Chapter 26 Cost Management for Just-in-Time Environments Financial and Managerial Accounting 8th Edition Warren Reeve Fess © Copyright 2004 South-Western, a division of Thomson Learning. All rights reserved. Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc. PowerPoint Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University

Some of the action has been automated, so click the mouse when you see this lightning bolt in the lower right-hand corner of the screen. You can point and click anywhere on the screen.

After studying this chapter, you should be able to: Objectives 1. Compare and contrast just-in-time (JIT) manufacturing practices with traditional manufacturing practices. 2. Apply just-in-time manufacturing practices to a traditional manufacturing illustration. 3. Describe the implications of a just-in-time manufacturing philosophy on cost accounting and performance measurement systems. After studying this chapter, you should be able to:

Objectives 4. Apply just-in-time practices to a nonmanufacturing setting. 5. Describe and illustrate activity analysis for improving operations.

What is Just-in-Time? JIT is a business philosophy that focuses on reducing time and cost and eliminating poor quality within manufacturing and non-manufacturing processes. Sometimes called short-cycle or lean manufacturing.

Just-in-Time Principles Just-in-Time Manufacturing Traditional Manufacturing Increases inventory to protect against process problems. Reduces inventory. Reduces lead time. Increases lead time as a buffer against uncertainty. Disregards setup time as an improvement priority. Reduces setup time. Emphasizes product-oriented layout Emphasizes process-oriented layout. Emphasizes team-oriented employee involvement. Emphasizes work of individuals following manager instructions. Continued

Just-in-Time Principles Just-in-Time Manufacturing Traditional Manufacturing Emphasizes pull manufacturing. Emphasizes push manufacturing. Emphasizes zero defects. Tolerates defects. Emphasizes supplier partners. Treats suppliers as “arm’s-length,” independent entities.

Assume the river is inventory. 8 Reducing Inventory Assume the river is inventory. As long as the river (the inventory) covers the rocks, the (production) problems are hidden.

If the river (inventory) is reduced, the problems are exposed. Reducing Inventory If the river (inventory) is reduced, the problems are exposed. 9 Machine breakdowns Poor quality Untrained employees Unreliable suppliers

Reducing Lead Time Lead time, sometimes called throughput time, is a measure of the time that elapses between starting a unit of product…

…into the beginning of a process and completing the unit of product. Reducing Lead Time …into the beginning of a process and completing the unit of product.

Reducing Lead Time Value-added lead time is the time required to actually manufacture a unit of a product.

Reducing Lead Time Nonvalue-added lead time is the time that a unit of product sits in inventories or moves unnecessarily.

Components of Lead Time Start of production for a single item End of production for a single item Conversion Time Value-added Wait Time Move Time Down Time Nonvalue-added Total Lead Time

Reducing Setup Time A setup is the effort required to prepare an operation for a new production run.

Relationship Between Setup Times and Lead Times Long Setup Times Large Batch Sizes Large Inventory Longer Lead Times

Automotive Components Inc Automotive Components Inc. manufactures a batch of 40 engine starters through three processing. Each unit in the batch requires the following processing time: Machining 6 minutes Assembly 10 Testing 8 Total 24 minutes

After machining, it takes 10 minutes to move the machined batch to assembly. It then takes 15 minutes to move the assembled batch to testing. Approximately 97.5 percent of the lead time is consumed by nonvalue-added waiting and moving.

How can we improve our lead time performance?

Solutions 1. Reduce setups so that the batch size could be reduced to one piece (one-piece flow). 2. Move the processes closer to each other so that the move time is eliminated.

Emphasizing Product-Oriented Layout Organizing work around the products is called a product-oriented layout (or product cells), while organizing around processes is called process-oriented layout.

Emphasizing Employee Involvement Employee involvement uses teams organized in product cells, rather than just efforts of isolated individuals. Such employee teams can be cross-trained to perform any operation within the product cell.

Emphasizing Pull Manufacturing Producing items only as they are needed by the customer is called pull manufacturing. The system that accomplishes pull manufacturing is often called kanban (Japanese for “cards”).

Emphasizing Zero Defects Poor quality results in increased need for inspection, more production interruptions, an increased need for rework, a higher cost from scrap, and additional warranty costs. MAKE IT RIGHT THE FIRST TIME!

