CHAPTER 2

• MODERN BUSINESS ENVIRONMENT

• CHAPTER SUMMARY
• OVERVIEW OF THE MODERN BUSINESS ENVIRONMENT
• JUST IN TIME (JIT)
• TOTAL QUALITY MANAGEMENT (TQM)
• COSTS OF QUALITY
• KAIZEN COSTING
• BUSINESS PROCESS RE-ENGINEERING (BPR)
• OUTSOURCING AND INSOURCING
• GAINSHARING
• OVERVIEW OF THE MODERN BUSINESS ENVIRONMENT
• MODERN BUSINESS ENVIRONMENT
• THE MODERN MANUFACTURING ENVIRONMENT IS VERY DIFFERENT FROM THE TRADITIONAL
PRODUCTION ENVIRONMENT. IT MEANS THAT TRADITIONAL COSTING METHODS ARE BECOMING
LESS RELEVANT.
• COMPANIES OPERATE IN A WORLD ECONOMY WHERE CUSTOMERS AND COMPETITORS COME FROM
ALL OVER THE WORLD. PRODUCTS ARE MADE FROM COMPONENTS FROM AROUND THE WORLD
AND FIRMS HAVE TO BE WORLD CLASS TO COMPETE WHILE ABIDING BY INTERNATIONAL LAWS
AND REGULATIONS.
• FEATURES OF THE MODERN BUSINESS ENVIRONMENT
• HUGE INCREASE IN DEMAND FOR NEW, CUTTING EDGE INNOVATIVE PRODUCTS
• CUSTOMERS HAVE FAR GREATER CHOICE THAN EVER BEFORE
• CUSTOMERS ARE DEMANDING EVER-IMPROVING LEVELS OF SERVICE IN COST, QUALITY,
RELIABILITY AND DELIVERY PUSHING BUSINESSES TO EXPLOIT CONCEPTS SUCH AS WORLD-CLASS
MANUFACTURING
• CUSTOMERS DEMAND FLEXIBILITY. COMPANIES NEED TO RESPOND TO THIS IN ORDER TO SURVIVE
• JUST IN TIME (JIT)
• JIT IS A SYSTEM WHOSE OBJECTIVE IS TO PRODUCE OR PROCURE PRODUCTS OR
COMPONENTS AS THEY ARE REQUIRED BY A CUSTOMER OR FOR USE, RATHER THAN FOR
INVENTORY.
• A JUST IN TIME SYSTEM IS A ‘PULL’ SYSTEM DEVELOPED BY TOYOTA, WHICH RESPONDS
TO DEMAND, IN CONTRAST TO A ‘PUSH’ SYSTEM, IN WHICH INVENTORY ACTS AS A
BUFFER BETWEEN THE DIFFERENT ELEMENTS OF THE SYSTEM, SUCH AS PURCHASING,
PRODUCTION AND SALES.
• AN IMPORTANT CONSEQUENCE OF THE ‘PULL’ SYSTEM, IS THAT PROBLEMS IN ANY PART
OF THE SYSTEM WILL IMMEDIATELY HALT THE PRODUCTION LINE, AS EARLIER
WORKSTATIONS WILL NOT RECEIVE THE ‘PULL’ SIGNAL AND LATER STATIONS WILL NOT
HAVE THEIR OWN ‘PULL’ SIGNALS ANSWERED. THIS HAS THE POWERFUL EFFECT OF
CONCENTRATING ALL MINDS ON FINDING A LONG TERM SOLUTION TO THE PROBLEM.
JIT EXPOSES PROBLEMS WITHIN A PLANT, AND FORCES MANAGEMENT TO ADDRESS
PROBLEMS AND RECTIFY THEM, RATHER THAN SIMPLY BURYING THEM BY HOLDING
EXCESS INVENTORY.
• JIT PURCHASING
• A PURCHASING SYSTEM IN WHICH MATERIAL PURCHASES ARE CONTRACTED
SO THAT THE RECEIPT AND USAGE OF MATERIAL, TO THE MAXIMUM EXTENT
POSSIBLE, COINCIDE.
• JIT PRODUCTION
• A PRODUCTION SYSTEM WHICH IS DRIVEN BY DEMAND FOR FINISHED
PRODUCTS WHEREBY EACH COMPONENT ON A PRODUCTION LINE IS
PRODUCED ONLY WHEN NEEDED FOR THE NEXT STAGE.
