Title: Management Accounting Information for Activity and Process Decisions
1Management Accounting Information for Activity
and Process Decisions
2Evaluation of Financial Implications
- Managers must evaluate the financial implications
of decisions that require trade-offs between the
costs and the benefits of different alternatives - Financial information about the different types
of costs form the basis of decisions about the
organizations activities and processes
3Relevant Costs and Revenues
- Whether particular costs and revenues are
relevant for decision making depends on the
decision context and the alternatives available - Relevant costs - costs and revenues that differ
across the decision alternatives
4Relevant Costs
- Opportunity costs by definition are relevant
costs for any decision - The costs that remain the same regardless of the
alternative chosen are not relevant for the
decision
5Sunk Costs are Not Relevant
- Sunk costs often cause confusion for decision
makers - Costs of resources that already have been
committed and no current action or decision can
change - Not relevant to the evaluation of alternatives
because they cannot be influenced by any
alternative the manager chooses
6Relevant Costs for the Replacement of a Machine
- Should Bonner dispose of the USC machine it just
purchased on September 1 and buy the new machine
from Teo Company? - What costs are relevant for this decision?
7Relevant Costs for the Replacement of a Machine
- Sunk costs
- 30,000 cost of old machine
- 5,200 monthly loan payment for old machine
8Relevant Costs for the Replacement of a Machine
- Cost increases and cash outflows
- 50,000 down payment on the new machine
- 6,000 monthly lease payments on new machine
9Relevant Costs for the Replacement of a Machine
- Cost Savings and Cash Inflows
- 50,000 disposal of old machine
- 6,200 monthly cost savings
- 4,400 labor
- 1,000 materials
- 800 maintenance
10Assuming Responsibility for Decision
- Reversing a decision made a month earlier may
look like an error - If the manager does not purchase the new machine,
his behavior may be viewed as suboptimal - The manager may garner respect by assuming
responsibility for error - Manager needs to recognize sunk costs
11Make-or-Buy Decisions
- As managers attempt to reduce costs and increase
the competitiveness of their products, they face
decisions about whether their companies should - Such make-or-buy decisions illustrate how to
identify relevant costs and revenues
12Make-or-Buy Decisions Example
Std. Rear Std. Front Multicolor Curved
Product cost per unit
Direct materials 36 49 56 58
Direct labor 22 25 24 28
Unit-related support 14 16 18 20
Batch-related support 10 16 19 22
Product-sustaining overhead 6 12 14 19
Facility-sustaining overhead 8 10 11 14
Total manufacturing costs 96 128 142 161
Bids from outside suppliers
Lowest bid 82 109 140 156
Second lowest 88 116 147 164
Annual production (units) 36,000 48,500 6,800 8,700
13Avoidable Costs
- Those that are eliminated when a part, product,
product line, or business segment is discontinued - If the production manager decides to outsource a
product, the company may avoid certain production
costs - Contraction or redeployment of resources may
allow the company savings
14Avoidable Costs
- The company cannot dispose of part of the
facility used to support the production of the
standard rear lamp without disposing of the
entire machine or building - Most facility-sustaining support costs represent
the prorated costs of indivisible common
facilities
15Avoidable Costs
- Is there an alternative use for the part of the
facility made available by not producing a
product? - Indirect savings in facility-sustaining costs for
the organization are relevant for the decision to
outsource production, because they can arise only
if the lamp is outsourced
16Summary of Financial Analysis
- If the standard rear lamp is outsourced, the
company may avoid 3,168,000 of manufacturing
costs - The company would spend 2,952,000 to purchase
the parts from the low-bid supplier - The company could save 216,000 by outsourcing
17Qualitative Factors
- For most decisions such as this, several
additional factors, which are more qualitative in
nature, need to be considered - Permanence of the lower price
- Reliability of the supplier
- Many companies have adopted the practice of
certifying a small set of suppliers who are
dependable and consistent in supplying
high-quality items as needed
18Facility Layout Systems
- There are three general types of facility
designs - Process layouts
- Product layouts
- Cellular manufacturing
- Regardless of the type of facility design, a
central goal of the design process is to
streamline operations and thus increase the
operating income of the system
19The theory of constraints (TOC)
- TOC maintains that operating income can be
increased by carefully managing the bottlenecks
in a process - A bottleneck 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 accumulating - The buildup of inventories also slows the cycle
time of production
20Theory of Constraints
- The theory of constraints relies on the use of
three measures - Throughput contribution is the difference between
revenues and direct materials for the quantity of
