Management Accounting Information for Activity and Process Decisions

1. Management Accounting Information for Activity and Process Decisions Chapter 6

2. Introduction • Tobor Toy Company’s 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. • Archer’s 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 organization’s 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.

12. 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:

14. 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

15. Four Years TogetherKeepReplace Difference Operating costs $220,000 $ 80,000 $140,000 Disposal value -- ($ 25,000) $ 25,000 New machineacquisition cost $120,000 ($120,000) Total costs $220,000 $175,000 $ 45,000 Relevant Costs and Revenues

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

25. 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

28. 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.

29. 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 layoutorganizes 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

40. 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.

45. 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 system’s 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.