• FEATURES OF A JIT SYSTEM
• FEATURES
• ZERO INVENTORY
• A PRODUCT IS NOT MADE UNTIL THE CUSTOMER REQUESTS IT AND COMPONENTS ARE NOT MADE UNTIL THEY ARE
REQUIRED BY THE NEXT
• PRODUCTION STAGE
• HIGHER NUMBER OF DELIVERIES BY SUPPLIERS
• PRODUCTION IS ORGANIZED IN MANUFACTURING CELLS
• HIGH NUMBER OF SET UPS BUT LOW SET UP TIME
• MULTI SKILLED WORKERS
• TOTAL QUALITY MANAGEMENT (TQM)
• LOWER LEAD TIME
• KEY SUCCESS FACTORS
• VERSATILE AND MULTI SKILLED LABOUR FORCE
• PRODUCTION PROCESSES MUST BE GROUPED BY PRODUCT LINES (MANUFACTURING CELLS) RATHER THAN BY
FUNCTIONS TO ELIMINATE INVENTORY BETWEEN FUNCTIONS
• A SIMPLE, INFALLIBLE INFORMATION SYSTEM (KANBANS). ORIGINALLY THE JAPANESE USED A SYSTEM BASED ON CARDS
WHICH WERE CALLED KANBANS. NOWADAYS COMPUTER SYSTEMS ARE LIKELY TO BE USED INSTEAD OF CARDS BUT THE
BASIC SIMPLICITY OF THE SYSTEM SHOULD NOT CHANGE.
• A ‘GET IT RIGHT FIRST TIME’ APPROACH AND AN AIM OF ‘ZERO DEFECTS’
• STRONG SUPPLIER RELATIONSHIPS
• TOTAL QUALITY MANAGEMENT (TQM)
• • TQM IS A MANAGEMENT SYSTEM FOR A CUSTOMER-FOCUSED ORGANIZATION THAT
INVOLVES ALL EMPLOYEES IN CONTINUAL IMPROVEMENT. IT USES STRATEGY, DATA,
AND EFFECTIVE COMMUNICATIONS TO INTEGRATE THE QUALITY DISCIPLINE INTO
THE CULTURE AND ACTIVITIES OF THE ORGANIZATION. GENERALLY, IT SEEKS TO
ENSURE THAT GOODS ARE PRODUCED AND SERVICES ARE SUPPLIED WITH THE
HIGHEST QUALITY.
• PRINCIPLES OF TQM
• GET IT RIGHT FIRST TIME - TQM CONSIDERS THAT THE COSTS OF PREVENTION ARE
LESS THAN THE COSTS OF CORRECTION. ONE OF THE MAIN AIMS OF TQM IS TO
ACHIEVE ZERO REJECTS AND 100% QUALITY.
• CONTINUOUS IMPROVEMENT (KAIZEN) - REALISTICALLY, A ZERO-DEFECT GOAL
MAY NOT BE OBTAINABLE. IT DOES HOWEVER PROVIDE A TARGET TO ENSURE THAT A
COMPANY SHOULD NEVER BE SATISFIED WITH ITS PRESENT LEVEL OF REJECTS. THE
MANAGEMENT AND STAFF SHOULD BELIEVE THAT IT IS ALWAYS POSSIBLE TO
IMPROVE AND TO BE ABLE TO GET MORE RIGHT NEXT TIME.
• CUSTOMER-FOCUSED - THE CUSTOMER ULTIMATELY DETERMINES THE LEVEL OF QUALITY. NO MATTER WHAT AN ORGANIZATION
DOES TO FOSTER QUALITY IMPROVEMENT - TRAINING EMPLOYEES, INTEGRATING QUALITY INTO THE DESIGN PROCESS, OR
UPGRADING COMPUTERS OR SOFTWARE -THE CUSTOMER DETERMINES WHETHER THE EFFORTS WERE WORTHWHILE.
• TOTAL EMPLOYEE INVOLVEMENT - ALL EMPLOYEES PARTICIPATE IN WORKING TOWARD COMMON GOALS. TOTAL EMPLOYEE
COMMITMENT CAN ONLY BE OBTAINED AFTER FEAR HAS BEEN DRIVEN FROM THE WORKPLACE, WHEN EMPOWERMENT HAS
OCCURRED, AND WHEN MANAGEMENT HAS PROVIDED THE PROPER ENVIRONMENT.
• PRINCIPLES OF TQM CONTINUED …
