Cost Management
Cost Management
Cost Management
JUST IN TIME
Traditional Manufacturing
Smooth operating activity
steady use of workforce
continuous machine utilization
Spread overhead over a maximum number of products
Inventory levels high enough to cover up inefficiencies in acquisition and/or production
Production Systems
Push system
Produce in anticipation of customer orders
Store raw material, work in process, and finished goods inventory
Pull system
Produce as needed
Minimal storage
Just-in-time is a philosophy centered on the reduction of costs through elimination of inventory. All
materials and components should arrive at a work station when they are needed—no earlier and no
later. Products should be completed and available to customers when the customers want them—no
earlier and no later.
Elimination of inventories eliminates storage and carrying costs; however it also eliminates the
cushion against production errors and imbalances that inventories provide. As a result, high quality
and balanced workloads are required in a JIT system to avoid costly shutdowns and customer ill will.
Because of the need for quality and balanced production, JIT has come to be closely identified with
efforts to eliminate waste in all forms, and thus is an important part of total quality management
(TQM) efforts.
The most visible aspect of JIT is the effort to reduce inventories of work in process and raw materials.
In this aspect, JIT is called stockless production, lean production, or zero inventory production (ZIP).
JIT Purchasing
Supplier evaluation. The firm’s purchasing department staff evaluates and investigates every
supplier and eliminates those who could not keep up with the delivery dates.
Supplier assistance. The firm’s engineering staff visits supplier sites and examines their
processes, not only to see if they can reliably ship high-quality parts but also to provide them
with engineering assistance to bring them up to a higher standard of product.
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Supplier information system. The firm installs a system—which is as simple as a fax
machine or as advanced as an electronic data interchange system or linked computer
systems— that communicates with suppliers as to exactly how much of specified parts are to
be sent to the firm.
Direct delivery: Deliveries—immediately preceding demand or use—are sent straight to the
production floor for use in manufactured products, so that no time is spent in inspecting the
parts for defects. Drivers, who bring supplies of materials, drop them off at the specific
machines that will use the materials first.
Goals of JIT
Reduction in total cost of production/performance while increasing quality
Elimination of any process or operation that does not add value
Continuous improvement in production/performance efficiency
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of materials, or production of finished goods.
Difficulties of backflushing
Does not strictly adhere to GAAP for external reporting
Absence of audit trails – ability of the accounting system to pinpoint uses of resources at
each step of the production process
A 3 Stage A. Purchase of DM
Stage D. Sale of FG
B 2 Stage A. Purchase of DM
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C 2 Stage C. Completion of FG
At the heart of lean manufacturing is the Toyota Production System (TPS). The main elements are:
1. Long-term focus on relationships with suppliers and coordination with these suppliers
2. Emphasis on balanced, continuous-flow manufacturing with stable production levels
3. Continuous improvement in product design and manufacturing processes with the objective
of eliminating waste
4. Flexible manufacturing systems in which different vehicles are produced on the same
assembly line and employees are trained for a variety of tasks.
Key focus points Reduce cost; reduce idle time Meet customer demand with short lead
time; reduce overproduction and inventory
levels
Manufacturing Goal is to meet forecasted demand Goal is to meet a customer order received
scheduling (push); production is in batches (pull); production is driven by the receipt
of customer orders
Batch production Reduce number of setups to reduce Reduce setup time to maximize
setup costs manufacturing flexibility and to reduce
inventory; maximize the ability to meet
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diverse customer needs; the principle of
one-piece flow.
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Cameraderie Company
Sample Value-Stream Income Statement
Key focus points Causality; linking resources, cost Process flow and throughput; speed up
drivers, and cost objects product throughput
Obtain accurate product costs Facilitate the 5 principles of lean
manufacturing
Support JIT and TOC efforts; reduce
inventory and customer lead time
Strategy Full cost based; can be used to Short-term focus on reducing lead times,
implementation support long-term decisions inventory levels and value stream income;
value-stream goals can be linked to
company strategy
Focus on day-to-day decisions
Cost allocation Trace direct costs and use cost The goal is to avoid cost allocation; use of
drivers for indirect costs the value stream, by aggregating products
into product families, means that many
costs can be traced directly to the value
stream so that allocation is not needed
Non-financial Can be supplemented as in a BSC Included in the box score report that
performance measures includes operational, capacity usage, and
financial measures
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Full Cost Accounting Lean Accounting
Product cost detail Individual product; product mix Aggregation of products; product cost at
and product-mix at the detail level the value-stream level; analysis of average
analysis product cost within value stream
Reflects the financial Only in the long term Directly shows the financial benefits of
benefits of lean lean efforts through value-stream
manufacturing? accounting and through the recognition of
the cost of decreasing inventory levels
Product costs for Products costs may or may not Assumes that a firm is a price-taker; costs
pricing play a role in pricing are not used in pricing
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TOTAL QUALITY MANAGEMENT (TQM)
Many companies have installed programs of total quality management (TQM), a broad set of
processes that focus the entire organization on providing products or services that do the best
possible job of satisfying the customer.
What it is
Company-wide approach to quality improvements
Seeks to eliminate poor quality and improve quality in all processes & activities
A philosophy and modus vivendi rather than a mere objective
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Accounting’s Role in the Management & Control of Quality
Accountants can add value to the organization by providing decision-makers with relevant
financial and nonfinancial information related to quality
Such information actively supports the quality initiatives embraced by management
Basic Terminology
“Quality”— customer satisfaction with the total experience of a product or service,
consisting of two components:
Design quality (focuses on the features that customers want). Design quality refers to
how closely the characteristics of a product or service meet the needs and wants of
customers. Design quality, then, involves giving customers what they desire in a
product or service.
