CIMA Paper P2Advanced Management Accounting
Ian Kusano and Nathi Thela
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2ChapterThe Modern Business
Environment
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Learning Objectives
Lead A1: Evaluate techniques for analysing and managing costs for
competitive advantage
Component A1b): Evaluate Total Quality Management techniques
-The impacts of just-in-time (JIT) production, the theory of constraints
and total quality management on efficiency, inventory and cost.
-The benefits of JIT production, total quality management and theory
of constraints and the implications of these methods for decision in
the contemporary manufacturing environment.
-Kaizen costing, continuous improvement and cost of quality reporting.
-Process re-engineering and the elimination of non-value adding
activities and reduction of activity costs.
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Introduction to the Modern Business
Environment
“To compete successfully in today’s highly competitive
global environment companies are making customer
satisfaction an overriding priority, adopting new
management approaches, changing their manufacturing
systems and investing in new technologies. These
changes are having a significant influence on
management accounting systems.”
Colin Drury in Cost and Management Accounting
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Session Content
The Global Environment
New Management
Approaches
• Just in time
• Total quality
management
• Theory of
constraints
Cost Planning and
Cost Reduction
• The value chain
• Value analysis
• Life cycle
costing
• Target costing
Logistics
• Supply chain
management
• Outsourcing
• Gain sharing
In this chapter we explore how the modern production system has changed, and
in the following chapters we examine how costing has adapted to this and created
new ways to calculate a product's production cost.
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Characteristics of the Modern Environment
Global environment
• Operate in World Economy
• Global customers and competition and sourcing
• International regulations
Flexibility
• Customers have far greater choice than ever before
• Huge increase in demand for new, cutting edge innovative products
• Customers are demanding ever improving levels of service in cost,
quality, reliability and delivery.
• Customers demand flexibility
As a consequence of this:
• Many companies now have very diverse product ranges, with a high level
of tailor made products and services;
• Product life cycles have dramatically reduced, often from several years to
just a few months.
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Characteristics of the Modern Environment
Employee Empowerment
1. To ensure this flexibility, managers need to empower their employees
to make decisions quickly, without reference to more senior managers.
2. By empowering employees and giving them relevant information they
will be able to respond faster to customers
3. Management accounting systems are moving from providing information
to managers to monitor employees to providing information to employees
to empower them to focus on continuous improvement.
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Just-in-Time
The emphasis of JIT is on produce or procure products or
components as they are required by a customer or for use, rather
than for inventory.
1. JIT Production 2. JIT Purchasing
• Push vs Pull system
Supplier to Production to Consumers
Consumers to Production to Suppliers
Toyota System
• In a full JIT system virtually no inventory is held, that is no raw
material inventory and no finished goods inventory is held, but
there will be a small amount of WIP, say one tenth of a day’s
production.
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Just-in-Time
To successfully adopt or implement JIT, the following is
required:
• labour force must be versatile
• Production processes must be grouped by product line
• infallible information system
• A ‘get it right first time’ approach and an aim of ‘zero
defects’.
• Strong supplier relationships.
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Total Quality Management
TQM is the general name given to programmes which
seek to ensure that goods are produced and services
supplied of the highest quality.
- Originates from Japan, its behind the success of
many Japanese businesses.
Two basic principles:
-Get it right first time – prevention costs are lesser
than correction costs.
- zero defects and 100% quality
-Continuous improvement – dissatisfied with the
status quo.
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Continuous Improvement and Cost of
Quality
There are two approaches to CI:
• Kaizen Costing and Target Costing
Quality costs are divided into compliance costs (or ‘conformance costs’)
and costs of failure to comply (‘nonconformance costs’).
• Prevention costs - costs of ensuring that defects do not occur in the
first place.
• Appraisal costs - are connected with measuring conformity with
requirements and includes
• Internal failure costs – includes reworking costs; costs of scrap;
correction costs
• External failure costs – there are several measurable costs for external
failure i.e. Marketing costs associated with failed products & loss of
goodwill.
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Example 1: Costs of Quality
X Ltd is a manufacturing company. Its monthly quality costs are
made up as follows:
$
Costs re-inspecting previously faulty finished goods 5,700
after reworking them
Costs of scrap 12,000
Costs of calibrating and measuring testing equipment 8,500
Costs of inspecting incoming material 1,000
Costs of conducting supplier capability surveys 2,000
Classify the above costs into the four components of costs of
quality?
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Example 2: Costs of Quality
Quality control costs can be categorised into internal and external
failure costs, appraisal costs and prevention costs. In which of
these four classifications would the following costs be included?
• The cost of a customer service team
• The cost of equipment maintenance
• The cost of operating test equipment
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Commitment to QualityFor TQM to bring about improved business efficiency and
effectiveness it must be applied throughout the whole
organisation.
It begins at the top with the managing director, the most senior
directors and managers who must demonstrate that they are
totally committed to achieving the highest quality standards.
Middle management must ensure that the efforts and achievements
of their subordinates receive appropriate recognition, attention and
reward.
This helps secure everyone’s full involvement – which is crucial to
the successful introduction of TQM.
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Successful implementation of TQM
• Total commitment throughout the organisation.
• Get close to their customers to fully understand their needs and expectations.
• Plan to do all jobs right first time.
• Agree expected performance standards with each employee and customer.
• Implement a company-wide improvement process.
• Continually measure performance levels achieved.
• Measure the cost of quality mismanagement and the level of firefighting.
• Demand continuous improvement in everything you and your employees do.
• Recognise achievements.
• Make quality a way of life.