• PROCESS-CENTERED - A FUNDAMENTAL PART OF TQM IS A FOCUS ON PROCESS THINKING. A PROCESS IS A SERIES OF STEPS THAT
TAKE INPUTS FROM SUPPLIERS (INTERNAL OR EXTERNAL) AND TRANSFORMS THEM INTO OUTPUTS THAT ARE DELIVERED TO
CUSTOMERS (INTERNAL OR EXTERNAL). THE STEPS REQUIRED TO CARRY OUT THE PROCESS ARE DEFINED, AND PERFORMANCE
MEASURES ARE CONTINUOUSLY MONITORED IN ORDER TO DETECT UNEXPECTED VARIATION.
• INTEGRATED SYSTEMS - ALTHOUGH AN ORGANIZATION MAY CONSIST OF MANY DIFFERENT FUNCTIONAL SPECIALTIES OFTEN
ORGANIZED INTO VERTICALLY STRUCTURED DEPARTMENTS, IT IS THE HORIZONTAL PROCESSES INTERCONNECTING THESE
FUNCTIONS THAT ARE THE FOCUS OF TQM.
• STRATEGIC AND SYSTEMATIC APPROACH - A CRITICAL PART OF THE MANAGEMENT OF QUALITY IS THE STRATEGIC AND
SYSTEMATIC APPROACH TO ACHIEVING AN ORGANIZATION’S VISION, MISSION, AND GOALS. THIS PROCESS, CALLED STRATEGIC
PLANNING OR STRATEGIC MANAGEMENT, INCLUDES THE FORMULATION OF A STRATEGIC PLAN THAT INTEGRATES QUALITY AS A
CORE COMPONENT.
• FACT-BASED DECISION MAKING - IN ORDER TO KNOW HOW WELL AN ORGANIZATION IS PERFORMING, DATA ON PERFORMANCE
MEASURES ARE NECESSARY. TQM REQUIRES THAT AN ORGANIZATION CONTINUALLY COLLECT AND ANALYZE DATA IN ORDER TO
IMPROVE DECISION MAKING ACCURACY, ACHIEVE CONSENSUS, AND ALLOW PREDICTION BASED ON PAST HISTORY.
• COMMUNICATION - DURING TIMES OF ORGANIZATIONAL CHANGE, AS WELL AS PART OF DAY-TO-DAY OPERATION, EFFECTIVE
COMMUNICATIONS PLAYS A LARGE PART IN MAINTAINING MORALE AND IN MOTIVATING EMPLOYEES AT ALL LEVELS.
COMMUNICATIONS INVOLVE STRATEGIES, METHOD, AND TIMELINESS.
• SUCCESSFUL IMPLEMENTATION OF TQM
• AN ORGANIZATION SHOULD UNDERTAKE TO ACHIEVE EACH OF THE FOLLOWING TO
ENSURE TQM IS SUCCESSFUL.
• TOTAL COMMITMENT THROUGHOUT THE ORGANIZATION
• 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 COMPANYWIDE 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
• RECOGNIZE ACHIEVEMENTS
• MAKE QUALITY A WAY OF LIFE
• QUALITY CIRCLES
• A QUALITY CIRCLE IS A TEAM OF FOUR TO TWELVE PEOPLE USUALLY COMING
FROM THE SAME AREA WHO VOLUNTARILY MEET ON A REGULAR BASIS TO
IDENTIFY, INVESTIGATE, ANALYZE AND SOLVE WORK RELATED PROBLEMS. THE
TEAM PRESENTS ITS SOLUTIONS TO MANAGEMENT AND IS THEN INVOLVED IN
IMPLEMENTING AND MONITORING THE EFFECTIVENESS OF THE SOLUTIONS.
• THE VOLUNTARY APPROACH AND THE PROCESS BY WHICH THE TEAM SELECTS
AND SOLVES ITS OWN PROBLEMS ARE KEY FEATURES WHICH GIVE THE QUALITY
CIRCLE A SPECIAL CHARACTER: A CHARACTER WHICH IS VERY DIFFERENT TO
OTHER PROBLEM SOLVING TEAMS.
Category Examples

