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LOGO Lean Accounting,Costs of Quality &

Target Costing

Oleh: Suyanto, MBA., Dipl. Res.

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Contents

Lean Accounting

Target Costing

Cost of Quality

Costs Associated with Goods for Sale

Value versus Supply Chain

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Supply vs Value Chain

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Supply vs Value Chain

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Key success factors:-Cost and efficiency-Quality-Time-Innovation

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Costs Associated with Goods for Sale

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Purchasing costs

Ordering costs

Carrying costs

Stockout costs

Costs of Quality

Shrinkage Costs

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Cost of Quality

Quality meets/exceeds customer expectations:

Performance, Aesthetics, Serviceability, Features,Reliability, Durability, Quality of conformance &

Fitness for use Zero defects versus defective product

Cost of quality

Costs of conformance (control activities) : the costs

incurred to produce a quality product or service Costs of nonconformance (failure activities): the costs

incurred to correct defects in a product or service.

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Cost of Quality

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Observable CQ

- Recorded in AIS

Hidden CQ

-Multiplier Method-Market Research

Method-Taguchi Quality

Loss Function

Control Activities

Failure Activities

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Reporting Quality Costs

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Rule of thumb: 2-4% of sales

THINK!!!

Reduce costs of quality,

Improve quality

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Analysis of Quality Costs

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Conformance vsNon-conformance!

-Avoid non-conformance?-Avoid External Failure?-Why?

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Case 1

Internal reports on quality at the EMCAP Publishing Companygenerated the following information for the Trade Division for thefirst three months of the year:

Total sales $60,000,000

Costs of quality: Prevention $ 523,000

Appraisal 477,000

Internal failure 1,360,000

External failure 640,000

Compute the following:a. Total costs of quality as a percentage of sales

b. Ratio of costs of conformance to total costs of quality

c. Ratio of costs of nonconformance to total costs of quality

d. Costs of nonconformance as a percentage of total sales

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Case 2

1. Which company is most likely to succeed in the competitivemarketplace?

2. Which company has serious problems with its products quality?

3. What do you think will happen to the total costs of quality for eachcompany over the next five years? Why

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Target Costing

Pricing method designed to enhance a companys ability

to compete, especially in markets for new or emergingproducts,

Procedures:1. identifies the price at which a product will be

competitive in the marketplace

2. defines the desired profit to be made on the product

3. computes the target cost for the product bysubtracting the desired profit from the competitivemarket price.

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Why?

1. gives managers the ability to control or dictatethe costs of a new product at the planningstage of the products life cycle.

2. enables managers to analyze a productspotential before they commit resources to itsproduction.

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Comparison of Price Decision Timing

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Case 3: Esemka Ltd

Esemka Ltd. is considering a new MPV car andmust make a go or no-go decision when itsplanning team meets tomorrow. Market research

shows that the unit selling price that would beagreeable to potential customers is Rp130million, and the companys desired profit is 25

percent of target cost. The design engineers

preliminary estimate of the products design,production, and distribution costs is Rp110million per unit. Using target costing, determinewhether the company should market the newproduct. 15

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Case 4: Elsinore Company

Router (R) and Tablet (T)

Market price: R=$320-380, T=$750-850

Target price: R=$300, T=$725

Profit: 25% of total unit cost

Cost information (ABC):

Material handling ($) 1.30 per dollar of direct material and purchased

parts cost Production ($) 3.50 per machine hour

Product delivery ($) 24 (R) 30 (T)

Projected unit demand 26,000 18,000

Direct material cost ($) 25 65

Purchased parts cost ($) 15 45

Manufacturing labor

Hours 2.6 4.8

Hourly labor rate ($) 12 15

Assembly labor

Hours 3.4 8.2

Hourly labor rate ($) 14 16

Machine hours 12.8 28.416

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Questions

1. Find the target cost per unit

2. Find the projected unit cost

3. Make a decision

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Lean Manufacturing

Competitive environment:

Needed to exercise better control, reduce costs,and become more efficient.

Successful firm: preservation of market share,stable growth, and continuation of efficientproduction

Needed an approach designed to eliminatewaste & maximize customer value.

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Basic Concepts of Lean Manu

1. Simple is better.

2. The quality of the product or service is critical to customersatisfaction.

3. The work environment must emphasize continuous improvement.

4. Maintaining large inventories wastes resources and may hide poorwork.

5. Activities or functions that do not add value to a product or serviceshould be eliminated or reduced.

6. Goods should be produced only when needed.

7. Workers must be multiskilled and must participate in eliminatingwaste.

8. Building and maintaining long-term relationships with suppliers isimportant.

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Dont try to focus on a few lean tools and

methodologies

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Dimension of Lean Manufacturing

Delivering the right product

Right quantity

Right quality (zero defect)

At time needed

At lowest possible cost

A cost reduction strategy that redefines activities

performed

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The Lean Thinking Model

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Just in Case - JIC

Inventories of raw materials are maintainedjust in case someitems are of poor quality or a key supplier is shut down by a strike.

