CIMA Paper P2Advanced Management Accounting

Ian Kusano and Nathi Thela

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2ChapterThe Modern Business

Environment

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Learning Objectives

Lead A1: Evaluate techniques for analysing and managing costs for

competitive advantage

Component A1b): Evaluate Total Quality Management techniques

-The impacts of just-in-time (JIT) production, the theory of constraints

and total quality management on efficiency, inventory and cost.

-The benefits of JIT production, total quality management and theory

of constraints and the implications of these methods for decision in

the contemporary manufacturing environment.

-Kaizen costing, continuous improvement and cost of quality reporting.

-Process re-engineering and the elimination of non-value adding

activities and reduction of activity costs.

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Introduction to the Modern Business

Environment

“To compete successfully in today’s highly competitive

global environment companies are making customer

satisfaction an overriding priority, adopting new

management approaches, changing their manufacturing

systems and investing in new technologies. These

changes are having a significant influence on

management accounting systems.”

Colin Drury in Cost and Management Accounting

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Session Content

The Global Environment

New Management

Approaches

• Just in time

• Total quality

management

• Theory of

constraints

Cost Planning and

Cost Reduction

• The value chain

• Value analysis

• Life cycle

costing

• Target costing

Logistics

• Supply chain

management

• Outsourcing

• Gain sharing

In this chapter we explore how the modern production system has changed, and

in the following chapters we examine how costing has adapted to this and created

new ways to calculate a product's production cost.

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Characteristics of the Modern Environment

Global environment

• Operate in World Economy

• Global customers and competition and sourcing

• International regulations

Flexibility

• Customers have far greater choice than ever before

• Huge increase in demand for new, cutting edge innovative products

• Customers are demanding ever improving levels of service in cost,

quality, reliability and delivery.

• Customers demand flexibility

As a consequence of this:

• Many companies now have very diverse product ranges, with a high level

of tailor made products and services;

• Product life cycles have dramatically reduced, often from several years to

just a few months.

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Characteristics of the Modern Environment

Employee Empowerment

1. To ensure this flexibility, managers need to empower their employees

to make decisions quickly, without reference to more senior managers.

2. By empowering employees and giving them relevant information they

will be able to respond faster to customers

3. Management accounting systems are moving from providing information

to managers to monitor employees to providing information to employees

to empower them to focus on continuous improvement.

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Just-in-Time

The emphasis of JIT is on produce or procure products or

components as they are required by a customer or for use, rather

than for inventory.

1. JIT Production 2. JIT Purchasing

• Push vs Pull system

Supplier to Production to Consumers

Consumers to Production to Suppliers

Toyota System

• In a full JIT system virtually no inventory is held, that is no raw

material inventory and no finished goods inventory is held, but

there will be a small amount of WIP, say one tenth of a day’s

production.

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Just-in-Time

To successfully adopt or implement JIT, the following is

required:

• labour force must be versatile

• Production processes must be grouped by product line

• infallible information system

• A ‘get it right first time’ approach and an aim of ‘zero

defects’.

• Strong supplier relationships.

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Total Quality Management

TQM is the general name given to programmes which

seek to ensure that goods are produced and services

supplied of the highest quality.

- Originates from Japan, its behind the success of

many Japanese businesses.

Two basic principles:

-Get it right first time – prevention costs are lesser

than correction costs.

- zero defects and 100% quality

-Continuous improvement – dissatisfied with the

status quo.

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Continuous Improvement and Cost of

Quality

There are two approaches to CI:

• Kaizen Costing and Target Costing

Quality costs are divided into compliance costs (or ‘conformance costs’)

and costs of failure to comply (‘nonconformance costs’).

• Prevention costs - costs of ensuring that defects do not occur in the

first place.

• Appraisal costs - are connected with measuring conformity with

requirements and includes

• Internal failure costs – includes reworking costs; costs of scrap;

correction costs

• External failure costs – there are several measurable costs for external

failure i.e. Marketing costs associated with failed products & loss of

goodwill.

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Example 1: Costs of Quality

X Ltd is a manufacturing company. Its monthly quality costs are

made up as follows:

$

Costs re-inspecting previously faulty finished goods 5,700

after reworking them

Costs of scrap 12,000

Costs of calibrating and measuring testing equipment 8,500

Costs of inspecting incoming material 1,000

Costs of conducting supplier capability surveys 2,000

Classify the above costs into the four components of costs of

quality?

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Example 2: Costs of Quality

Quality control costs can be categorised into internal and external

failure costs, appraisal costs and prevention costs. In which of

these four classifications would the following costs be included?

• The cost of a customer service team

• The cost of equipment maintenance

• The cost of operating test equipment

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Commitment to QualityFor TQM to bring about improved business efficiency and

effectiveness it must be applied throughout the whole

organisation.

It begins at the top with the managing director, the most senior

directors and managers who must demonstrate that they are

totally committed to achieving the highest quality standards.

Middle management must ensure that the efforts and achievements

of their subordinates receive appropriate recognition, attention and

reward.

This helps secure everyone’s full involvement – which is crucial to

the successful introduction of TQM.

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Successful implementation of TQM

• Total commitment throughout the organisation.

• Get close to their customers to fully understand their needs and expectations.

• Plan to do all jobs right first time.

• Agree expected performance standards with each employee and customer.

• Implement a company-wide improvement process.

• Continually measure performance levels achieved.

• Measure the cost of quality mismanagement and the level of firefighting.

• Demand continuous improvement in everything you and your employees do.

• Recognise achievements.

• Make quality a way of life.