 Cost of designing products and services with built in quality

 Training costs of employees
Prevention cost  Cost of equipment testing to ensure it conformity

 Inspection costs
Appraisal costs  Testing costs

 Cost of rework
 Machine downtime due to quality issue
 Cost of scrapped material due to poor quality
Internal failure cost  Reduced selling prices for sub-quality products

 Warranty claims
 Costs of repairing or replacing faulty goods
 Product recall cost
External failure cost  Loss in goodwill
• THE QUALITY COST CURVE
• IT IS GENERALLY ACCEPTED THAT AN INCREASED INVESTMENT IN PREVENTION
AND APPRAISAL IS LIKELY TO RESULT IN A SIGNIFICANT REDUCTION IN FAILURE
COSTS. AS A RESULT OF THE TRADEOFF, THERE MAY BE AN OPTIMUM OPERATING
LEVEL IN WHICH THE COMBINED COSTS ARE AT A MINIMUM. IN SHORT, AN
INVESTMENT IN “PREVENTION” INEVITABLY RESULTS IN A SAVING ON TOTAL
QUALITY COSTS.
• TIPS TO STRENGTHEN QUALITY
• ACCEPT THAT THE ONLY THING THAT MATTERS IS THE CUSTOMER. THE ONLY WAY TO STAY IN
BUSINESS IS TO RELATE EVERYTHING TO CUSTOMER PRIORITIES
• RECOGNIZE THE ALL-PERVASIVE NATURE OF THE CUSTOMER/SUPPLIER RELATIONSHIP. THIS
INCLUDES INTERNAL CUSTOMERS. IN A TRANSFER ENVIRONMENT, PASSING SUBSTANDARD
MATERIAL DOWN TO ANOTHER DIVISION JUST TO CLAIM OUTPUT IS NOT SATISFACTORY.
ULTIMATELY, THE COMPANY MUST BARE THE COST OF THE DEFECTIVE PRODUCT/SERVICE
• MOVE FROM RELYING ON INSPECTING TO A PREDEFINED LEVEL OF QUALITY TO ACTUALLY
PREVENTING THE CAUSE OF THE DEFECT IN THE FIRST PLACE.
• EACH OPERATIVE OR TEAM OF OPERATIVES MUST BE PERSONALLY RESPONSIBLE FOR DEFECT
FREE PRODUCTION OR SERVICE IN THEIR DOMAIN. THIS SHOULD NOT JUST BE CONFINED TO
PRODUCTION STAFF IT SHOULD BE EXTENDED THROUGHOUT THE ORGANIZATION
• IN PRODUCTION THERE SHOULD BE A MOVE AWAY FROM ACCEPTABLE QUALITY LEVELS (AQL) TO
DEFECT LEVELS MEASURED IN PARTS PER MILLION
• IMPLEMENT TQM AND ENFORCE ZERO DEFECT PROGRAMS
• QUALITY CERTIFICATION PROGRAMS SUCH AS ISO9002 SHOULD BE INTRODUCED
• EMPHASIZE THE IMPORTANCE OF QUALITY THROUGH AWARENESS PROGRAMS
• MANAGEMENT ACCOUNTING REPORTS
• 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.
• NON-FINANCIAL MEASURES
• NUMBER OF DEFECTS AT INSPECTION EXPRESSED AS A PERCENTAGE OF THE NUMBER
OF UNITS COMPLETED
• NUMBER OF REWORKED UNITS EXPRESSED AS A PERCENTAGE OF TOTAL SALES
VALUE
• NUMBER OF DEFECTIVE UNITS DELIVERED TO CUSTOMERS AS A PERCENTAGE OF
TOTAL UNITS DELIVERED
• NUMBER OF CUSTOMER COMPLAINTS
• NUMBER OF DEFECTIVE UNITS SUPPLIED BY SUPPLIERS
• TIME TAKEN TO RESPOND TO CUSTOMER REQUESTS
• KAIZEN COSTING

