CHAPTER 20 USING ACCOUNTING FOR QUALITY AND COST MANAGEMENT 1st 1st

Quality and the New Production Environment Objective – To stay competitive through: Improving customer service and product quality Reducing costs

Improving Quality How much will it cost to improve quality? What can we do to improve quality?

Cost of Quality Texas Instruments Approach Prevention costs Inspection of materials upon delivery Inspection of production process Equipment inspection Employee training Appraisal costs Finished goods inspection Field testing of products .

Cost of Quality Texas Instruments Approach Internal failure costs are due to defects discovered before delivery to customers. Scrap materials Rework Reinspection Lost sales resulting from late deliveries Cost Report

Cost of Quality Texas Instruments Approach External failure costs are due to defects discovered after delivery to customers. Warranty repairs Product liability Marketing costs to improve product image Lost sales due to poor product quality

Cost of Quality Texas Instruments Approach Cost of prevention and appraisal Internal and external failure costs Objective Zero defects while minimizing all four quality cost categories

Improving Quality Total Quality Management (TQM) Managing an organization so that it excels in areas important to the customer Organization strives for excellence Quality is defined by the customer

Is Quality Worth the Investment? Two Views Cost vs. Benefit Quality is free Costs of quality programs are easily measured, but benefits of increased customer satisfaction are difficult to measure. The long-run benefits of increased customer satisfaction far outweigh the costs of improving quality.

The Quality Is Free Concept Quality products and services Increased business and profits Greater customer satisfaction

Methods to Identify Quality Problems Control charts Pareto diagrams Cause and effect analysis

Quality & Customer Satisfaction Measures 746 Performance measure Quality control Number of customer complaints and defects Delivery performance Percentage of on-time deliveries Materials waste Scrap and waste as a percentage of materials used Machine Downtime Percentage of time machines are not working Objective Customer satisfaction and high quality products Increase on-time deliveries Decrease scrap and waste; improve product quality Increase efficiency; increase on-time deliveries

Additional Quality Concepts Motivation Employees respond favorably to quality initiatives Strategic advantages Favorable reputation among competitors Benchmarking Continuous process of measuring performance against best of similar organizations

Just-In-Time (JIT) Inventory Products are completed just in time for shipment to customers Raw materials are received just in time for production

Just-In-Time (JIT) Inventory In conventional system, materials are “pushed” through assembly process. In JIT system, materials are “pulled” through assembly process by customers’ needs.

Just-In-Time (JIT) Inventory Receive customer orders Complete products just in time to ship to customers Schedule production Receive materials just in time for production Complete parts just in time for assembly into products

Relationship Between JIT and Total Quality Management Less warehouse space needed Reduced inventory carrying costs Reduced risk of obsolete inventory

Relationship Between JIT and Total Quality Management Less warehouse space needed Higher quality products Reduced inventory carrying costs More rapid response to customer orders Greater customer satisfaction Reduced risk of obsolete inventory

Relationship Between JIT and Total Quality Management Unhappy customer Late delivery Quality must be stressed from the very beginning for JIT to be successful. Raw materials JIT factory is idle, waiting on quality raw materials Poor quality items returned

Impact of Just-in-Time on Accounting Procedures JIT goal is to minimize inventories: Raw Materials Work in Process Finished Goods Production costs are assigned directly to cost of goods sold.

Impact of Just-in-Time on Accounting Procedures Any end-of-period inventory is recorded in a procedure known as backflush costing. Cost of Goods Sold Inventory

Impact of Just-in-Time on Accounting Procedures JIT accounting entries

Impact of Just-in-Time on Accounting Procedures Backflush entry if inventory remains unsold or in process

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Activity-Based Costing (ABC) A costing method that first assigns indirect costs to activities, then to products based on their consumption of the activities. Products Consume Activities Activities Consume Resources People Manage Activities

Activity-Based Costing Benefits More detailed measures of costs More accurate product costs for... Pricing decisions Product elimination decisions Better information for use in managing activities that cause costs Benefits should always be compared to costs of implementation

Methods Used for Activity-Based Costing Activity-based costing involves these steps: Identify the activities that consume resources, and assign costs to those activities. Identify the cost driver(s) associated with each activity. A cost driver is a factor that causes, or “drives,” an activity’s cost.

