Value-Based Systems: ABM and Lean

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Value-Based Systems: ABM and Lean5

Value-Based Systems and Management

OBJECTIVE 1: Explain why managers use value-based systems and discuss their relationship to the supply chain and the value chain.

Figure 1: The Supply Chain and Value Chain in a Furniture Company

• Managers create value and satisfy customers five ways.– Work with suppliers and customers– View the organization as a collection of value-

adding activities– Use resources for value-adding activities– Reduce or eliminate non-value-adding activities– Know the total cost of creating value for a

customer

• Value chains and supply chains give managers a better understanding of their company’s internal and external operations.– A value chain is a sequence of activities that add

value to a company’s product or service.– A supply chain is the path that leads from the

suppliers of the materials from which a product is made to the final customer; it includes both suppliers and suppliers’ suppliers, and customers and customers’ customers.

• Process value analysis helps managers reduce costs by identifying and eliminating non-value-adding activities.

• Compare value-adding and non-value-adding activities.– A value-adding activity adds market value to a

product or service.– A non-value-adding activity adds cost to a

product or service but does not increase its market value.

• Value-based systems– Create opportunities to improve nonfinancial

performance measures and cost information supplied to managers

– Help managers view their organization as a collection of activities

• Activity-based management (ABM)– Provides financial and performance

information at key operational activity levels.– Eliminates waste and inefficiencies.

• A lean operation eliminates waste three ways– Good planning and design– Smart production scheduling and standardized

product and processing plans– Analysis of worker and machine actions

Activity-Based Costing

OBJECTIVE 2: Define activity-based costing and explain how a cost hierarchy and a bill of activities are used.

Table 1: Sample Activities in Cost Hierarchies

• Activity-based costing (ABC) calculates a more accurate product cost than traditional methods.

• A cost hierarchy is a framework for classifying activities according to the level at which their costs are incurred; in a manufacturing organization, the cost hierarchy typically has four levels:– Unit level– Batch level– Product level– Facility level

• A bill of activities is used to compute the following:– Costs assigned to activities– Product unit cost

The New Operating Environment and Lean Operations

OBJECTIVE 3: Define the elements of a lean operation and identify the changes in inventory management that result when a firm adopts its just-in-time operating philosophy.

Table 2: Direct and Indirect Costs in Traditional and JIT Environments

• Lean operations philosophy– Simple is better– Quality of product or service critical– Work environment emphasizes continuous

improvement

• Lean operations philosophy (cont.)– Large inventories was resources and might

hide poor work– Reduce or eliminate activities or functions that

do not add value– Goods should be produced only when needed

• Lean operations philosophy (cont.)– Workers must be multiskilled and help

eliminate waste– Long-term relationships with suppliers is

important

• Just-in-time (JIT) operating environment eliminates waste through 6 principles.– Minimum inventory levels– Pull-through production– Quick setup and flexible work cells

• Just-in-time (JIT) operating environment eliminates waste through 6 principles. (cont.)– A multiskilled work force– High levels of product quality– Effective preventive maintenance

• Continuous improvement of the work environment

• Accounting for product costs in a JIT Operating Environment– Classifying costs

• Processing time

• Inspection time

• Moving time

• Queue time

• Storage time

• Accounting for product costs in a JIT Operating Environment (cont.)– Assigning costs

• Managers focus on throughput time.

• Several costs that are treated as indirect costs in a traditional environment are treated as direct costs of a JIT work cell.

Backflush Costing

OBJECTIVE 4: Define and apply backflush costing, and compare the cost flows in traditional and backflush costing.

Figure 2: Comparison of Cost Flows in Traditional and Backflush Costing

Figure 3: Cost Flows Through T Accounts in Traditional and Backflush Costing

Backflush Costing

• A JIT operating environment simplifies cost flows through the accounting system.– Conversion costs– Elimination of Materials Inventory account

Backflush Costing

• Backflush costing saves time and cuts costs.

Comparison of ABM and Lean

OBJECTIVE 5: Compare ABM and lean operations as value-based systems.

Table 3: Comparison of ABM and Lean Value-Based Systems

• Both ABM and lean seek to eliminate waste, reduce non-value-adding activities, and improve allocation of resources.

• The two systems differ in their methods of costing and cost assignment:– ABM uses cost drivers to assign indirect costs.– The overhead costs incurred in a JIT work cell

become direct costs of the products made in that cell.

• The two systems differ in their methods of costing and cost assignment: (cont.)– ABM uses job order or process costing to

calculate product costs.– Lean may use backflush costing.

Value-Based Systems: ABM and Lean

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