Needles Powers Crosson Principles of Accounting 12e Value-Based Systems: Activity-Based Costing and...

NeedlesPowersCrosson

Principles of Accounting

12e

Value-Based Systems: Activity-Based Costing and Lean Accounting20

C H A P T E R

LEARNING OBJECTIVES

©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

LO1: Describe value-based systems, and discuss their relationship to the supply chain and the value chain.

LO2: Define activity-based costing, and explain how a cost hierarchy and a bill of activities are used.

LO3: Define the elements of a lean operation, and identify the changes in inventory management that result when a firm adopts its just-in-time operating philosophy.

LO4: Define and apply backflush costing, and compare the cost flows in traditional and backflush costing.

LO5: Identify the management tools used for continuous improvement, and compare ABM and lean operations.

SECTION 1: CONCEPTS


Relevance: the qualitative characteristic of information that has a direct effect on a decision

Reliability: the characteristic of information that is complete, neutral, and free from material error

Concepts Underlying Value-Based Systems

Value-based systems provide customer-related, activity-based information.– They focus on eliminating waste as companies

produce and deliver quality products and services.

– Managers can use value-based information reliably to compare the value created by products or services with the full product cost, which includes not only the costs of direct materials and direct labor, but also the costs of all production and nonproduction activities required to satisfy the customer.


Value Chain Analysis

Each step in making a product or delivering a service is a link in a chain that adds value to the product or service. This sequence of activities inside the organization that adds value to a company’s product or service is known as the value chain.– The steps that add value to a product or

service—which range from research and development to customer service—are known as primary processes.

– The value chain in a furniture company is illustrated on the next slide.


The Value Chain in a Furniture Company


Value Chain Analysis

– The value chain also includes support services, such as legal services, human resources, information technology, and accounting, which facilitate the primary processes by providing business infrastructure but do not add value to the final product or service.

– Value chain analysis allows a company to focus on its core competencies. A core competency is the activity that a company does best and that gives it an advantage over its competitors. A common result of value chain analysis is outsourcing.

Outsourcing is engagement of other companies to perform a process or service in the value chain that is not among an organization’s core competencies.


Supply Chains

Managers see their organization’s internal value chain as part of a larger system. This larger system is the supply chain (or the supply network)—the path that leads from the suppliers of the materials from which a product is made to the final customer.– The supply chain includes both suppliers and

suppliers’ suppliers, and customers and customers’ customers.

– Each organization in the supply chain is a customer of an earlier supplier, and each has its own value chain.

– The supply chain in a furniture company is shown on the next slide.


The Supply Chain in a Furniture Company


Using Information from Value Chains and Supply Chains

Managers who understand how their company’s value-adding activities fit into their suppliers’ and customers’ value chains can see their company’s role in the overall process of creating and delivering products or services.

When organizations work cooperatively with others in their supply chain, they can develop new processes that reduce the total costs of their products or services.


Process Value Analysis

Managers use process value analysis (PVA) to identify and link all the activities involved in the value chain.– PVA analyzes business processes by relating

activities to the events that prompt those activities and to the resources that the activities consume.

– PVA forces managers to look critically at all phases of their operations.

– By using PVA to identify non-value-adding activities, companies can improve the relevance and reliability of their data to reduce their costs and redirect their resources to value-adding activities.


Value-Adding and Non-Value-Adding Activities

A value-adding activity is one that adds value to a product or service as perceived by the customer. In other words, if customers are willing to pay for the activity, it adds value to the product or service.

A non-value-adding activity is one that adds cost to a product or service but does not increase its market value.– Managers eliminate non-value-adding activities

that are not essential and reduce the costs of those that are, such as legal services, management accounting, machine repair, materials handling, and building maintenance.


SECTION 2: ACCOUNTING APPLICATIONS

Classify activities using a cost hierarchy Prepare a bill of activities Understand the elements of a lean

operation Apply backflush costing


Activity-Based Management

Activity-based management (ABM) identifies all major operating activities, determines the resources consumed by each activity and the cause of the resource usage, and categorizes the activities as adding value to a product or service or not adding value.– ABM focuses on reducing or eliminating non-value-

adding activities.– It helps managers eliminate waste and

inefficiencies and redirect resources to activities that add value to the product or service.


