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Lean Accounting, Costs of Quality & Target Costing

Oleh: Suyanto, MBA., Dipl. Res.

Contents

Value versus Supply Chain Costs Associated with Goods for Sale Cost of Quality Target Costing Lean Accounting

Supply vs Value Chain

Supply vs Value Chain

Key success factors: -Cost and efficiency -Quality -Time -Innovation

Costs Associated with Goods for Sale

Ordering costs
Carrying costs

Stockout costs

Purchasing costs

Costs of Quality
Shrinkage Costs

Cost of Quality
Quality meets/exceeds customer expectations: Performance, Aesthetics, Serviceability, Features, Reliability, Durability, Quality of conformance & Fitness for use Zero defects versus defective product Cost of quality Costs of conformance (control activities) : the costs incurred to produce a quality product or service Costs of nonconformance (failure activities): the costs incurred to correct defects in a product or service.

Cost of Quality

Control Activities

Observable CQ - Recorded in AIS

Failure Activities Hidden CQ -Multiplier Method -Market Research Method -Taguchi Quality Loss Function

Reporting Quality Costs

Rule of thumb: 2-4% of sales

THINK!!! Reduce costs of quality, Improve quality

Analysis of Quality Costs

Conformance vs Non-conformance! -Avoid non-conformance? -Avoid External Failure? -Why?

Case 1
Internal reports on quality at the EMCAP Publishing Company generated the following information for the Trade Division for the first three months of the year: Total sales $60,000,000
Costs of quality: Prevention Appraisal Internal failure External failure a. b. c. d. $ 523,000 477,000 1,360,000 640,000

Compute the following:

Total costs of quality as a percentage of sales Ratio of costs of conformance to total costs of quality Ratio of costs of nonconformance to total costs of quality Costs of nonconformance as a percentage of total sales
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Case 2

1. 2. 3.

Which company is most likely to succeed in the competitive marketplace? Which company has serious problems with its products quality? What do you think will happen to the total costs of quality for each company over the next five years? Why
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Target Costing
Pricing method designed to enhance a companys ability to compete, especially in markets for new or emerging products, Procedures: 1. identifies the price at which a product will be competitive in the marketplace 2. defines the desired profit to be made on the product 3. computes the target cost for the product by subtracting the desired profit from the competitive market price.

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Why?
1. gives managers the ability to control or dictate the costs of a new product at the planning stage of the products life cycle. 2. enables managers to analyze a products potential before they commit resources to its production.

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Comparison of Price Decision Timing

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Case 3: Esemka Ltd

Esemka Ltd. is considering a new MPV car and must make a go or no-go decision when its planning team meets tomorrow. Market research shows that the unit selling price that would be agreeable to potential customers is Rp130 million, and the companys desired profit is 25 percent of target cost. The design engineers preliminary estimate of the products design, production, and distribution costs is Rp110 million per unit. Using target costing, determine whether the company should market the new product.
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Case 4: Elsinore Company

Router (R) and Tablet (T) Market price: R=$320-380, T=$750-850 Target price: R=$300, T=$725 Profit: 25% of total unit cost Cost information (ABC):
Material handling ($) parts cost Production ($) Product delivery ($) Projected unit demand Direct material cost ($) Purchased parts cost ($) Manufacturing labor
Hours Hourly labor rate ($)

1.30 per dollar of direct material and purchased 3.50 per machine hour 24 (R) 30 (T) 26,000 18,000 25 65 15 45
2.6 12 4.8 15

Assembly labor
Hours Hourly labor rate ($) 3.4 14 8.2 16

Machine hours

12.8 16

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Questions
1. Find the target cost per unit 2. Find the projected unit cost 3. Make a decision

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Lean Manufacturing
Competitive environment:
Needed to exercise better control, reduce costs, and become more efficient. Successful firm: preservation of market share, stable growth, and continuation of efficient production

Needed an approach designed to eliminate waste & maximize customer value.

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Basic Concepts of Lean Manu

Dont try to focus on a few lean tools and methodologies

1. 2. 3. 4. 5. 6. 7. 8.

Simple is better. The quality of the product or service is critical to customer satisfaction. The work environment must emphasize continuous improvement. Maintaining large inventories wastes resources and may hide poor work. Activities or functions that do not add value to a product or service should be eliminated or reduced. Goods should be produced only when needed. Workers must be multiskilled and must participate in eliminating waste. Building and maintaining long-term relationships with suppliers is important.
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Dimension of Lean Manufacturing

Delivering the right product
Right quantity Right quality (zero defect) At time needed At lowest possible cost

A cost reduction strategy that redefines activities performed

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The Lean Thinking Model

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Just in Case - JIC

Inventories of raw materials are maintained just in case some items are of poor quality or a key supplier is shut down by a strike. Subassembly parts are manufactured and stored just in case they are needed later in the manufacturing process. Finished goods are completed and stored just in case unexpected and rush customer orders are received. push approach, raw materials and subassembly parts are pushed through each process.

