Evolution of Management Accounting- Part 3

Contemporary Issues And The

Impact Of Technology On
Management Accounting
 Reasons for carrying inventory
1. To balance ordering or setup costs and carrying costs
2. Demand uncertainty
3. Machine failure
4. Defective parts
5. Unavailable parts
6. Late delivery of parts
7. Unreliable production processes
8. To take advantage of discounts
9. To hedge against future price increases
 Inventory Management
Costs related to holding & managing inventories
• Three types of inventory costs can be readily
identified with inventory:
(1)The cost of acquiring inventory.
(2)The cost of holding inventory.
(3)The cost of not having inventory on hand when
needed.
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 Inventory Management
Economic Order Quantity (EOQ)

TC = PD/Q + CQ/2
• TC = The total ordering (or setup) and carrying cost
• P = The cost of placing and receiving an order (or the
cost of setting up a production run)
• Q = The number of units ordered each time an order is
placed (or the lot size for production)
• D = The known annual demand
• C = The cost of carrying one unit of stock for one year
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 An EOQ Illustration
EOQ =  2DP/C
D = 25,000 units P = $40 per order

Q = 500 units C = $2 per unit

EOQ =  (2 x 25,000 x $40) / $2

EOQ =  1,000,000
EOQ = 1,000 units
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 Traditional Production Systems
• Often described as “push systems.”
• Keep large inventories on hand
• Problems:
• Storage cost
• Hide quality
• Bottlenecks and obsolete products
• Solution: Lean Productions System

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 Lean Production System

• Philosophy and a business strategy

• Primary goal is to eliminate waste and
cost
• Focus of JIT:
– Purchase raw materials just in time for
production
– Finish goods just in time for delivery

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 “Just-in-Time” (JIT)
• Common characteristics
– Production occurs in self-contained cells
– Broad employee roles
– Small batches produced just in time –
“demand-pull system”
– Shortened setup times
– Shortened manufacturing cycle times
– Emphasis on quality
– Supply-chain management

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 Just In Time (JIT)
Receive
Receivecustomer
customer Complete
Completeproducts
products
orders.
orders. just
justin
intime
timeto
to
ship
shipcustomers.
customers.
Schedule
Schedule
production.
production.

Receive
Receivematerials
materials Complete
Completeparts
parts
just
justin
intime
timefor
for just
justin
intime
timefor
for
production.
production. assembly
assemblyinto
intoproducts.
products.

10
Drawbacks to Lean Production System
• Vulnerable when problems strike suppliers
or distributors

• Examples
– Delays in delivery
– Personnel problems – union strikes
– Shortage of parts due to recalled products
– Weather related issues

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Just In Time (JIT) Consequences
Improved
Improved Reduced
Reduced
plant
plantlayout
layout inventory
inventory
Zero
Zeroproduction
production
defects
defects Flexible
Reduced
Reduced Flexible
setup
setuptime
time workforce
workforce

JIT
JITpurchasing
purchasing
Fewer,
Fewer,but
butmore
moreultra
ultrareliable
reliablesuppliers.
suppliers.
Frequent
FrequentJIT
JITdeliveries
deliveriesininsmall
smalllots.
lots.
Defect-free
Defect-freesupplier
supplierdeliveries.
deliveries.
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Benefits of Just In Time (JIT) System
Reduced
Reduced Freed-up
Freed-up funds
funds
inventory
inventory costs
costs
Higher
Higher quality
quality Greater
Greater customer
customer
products
products satisfaction
satisfaction
Increased
Increased More
More rapid
rapid response
response
throughput
throughput to
to customer
customer orders
orders

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Accounting System Changes in Response
to JIT
• For control purposes, performance measures
should coincide with the goals of JIT
– Reducing throughput time is a primary
performance measurement for JIT
organisation.
– Team effort is important in JIT
environments, so performance measures
should reflect cooperative goals.
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Accounting System Changes in Response
to JIT
• Significantly reduced the number of
accounting transactions.
• There is less need to worry about valuing
partially completed products (WIP).