product sold - 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
21Theory of Constraints
- Emphasis is on the short-run optimization of
throughput contribution - Assumes that operating costs as difficult to
alter in the short run
22Process Layouts
- All similar equipment or functions are grouped
together - Production of unique products is done in small
batches - Product follows a serpentine path, usually in
batches - High inventory levels
- Products might travel for several miles within a
factory during the production process
23Process Layout in a Bank
- The customer goes to the bank (a moving activity)
- The bank takes the loan application from the
customer (processing activity) - Loan applications are accumulated (storage
activity) and passed to a loan officer (moving
activity) for approval (both processing and
inspection activity) - Loans that violate standard loan guidelines are
accumulated (storage activity) then passed
(moving activity) to a regional supervisor for
approval (processing activity)
24Process Layout in a Bank (
- The customer is contacted when a decision has
been made (processing activity) - If the loan is approved, then the loan proceeds
are deposited in the customers account
(processing activity) - In most banks, work-in-process stockpiles at each
of the processing points or stations - Loan applications may be piled on desk of the
bank teller, the loan office or the regional
supervisor
25WIP Accumulation
- Work-in-process inventory accumulates at
processing stations in a conventional
organization for three reasons - Handling work in batches
- If the rate at which each processing area handles
work is unbalanced, work piles up at the slowest
processing station - If processing area managers are evaluated on
their ability to meet production quotas
26Product Layouts
- In a product layout, equipment is organized to
accommodate the production of a specific product - Product layouts exist primarily in companies with
high-volume production - The product moves along an assembly line beside
which the parts to be added to it have been
stored - Placement of equipment or processing units is
made to reduce the distance that products must
travel
27Product Layout in a Cafeteria
- People pass by containers of food and take what
they want - Employees organize the food preparation
activities so that the containers are refilled
just as they are being emptied - The ultimate goal is to reduce setup costs to
zero and to reduce processing time to as close to
zero as possible so that the system can produce
and deliver individual products just as they are
needed
28Cellular Manufacturing
- The organization of a plant into a number of
cells - Within each cell all machines required to
manufacture a group of similar products are
arranged in close proximity to each other - The machines in a cellular manufacturing layout
are usually flexible and can be adjusted easily
or even automatically to make different products
29Cellular Manufacturing
- The shape of a cell is often a U shape,
- The number of employees needed to produce a
product can often be reduced due to the new work
design - U shape also provides better visual control of
the work flow
30Problems with Batch Production
- Creates inventory costs
- Creates delays associated with storing and moving
inventory - These delays increase cycle times, thereby
reducing service to customers - Delays may even happen before manufacturing begins
31Inventory-Related Costs
- Demands for inventory lead to huge costs in
organizations, including the cost of moving,
handling, storing, obsolescence damage - Factory layouts and inefficiencies that create
the need to hold work-in-process inventory may
hide other problems leading to excessive costs of
rework
32Processing time
- Processing time time expended for the product
to be made - Processing cycle efficiency (PCE) measure of
the efficiency of the manufacturing process - PCE processing time
- processing time moving time
- storage time inspection time
33Analysis of relevant costs and benefits of
reorganization
- Total costs 1,000,000
- Three main benefits
- 1. Increase in sales due to decreased production
cycle time - 2. Reduction in inventory-related costs because
of reduced handling of WIP - 3. Improvement in quality since defective
processes are detected more quickly
34Cost of Nonconformance and Quality Issues
- Cost reduction has become a significant factor in
the management of most organizations - The premise underlying cost reduction efforts
today is to decrease costs while maintaining or
improving product quality in order to be
competitive - If the quality of products and services does not
conform to quality standards, then the
organization incurs a cost known as the cost of
nonconformance (CONC) to quality standards
35Quality
- Quality usually may 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 and performance conform to the
manufacturers standards
36Quality Standards
- Global competition has led to the development of
international quality standards - Company certification under these standards
indicates to customers that management has
committed their company to follow procedures and
processes that will ensure the production of the
highest-quality goods and services
37ISO9000
- In 1987, the International Organization for
