20-1 using accounting for quality and cost management chapter 20 1 st

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USING ACCOUNTING FORQUALITY AND COST

MANAGEMENT

CHAPTER 20CHAPTER 20

1st1st

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Quality and the NewQuality and the New Production Environment Production Environment

Objective – To stay competitive through: Improving customer service and product

quality

Reducing costs

Objective – To stay competitive through: Improving customer service and product

quality

Reducing costs

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Improving QualityImproving Quality

What can wedo to improve

quality?

How much willit cost to

improve quality?

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Prevention costs Inspection of materials upon delivery Inspection of production process Equipment inspection Employee training

Appraisal costs Finished goods inspection Field testing of products

Cost of QualityCost of QualityTexas Instruments ApproachTexas Instruments Approach

.

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Internal failure costs are due to defects discovered before delivery to customers. Scrap materials Rework Reinspection Lost sales resulting

from late deliveries

CostReport


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External failure costs are due to defects discovered after delivery to customers. Warranty repairs Product liability Marketing costs to

improve product image Lost sales due to poor

product quality


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Cost of prevention

and appraisal

Internaland external failure costs


Objective

Zero defectswhile minimizing

all four qualitycost categories

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Improving QualityImproving Quality

Total Quality Management (TQM)Managing an organization so that it excels in

areas important to the customer

Total Quality Management (TQM)Managing an organization so that it excels in

areas important to the customer

Organization strives for excellence

Quality is definedby the customer

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Is Quality Worth the Investment?Is Quality Worth the Investment?

Cost vs. Benefit Quality is free

Costs of quality programsare easily measured, but

benefits of increasedcustomer satisfaction are

difficult to measure.

The long-run benefits ofincreased customer

satisfaction far outweighthe costs of improving

quality.

Two Views

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The Quality Is Free ConceptThe Quality Is Free Concept

Greatercustomer

satisfaction

Qualityproducts

andservices

Increasedbusiness

andprofits

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Methods to IdentifyMethods to IdentifyQuality ProblemsQuality Problems

Control charts

Pareto diagrams

Cause andeffect analysis

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Quality & Customer Satisfaction Quality & Customer Satisfaction MeasuresMeasures

Performance measureQuality control

Number of customer complaints and defects

Delivery performancePercentage of on-time deliveries

Materials wasteScrap and waste as a percentage of materials used

Machine DowntimePercentage of time machines are not working

ObjectiveCustomer satisfaction and

high quality products

Increase on-time deliveries

Decrease scrap and waste; improve product quality

Increase efficiency; increase on-time deliveries

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Additional Quality ConceptsAdditional Quality Concepts

MotivationEmployees respond favorably

to quality initiatives

MotivationEmployees respond favorably

to quality initiatives

Strategic advantagesFavorable reputation among competitors

Strategic advantagesFavorable reputation among competitors

BenchmarkingContinuous process of measuring performance

against best of similar organizations

BenchmarkingContinuous process of measuring performance

against best of similar organizations

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Products are completed just in

time for shipment to customers

Raw materials are received just in time

for production

Just-In-Time (JIT) Inventory Just-In-Time (JIT) Inventory

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In conventional system, materials are

“pushed” through assembly process.

In JIT system, materials are “pulled”

through assembly process by

customers’ needs.


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Complete partsjust in time for

assembly into products

Receive materialsjust in time for

production

Receivecustomer

ordersComplete products

just in time toship to customers

Scheduleproduction


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Relationship Between JIT andRelationship Between JIT andTotal Quality ManagementTotal Quality Management

Less warehousespace needed

Reducedinventory

carrying costs

Reduced riskof obsoleteinventory

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More rapidresponse to

customer orders

Greatercustomer

satisfaction

Higher qualityproducts

Less warehousespace needed

Reducedinventory

carrying costs

Reduced riskof obsoleteinventory

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JIT factory isidle, waiting on

quality rawmaterials

Raw materials

Poor qualityitems returned

Unhappy customer

Late

deliv

ery

Quality must be stressedfrom the very beginning for

JIT to be successful.

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Impact of Just-in-Time on Impact of Just-in-Time on Accounting ProceduresAccounting Procedures

JIT goal is to minimize inventories:JIT goal is to minimize inventories:

Production costs are assigned directlyto cost of goods sold.

Production costs are assigned directlyto cost of goods sold.

Raw Materials

Work inProcess

FinishedGoods

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Any end-of-period inventory is recorded in a procedure known

as backflush costing.

Any end-of-period inventory is recorded in a procedure known

as backflush costing.

Cost ofGoods Sold

Inventory

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JIT accounting entries


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Backflush entry if inventory remains unsold or in process


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ROLL ‘EM !ROLL ‘EM !

Video #1(Approx. 8 min.)

Video #2(Approx. 3 min.)