Activity-Based Costing(slide 1 of 2)

Activity-based costing (ABC) is the tool used in an ABM environment to assign activity costs to cost objects.– It calculates a more accurate product cost than

traditional methods.– It categorizes all indirect costs by activity, traces

the indirect costs to those activities, and assigns those costs to products or services using a cost driver related to the cause of the cost.

– It improves the accuracy in allocating activity-driven costs to cost objects (i.e., products or services).


Activity-Based Costing(slide 2 of 2)

– To implement ABC, managers complete the following steps: Step 1: Identify and classify each activity. Step 2: Estimate the cost of resources for each activity. Step 3: Identify a cost driver for each activity, and

estimate the quantity of each cost driver. Step 4: Calculate an activity cost rate for each activity. Step 5: Assign costs to cost objects based on the level

of activity required to make the product or provide the service.

– While ABC gives managers greater control over the costs they manage, it can also be costly and complex to use.


Cost Hierarchy

A cost hierarchy is a framework for classifying activities according to the level at which their costs are incurred.– In a manufacturing company, as shown on the next

slide, the cost hierarchy typically has four levels. Unit-level activities are performed each time a unit is

produced and are generally considered variable costs. Batch-level activities are performed each time a batch

or production run of goods is produced. Product-level activities are performed to support a

particular product line. Facility-level activities are performed to support a

facility’s general manufacturing process and are generally fixed costs.


Sample Activities in Cost Hierarchies


Bill of Activities

A bill of activities is a list of activities and related costs that is used to compute the costs assigned to activities and the product unit cost.– A bill of activities may be used as the primary

document or as a supporting schedule to calculate the product unit cost in both job order and process costing systems and in both manufacturing and service businesses.

– A bill of activities for a furniture manufacturer completing an order for 100 chairs is shown on the next slide.


Bill of Activities



(slide 1 of 2)


(slide 2 of 2)

The New Operating Environment and Lean Operations (slide 1 of 2)

A lean operation focuses on eliminating waste in an organization and on what a customer is willing to pay for.– To achieve lean operations, a company

must redesign its operating systems, plant layout, and basic management methods to conform to several basic concepts: Simple is better. The quality of a product or service is critical from

product design to customer satisfaction. The work environment must emphasize

continuous improvement.©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

The New Operating Environment and Lean Operations (slide 2 of 2)

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.

– Piecemeal attempts at lean operations have proved disastrous when the implementation focused on a few lean tools and methodologies instead of understanding how to think lean throughout the organization.


Just-in-Time (JIT)

In a lean operation, the just-in-time (JIT) operating philosophy requires that all resources—materials, personnel, and facilities—be acquired and used only as needed to create value for customers.– A JIT environment reveals waste and

eliminates it by using the principles discussed on the next six slides.


Minimum Inventory Levels

In a JIT environment, materials and parts are purchased and received only when they are needed.– The JIT approach lowers costs by reducing the

space needed for inventory storage, the amount of materials handling, and the amount of inventory obsolescence.

– It reduces the need for inventory control facilities, personnel, and recordkeeping.

– It significantly decreases the amount of work in process inventory and the amount of working capital tied up in all inventories.


Pull-Through Production

In pull-through production, a customer’s order triggers the purchase of materials and the scheduling of production for the products that have been order.– In contrast, with the push-through production

method used in traditional manufacturing operations, products are manufactured in long production runs and stored in anticipation of customers’ orders.

– With pull-through production, the size of a customer’s order determines the size of a production run, and the company purchases materials and parts as needed.


Quick Setup and Flexible Work Cells

By placing machines in more efficient locations and standardizing setups, setup time can be minimized in a JIT environment.– By changing the factory layout so that all the

machines needed for sequential processing are placed together, JIT may cut the manufacturing time significantly.

– The new cluster of machinery forms a flexible work cell, an autonomous production line that can perform all required operations efficiently and continuously.

– The more flexible the work cell is, the greater its potential to minimize total production time.


A Multiskilled Workforce

In flexible work cells, one worker may be required to operate several types of machines simultaneously.– The worker may have to set up and retool

the machines and even perform routine maintenance on them.