• CONTINUOUS IMPROVEMENT OR ‘KAIZEN’ IS AN INTEGRAL PART OF THE JUST IN TIME

MANAGEMENT PHILOSOPHY.
• ‘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
EMPHASIZES REDUCING VARIABLE COSTS OF A PERIOD BELOW THE COST LEVEL IN THE
BASE PERIOD. THE TARGET REDUCTION RATE IS THE RATIO OF THE TARGET REDUCTION
AMOUNT TO THE COST BASE. THIS IS AN EVOLVING/NEVER ENDING PROCESS.
• FOR EXAMPLE, AN ORGANIZATION’S CONTINUOUS IMPROVEMENT TARGET CAN BE TO
DECREASE THE COST OF PRODUCING A PRODUCT BY 1% WITHIN THE NEXT 3 MONTHS.
ONCE ACHIEVED, THE ORGANIZATION CAN SET ITS NEXT TARGET TO ACHIEVE A COST
REDUCTION OF A FURTHER 1% DURING THE NEXT 3 MONTHS.
Standard Costing Kaizen Costing

Cost control system Cost reduction system

Meet cost performance standards Achieve cost reduction targets

Standards are set annually or semi annually Set and applied frequently
• BUSINESS PROCESS RE-ENGINEERING
• • MICHAEL HAMMER & JAMES CHAMPY DEFINE BPR AS 'THE FUNDAMENTAL RETHINKING AND RADICAL
REDESIGN OF BUSINESS PROCESSES TO ACHIEVE DRAMATIC IMPROVEMENTS IN CRITICAL
CONTEMPORARY MEASURES OF PERFORMANCE SUCH AS COST, QUALITY, SERVICE AND SPEED.' IN
OTHER WORDS, BPR FOCUSES ON AMENDING EXISTING PROCESSES, STREAMLINING PROCESSES THAT
ARE ALREADY IN PLACE.
• STAGES OF A BPR PROJECT
• DEVELOP THE BUSINESS VISION AND PROCESS OBJECTIVES - STATE WHICH IMPROVEMENTS ARE
EXPECTED FROM PROCESSES BASED ON SOME OVERALL BUSINESS VISION OF TOTAL QUALITY
MANAGEMENT
• IDENTIFY THE PROCESSES TO BE REDESIGNED - MOST FIRMS TEND TO FOCUS ON THE MORE IMPORTANT
PROCESSES, ALTHOUGH SIGNIFICANT IMPROVEMENTS MAY STILL BE OBTAINED BY REDESIGNING
INEFFICIENT PROCESSES IN ANY PART OF THE ORGANIZATION
• UNDERSTAND AND MEASURE THE EXISTING PROCESSES SO THAT A BASELINE AGAINST WHICH TO
MEASURE IMPROVEMENT IS SET
• IDENTIFY 'IT LEVERS' THAT CAN BE USED TO APPLY CHANGE
• DESIGN AND BUILD A PROTOTYPE TO SHOW WHICH CHANGES ARE POSSIBLE AND INVOLVE CUSTOMERS
BEFORE IMPLEMENTING ANY REVISED SYSTEM
 Merits and De-merits
Merits
Highlights the deficiencies of a procedure and shows
areas where business is incurring costs without getting
required returns.
Provides management an opportunity to understand the
systems of their business in more detail
Presents a better picture of the strengths and weaknesses
of the business and business’s ability to adapt and
respond towards the changes in external environment
