1. Management Accounting Information for Activity and Process Decisions
Chapter 5

2. Evaluation of Financial Implications
Managers must evaluate the financial implications of decisions that require trade-offs between the costs and the benefits of different alternatives
Financial information about the different types of costs form the basis of decisions about the organization’s activities and processes

3. Relevant Costs and Revenues
Whether particular costs and revenues are relevant for decision making depends on the decision context and the alternatives available
Relevant costs - costs and revenues that differ across the decision alternatives

4. Relevant Costs
Opportunity costs by definition are relevant costs for any decision
The costs that remain the same regardless of the alternative chosen are not relevant for the decision

5. Sunk Costs are Not Relevant
Sunk costs often cause confusion for decision makers
Costs of resources that already have been committed and no current action or decision can change
Not relevant to the evaluation of alternatives because they cannot be influenced by any alternative the manager chooses

6. Relevant Costs for the Replacement of a Machine
Should Bonner dispose of the USC machine it just purchased on September 1 and buy the new machine from Teo Company?
What costs are relevant for this decision?

7. Relevant Costs for the Replacement of a Machine
Sunk costs
$30,000 cost of old machine
$5,200 monthly loan payment for old machine

8. Relevant Costs for the Replacement of a Machine
Cost increases and cash outflows:
$50,000 down payment on the new machine
$6,000 monthly lease payments on new machine

9. Relevant Costs for the Replacement of a Machine
Cost Savings and Cash Inflows
$50,000 disposal of old machine
$6,200 monthly cost savings:
$4,400 labor
$1,000 materials
$800 maintenance

10. Assuming Responsibility for Decision
Reversing a decision made a month earlier may look like an error
If the manager does not purchase the new machine, his behavior may be viewed as suboptimal
The manager may garner respect by assuming responsibility for error
Manager needs to recognize sunk costs

11. Make-or-Buy Decisions
As managers attempt to reduce costs and increase the competitiveness of their products, they face decisions about whether their companies should
Such make-or-buy decisions illustrate how to identify relevant costs and revenues

12. Make-or-Buy Decisions – Example
Std. Rear
Std. Front
Multicolor
Curved
Product cost per unit:
Direct materials
$ 36
$ 49
$ 56
$ 58
Direct labor 22 25 24 28
Unit-related support 14 16 18 20
Batch-related support 10 19
Product-sustaining overhead 6 12
Facility-sustaining overhead 8 11
Total manufacturing costs
$ 96
$ 128
$ 142
$ 161
Bids from outside suppliers:
Lowest bid
$ 82
$ 109
$ 140
$ 156
Second lowest
$ 88
$ 116
$ 147
$ 164
Annual production (units)
36,000
48,500
6,800
8,700

13. Avoidable Costs
Those that are eliminated when a part, product, product line, or business segment is discontinued
If the production manager decides to outsource a product, the company may avoid certain production costs
Contraction or redeployment of resources may allow the company savings

14. Avoidable Costs
The company cannot dispose of part of the facility used to support the production of the standard rear lamp without disposing of the entire machine or building
Most facility-sustaining support costs represent the prorated costs of indivisible common facilities

15. Avoidable Costs
Is there an alternative use for the part of the facility made available by not producing a product?
Indirect savings in facility-sustaining costs for the organization are relevant for the decision to outsource production, because they can arise only if the lamp is outsourced

16. Summary of Financial Analysis
If the standard rear lamp is outsourced, the company may avoid $3,168,000 of manufacturing costs
The company would spend $2,952,000 to purchase the parts from the low-bid supplier
The company could save $216,000 by outsourcing

17. Qualitative Factors
For most decisions such as this, several additional factors, which are more qualitative in nature, need to be considered:
Permanence of the lower price
Reliability of the supplier:
Many companies have adopted the practice of certifying a small set of suppliers who are dependable and consistent in supplying high-quality items as needed

18. Facility Layout Systems
There are three general types of facility designs:
Process layouts
Product layouts
Cellular manufacturing
Regardless of the type of facility design, a central goal of the design process is to streamline operations and thus increase the operating income of the system

19. The theory of constraints (TOC)
TOC maintains that operating income can be increased by carefully managing the bottlenecks in a process
A bottleneck is any condition that impedes or constrains the efficient flow of a process
A bottleneck can be identified by determining points at which excessive amounts of work-in-process inventories are accumulating
The buildup of inventories also slows the cycle time of production

