27
Qualitative Factors

• Reputation of supplier
• Suppliers ability to meet performance standards
• Suppliers ability to meet time commitments

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Qualitative Factors

• What is a certified supplier?
• It is a specially selected supplier who is
  assured a high level of business for conforming
  to high standards for quality and delivery
  schedules.

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Learning Objective 4

• Describe the different types of facilities
  layouts.

30
Facility Layout Systems

• What are the three general types of facility
  designs?
• Process layouts
• Product layouts
• Cellular manufacturing

31
Facility Layout Systems

• Process layouts group similar equipment or
  functions together.
• Process layouts exist in organizations in which
  production is done in small batches of unique
  products.
• Products follow long production paths.
• Process layouts are characterized by high
  inventory levels.

32
Facility Layout Systems

• Product layout organizes equipment to accommodate
  the production of a specific product.
• Product layout exists primarily in companies with
  high volume production.
• The product moves along an assembly line.
• Product layouts reduce the level of inventory in
  the system.

33
Facility Layout Systems

• Cellular manufacturing layout refers to the
  organization of a plant into a number of cells.
• All machines required to manufacture a group of
  similar products are arranged in close proximity.
• The machines in a cellular manufacturing layout
  can be adjusted to make different products.

34
Facility Layout Systems
Cellular Manufacturing
35
Inventory Costs and Processing Time

• Moving and storage costs of inventory can be
  significant and are non-value added.
• Managers may stockpile work to avoid idle
  facilities.
• Batch production creates inventory costs.

36
Inventory Costs and Processing Time

• What are some inventory problems associated with
  batch production?
• Unbalanced work rates cause inventory stockpiles.
• Defects are often found at the end of production.

37
Inventory Costs and Processing Time

• What is processing time?
• It is the time spent in making a product.
• What is manufacturing cycle time.
• It is the time from the receipt of the raw
  materials from the supplier to the delivery of
  the finished goods to the distributors and
  customers.

38
Inventory Costs and Processing Time

• One method used by organizations to assess the
  efficiency of their manufacturing process is
  known as manufacturing cycle efficiency.

MCE

Processing Time

(Processing time Moving time
Storage time Inspection time)
39
Inventory Costs and Processing Time

• What are some benefits of layout reorganization?
• Reduced production cycle time
• Reduced work-in-process inventory
• Reduced production costs
• Reduced costs of rework
• Reduced inventory carrying charges
• Improvements in production yield rate

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Learning Objective 5

• Discuss the theory of constraints.

41
Theory of Constraints

• A central goal of the design process is to
  streamline operations and thus increase the
  operating income of the system.
• The theory of constraints (TOC) maintains that
  operating income can be increased by carefully
  managing the bottlenecks in a
  process.
• What is a bottleneck?

42
Theory of Constraints

• It is any condition that impedes or constrains
  the efficient flow of a process.
• A bottleneck can be identified by determining
  points at which excessive amounts of
  work-in-process inventories are accumulated.
• The building of inventories also slows the
  cycle-time production.

43
Theory of Constraints

• The theory of constraints relies on the use of
  three measures.
• The throughput contribution
• Investments
• Operating costs
• The throughput contribution is the difference
  between revenues and direct materials for the
  quantity of product sold.

44
Theory of Constraints

• Investments equal the materials costs contained
  in raw materials, work in process, and finished
  goods inventories.
• Operating costs are all other costs, except for
  direct materials costs, that are needed to obtain
  throughput contribution.
• The TOC emphasizes the short-run optimization of
  throughput contribution.

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Learning Objective 6

• Explain the purpose of just-in-time
  manufacturing systems.

46
Just-In-Time Manufacturing

• Just-in-time production requires making a good or
  service only when the customer, internal or
  external, requires it.
• It uses a product layout with a continuous flow.
• At the core of the JIT process is a highly
  trained work force.

47
JIT Manufacturing and Management Accounting

• Just-in-time manufacturing has two major
  implications for management accounting.
• First, management accounting must support the
  move to just-in-time manufacturing by monitoring,
  identifying, and communicating to decision makers
  the sources of delay, error, and waste in the
  system.

48
JIT Manufacturing and Management Accounting

• Second, the clerical process of management
  accounting is simplified by JIT because there are
  fewer inventories to monitor and report.
• What are some measures of a JIT systems
  reliability?
• Defect rates
• Cycle times

49
JIT Manufacturing and Management Accounting

• Percent of time that deliveries are on time
• Order accuracy
• Actual production as a percent of planned
  production
• Actual machine time available compared to planned
  machine time available

50
Learning Objective 7

• Describe the concept of the cost of
  quality.

51
Quality Issues

• The premise underlying cost reduction is to
  decrease costs while maintaining or improving
  product quality.
• If the quality of products and services does not
  conform to quality standards, the organization
  incurs the cost of nonconformance to quality
  standards.

52
Quality Issues

• What is quality?
• Quality can be viewed as hinging on two major
  factors
• Satisfying customer expectations regarding the
  attributes and performance of the product
• Ensuring that the technical aspects of the
  products design conform to the manufactures
  standards

53
Costs of Quality

• How are quality costs classified?
• Prevention costs
• Appraisal costs
• Internal failure costs
• External failure costs
• Prevention costs are incurred to ensure that
  companies produce products according to quality
  standards.

54
Costs of Quality

• Appraisal costs relate to inspecting products to
  make sure they meet both internal and external
  customers expectations.
• Internal failure costs are incurred when the
  company detects defective products before they
  are delivered to customers.
• External failure costs occur when customers
  discover a defect.

55
Costs of Quality

• What is a cost-of-quality report?
• It is a report that details the cost of quality
  by the categories prevention, appraisal, internal
  failure, and external failure.

56
Learning Objective 8

• Describe the cost savings resulting from
  reductions in inventories, reduction in
  production cycle time, production yield
  improvements, and reductions in rework and defect
  rates.

57
Tobor Toy Company Revisited

• Tobor Toy Company adopted a just-in-time
  manufacturing system.
• Tobor succeeded in decreasing its major and minor
  rework rates.
• Average production cycle time was also reduced.

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Production Flows
Yes
Injection Molding
First Inspection
Major Defect?
Component and Final Assembly
No
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Production Flows
Finishing and Second Inspection
Yes
Rework
Major Defect
Minor Defect
No
Packing
Scrap
60
Work-in-Process Inventory

• The average work-in-process inventory decreased.
• Work-in-process inventory was directly influenced
  by the number of major and minor defects.
• Production managers attributed the reduction in
  work-in-process inventory entirely to reduction
  in defect rates.

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Conclusion

• The marketing manager, Kathie Heine, believed
  that the improvement in the production cycle time
  had an impact on sales.
• She believed that the shorter production cycle
  time led to maintaining sales that otherwise
  would have been lost.

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End of Chapter 6