Management Accounting:

A Road of Discovery

Management Accounting:

A Road of Discovery

James T. Mackey

Michael F. Thomas

Presentations by:

Roderick S. BarclayTexas A&M University - Commerce

James T. MackeyCalifornia State University - Sacramento

© 2000 South-Western College Publishing

Chapter 10

Should we start all over?

Strategic cost management

Key Learning Objectives

4. Illustrate product line management with target costing, simultaneous engineering and quality function deployment, and life cycle costing.

2. Demonstrate the use of strategic partnering and activity-based management performance measures in managing suppliers.

3. Create activity-based management measures for customer satisfaction and explain the role of ABC in managing customer relations.

1. Discuss how industry-wide value chains and accounting information aid firms in identifying their core competencies.

Part I

Strategic Value Chain Management

What Business Are We In?

Long-term value is Created by our business choices and Strategies we apply within our line of

business. Short-term value is

Created through the management of resources within the long-term plan and strategic value chain.

This is where traditional cost based accounting management is primarily applied.

An industry-wide value chain measures the provision of an industry’s goods or services from ‘cradle to grave’. The value chain identifies and defines the industry.

Pizza’s Industry-Wide Value Chain

Refuse companies dispose of

trashPizza

restaurants deliver to customers

Pizza restaurants

prepare pizzas

Pizza restaurants

purchase materials

Pizza restaurants

serve customers and

clean up

Truckers ship to distribution cen-ters and

retailers

Plants process into meat products

Truckers ship to processing

plants

Farmers (ranchers) raise beef

cattle

Truckers ship to distribution cen-ters and

retailers

Plants process into cheese

products

Truckers ship to processing

plants

Farmers maintain and

milk dairy cattle

Truckers ship to distribution cen-ters and

retailers

Plants process and pack vege-

tables and grains

Truckers ship to processing

plants

Farmers grow and harvest

crops

Part II

Using Accounting Data to Identify

Opportunities

Return on Investment Ratios in the Pizza Industry

Refuse companies dispose of

trashPizza

restaurants deliver to customers

Pizza restaurants

prepare pizzas

Pizza restaurants

purchase materials

Pizza restaurants

serve customers and

clean up

Truckers ship to distribution cen-ters and

retailers

Plants process into meat products

Truckers ship to processing

plants

Farmers (ranchers) raise beef

cattle

Truckers ship to distribution cen-ters and

retailers

Plants process into cheese

products

Truckers ship to processing

plants

Farmers maintain and

milk dairy cattle

Truckers ship to distribution cen-ters and

retailers

Plants process and pack vege-

tables and grains

Truckers ship to processing

plants

Farmers grow and harvest

crops

ROI = 10%-20%

ROI = 5%-10%

ROI = 10%-20%

ROI = 3%-8% ROI = 10%-15% ROI = 5%-10%

ROI = 15%-30%

Using Accounting Data

Using larger ROI as an indication of greater power and value, we can reconfigure the business by moving up and down the value chain.

Different combinations of activities allow companies to differentiate their goods or services to create more value.

In the pizza example, the objective was to capture the more profitable garbage disposal activity.

Different combinations of activities allow companies to differentiate their goods or services.

A larger ROI indicates greater economic power. By absorbing sequential activities, efficiency can

be created by combining core competencies and reducing redundant activities.

By focusing on our value chain, we can identify potential ways to increase value and decrease costs.

Part III

The Need for Cost Management Analysis

Using CVP analysis

CVP Analysis for Pizza Delivery, Cleanup,and Disposal

Break even point = 8 pizzas

$ 20Net Income

$ 80Total batch costs

20Disposal

10Cleanup

25Return

25 Delivery

Less: Batch costs

$100 67%$10Contribution margin

50 33% 5Less: Variable costs

$150100%$15Sales revenues

Cost-volume-profit analysis allows us to examine the projected costs and the benefits of moving into the clean-up and disposal business.

Analysis of Pizza Business

The target sales price per pizza is $15. Unit costs for each pizza are the variable costs

which include labor and materials of $5. The contribution margin per pizza is $10. The batch costs include delivery, return, clean-

up, and disposal of $80. Each pizza sale with clean-up loses $70! However, by covering only the clean-up with

orders of ten pizza’s or more, the contribution margin per batch order increases to at least $20.