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Quality Circles

• Is a team of four to twelve people usually coming from the same area

who voluntarily meet on a regular basis to identify, investigate, analyse

and solve work-related problems.

• They present their solutions to management and is then involved in

implementing and monitoring the effectiveness of the solutions.

• The problems that quality circles tackle may not be restricted to quality

of product or service topics, but may include anything associated with

work or its environment.

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The role of Management Accounting

• Management accounting systems can help organisations achieve their

quality goals by providing a variety of reports and measures that

motivate and evaluate managerial efforts to improve quality – including

financial and nonfinancial measures.

• Traditionally, the management accounting systems focused on output, not

quality.

• Nonfinancial measures include:

-Number of defects at inspection expressed as a percentage of the

number of units completed.

-Number of customer complaints.

-Number of defectives supplied by suppliers.

-Time taken to respond to customer requests.

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Throughput Accounting

Throughput = Sales Revenue Less Direct Material

Cost

• Aim to maximise throughput

• Fully utilise bottlenecks

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Goldratt and Cox’s 5 steps

1. Identify bottlenecks

2. Exploit bottlenecks

3. Subordinate to bottlenecks

4. Elevate bottlenecks

5. If break a bottleneck return to step 1

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Accounting Measures

Return Per Hour =Throughput Per Unit

Time on Bottleneck

Cost Per Hour =Total Factory Costs

Total Time on Bottleneck

T A Ratio =Return Per Factory Hour

Cost Per Factory Hour

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Example 3: Throughput Accounting

X Limited manufactures a product that requires 1.5 hours of

machining. Machine time is a bottleneck resource, due to the

limited number of machines available. These are 10 machines

available, and each machine can be used for u to 40 hours per

week.

The product is sold for $85 per unit and the direct material cost per

unit is $42.50. total factory costs are $8,000 each week.

Calculate

1. The return per factory hour

2. The TPAR.

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Example 4: Throughput Accounting

The following data relates to three products manufactured by BJS

Ltd. Product Product Product

X Y Z

Selling price per unit $12 $16 $14

Direct material per unit $3 $10 $7

Maximum demand (units) 15,000 40,000 20,000

Time required on the b/neck 3 1,5 7

(hours per unit)

The firm has 80,000 bottleneck hours available each period, and

total factory costs amount to $1000,000 in the period.

Calculate: 1. The TPAR for each product 2. The maximum profit

achievable by BJS, in $ (this involves a calculation of the optimum

product mix)

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Kaizen Costing

• Kaizen’ is a Japanese term meaning to improve processes via small,

incremental amounts rather than through large innovations.

• Kaizen costing is a planning method used during the manufacturing cycle

that emphasises reducing variable costs of a period below the cost level in

the base period.

-The organisation should always seek perfection. Improvements should

be sought all the time.

- Improvements will be small and numerous rather than occasional and

far reaching.

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Kaizen Costing & BPR-Cost reduction targets are set and applied on a more frequent basis

than standard costs. Refer to 64-65 for comparisons of Kaizen and

Standard Costing.

• The continuous improvement philosophy contrasts sharply with the

concept underlying business process reengineering (BPR). BPR is

concerned with making far reaching one off changes to improve

operations or processes.

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Kaizen Costing

A company experiences changing levels of demand, but produces

a constant number of units during each quarter. The company

allows inventory levels to rise and fall to satisfy the differing

quarterly demand levels for its product.

Required:

1. Identify and explain the reasons for three cost changes that

would result if the company changed to a Just In Time production

method for 2009. Assume there will be no inventory at the start

and end of the year.

2. Briefly discuss the importance of Total Quality Management to

a company that operates a Just In Time production method.

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Five stages in BPR project

1. Develop the business vision and process objectives

2. Identify the processes to be redesigned

3. Understand and measure the existing processes so that a baseline

against which is to measure improvement is set.

4. Identify ‘IT levers’ that can be used to apply is set

5. Design and build a prototype to show which changes are possible,

and involve customers before implementing any revised system

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Logistics in a Modern Environment

Supply Chain

ManagementOutsourcing

Gain Sharing

Arrangements

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Supply Chain Management

• SCM considers logistics but also relationships between members of

the supply chain, identification of end-customer benefit and the

organisational consequences of greater inter-firm integration to

form ‘network organisations’.

• SCM may be broken down into several areas:

- Purchasing

- Inventories

- Customer Ordering

- Delivery and logistics

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Outsourcing

• Outsourcing involves the buying in of components, sub-assemblies,

finished products and services from outside suppliers rather than

supplying them internally.

• Non-core activities are outsourced

Advantages Disadvantages

- Greater flexibility - Possibility of choosing wrong

supplier

- Lower investment risk - Loss of visibility and control over

process

- Improved cash flow - Possibility of increased lead

times

- Concentrates on core competence

- Enables more advanced technologies to

be used without making investment

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Insourcing

• Insourcing is a business practice in which work that would otherwise

have been contracted out is performed in house.

Advantages Disadvantages

- Higher degrees of control over input - Requires high volumes

- Increases visibility over the process - High investment

- Economies of scale/scope to use

integration

- Dedicated equipment has limited

flexibility

- Not a core competence

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Gain Sharing Arrangements

• Gain Sharing is a program that returns cost savings to the

employees.

• Companies typically guarantee their customers that they will achieve

a certain amount of savings or top-line improvement.

- If targets are not met, the company commits to making up the

difference in cash.

- If however targets are exceeded, the supplier may also receive a

pre-specified percentage of the gains.

•