Hey! You’re

just in tim

e

for the movies.Put on your

hard hat and

click the reels.

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Let’s change the subject!Let’s change the subject!

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Activity-Based Costing (ABC)Activity-Based Costing (ABC)

A costing method that first assigns indirect costs to activities, then to products based

on their consumption of the activities.

A costing method that first assigns indirect costs to activities, then to products based

on their consumption of the activities.

ProductsConsumeActivities

ActivitiesConsume

Resources

PeopleManage

Activities

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Activity-Based CostingActivity-Based CostingBenefitsBenefits

More detailed measures of costs More accurate product costs for...

Pricing decisions Product elimination decisions

Better information for use in managing activities that cause costs

Benefits should always be compared to costs of implementation

More detailed measures of costs More accurate product costs for...

Pricing decisions Product elimination decisions

Better information for use in managing activities that cause costs

Benefits should always be compared to costs of implementation

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Activity-based costing involves these steps: Identify the activities that consume resources,

and assign costs to those activities. Identify the cost driver(s) associated with each

activity.



activity.

Methods Used forMethods Used forActivity-Based CostingActivity-Based Costing

A cost driver is a factor that causes, or “drives,” an

activity’s cost.

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activity. Compute a cost rate per cost driver unit or

transaction. Assign costs to products as follows:



activity. Compute a cost rate per cost driver unit or

transaction. Assign costs to products as follows:

Cost driver rate × Cost driver units consumed

Methods Used forMethods Used forActivity-Based CostingActivity-Based Costing

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Cost drivers are related to volume or complexity of production. Examples: machine time, machine setups,

purchase orders, production orders

Cost driver factors (in order of preference): Causal relationship Benefits received Reasonableness

Cost drivers are related to volume or complexity of production. Examples: machine time, machine setups,

purchase orders, production orders

Cost driver factors (in order of preference): Causal relationship Benefits received Reasonableness

Activity-Based CostingActivity-Based CostingIdentifying Cost DriversIdentifying Cost Drivers

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Predeterminedindirect cost rate

Estimated indirect costs Estimated cost driver

units of activity=

For a period of time, estimate total . . . indirect costs for the activity cost driver units of activity


Activity-Based CostingActivity-Based CostingCost Rate Per Cost Driver UnitCost Rate Per Cost Driver Unit

This formula applies to any indirect cost.(e.g., manufacturing overhead,

administrative, distribution, marketing, etc.

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Predeterminedindirect cost rate

Estimated indirect costs Estimated cost driver

units of activity=



Activity-Based CostingActivity-Based CostingCost Rate Per Cost Driver UnitCost Rate Per Cost Driver Unit

Note that this concept is identical to that used to calculate the predetermined

overhead rate in Chapter 18.

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At this point, we need to look at an example to illustrate the concepts.

Activity-Based CostingActivity-Based CostingExampleExample

.

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Ritz Company manufactures a product in regular and deluxe models. Overhead is assigned on the basis of direct labor hours. Estimated overhead for the

current year is $2,000,000. Other information:

Deluxe RegularModel Model

Direct Material 150$ 112$ Direct Labor Cost 16 8 Direct Labor Time 1.6 hours 0.8 hoursExpected Volume (units) 5,000 40,000

First, determine the unit cost of each model using traditional costing methods.


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Traditional Costing

DirectLabor Hours

Deluxe Model 5,000 units @ 1.6 hours 8,000 Regular Model 40,000 units @ 0.8 hours 32,000 Total Direct Labor Hours 40,000


(Overhead Allocation)

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Traditional Costing

DirectLabor Hours

Deluxe Model 5,000 units @ 1.6 hours 8,000 Regular Model 40,000 units @ 0.8 hours 32,000 Total Direct Labor Hours 40,000

Overhead Rate = $2,000,000 ÷ 40,000 hours = $50 per hour


(Overhead Allocation)

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Traditional Costing


Direct Material 150$ 112$ Direct Labor 16 8 Manufacturing Overhead

Total Unit Cost


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Traditional Costing


Direct Material 150$ 112$ Direct Labor 16 8 Manufacturing Overhead$50 per hour × 1.6 hours 80 $50 per hour × 0.8 hours 40 Total Unit Cost 246$ 160$


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Ritz Company plans to adopt activity-based costing. Using the

following activity center data, determine the unit cost of the two products if

activity-based costing is implemented.