20. Theory of Constraints
The theory of constraints relies on the use of three measures
Throughput contribution is the difference between revenues and direct materials for the quantity of product sold
Investments equal the materials costs contained in raw materials, work-in-process, and finished goods inventories
Operating costs are all other costs, except for direct materials costs, that are needed to obtain throughput contribution

21. Theory of Constraints
Emphasis is on the short-run optimization of throughput contribution
Assumes that operating costs as difficult to alter in the short run

22. Process Layouts
All similar equipment or functions are grouped together
Production of unique products is done in small batches
Product follows a serpentine path, usually in batches
High inventory levels
Products might travel for several miles within a factory during the production process

23. Process Layout in a Bank
The customer goes to the bank (a moving activity)
The bank takes the loan application from the customer (processing activity)
Loan applications are accumulated (storage activity) and passed to a loan officer (moving activity) for approval (both processing and inspection activity)
Loans that violate standard loan guidelines are accumulated (storage activity) then passed (moving activity) to a regional supervisor for approval (processing activity)

24. Process Layout in a Bank (
The customer is contacted when a decision has been made (processing activity)
If the loan is approved, then the loan proceeds are deposited in the customer’s account (processing activity)
In most banks, work-in-process stockpiles at each of the processing points or stations
Loan applications may be piled on desk of the bank teller, the loan office or the regional supervisor

25. WIP Accumulation
Work-in-process inventory accumulates at processing stations in a conventional organization for three reasons
Handling work in batches
If the rate at which each processing area handles work is unbalanced, work piles up at the slowest processing station
If processing area managers are evaluated on their ability to meet production quotas

26. Product Layouts
In a product layout, equipment is organized to accommodate the production of a specific product
Product layouts exist primarily in companies with high-volume production
The product moves along an assembly line beside which the parts to be added to it have been stored
Placement of equipment or processing units is made to reduce the distance that products must travel

27. Product Layout in a Cafeteria
People pass by containers of food and take what they want
Employees organize the food preparation activities so that the containers are refilled just as they are being emptied
The ultimate goal is to reduce setup costs to zero and to reduce processing time to as close to zero as possible so that the system can produce and deliver individual products just as they are needed

28. Cellular Manufacturing
The organization of a plant into a number of cells
Within each cell all machines required to manufacture a group of similar products are arranged in close proximity to each other
The machines in a cellular manufacturing layout are usually flexible and can be adjusted easily or even automatically to make different products

29. Cellular Manufacturing
The shape of a cell is often a U shape,
The number of employees needed to produce a product can often be reduced due to the new work design
U shape also provides better visual control of the work flow

30. Problems with Batch Production
Creates inventory costs
Creates delays associated with storing and moving inventory
These delays increase cycle times, thereby reducing service to customers
Delays may even happen before manufacturing begins

31. Inventory-Related Costs
Demands for inventory lead to huge costs in organizations, including the cost of moving, handling, storing, obsolescence & damage
Factory layouts and inefficiencies that create the need to hold work-in-process inventory may hide other problems leading to excessive costs of rework

32. Processing time
Processing time – time expended for the product to be made
Processing cycle efficiency (PCE) – measure of the efficiency of the manufacturing process
PCE = processing time
processing time + moving time
+ storage time + inspection time

33. Analysis of relevant costs and benefits of reorganization
Total costs: $1,000,000
Three main benefits:
1. Increase in sales due to decreased production cycle time
2. Reduction in inventory-related costs because of reduced handling of WIP
3. Improvement in quality since defective processes are detected more quickly

34. Cost of Nonconformance and Quality Issues
Cost reduction has become a significant factor in the management of most organizations
The premise underlying cost reduction efforts today is to decrease costs while maintaining or improving product quality in order to be competitive
If the quality of products and services does not conform to quality standards, then the organization incurs a cost known as the cost of nonconformance (CONC) to quality standards

35. Quality Quality usually may be viewed as hinging on two major factors:
Satisfying customer expectations regarding the attributes and performance of the product
Ensuring that the technical aspects of the product’s design and performance conform to the manufacturer’s standards

