COSTING AND THE VALUE CHAIN CHAPTER 18 PAGE# 794 Faisal

Costing and Value Chain Value chain Components of value chain Activity based management Target costing process Component of target costing process Just in time inventory system

Value chain Value chain is a set of activities and resources necessary to create and deliver the products and services to the customers. Value chain has components The value chain consists of four components

Research & development and design Activities It includes idea, production process and product sample. It includes the creation of idea and the development of prototype products, process and services. Prototypes (Sample Product to get feed back of customers)

Supplier & production related activities Supplier related activities  Procurement of raw material. Production related activities  Methods of manufacturing It includes the procurement of raw material and the supplies and the activities needed to convert raw material into finished goods.

3)Marketing & Distribution activities It includes the provision of information to the customer and make the products and services accessible to the customers. 4)Customer services activities: Customer services activities are those resources consumed by supporting the products or services after it is not sold to the customer.

Value added & Non- value added activities Value added: Includes manufacturing process, product design etc.. Non-value added: time used in manufacturing process, breakdown of electricity, setup mechanism. Value added activities: Desirability of product or services in the eyes of customers.

Value-added activities VAA add to the product and services desirability (acceptable) in the eyes of customers. E.g. Product design, manufacturing process, convenient channels of distribution. Non- value added activities: NVAA does not add to the product and services desirability in the eyes of customers. E.g. Setting of machinery, storing direct material, time during which machinery or employees spend idle.

Activity based management Activity based management are used in activity based costing to eliminate the non value added activities. AB management is the process of using activity based cost to help reduce and eliminate the non value added activities. Target Costing Process Is a business process aimed at the earliest stages of a new product and service development before creation and design of product method.

Target cost Cost of resources amount spent on resources. Components of target costing: 1) Significant resources are consumed in planning and market analysis. 2) concept development This component focuses on product feasibility studies. Development involves a cycle of testing and manufacturing again reformulating the product to understand the customer’s requirement.

Production design Follow the establishment of the product concept in the development phase. Value engineering Combination of resources which yields less cost. V.E determines the least combination of resources to create a product desire by the customer.

Life cycle costing Is the combination of all potential resources consume by the product over its entire life. E.g.. Mobile Phones (X mobile is Reliable then Y in North Cyprus, because it includes all potential resources. Finally production begins and continuous improvement process is used to attain the target cost.

Just in Time inventory procedure (JIT) In it time is examined and manufacturing efficiency ratio is calculated and equality is examined. JIT system refers to acquiring material and manufacturing goods only as needed to fill the demand of the customers or orders. Eliminating the non value added activities and inculcate the quality of product through out the manufacturing process.

Continue.. Products are manufactured instantly ads the customer places the order. Measuring of efficiency in JIT system. Time is of critical importance in JIT system Therefore time measurement are essential for scheduling production activities in a manner that avoids constraints and ensure that jobs are completed just in time.

Continue… The length of the time required for a product to pass completely through a manufacturing process is called time cycle. Time starts from the first step of manufacturing process to the time when finished products are achieved, called time cycle.

Elements of time cycle Consists of four elements 1) Processing time 2) storage and waiting time 3) movement time 4) inspection time Only during processing time however is value added activities to the product. The other elements of the product cycle time should reduced as much as possible.

Continue.. A widely use measure of efficiency in JIT system is the manufacturing efficiency ratio. Manufacturing efficiency ratio MER express the time spend in value added activities (Processing time) as percentage of the total cycle time MER= value added activities Total cycle time

Continue.. The primary function of manufacturing efficiency ratio is to highlight the percentage of time spend in non value added activities. Measuring Quality According to the system in JIT companies measures quality, as well as costs and cycle time. One widely used measure of productive quality is deficits per million units produced.

Continue In some companies defect rate have been reduced less then defective part per million units of production. Other method of quality include merchandize returns, number of warranty claims, customer complaints, and the result of customer satisfaction survey. A JIT does not itself ensured quality, rather it establishes striving for quality as basic goal of organization.

Total quality management Companies that enable to compute globally on quality and cost develop TQM process. TQM includes assigning responsibilities for managing quality, providing good quality measure of decision making process, & evaluating rewarding quality performances. Accountant participate in this measurement and reporting process by designing the system that can track quality and assign cost to the quality failure.

Continue.. Four components of the cost of quality are considered when designing a measurement system to track the quality cost. Prevention cost: Are the cost of resources consumed in activities that prevents defects from occurring. E.g.. Prevention costs includes employees training, quality process audits, quality concerned issues.

Appraisal Cost (improve Quality) Are incurred to ensure that the product confirm to the quality standards. E.g. it includes inspection of raw materials, inventories and finished goods, inspection and monitoring of production process and equipment, inspection and maintenance programs to ensure quality.

Internal failure Cost Internal failure cost includes additional production related costs incurred to correct low quality out. E.g. It includes re-work downtime, re-testing and re- inspections etc., External failure Cost: EF costs are the largest and most difficult to measure. These costs are incurred because quality failure are allowed to enter the market.

Continue.. External failure cost includes cost sales, cost due to return and allowances, and loss good –will, warranty.