AB C


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OverheadActivity Cost Cost for Cost Driver UnitsCenter Driver Activity Deluxe Regular

Purchasing Orders 84,000$ 400 800 Scrap Rework Orders 216,000 300 600 Testing Tests 450,000 4,000 11,000 Machine Related Hours 1,250,000 20,000 30,000 Total Overhead 2,000,000$

AB C


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OverheadActivity Cost Cost for Cost Driver UnitsCenter Driver Activity Deluxe Regular

Purchasing Orders 84,000$ 400 800 Scrap Rework Orders 216,000 300 600 Testing Tests 450,000 4,000 11,000 Machine Related Hours 1,250,000 20,000 30,000 Total Overhead 2,000,000$

Original budgeted overhead total for

the period

AB C


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TotalActivity Cost Cost Driver Cost Driver UnitsCenter Driver Units Deluxe Regular

Purchasing Orders 1,200 400 800 Scrap Rework Orders 900 300 600 Testing Tests 15,000 4,000 11,000 Machine Related Hours 50,000 20,000 30,000

AB C


++++

====

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Overhead Total Cost Rate perActivity Cost Cost for Driver Cost DriverCenter Driver Activity Units Unit

Purchasing Orders 84,000$ 1,200 Scrap Rework Orders 216,000 900 Testing Tests 450,000 15,000 Machine Related Hours 1,250,000 50,000 Total Overhead 2,000,000$

Rate = Overhead Cost for Activity ÷ Total Cost Driver Units

AB C


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Overhead Total Cost Rate perActivity Cost Cost for Driver Cost DriverCenter Driver Activity Units Unit

Purchasing Orders 84,000$ 1,200 $ 70 per orderScrap Rework Orders 216,000 900 240 per orderTesting Tests 450,000 15,000 30 per testMachine Related Hours 1,250,000 50,000 25 per hourTotal Overhead 2,000,000$

Rate = Overhead Cost for Activity ÷ Total Cost Driver Units

AB C


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AB C

Deluxe Model Regular ModelRate per Actual Cost Actual Cost

Cost Cost Driver Allocated Cost Driver AllocatedActivity Driver Unit Units to Product Units to Product

Purchasing $ 70/order 400 800 Scrap Rework 240/order 300 600 Testing 30/test 4,000 11,000 Machine Related 25/hour 20,000 30,000 Total overhead

Cost Allocated to Product = Rate × Actual Cost Driver Units


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AB C

Deluxe Model Regular ModelRate per Actual Cost Actual Cost

Cost Cost Driver Allocated Cost Driver AllocatedActivity Driver Unit Units to Product Units to Product

Purchasing $ 70/order 400 28,000$ 800 56,000$ Scrap Rework 240/order 300 72,000 600 144,000 Testing 30/test 4,000 120,000 11,000 330,000 Machine Related 25/hour 20,000 500,000 30,000 750,000 Total overhead 720,000$ 1,280,000$

Cost Allocated to Product = Rate × Actual Cost Driver Units

Overhead assigned to Deluxe 720,000$ Overhead assigned to Regular 1,280,000 Total overhead 2,000,000$


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Costs Assigned to Products: Deluxe Model $720,000 ÷ 5,000 units = $144 per unit Regular Model $1,280,000 ÷ 40,000 units = $32 per unit


AB C

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Direct MaterialsDirect LaborManufacturing Overhead 144 32 Total Unit Cost 310$ 152$


AB C

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Direct Materials 150$ 112$ Direct Labor 16 8 Manufacturing Overhead 144 32 Total Unit Cost 310$ 152$


AB C

These amounts did notchange as a result of

using ABC.

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Summary


Activity-based Costing 310$ 152$ Traditional Costing 246 160


Comparison

AB C

Remember, we originally used aplant-wide rate, based on direct

labor hours, to allocate overhead.

Remember, we originally used aplant-wide rate, based on direct

labor hours, to allocate overhead.

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Many companies have found that low-volume, specialized products havegreater costs than previously realized.

Many companies have found that low-volume, specialized products havegreater costs than previously realized.

Summary




Comparison

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Can you see how different allocationmethods might lead management

to make different decisions?

Summary




Comparison

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Activity-Based CostingActivity-Based CostingFinal ObservationsFinal Observations

As companies become more automated... Overhead tends to become a larger portion

of product cost.

Direct labor becomesa smaller portion ofproduct cost andconsequently a lessreliable cost driver.

As companies become more automated... Overhead tends to become a larger portion

of product cost.

Direct labor becomesa smaller portion ofproduct cost andconsequently a lessreliable cost driver.

DirectMaterial

Product Cost

Do

llar

Am

ou

nt Mfg.

OH

DirectLabor

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ABC is likely to result in cost reductions. Focus is on activity analysis. Cost reduction usually requires a change

in activities.


in activities.


Co

sts

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in activities. Activity-based costing concepts and

methods are also applicable to marketing and administrative activities.





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Accountants implementing activity-based costing may experience opposition to change.




Accountants implementing activity-based costing may experience opposition to change.


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THE ENDTHE ENDWe finished just in time!

20-1 using accounting for quality and cost management chapter 20 1 st

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