Standardization (ISO) developed the first ISO9000
Series of Standards - These standards were revised in 1994 and again in
2000 - The goal of the member nations is to develop
globally recognized independent (third party)
quality system verification
38ISO9000 (2 of 6)
- ISO 9000 contains more than 20 standards and
documents - Because of the increase in the number of
standards, ISO 90002000 was developed - ISO 90002000 consists of four primary standards
and a greatly reduced number of supporting
documents (guidance standards, brochures,
technical reports, technical specifications)
39ISO9000
- The four primary standards are
- ISO 9000 Quality management systems
Fundamentals and vocabulary - ISO 9001 Quality management systems
Requirements - ISO 9004 Quality management systems Guidance
for performance improvement - ISO 19011 Guidelines on quality and/or
environmental management systems auditing (To be
published)
40ISO9000
- The most significant changes in the revised ISO
9000 standards are - Increased focus on top management commitment
- Emphasis on a process approach within the
organization - Continual improvement
- Increased focus on enhancing satisfaction for
customers and other interested parties
41ISO9000
- Eight quality management principles from best
management practices - Customer focus
- Leadership
- Involvement of people
- Process approach
- System approach to management
- Continual improvement
- Factual approach to decision making
- Mutually beneficial supplier relationships
42Costs Of Quality Control
- Classification of quality costs
- Prevention costs
- Appraisal costs
- Internal failure costs
- External failure costs
- Experience shows that it is much less expensive
to prevent defects than to detect and repair them
after they have occurred
43Prevention Costs
- Prevention costs are incurred to ensure that
companies produce products according to quality
standards - Quality engineering
- Training employees in methods designed to
maintain quality - Statistical process control
- Training and certifying suppliers so that they
can deliver defect-free parts and materials and
better, more robust, product designs
44Appraisal Costs
- Appraisal costs relate to inspecting products to
make sure they meet both internal and external
customers requirements - Inspection costs of purchased parts and materials
45Internal Failure Costs
- An internal failure occurs when the manufacturing
process detects a defective component or product
before it is shipped to an external customer - Reworking defective components or products is a
significant cost of internal failures - The cost of downtime in production is another
example of internal failure
46External Failure Costs
- External failures occur when customers discover a
defect - All costs associated with correcting the problem
- For many companies, this is the most critical
quality cost to avoid
47Cost-of-Quality Report
- This information is compiled in a cost-of-quality
(COQ) report, developed for several reasons - The report illustrates the financial magnitude of
quality factors - Cost-of-quality information helps managers set
priorities for the quality issues and problems
they should address
48Cost-of-Quality Report
- The cost of quality report allows managers to see
the big picture of quality issues - It allows them to try to find the root causes of
their quality problems
49Just-in-Time Manufacturing
- Just-in-time (JIT) manufacturing is a
comprehensive and effective manufacturing system - Just-in-time production requires making a product
or service only when the customer, internal or
external, requires it - It uses a product layout with a continuous flow
50Implications Of JIT Manufacturing
- Just-in-time manufacturing is simple in theory
but hard to achieve in practice - Organizations that use just-in-time manufacturing
must eliminate all sources of failure in the
system
51Implications Of JIT Manufacturing
- At the core of the JIT process is a highly
trained workforce whose task is to carry out
activities using the highest standards of quality - When an employee discovers a problem with a
component, it is the responsibility of that
employee to call immediate attention to the
problem so that it can be corrected - Suppliers must be able to produce and deliver
defect-free materials or components just when
they are required - Preventative maintenance is also employed so that
equipment failure is a rare event
52Implications Of JIT Manufacturing
- Just-in-time manufacturing has two major
implications for management accounting - management accounting must support the move to
JIT manufacturing by monitoring, identifying, and
communicating to decision makers the sources of
delay, error, and waste in the system - the clerical process of management accounting is
simplified by JIT manufacturing, due to the
smaller inventory to monitor and report
53Implications Of JIT Manufacturing
- Important measures of a JIT systems reliability
include the following benchmarks of manufacturing
cycle effectiveness - Conventional labor and machine productivity
ratios are inconsistent with the just-in-time
production philosophy - Any significant management innovation, such as
ABC or JIT, requires a major cultural change for
an organization