– Under a JIT operating philosophy, multiskilled workers have been very effective in contributing to high levels of productivity.


High Levels of Product Quality

A JIT environment results in high-quality products, since high-quality direct materials are used and inspections are made throughout the production process.– In a JIT environment, inspection as a separate step

does not add value to a product, so inspection is incorporated into ongoing operations.

– A JIT machine operator inspects the products as they pass through the manufacturing process and, if he or she detects a flaw, shuts down the work cell until the problem can be determined and corrected.


Effective Preventive Maintenance

Continuous JIT operations require an effective system of preventive maintenance.– In a flexible work cell, if one machine breaks down,

the entire work cell stops functioning, and the product cannot easily be routed to another machine.

– Preventing machine breakdowns is considered more important than keeping machines running continuously.

– Machine operators are trained to perform minor repairs when they detect problems.

– Machines are serviced regularly to help guarantee continued operation.


Continuous Improvement of the Work Environment

A JIT operating philosophy fosters loyalty among workers, who are likely to see themselves as part of a team that is deeply involved in the production process.

Each worker is encouraged to suggest improvements to the production process. – In Japanese, this is called kaizen, meaning

“good change.”– Workers are rewarded for suggestions that

improve the process.


Accounting for Product Costs in a JIT Operating Environment

When a firm shifts to lean operations and adopts a JIT operating philosophy, the changes in operations will affect how costs are determined and what measures are used to monitor performance.

The work cells and the goal of reducing or eliminating non-value-adding activities change the way costs are classified and assigned.


Classifying Costs(slide 1 of 2)

The traditional production process includes:– Processing time—the actual amount of time spent

working on a product

– Inspection time—the time spent looking for product flaws or reworking defective units

– Moving time—the time spent moving a product from one operation or department to another

– Queue time—the time a product spends waiting to be worked on once it arrives at the next operation

– Storage time—the time a product spends in materials, work in process, or finished goods inventory


Classifying Costs(slide 2 of 2)

In product costing under JIT, costs associated with processing time are relevant, but costs associated with inspection, moving, queue, and storage time should be reduced or eliminated because they do not add value to the product.


Assigning Costs

In a JIT operating environment, managers focus on throughput time, the time it takes to move a product through the entire production process.

Sophisticated computer monitoring of the work cells allows many costs to be traced directly to the cells in which products are manufactured.

As shown on the next slide, several costs that in a traditional environment are treated as indirect costs and applied to products using an overhead rate are treated as direct costs of a JIT work cell.


Direct and Indirect Costs in Traditional and JIT Environments


Backflush Costing

Because a lean operation reduces labor costs, the accounting system can combine the costs of direct labor and overhead into a single category of conversion costs.

Because materials arrive just in time to be used in the production process, there is little reason to maintain a separate Materials Inventory account.– By simplifying cost flows through the accounting

records, it is possible to reduce the time it takes to record and account for the costs of the manufacturing process.


Cost Flows in Traditional and Backflush Costing

A lean organization can also streamline its accounting process by using backflush costing.– In backflush costing, all product costs are first

accumulated in the Cost of Goods Sold account. – At the end of the period, they are “flushed back,”

or worked backward, into appropriate inventory accounts.

– As shown on the next slide, this method saves recording time by eliminating the need to record several transactions that must be recorded in traditional operating environments.


Comparison of Cost Flows in Traditional and Backflush Costing


Traditional Costing Method

When a traditional method is used:– Direct materials costs are entered into the Materials

Inventory account upon arrival at the factory.

– Direct materials costs flow into the Work in Process Inventory account as materials are requisitioned into production. Direct labor and overhead are added to the Work in Process Inventory account.

– The costs of the finished units are transferred to the Finished Goods Inventory account at the end of the manufacturing process. When the units are sold, their costs are transferred to Cost of Goods Sold.


Backflush Costing Method(slide 1 of 2)

When the backflush costing method is used:– Direct materials arrive just in time to be placed into

production. The direct materials and conversion costs (direct labor and overhead) are immediately charged to the Cost of Goods Sold account.