Anderson Metal Fabricators (AMF) makes two types of metal covers, large and small. Metal covers are made by stamping a pattern of the cover from sheet steel. The stamped patterns are then sent through a hole punching operation, then a forming operation.

Traditional Operations—Anderson Metal Fabricators Administrative Offices: Accounting Sales Customer Service Technical Offices: Design Scheduling Manufacturing Maintenance and Tooling Receiving and Raw Materials Inventory Stamping WIP Forming WIP Punching WIP Finished Goods Inventory Shipping Department Work in Process Areas

Just-in-Time Operations—AMF Administrative Offices: Accounting Sales Customer Service Technical Offices: Design Scheduling Manufacturing Receiving Maintenance and Tooling Small covers Stamping Shipping Maintenance and Tooling Medium covers Stamping Maintenance and Tooling Large covers Stamping = Work in Process Areas = Pull Kanban Signal

Just-in-Time Operations—AMF Administrative Offices: Accounting Sales Customer Service Technical Offices: Design Scheduling Manufacturing Receiving Maintenance and Tooling Small covers Stamping Medium covers Large covers = Work in Process Areas = Pull Kanban Signal Shipping Punching Forming

Accounting for Just-in-Time Operations In a just-in-time operating environment, the accounting system will have the following characteristics: Fewer transactions. The accounting system is simpler because there are fewer transactions to record. Combined accounts. All in-process work is combined with raw materials to form a new account, Raw and In Process (RIP) Inventory. Nonfinancial Performance Measures. There is a greater emphasis on nonfinancial measures. Direct Tracing of Overhead. Indirect labor is directly assigned to product production cells.

The transfer of costs as products move through the production process is termed backflush accounting.

Combined Transactions

Budgeted cell conversion cost rate The annual budgeted conversion cost for AMF’s medium-cover product cell is $2,400,000. These costs will support 1,920 planned hours of production. Budgeted cell conversion cost rate = $2,400,000 1,920 = $1,250 per hour

Conversion cost per unit = 0.02 x $1,250 The medium-cover product cell is expected to require 0.02 hours of manufacturing time per unit. Conversion cost per unit = 0.02 x $1,250 = $25 conversion cost per unit

A separate materials account is not used. Steel coil is purchased for producing 8,000 medium covers. The purchase cost was $120,000, or $15 per unit. Raw and In Process Inventory 120,000 Accounts Payable 120,000 A separate materials account is not used.

Conversion costs are applied to 8,000 medium covers at a rate of $25 per cover. Raw and In Process Inventory 200,000 Conversion Costs 200,000 The Raw and In Process Inventory account is used to accumulate the applied conversion costs.

This is a backflush transaction. All 8,000 medium covers were completed in the cell. The cost is $40 per unit (materials, $15; conversion costs, $25). Finished Goods Inventory 320,000 Raw and In Process Inventory 320,000 This is a backflush transaction.

Of the 8,000 units completed, 7,800 were sold and shipped to customers at $70 per unit. Accounts Receivable 546,000 Sales 546,000 7,800 x $70 Cost of Goods Sold 312,000 Finished Goods 312,000 7,800 x $40

Nonfinancial Performance Measurement Just-in-time principle addressed by performance measures (% of respondents): Inventory turnover 82% On-time delivery rates 41 Production lead time 35 Quality yield 32 Throughput 32 Time required for setups 26 Space utilized 12 Extent of cross-training or new skills obtained 8

Typical Hospital Process Flow Patient Admitted Admitting Clerks Collect Patient Information

Typical Hospital Process Flow Patient transported to Radiology X ray made Patient transported back to Nursing Unit Patient Admitted Tests Conducted

Typical Hospital Process Flow Specimen transported to Lab Tests performed Results reported to Nursing Unit Patient Admitted Tests Conducted

Typical Hospital Process Flow Drugs ordered Order filled Drugs sent back to Nursing Unit Patient Admitted Tests Conducted Procedure Performed

Typical Hospital Process Flow Patient Admitted Tests Conducted Procedure Performed Patient Discharged

Just-in-Time Hospital Unit Layout Patient Rooms Chemistry Lab Cross-trained Caregivers Patient Rooms X ray Admitting Office

Costs of Quality Using Activity Analysis Prevention costs are the costs of activities that prevent defects from occurring during the design and delivery of products or services. Appraisal costs are the costs of activities that detect, measure, evaluate, and audit products and processes to ensure that they conform to customer requirements and performance standards.

