MANAGEMENT ACCOUNTING WEEK 9

O VERVIEW – C HAPTER 11 Operations & accounting The value chain Manufacturing v. services Standard costs Capacity utilization, spare capacity and product mix

O PERATIONS & ACCOUNTING Operations is the function that produces the goods or services to satisfy demand from customers purchasing, manufacturing, distribution and logistics Four aspects of the operations function: quality, speed, dependability and flexibility - each has cost implications Slack et al.  What is the cost of spare capacity?  What product/service mix should be produced where there are capacity constraints?

V ALUE CHAIN

V ALUE C HAIN - P ORTER activities themselves’ ‘a collection of activities that are performed to design, produce, market, deliver, and support its product … A firm’s value chain and the way it performs individual activities are a reflection of its history, its strategy, its approach to implementing its strategy, and the underlying economics of the activities themselves’ Porter Costs should be assigned to the value chain but accounting systems can get in the way of analysing those costs Hierarchical departments v. value processes The cost drivers of each value activity should be analysed to enable comparisons with competitor value chains

P RODUCTION METHODS Custom Unique, single products Batch A quantity of the same goods produced at the same time ( a production run) Continuous (or process) Continuous production process of the same, indistinguishable goods

M ANUFACTURING V. S ERVICES Inventory Raw materials Finished goods Work in progress Costing methods Job costing Bill of materials Labour routing Process costing

S ERVICES Differences Intangibility, heterogeneity, simultaneity and perishability Types Professional services Mass services (transport, retail) Service shop (banks, hotels) Fitzgerald et al.  Professional service equal to customised or batch manufacturing; mass service with continuous manufacture; and service shop as a batch-type process - Slack et al.

S TANDARD COSTS Anticipated or budget cost for a unit or batch of units Standard quantities multiplied by ‘standard’ costs: the current/ anticipated purchase prices for materials and labour rates of pay Materials, labour & overhead Expressed per unit

S TANDARD COSTS

C APACITY UTILIZATION & THE COST OF SPARE CAPACITY Utilization of capacity is a key performance driver Accounting traditionally equates the cost of using resources with the cost of supplying resources Accounting traditionally equates the cost of using resources with the cost of supplying resources Unused capacity  Reduce the supply of resources or  Increasing the quantity of activities Kaplan & Cooper Activity-based costing cost of resources supplied – cost of resources used = cost of unused capacity

C OST OF SPARE CAPACITY Cost of resources supplied – cost of resources used = cost of spare capacity 10 $30,000 Cost driver is 2,000 transactions per person (capacity) Cost of resources supplied 10 x $30,000 = $300,000 Standard cost per transaction is $300,000/20,000 = $15 per transaction Actual 18,000 transactions Cost of resources used 18,000 x $15 = $270,000 Cost of unused capacity = 300,000 – 270,000 = $30,000

C APACITY UTILIZATION & PRODUCT MIX Capacity as the limiting factor Ranking of product/services Contribution per unit of limiting factor

C APACITY UTILIZATION AND PRODUCT MIX

C ONTRIBUTION PER UNIT OF LIMITING FACTOR

O PTIMUM CAPACITY UTILISATION

B OTTLENECK CAPACITY Seating capacity in restaurant = 100 seats but not all can be served simultaneously Bottleneck capacity is ability of kitchen to serve a maximum of 70 people at the same time Medium term: increase kitchen capacity or reduce seating capacity Short term: capacity limitation is 70, not 100 Note: in this example waiters are a variable labour cost, kitchen staff are a fixed labour cost

T HROUGHPUT ACCOUNTING Theory of constraints  Bottleneck defines capacity Throughput contribution = sales – cost of materials  All other costs are fixed Ranking of product/services Throughput contribution per unit of bottleneck resource

T HROUGHPUT CONTRIBUTION

Product RProduct S Selling price$12$20 Materials$4$11 Labour hours 24 Machine hours 43 I LLUSTRATIVE QUESTIONS Q 11.2 Maxitank makes two products. Its costs are: Maxitank’s sales are limited by the bottleneck (machine) capacity of the factory. Which of the two products should be produced first in order to maximize the throughput contribution generated from the limited capacity?

Product RProduct S Selling price$12$20 Materials$4$11 Labour cost$2$5 Labour hours 24 V ARIATION TO Q11.2 Maxitanks’ cost of labour is now included: Which of the two products should be produced first in order to maximize the profits generated from the limited capacity, taking material and labour costs into account?

Q 11.5 Sales 12,000 $100$1,200,000 Variable costs588,000 Contribution margin612,000 Fixed costs245,000 Profit$367,000 Harrison products capacity is 20,000 units per year. Their results for last year are: Harrison expects its regular sales next year to be 15,000 units. They also expect fixed costs to increase by $100,000. A foreign distributor has offered to buy a guaranteed 8,000 units at $95 per unit next year. Should Harrison accept this offer?