Methods Used for Activity-Based Costing Activity-based costing involves these steps: Identify the activities that consume resources, and assign costs to those activities. Identify the cost driver(s) associated with each activity. Compute a cost rate per cost driver unit or transaction. Assign costs to products as follows: Cost driver rate × Cost driver units consumed

Activity-Based Costing Identifying Cost Drivers Cost drivers are related to volume or complexity of production. Examples: machine time, machine setups, purchase orders, production orders Cost driver factors (in order of preference): Causal relationship Benefits received Reasonableness

Activity-Based Costing Cost Rate Per Cost Driver Unit For a period of time, estimate total . . . indirect costs for the activity cost driver units of activity Predetermined indirect cost rate Estimated indirect costs Estimated cost driver units of activity = This formula applies to any indirect cost. (e.g., manufacturing overhead, administrative, distribution, marketing, etc.

Activity-Based Costing Cost Rate Per Cost Driver Unit For a period of time, estimate total . . . indirect costs for the activity cost driver units of activity Predetermined indirect cost rate Estimated indirect costs Estimated cost driver units of activity = Note that this concept is identical to that used to calculate the predetermined overhead rate in Chapter 18.

Activity-Based Costing Example At this point, we need to look at an example to illustrate the concepts. .

Activity-Based Costing Example Ritz Company manufactures a product in regular and deluxe models. Overhead is assigned on the basis of direct labor hours. Estimated overhead for the current year is $2,000,000. Other information: First, determine the unit cost of each model using traditional costing methods.

Activity-Based Costing Example (Overhead Allocation)

Activity-Based Costing Example (Overhead Allocation)

Activity-Based Costing Example

Activity-Based Costing Example

Activity-Based Costing Example Ritz Company plans to adopt activity-based costing. Using the following activity center data, determine the unit cost of the two products if activity-based costing is implemented. A B C

Activity-Based Costing Example

Activity-Based Costing Example Original budgeted overhead total for the period

Activity-Based Costing Example = = = = + + + + A B C

Activity-Based Costing Example

Activity-Based Costing Example

Activity-Based Costing Example

Activity-Based Costing Example

Activity-Based Costing Example

Activity-Based Costing Example

Activity-Based Costing Example These amounts did not change as a result of using ABC.

Activity-Based Costing Example Comparison Remember, we originally used a plant-wide rate, based on direct labor hours, to allocate overhead. A B C

Activity-Based Costing Example Comparison Many companies have found that low-volume, specialized products have greater costs than previously realized.

Activity-Based Costing Example Comparison Can you see how different allocation methods might lead management to make different decisions?

Activity-Based Costing Final Observations As companies become more automated... Overhead tends to become a larger portion of product cost. Direct labor becomes a smaller portion of product cost and consequently a less reliable cost driver. Direct Material Product Cost Dollar Amount Mfg. OH Direct Labor

Activity-Based Costing Final Observations ABC is likely to result in cost reductions. Focus is on activity analysis. Cost reduction usually requires a change in activities. Costs

Activity-Based Costing Final Observations ABC is likely to result in cost reductions. Focus is on activity analysis. Cost reduction usually requires a change in activities. Activity-based costing concepts and methods are also applicable to marketing and administrative activities.

Activity-Based Costing Final Observations ABC is likely to result in cost reductions. Focus is on activity analysis. Cost reduction usually requires a change in activities. Activity-based costing concepts and methods are also applicable to marketing and administrative activities. Accountants implementing activity-based costing may experience opposition to change.

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