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Quality Circles
• Is a team of four to twelve people usually coming from the same area
who voluntarily meet on a regular basis to identify, investigate, analyse
and solve work-related problems.
• They present their solutions to management and is then involved in
implementing and monitoring the effectiveness of the solutions.
• The problems that quality circles tackle may not be restricted to quality
of product or service topics, but may include anything associated with
work or its environment.
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The role of Management Accounting
• Management accounting systems can help organisations achieve their
quality goals by providing a variety of reports and measures that
motivate and evaluate managerial efforts to improve quality – including
financial and nonfinancial measures.
• Traditionally, the management accounting systems focused on output, not
quality.
• Nonfinancial measures include:
-Number of defects at inspection expressed as a percentage of the
number of units completed.
-Number of customer complaints.
-Number of defectives supplied by suppliers.
-Time taken to respond to customer requests.
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Throughput Accounting
Throughput = Sales Revenue Less Direct Material
Cost
• Aim to maximise throughput
• Fully utilise bottlenecks
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Goldratt and Cox’s 5 steps
1. Identify bottlenecks
2. Exploit bottlenecks
3. Subordinate to bottlenecks
4. Elevate bottlenecks
5. If break a bottleneck return to step 1
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Accounting Measures
Return Per Hour =Throughput Per Unit
Time on Bottleneck
Cost Per Hour =Total Factory Costs
Total Time on Bottleneck
T A Ratio =Return Per Factory Hour
Cost Per Factory Hour
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Example 3: Throughput Accounting
X Limited manufactures a product that requires 1.5 hours of
machining. Machine time is a bottleneck resource, due to the
limited number of machines available. These are 10 machines
available, and each machine can be used for u to 40 hours per
week.
The product is sold for $85 per unit and the direct material cost per
unit is $42.50. total factory costs are $8,000 each week.
Calculate
1. The return per factory hour
2. The TPAR.
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Example 4: Throughput Accounting
The following data relates to three products manufactured by BJS
Ltd. Product Product Product
X Y Z
Selling price per unit $12 $16 $14
Direct material per unit $3 $10 $7
Maximum demand (units) 15,000 40,000 20,000
Time required on the b/neck 3 1,5 7
(hours per unit)
The firm has 80,000 bottleneck hours available each period, and
total factory costs amount to $1000,000 in the period.
Calculate: 1. The TPAR for each product 2. The maximum profit
achievable by BJS, in $ (this involves a calculation of the optimum
product mix)
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Kaizen Costing
• Kaizen’ is a Japanese term meaning to improve processes via small,
incremental amounts rather than through large innovations.
• Kaizen costing is a planning method used during the manufacturing cycle
that emphasises reducing variable costs of a period below the cost level in
the base period.
-The organisation should always seek perfection. Improvements should
be sought all the time.
- Improvements will be small and numerous rather than occasional and
far reaching.
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Kaizen Costing & BPR-Cost reduction targets are set and applied on a more frequent basis
than standard costs. Refer to 64-65 for comparisons of Kaizen and
Standard Costing.
• The continuous improvement philosophy contrasts sharply with the
concept underlying business process reengineering (BPR). BPR is
concerned with making far reaching one off changes to improve
operations or processes.
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Kaizen Costing
A company experiences changing levels of demand, but produces
a constant number of units during each quarter. The company
allows inventory levels to rise and fall to satisfy the differing
quarterly demand levels for its product.
Required:
1. Identify and explain the reasons for three cost changes that
would result if the company changed to a Just In Time production
method for 2009. Assume there will be no inventory at the start
and end of the year.
2. Briefly discuss the importance of Total Quality Management to
a company that operates a Just In Time production method.
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Five stages in BPR project
1. Develop the business vision and process objectives
2. Identify the processes to be redesigned
3. Understand and measure the existing processes so that a baseline
against which is to measure improvement is set.
4. Identify ‘IT levers’ that can be used to apply is set
5. Design and build a prototype to show which changes are possible,
and involve customers before implementing any revised system
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Logistics in a Modern Environment
Supply Chain
ManagementOutsourcing
Gain Sharing
Arrangements
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Supply Chain Management
• SCM considers logistics but also relationships between members of
the supply chain, identification of end-customer benefit and the
organisational consequences of greater inter-firm integration to
form ‘network organisations’.
• SCM may be broken down into several areas:
- Purchasing
- Inventories
- Customer Ordering
- Delivery and logistics
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Outsourcing
• Outsourcing involves the buying in of components, sub-assemblies,
finished products and services from outside suppliers rather than
supplying them internally.
• Non-core activities are outsourced
Advantages Disadvantages
- Greater flexibility - Possibility of choosing wrong
supplier
- Lower investment risk - Loss of visibility and control over
process
- Improved cash flow - Possibility of increased lead
times
- Concentrates on core competence
- Enables more advanced technologies to
be used without making investment
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Insourcing
• Insourcing is a business practice in which work that would otherwise
have been contracted out is performed in house.
Advantages Disadvantages
- Higher degrees of control over input - Requires high volumes
- Increases visibility over the process - High investment
- Economies of scale/scope to use
integration
- Dedicated equipment has limited
flexibility
- Not a core competence
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Gain Sharing Arrangements
• Gain Sharing is a program that returns cost savings to the
employees.
• Companies typically guarantee their customers that they will achieve
a certain amount of savings or top-line improvement.
- If targets are not met, the company commits to making up the
difference in cash.
- If however targets are exceeded, the supplier may also receive a
pre-specified percentage of the gains.
•