– The costs of goods in work in process and finished goods inventory are determined at the end of the period, and those costs are flushed back to the Work in Process Inventory and Finished Goods Inventory accounts. Once those costs have been flushed back, the Cost of Goods Sold account contains only the costs of units completed and sold during the period.


Backflush Costing Method(slide 2 of 2)

– Assume that the following transactions occurred at Bean Bag Convertible’s facilities last month: 1. Purchased $20,000 of direct materials on account. 2. Used all of the direct materials in production. 3. Incurred direct labor costs of $8,000. 4. Applied $24,000 of overhead to production. 5. Completed units costing $51,600. 6. Sold units costing $51,500.

– The next slide shows how these transactions would be entered in T accounts using traditional and backflush costing. Trace the flow of each cost by following its transaction number.


Comparison of Cost Flows Through T Accounts with Traditional and Backflush Costing


JIT Costing Method(slide 1 of 3)

In backflush costing, the cost of direct materials (Transaction 1) is charged directly to the Cost of Goods Sold account.

Transaction 2, which is included in the traditional method, is not included when backflush costing is used because there is no Materials Inventory account.

The costs of direct labor (Transaction 3) and overhead (Transaction 4) are combined and transferred to the Cost of Goods Sold account.



Once all product costs for the period have been entered in the Cost of Goods Sold account, the amounts to be transferred back to the inventory accounts are calculated.– The amount to be transferred to the Finished

Goods Inventory account is computed as follows:Cost of Completed Units − Cost of Units Sold

= $51,600 − $51,500 = $100



- The amount to be transferred to the Work in Process Inventory account is computed as follows:

Costs Charged to Cost of Goods Sold − Cost of Completed Units

= ($20,000 + $8,000 + $24,000) − $51,600 = $400

- The ending balance in the Cost of Goods Sold account, $51,500, is the same as the ending balance when traditional costing is used. The difference is that backflush costing uses fewer accounts and avoids recording several transactions.


SECTION 3: BUSINESS APPLICATIONS

Total quality management Theory of constraints Activity-based management Lean accounting Planning Performing Evaluating Communicating


Management Tools for Continuous Improvement

Organizations that adhere to continuous improvement are never satisfied with what is.– They continuously seek improved quality

and lower cost through better methods, products, services, processes, or resources.

– In response to this concept, several important management tools have emerged, as described on the next few slides.


Total Quality Management

Total quality management (TQM) requires that all parts of a business focus on quality.– Workers are tasked to spot possible causes of poor

quality, use resources efficiently and effectively to improve quality, and reduce the time needed to complete a task or provide a service.

– To determine the impact of poor quality on profits, TQM managers use information about the costs of quality. The costs of quality include both the costs of achieving quality (such as training costs and inspection costs) and the costs of poor quality (such as the costs of rework and of handling customer complaints).


Theory of Constraints

According to the theory of constraints (TOC), limiting factors, or bottlenecks, occur during the production of any product or service.– Once managers identify such a constraint,

they can focus their attention and resources on it and achieve significant improvements.

– TOC helps managers set priorities for how they spend their time and resources.


Comparison of ABM and Lean Operations(slide 1 of 2)

ABM and lean have several things in common as value-based systems:– Both analyze processes and identify value-

adding and non-value-adding activities.– Both seek to eliminate waste and reduce non-

value-adding activities to improve product or service quality, reduce costs, and improve an organization’s efficiency and productivity.

– Both improve the quality of the information that managers use to make decisions about bidding, pricing, product lines, and outsourcing.


Comparison of ABM and Lean Operations(slide 2 of 2)

The two systems differ in their methods of costing and cost assignment.– ABM’s tool, ABC, calculates product or service cost

by using cost drivers to assign the indirect costs of production to cost objects.

– A lean operation uses JIT and reorganizes many activities so they are performed within work cells. The costs of these activities become direct costs of the work cell and of the products made in that cell.

– The next slide summarizes the characteristics of ABM and lean operations. A company can use both ABM and lean.


Comparison of ABM and Lean Operations


Managing for Value and Controlling Costs


The graphic below summarizes the steps managers take during the management process to manage for value and control costs.

Needles Powers Crosson Principles of Accounting 12e Value-Based Systems: Activity-Based Costing and...

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