36. Quality Standards
Global competition has led to the development of international quality standards
Company certification under these standards indicates to customers that management has committed their company to follow procedures and processes that will ensure the production of the highest-quality goods and services

37. ISO9000
In 1987, the International Organization for Standardization (ISO) developed the first ISO9000 Series of Standards
These standards were revised in 1994 and again in 2000
The goal of the member nations is to develop globally recognized independent (third party) quality system verification

38. ISO9000 (2 of 6)
ISO 9000 contains more than 20 standards and documents
Because of the increase in the number of standards, ISO 9000:2000 was developed
ISO 9000:2000 consists of four primary standards and a greatly reduced number of supporting documents (guidance standards, brochures, technical reports, technical specifications)

39. ISO9000 The four primary standards are:
ISO 9000: Quality management systems – Fundamentals and vocabulary
ISO 9001: Quality management systems – Requirements
ISO 9004: Quality management systems –  Guidance for performance improvement
ISO 19011: Guidelines on quality and/or environmental management systems auditing (To be published)

40. ISO9000
The most significant changes in the revised ISO 9000 standards are:
Increased focus on top management commitment
Emphasis on a process approach within the organization
Continual improvement
Increased focus on enhancing satisfaction for customers and other interested parties

41. ISO9000
Eight quality management principles from best management practices:
Customer focus
Leadership
Involvement of people
Process approach
System approach to management
Continual improvement
Factual approach to decision making
Mutually beneficial supplier relationships

42. Costs Of Quality Control
Classification of quality costs:
Prevention costs
Appraisal costs
Internal failure costs
External failure costs
Experience shows that it is much less expensive to prevent defects than to detect and repair them after they have occurred

43. Prevention Costs
Prevention costs are incurred to ensure that companies produce products according to quality standards:
Quality engineering
Training employees in methods designed to maintain quality
Statistical process control
Training and certifying suppliers so that they can deliver defect-free parts and materials and better, more robust, product designs

44. Appraisal Costs
Appraisal costs relate to inspecting products to make sure they meet both internal and external customers’ requirements
Inspection costs of purchased parts and materials

45. Internal Failure Costs
An internal failure occurs when the manufacturing process detects a defective component or product before it is shipped to an external customer
Reworking defective components or products is a significant cost of internal failures
The cost of downtime in production is another example of internal failure

46. External Failure Costs
External failures occur when customers discover a defect
All costs associated with correcting the problem
For many companies, this is the most critical quality cost to avoid

47. Cost-of-Quality Report
This information is compiled in a cost-of-quality (COQ) report, developed for several reasons
The report illustrates the financial magnitude of quality factors
Cost-of-quality information helps managers set priorities for the quality issues and problems they should address

48. Cost-of-Quality Report
The cost of quality report allows managers to see the big picture of quality issues
It allows them to try to find the root causes of their quality problems

49. Just-in-Time Manufacturing
Just-in-time (JIT) manufacturing is a comprehensive and effective manufacturing system
Just-in-time production requires making a product or service only when the customer, internal or external, requires it
It uses a product layout with a continuous flow

50. Implications Of JIT Manufacturing
Just-in-time manufacturing is simple in theory but hard to achieve in practice
Organizations that use just-in-time manufacturing must eliminate all sources of failure in the system

51. Implications Of JIT Manufacturing
At the core of the JIT process is a highly trained workforce whose task is to carry out activities using the highest standards of quality
When an employee discovers a problem with a component, it is the responsibility of that employee to call immediate attention to the problem so that it can be corrected
Suppliers must be able to produce and deliver defect-free materials or components just when they are required
Preventative maintenance is also employed so that equipment failure is a rare event

52. Implications Of JIT Manufacturing
Just-in-time manufacturing has two major implications for management accounting
management accounting must support the move to JIT manufacturing by monitoring, identifying, and communicating to decision makers the sources of delay, error, and waste in the system
the clerical process of management accounting is simplified by JIT manufacturing, due to the smaller inventory to monitor and report

53. Implications Of JIT Manufacturing
Important measures of a JIT system’s reliability include the following benchmarks of manufacturing cycle effectiveness
Conventional labor and machine productivity ratios are inconsistent with the just-in-time production philosophy
Any significant management innovation, such as ABC or JIT, requires a major cultural change for an organization