The PARTY PIZZA CLEAN-UP BUSINESS is born.

Limitations on Value Chain Analysis

Truly comparable activities may be difficult to identify.

Information may be difficult to obtain. ROI approximates profitability and power

(accounting profitability is not necessarily economic value).

We need better measures that correlate better with firm value.

Successful differentiation and cost management will require detailed cost analysis.

Part IV

Using value Chains to Manage Multree Homes

Where We Are on the Industry-Wide Value Chain

Sell houses

Build houses

Customer order-taking1.1 Sales1.2 Credit check (Finance)1.3 Accounts receivable

Materials acquisition (inbound)2.1 Scheduling2.2 Purchasing2.3 Receiving, inspection,

storage2.4 Delivery to factory

Industry goods and services (Exhibit 2-3)

Multree Homes value chain (Exhibit 2-5)

Continued Value Chain

Build Houses Manufacturing3.1 Lumber sawing3.2 Wall assembly

(framing)3.3 Rough wiring3.4 Rough plumbing3.5 Wall finishing (all

inclusive)3.6 Roof construction3.7 Finish carpentry3.8 Top-off plumbing3.9 Finish electric3.10 Carpeting3.11 Inspection

Concluded Value Chain

Build Houses

Sell houses

Customer service (warranty)

Shipping (outbound logistics)4.1 Packing4.2 Shipping4.3 Set up for dealer,

customer Close sales

5.1 Customer inspection5.2 Bill customer5.3 Collect and deposit cash

After sale customer services6.1 Provide warranty work6.2 Survey customer

satisfaction6.3 New product and service advertising

Value Chain Discussion

A process is the set of activities required to provide goods and services.

Exhibit 10-4 list the 6 processes that Multree needs to manage.

For example, customer order-taking has three activities — sales, credit checks, and accounts receivable. Each activity becomes the cost

objective for management accounting. Activities are significant costs. Activities are assigned cost drivers. Often activities or processes can be

outsourced.

Core Competencies

Core competencies are activities or processes where companies excel.

They are the process that individual companies do better than their competitors.

Multree has identified six processes in Exhibit 10-4 illustrated previously.

Multree’s core competency is the management of activities in the Organization value chain.

Superior cost and earnings performance measures are ways to identify the relative advantage of core competencies. Multree’s advantage against a general contractor is in production costs — see Exhibit 10-6, p. 358.

Core Competencies in Well-Known Companies

Developed icons, pull-down menus, mouse

Information processingXerox

Ivory, Tide , Folgers, Crisco, Pampers

Research and developmentMarketing and distribution

Proctor &Gamble

New ways to use information technology

ImaginationMicrosoft/Apple

Mainframe computers and software

Research and developmentExperienced sales force

IBM

Motorcycles, snowmobiles, lawnmowers, snow blowers, chain saws

Small engine productionHonda

Telecommunications products

Technological leadership through Bell Labs

AT&T

Products or servicesCore competenciesCompany

Part V

Value Chain Approach to Vendor Management

Vendors

Vendors costs are usually a major product cost. Improving costs is dependent on improving

vendor efficiencies. I.E., if 70% of a company’s unit costs are

paid to vendors, a 50% improvement in internal processes would only reduce costs by 15%.

Therefore, vendor management is a significant management consideration.

Decisions Regarding Vendors and Value Chains

Strategic partnering with selected vendors can result in significant competitive advantage. By working with a small number of vendors,

Multree has more influence over them. Long-term relationships allow differentiated

products to be developed to eliminate redundant activities and complement core activities.

Let’s Look at Multree

Multree builds a standard 26-foot roof. They bid for the standard 10-foot bundles of

plywood on the open market to obtain the best price.

Each span requires three sheets. Four feet must be cut off every third sheet and

thrown away. Using three sheets leaves two seams that

must be sealed and forms weak points for leaks.

Multree’s Solution

By strategic partnering with the plywood mill, Multree can eliminate redundant activities between it and the mill.

Multree pays for an additional setup on the plywood saw to cut 13-foot sheets.

Exhibit 10-7a, p.362 and 7b, p. 363, summarize the costs before and after the process redesign.