Subassembly parts are manufactured and storedjust in case theyare needed later in the manufacturing process.

Finished goods are completed and storedjust in case unexpectedand rush customer orders are received.

push approach, raw materials and subassembly parts arepushed through each process.

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Just in Time - JIT

A lean operation embraces the just-in-time (JIT) operatingphilosophy.

Requires that all resourcesmaterials, personnel, and facilitiesbeacquired and used only as needed to create value for customers.

A JIT environment reveals waste and eliminates it by adhering tothe principles:

Minimum Inventory Levels

Quick Setup and Flexible Work Cells

A Multiskilled Work Force

High Levels of Product Quality

Effective Preventive Maintenance

Pull-Through Production

Backflush Costing (lean operation)

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JIT

24 Source: Weygandt et al. (2012)

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Direct vs Indirect Costs

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Why?

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Backflush Costing

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Track cost flows throughthe production

process as the productis made.

1.Accumulated in CGS2.Flushed back into theappropriate inventory

accounts.

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La-Z-Boy

1. Purchased $20,000 of direct materials onaccount.

2. Used all of the direct materials in production

during the month.3. Incurred direct labor costs of $8,000.

4. Applied $24,000 of overhead to production.

5. Completed units costing $51,600 during themonth.

6. Sold units costing $51,500 during the month.

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Backflush Costing

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Track cost flows throughthe productionprocess as the productis made.

1.Accumulated in CGS2.Flushed back into theappropriate inventory

accounts.

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Case 5

For work done during August, Plush Furniture Company,incurred direct materials costs of $123,450 and conversioncosts of $265,200. The company employs a just-in-timeoperating environment and backflush costing. At the end of

August, it was determined that the Work in ProcessInventory account had been assigned $980 of costs, andthe ending balance of the Finished Goods Inventoryaccount was $1,290. There were no beginning inventory

balances.How much was charged to the Cost of Goods Sold accountduring August? What was the ending balance of the Costof Goods Sold account?

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Practical Insight

Toyota Production System (Shigeo Shingo andTaaichi Ohno)

World-class manufacturing

Just-in-time (JIT) manufacturing and purchasing

Fords lean enterprise system, minus:

did not properly value employees

was not structured to deal with product variety

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ABM versus Lean ABS

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Source: Value Based Systems: ABM and Lean, 2011

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Case 6

Couch Potato, Inc., produces futon mattresses.The company recently changed from a traditionalproduction environment to just-in-time work cells.

Would you recommend the use of ABM/ABC orbackflush costing for tracking product costs?Explain your choice.

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Value Streams

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LOGO

ssuy@ugm.ac.id

Any comment or question

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Case 7

A company manufactures pottery products. One of its value streamsproduces three prod-ucts: X, Y, and Z. Each pottery product goesthrough two cells sequentially: shaping and firing. Each cell hasimplemented lean manufacturing and has a team of people and equip-ment fully dedicated to the cell. The time the products spend in eachcell is as follows:

The cost of materials for each product is $5. Total conversion cost(labor and overhead) of the value stream is $22 per production hour.

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Case 7

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Is all activities, both value-added

& non-value-added, required to

bring product group or service from

starting point to finished product in

hands of customer.

VALUE STREAM: Definition

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VALUE STREAM

Types of value streams

Order fulfillment

New product

Value stream activities Non-value-added

Activities avoidable in the short run

Unavoidable activities due to current technology

or production method Value added

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MANUFACTURING CELL: Definition

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Contains all operations in closeproximity that are needed to

produce a family of products.

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LEAN ACCOUNTING: A Comparison

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Traditional cost management systems maynot be compatible with Lean Accounting.

Lean Accounting makes product costsmore simple & direct. More labor andoverhead costs are assigned to productsthrough direct tracing rather than

allocation.

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FOCUSED VALUE STREAMS

Are more simple & accurate in product costing

Have limitations

Initially, labor costs may be difficult to assign if

people are employed in several value streams Labor costs should assigned proportionately

Are organized around a family of products

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VALUE STREAM DECISIONS

May lead to

Short term decisions

May not reflect long term consequences

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PERFORMANCE MEASUREMENT: AComparison

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Lean accounting replaces standard costsystem measurements with a Box

Scorecard that compares a) operational,b) capacity, & c) financial metrics withprior week performances. A mixture offinancial & nonfinancial measures are

used.

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What are product life cycle

& life cycle costs?

Product life cycle is the time aproduct exists from conception

to abandonment. Life cycle

costs are all costs associated

with a product for its life cycle.

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VALUE CHAIN: Definition

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Is the set of activities requiredto design, develop, produce,

market, and service a product.

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When are most costs

incurred?

During the development stage.

This is also the time costs

should best be managed.

development stage

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TARGET COSTING

Uses 1 of 3 methods

Reverse engineering

Tearing down a competitors product to

discover design features that create costreductions

Value analysis

Attempting to assess the value placed on

product functions by customers Process improvement