Performance or conformance quality (focuses on product/service performance).
Conformance quality refers to the performance of a product or service relative to its
design and product specifications. For example, if one buys an iPad and it breaks
during the first week of use, there is a failure of conformance quality, as one
anticipated it would last longer than one week.
Total quality management (TQM)
Importance of having a good measurement system to support TQM
Limitations of conventional accounting systems?
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Absolute quality conformance (robust quality approach) requires that all products or
services meet exactly the target value with no variation allowed.
COQ Reports
Four categories of quality costs include the following:
1. Prevention costs are incurred to prevent poor quality. These expenditures incurred to keep quality
defects from occurring. Examples of prevention costs include:
quality engineering
quality training programs
quality planning
quality reporting
supplier evaluation and selection
quality audits
quality circles
field trials
design reviews
2. Appraisal costs are incurred to determine whether products and services are conforming to
requirements or customer needs. These are costs incurred in the measurement and analysis of
data to find out if products and services conform to specification/customer expectations. The
main objective is to prevent nonconforming goods from being shipped to customers. Examples of
appraisal costs include:
inspecting and testing of materials
packaging inspection
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supervising appraisal activities
process acceptance (sampling goods in process to see if the process is in control and
producing non-defective goods)
product acceptance (sampling finished goods to determine if the finished goods meet an
acceptable quality level)
measurement (inspection and test) equipment
outside endorsements
3. Internal failure costs are incurred because products or services do not meet requirements and the
defect is discovered before the external sale. These costs incurred as a result of poor quality found
through appraisal prior to delivery to customers Examples of internal failure costs include:
scrap
rework
downtime (due to defects)
reinspection
retesting
design changes
4. External failure costs are incurred because products fail to meet requirements after delivery to
customers. These are incurred to rectify quality defects after unacceptable products or services
reach the customer Examples include:
the cost of recalling defective products
lost sales because of poor product performance
returns and allowances because of poor quality
warranty costs
repair costs
product liability
customer dissatisfaction
lost market share
complaint adjustment
Cost of Nonconformity:
Internal Failure Costs
External Failure Costs
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Cycle time efficiency
Example:
Your firm has determined that no customer will accept sheet-metal deviating more than 0.05‛
from the target thickness (0.50‛). The cost to the firm is estimated as P5,000 for each rejection by a
customer.
5,000
k = (0.05 2 = 2,000,000
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L(x) = k(x -T)2
Thus, if the actual thickness of a unit is 0.47, then the estimated total loss for the unit is P1,800.
The costs of dealing with environmental issues are significant and take on many forms.
Private versus social costs
Private environmental costs are those borne by a company or individual (e.g., the
costs incurred by an organization to clean up a polluted lake).
Social environmental costs are costs borne by the public at large (such as the costs
incurred by taxpayers to staff the Environmental Protection Agency).
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3. Environmental internal failure costs. Costs incurred after contaminants are produced but
before they are introduced into the environment. Examples of internal failure costs include
treating and disposing of toxic materials and recycling scrap.
4. Environmental external failure costs. Costs incurred after contaminants are introduced into
the environment. Realized external failure costs are external costs the firm has to pay. Unrealized
external failure costs (or societal costs) are external costs caused by the firm but paid for by society.
Environmental reporting
An environmental cost report lists the environmental costs by category (prevention,
detection, internal failure, and external failure) and as a percentage of operating costs.
An environmental financial report lists environmental benefits (such as income from
recycling) as well as environmental costs.
ABM is a discipline that focuses on the management of activities as the route to improving the value
received by the customer and the profit achieved by providing this value. This discipline includes:
a. Cost driver analysis. Cost driver analysis identifies the factors that cause activities to be
performed in order to manage activity costs. An activity may be performed inefficiently due
to a particular reason. Managers have to address this cost driver to correct the root cause of
the problem.
b. Activity analysis (value analysis). This involves identification of the activities of an
organization and the activity centers (or activity cost pools that should be used in an ABC
system). Activity analysis also identifies value-added (VA) and non-value-added (NVA)
activities, so that all non-value- added activities can be eliminated from the process in order
to control costs.
c. Performance analysis. This involves the identification of appropriate measures to report the
performance of activity centers or other organizational units, consistent with each unit’s goals
and objectives. Performance analysis aims to identify the best ways to measure the
performance factors that are important to organizations in order to stimulate continuous
improvement.
Benefits of ABM
1. Cost reduction. Provision of excellent basis and focus for cost reduction.
2. Budget implementation. Provides operational management with a clear view of ‚how to
implement an activity-based budget.‛
3. Cost definition. Provision of clear understanding of the underlying causes of business
processing costs.
4. Decision making. Provision of excellent basis for effectiveness of management decision-
making.
5. Resource utilization. Identification of key process waste elements permits management
prioritization and leverage of key resource.
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Differences between ABC and ABM
ABC ABM
ABC refers to the technique of determining the ABM refers to the management philosophy that
costs of activities and the cost of output that those focuses on the planning, execution and
activities produce. measurement of activities as the key to
competitive advantage.
The aim of ABC is to generate improved cost data Being a much broader concept, ABM strives to
for use in managing a company’s activities. use information generated by ABC for effective
business processes and profitability.
End of Handouts
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