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Just in Time - JIT

A lean operation embraces the just-in-time (JIT) operating philosophy. Requires that all resourcesmaterials, personnel, and facilitiesbe acquired and used only as needed to create value for customers. A JIT environment reveals waste and eliminates it by adhering to the principles: Minimum Inventory Levels Quick Setup and Flexible Work Cells A Multiskilled Work Force High Levels of Product Quality Effective Preventive Maintenance Pull-Through Production Backflush Costing (lean operation)
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JIT

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Source: Weygandt et al. (2012)

Direct vs Indirect Costs

Why?

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Backflush Costing
Track cost flows through the production process as the product is made.

1.Accumulated in CGS 2.Flushed back into the appropriate inventory accounts.

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La-Z-Boy
1. Purchased $20,000 of direct materials on account. 2. Used all of the direct materials in production during the month. 3. Incurred direct labor costs of $8,000. 4. Applied $24,000 of overhead to production. 5. Completed units costing $51,600 during the month. 6. Sold units costing $51,500 during the month.
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Backflush Costing

Track cost flows through the production process as the product is made.

1.Accumulated in CGS 2.Flushed back into the appropriate inventory accounts.

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Case 5
For work done during August, Plush Furniture Company, incurred direct materials costs of $123,450 and conversion costs of $265,200. The company employs a just-in-time operating environment and backflush costing. At the end of August, it was determined that the Work in Process Inventory account had been assigned $980 of costs, and the ending balance of the Finished Goods Inventory account was $1,290. There were no beginning inventory balances. How much was charged to the Cost of Goods Sold account during August? What was the ending balance of the Cost of Goods Sold account?
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Practical Insight
Toyota Production System (Shigeo Shingo and Taaichi Ohno)
World-class manufacturing Just-in-time (JIT) manufacturing and purchasing

Fords lean enterprise system, minus:

did not properly value employees was not structured to deal with product variety

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ABM versus Lean ABS

Source: Value Based Systems: ABM and Lean, 2011

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Case 6
Couch Potato, Inc., produces futon mattresses. The company recently changed from a traditional production environment to just-in-time work cells. Would you recommend the use of ABM/ABC or backflush costing for tracking product costs? Explain your choice.

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Value Streams

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LOGO

Any comment or question

ssuy@ugm.ac.id

Case 7
A company manufactures pottery products. One of its value streams produces three prod-ucts: X, Y, and Z. Each pottery product goes through two cells sequentially: shaping and firing. Each cell has implemented lean manufacturing and has a team of people and equipment fully dedicated to the cell. The time the products spend in each cell is as follows: The cost of materials for each product is $5. Total conversion cost (labor and overhead) of the value stream is $22 per production hour.

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Case 7

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VALUE STREAM: Definition

Is all activities, both value-added & non-value-added, required to bring product group or service from starting point to finished product in hands of customer.

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VALUE STREAM
Types of value streams
Order fulfillment New product

Value stream activities

Non-value-added
Activities avoidable in the short run Unavoidable activities due to current technology or production method

Value added

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MANUFACTURING CELL: Definition

Contains all operations in close proximity that are needed to produce a family of products.

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LEAN ACCOUNTING: A Comparison

Traditional cost management systems may not be compatible with Lean Accounting. Lean Accounting makes product costs more simple & direct. More labor and overhead costs are assigned to products through direct tracing rather than allocation.

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FOCUSED VALUE STREAMS

Are more simple & accurate in product costing Have limitations
Initially, labor costs may be difficult to assign if people are employed in several value streams Labor costs should assigned proportionately

Are organized around a family of products

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VALUE STREAM DECISIONS

May lead to
Short term decisions May not reflect long term consequences

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PERFORMANCE MEASUREMENT: A
Comparison

Lean accounting replaces standard cost system measurements with a Box Scorecard that compares a) operational, b) capacity, & c) financial metrics with prior week performances. A mixture of financial & nonfinancial measures are used.

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What are product life cycle & life cycle costs?

Product life cycle is the time a product exists from conception to abandonment. Life cycle costs are all costs associated with a product for its life cycle.

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VALUE CHAIN: Definition

Is the set of activities required to design, develop, produce, market, and service a product.

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When are most costs incurred?

During the development stage. stage This is also the time costs should best be managed.

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TARGET COSTING
Uses 1 of 3 methods
Reverse engineering
Tearing down a competitors product to discover design features that create cost reductions

Value analysis
Attempting to assess the value placed on product functions by customers

Process improvement

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