Costs of Quality Using Activity Analysis Internal failure costs are the costs associated with defects discovered by a business before the product or service is delivered to the consumer. External failure costs are the costs incurred after defective units or services have been delivered to consumers. Although difficult to measure, it may be the largest cost in the quality equation.

Quality Control Activity Analysis—Gifford Co. Quality Cost Quality Control Activities Activity Cost Classification Design engineering $ 55,000 Disposal of rejected materials 160,000 Finished goods inspection 140,000 Materials inspection 70,000 Preventive maintenance 80,000 Processing returned materials 150,000 Disposing of scrap 195,000 Assessing vendor quality 45,000 Rework 380,000 Warranty work 225,000 Total activity cost $1,500,000 Prevention Internal Failure Appraisal External Failure

Pareto Chart of Quality Costs $400,000 350,000 300,000 250,000 200,000 150,000 100,000 50,000 Costs Quality Control Activities Rework Warranty work Disposing of scrap Disposal of rejected materials Processing returned materials Finished goods inspection Preventive maintenance Materials inspection Design engineering Assessing vendor quality Activity Categories

Cost of Quality Report Cost Summary Quality Cost Percent of Total Percent of Total Classification Quality Cost Quality Cost Sales Prevention $ 180,000 12.00% 3.6% Appraisal 210,000 14.00% 4.2% Internal failure 735,000 49.00% 14.7% External failure 375,000 25.00% 7.5% Total $1,500,000 100.00% 30.0%

Indicate whether the item is value-added or nonvalue-added. Quality Control Activities Activity Cost Classification Design engineering $ 55,000 Disposal of rejected materials 160,000 Finished goods inspection 140,000 Materials inspection 70,000 Preventive maintenance 80,000 Processing returned materials 150,000 Disposing of scrap 195,000 Assessing vendor quality 45,000 Rework 380,000 Warranty work 225,000 Total activity cost $1,500,000 Value-added Nonvalue-added

What percentage is value-added and what percentage is nonvalue-added? Design engineering $ 55,000 Disposal of rejected materials 160,000 Finished goods inspection 140,000 Materials inspection 70,000 Preventive maintenance 80,000 Processing returned materials 150,000 Disposing of scrap 195,000 Assessing vendor quality 45,000 Rework 380,000 Warranty work 225,000 Total activity cost $1,500,000 Quality Control Activities Activity Cost Classification Value-added Nonvalue-added Quality Cost $390,000 ÷ $1,500,000 = 26%

What percentage is value-added and what percentage is nonvalue-added? Design engineering $ 55,000 Disposal of rejected materials 160,000 Finished goods inspection 140,000 Materials inspection 70,000 Preventive maintenance 80,000 Processing returned materials 150,000 Disposing of scrap 195,000 Assessing vendor quality 45,000 Rework 380,000 Warranty work 225,000 Total activity cost $1,500,000 Quality Control Activities Activity Cost Classification Value-added Nonvalue-added Quality Cost $1,110,000 ÷ $1,500,000 = 74%

Activity Analysis for Processes Order Entered into a Computer System Sales Order Submitted by Customer Customer Credit Check

Activity Analysis for Processes Order Picked from Warehouse Order Shipped Product Received by Customer

Activity Analysis for Processes Management determines that not all customer orders need to go through credit check, but only orders from new customers require this effort. If this change is made, only 2,500 of the 10,000 sales orders will require credit checks. Management introduced a more efficient warehouse product layout. This layout reduces the cost of picking orders by 35%.

Activity Analysis for Processes Activity Cost Prior to Improvement Activity Cost After Improvement Customer credit check $14,400 $ 3,600 Order entering 9,600 9,600 Order picking 36,000 23,400 Order shipping 20,000 20,000 $36,000 x 65% Total sales order fulfillment $80,000 $56,600 Cost per shipped order $8.00 $5.66 Savings = $23,400

Chapter 26 The End