Needles Powers Crosson Financial and Managerial Accounting 10e Value-Based Systems: Activity-Based Costing and Lean Accounting 18 C H A P T E R ©human/iStockphoto ©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.

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. ©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.

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

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. ©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.

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. ©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.

Process Value Analysis  Managers use process value analysis (PVA) to identify and link all the activities involved in the value chain. –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. ©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.

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 redirect resources to activities that add value to the product or service. –Activity-based costing (ABC) is the tool used in an ABM environment to assign activity costs to cost objects.  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. ©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.

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, 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. ©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.

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. ©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  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 that emphasize simplicity, quality, continuous improvement, minimum inventories, multiskilled workers, and eliminating waste and non-value-adding activities. –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. ©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.

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. ©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.

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. ©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.

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. ©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.

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. ©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.

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. ©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.

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. ©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.

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. ©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.

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. ©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.

Classifying and Assigning 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 ©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.

Classifying and Assigning 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. –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. ©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.

Backflush Costing  A lean organization can also streamline its accounting process by using backflush costing. –In backflush costing, direct materials costs and conversion costs (direct labor and overhead) are immediately charged to the Cost of Goods Sold account. –At the end of the period, they are “flushed back,” or worked backward, into appropriate inventory accounts. –This method saves recording time by eliminating the need to record several transactions that must be recorded in traditional operating environments. ©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.

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, including the theory of constraints and total quality management. –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. ©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.

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). ©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.

Managing for Value and Controlling Costs  The steps managers take during the management process to manage for value and control costs are: –Plan –Perform –Evaluate –Communicate ©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.