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Material Requirements Planning (MRP)
• The oldest manufacturing control system.
• MRP – is an operation management tool that uses a
computer to help manage materials & inventories.
• Components:
– Bills of materials (BOM)
– Master production schedule (MPS)
– Material requirement planning system (MRPS)
• Nowadays MRP/MRPII is embedded in ERP.

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Material Requirements Planning (MRP)
• Objectives of MRP:
– To ensure – right materials, in right
quantities
and at right time are on hand
• Strength of MRP – ability to determine precisely
the feasibility of a schedule within capacity
constraints

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Master Production Schedule (MPS)
• MPS:
– Specifies what is to be made and when
– Must be in accordance with a
production plan (sets the overall level of
output in broad terms)
– Tells what is required to satisfy demand
and meet the production plan

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 Management Accounting
Changes/Innovations
• Activity-based management
• Just in Time
• Total Quality Management
 Activity-Based Management (ABM)
• ABM focuses on the activities incurred during
the production or performance process
=> improved the value received by a customer
& profit.
• ABM focuses on accountability for activities
rather than costs & emphasis the maximization
of system-wide performance instead of
individual performance => global approach to
control.
• In ABM – both financial & non-financial
measures of performance are important.
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Activity-Based Management - Concept
• Continuous
improvement
• Activity analysis • Operational control
• Cost driver • Performance
analysis evaluation
• Activity-based • Business process
costing reengineering

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Activity-Based Management (ABM)
• Activity analysis – primary component of
ABM.
• Activity analysis => process of studying the
activities
• Activity => repetitive action performed in
fulfillment of business functions
• Activity :
– Value-added (VA)
– Non-value-added (NVA)
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 Activity-Based Management (ABM)
• VA – increases significantly the value of the
product/services to the customers.
• VA are those:
– Necessary or required to meet customer
requirements or expectations;
– That enhance purchased materials of a product;
– That are critical steps and cannot be eliminated in
a business process;
– That are performed to resolve or eliminate quality
problems.
 Activity-Based Management
(ABM)
• NVA – consumes time, resources, or space, but
adds little in satisfying customer needs.
• If eliminated, customer value or satisfaction remains
unchanged.
• NVA are those that:
– Can be eliminated without affecting the form, fit, or function
of the product/service;
– Begin with prefix “re” (such as rework or returned goods);
– Result in waste and add little or no value to the
product/service;
– Are performed due to a request of an unhappy or
dissatisfied customers;
– If given the option, you would prefer to do less of.
 Activity-Based Management (ABM)
VA NVA
Designing products X
Setting up X
Waiting X
Moving X
Processing X
Reworking X
Repairing X
Storing X
Inspecting X
Delivering product X
 Activity-Based Management (ABM)
• ABC/ABM helps manager understand the
relationship between the firm’s strategy & the
activities & resources needed to put strategy
into place.
– Cost leadership (business strategy)
=> ABC/ABM is critical to this strategy
– Identify value-enhancement opportunities
– Develop customer strategy
– Support a technology leadership strategy
– Establish a pricing strategy
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 Total Quality Management (TQM)
• TQM
=> All business functions are involved in a
process of continuous quality improvement
• Goals of TQM
=> Customer satisfaction
• TQM minimizes costs by maximizing quality.
• TQM focuses on continuous improvement and
satisfying customers.

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Total Quality Management (TQM)

Key success factors Continuous

Cost, quality, improvement
innovation
Customer
satisfaction

Total value Employee

chain analysis empowerment
Top priority
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 Four Types of Quality Costs
1. Prevention costs – avoid poor quality
goods or services
– Employee training
– Improved materials
– Preventive maintenance
2. Appraisal costs – detect poor quality
goods or services
– Inspection throughout production
– Inspection of final product
– Product testing

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 Four Types of Quality Costs
3. Internal failure costs – avoid poor quality
goods or services before delivery to
customers
– Production loss caused by downtime
– Rejected product units
4. External failure costs – incurred after
defective product is delivered
– Lost profits from lost customers
– Warranty costs
– Service costs at customer sites
– Sales returns due to quality problems
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END