Multree reduces it’s cost per roof by 35% or $141.38.

Let’s Analyze Multree’s Solution

Multree’s core competency is manufacturing. By strategic partnering it’s non-core activities in

purchasing, shipping, and preparation, Multree can eliminate some less efficient activities and reduce unit costs.

Value-chain thinking leads to a shift in value creation focus from separate cost centers to maximizing the efficiency of the entire value chain.

The virtual company they formed can maximize its competitiveness by combining the core competencies of several organizations.

Part VI

Value Based Vendor Performance Measures

The Vendor Performance Index (VPI)

VPI measures the cost of purchasing goods from a vendor. The costs to work with a vendor are not limited

to the invoice costs that are measured by GAAP.

Rather, the non-value added activities caused by the vendor’s produce and performance need to be considered.

VPI = Purchase Cost + Non-Value Added Costs

Purchase Cost

VPI Calculations

$1,000Materials purchase cost

$20020 Totals

50 5Waiting for late deliveries

30 3Returning bad materials

20 2Processing paperwork

$10010Inspection

Materials

purchase cost

Nonvalue added

costs+

Materials purchase cost

VPI =

$1,000 + $200

$1,000VPI =

VPI = 1.2

Nonvalue added activities

Labor hours

Labor cost at $10/hr

VPI Components

On-Time Delivery — measures of delivery are useful when VPI is unavailable. On-time measures are easy, cheap, and meaningful to the shop floor.

Complete Order Filling — is an example of a quality of service measure.

On-Time Deliveries

012

34

# of

Lat

e D

eliv

erie

s

(5) (4) (3) (2) (1) 0 1 2

Woods LumberMurry Electric

Adams Supplies

Days (Late)/Early

Late Deliveries by Suppliers

Woods Lumber

Murry Electric

Adams Supplies

Part VII

Managing Value Chain Relationships with

Customers

Customer Ratings

Var

iety

in ty

pes

of h

omes

Abi

lity

to c

usto

miz

e flo

or p

lans

On-

time

deliv

ery

Com

plet

e or

der

fillin

g

Con

stru

ctio

n/in

stal

latio

n su

ppor

t

War

rant

y se

rvic

e

0

1

2

3

4

5

6

7

8

9

10

Ra

tin

gs

Attributes

Customer ratings

Importance

Performance

Exhibit 10-10 Analysis

The snake chart allows companies to monitor their product as viewed by the customer.

Customers identify and rank these attributes on a 1 (lease important) to 10 (most important) scale for their importance and the perceived quality Multree provides.

To improve value Multree needs to improve where it is under

performing (warranty service) — a 9 in importance and a 4 in performance.

They also may need to consider reducing the variety of homes (2 in importance vs. an 8 in performance).

These are non-financial measures and do not score on value. Further cost analysis is needed before decisions are made.

Activity Analysis of Customer Delivery Costs

First, review and analyze Exhibit 10-11, p. 370.

A firm can develop competitive advantage by matching their core competency to their customers.

Activity analysis of customer delivery activities allows companies to focus on customers with which they have a core competency advantage.

Different support resources have unique cost drivers.

Customers consume resources differently.

Part VIII

Product Line Strategic Cost Management

Target Costing

TARGET COST = REVENUE – DESIRED PROFIT

First, calculate the value of products to customers, then subtract the desired profit.

Customers set the cost standard that the company must reach.

Simultaneous Engineering Using QFD Analysis

There is a high cost of independent, functional specializations like design, manufacturing and sales. Significant costs are locked in at the design

stage. These costs cannot be changed significantly

after production begins. Concurrent or simultaneous design means the

design team needs to include members of, and cost data from, each activity in the life-cycle of the product.

Quality function deployment (QFD) starts with characteristics that the customer desires.

ABC Quality Function Deployment (QFD) Analysis

Note: The chalet home is a purchased kit (package) assembled at the site.

None($100)Drift

$900$900Target costing allowance

$900$1,000Budgeted cost

0250Warranty work

250Extra sealing materials

10075Special installation labor

2525Package glass for shipping

100100Cut frame lumber

5050Purchase framing materials

$600$500Purchase glass

Picture Window Activities

Original ABC

analysis

Revised ABC

analysis