Provides long term solutions to minimize the deficiencies The sustainability of a change in a business process is a
of a business
De-merits
Requires monetary assets of a company but also
consumes time and human resources.
Business process reengineering may not suit to every
business. BPR usually benefits large organizations
Incremental improvements in processes can be seen
instantly as these focus upon the costs of business, but
BPR focuses majorly upon long term revenue synergies
of a business which take time
difficult task. BPR follows many aspects that are
unfavorable for certain levels of business
OUTSOURCING
• OUTSOURCING INVOLVES THE BUYING IN OF COMPONENTS, SUBASSEMBLIES,
FINISHED PRODUCTS AND SERVICES FROM OUTSIDE SUPPLIERS RATHER THAN
SUPPLYING THEM INTERNALLY. IT MAY BE REGARDED AS A MANAGEMENT
STRATEGY BY WHICH AN ORGANIZATION DELEGATES MAJOR NONCORE
FUNCTIONS TO SPECIALIZED, EFFICIENT SERVICE PROVIDERS.
• A SIGNIFICANT TREND IN RECENT YEARS HAS BEEN FOR ORGANIZATIONS AND
GOVERNMENT BODIES TO CONCENTRATE ON THEIR CORE COMPETENCIES

Advantages Disadvantages

Greater flexibility Possibility of choosing wrong supplier

Lower investment risk Loss of visibility and control over process

Concentrates on core competence Possibility of increased lead times

Improved cash flow

Enables more advanced technologies to be used

without making investment
• INSOURCING
• ASSIGNING A PROJECT TO A PERSON OR DEPARTMENT WITHIN THE COMPANY
INSTEAD OF HIRING AN OUTSIDE PERSON OR COMPANY TO DO THE WORK IS
CONSIDERED INSOURCING.
• THE COST ASSOCIATED WITH INSOURCING IS DIFFERENT FROM THE COST
ASSOCIATED WITH OUTSOURCING. INSOURCING IS TYPICALLY MORE EXPENSIVE
FOR AN ORGANIZATION AS A RESULT OF IMPLEMENTING NEW PROCESSES TO
START A DIFFERENT DIVISION OF THE ORGANIZATION. INSOURCING UTILIZES
DEVELOPED RESOURCES WITHIN THE ORGANIZATION TO PERFORM TASKS OR TO
ACHIEVE A GOAL.
Advantages Disadvantages
Higher degree of control over inputs 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
• GAINSHARING
• IN SIMPLE TERMS, GAINSHARING IS A PRODUCTIVITY MEASURE THAT RETURNS COST
SAVINGS TO EMPLOYEES.
• GAINSHARING’S GOAL IS TO IMPROVE PERFORMANCE AND ELIMINATE WASTE (TIME,
ENERGY, AND MATERIALS) BY MOTIVATING EMPLOYEES TO WORK SMARTER AS A TEAM
RATHER THAN JUST WORKING HARDER.
• THESE AGREEMENTS ARE ATTRACTIVE TO COMPANIES BECAUSE THEY CAN PROVIDE
INSULATION FROM THE CUT THROAT PRICE COMPETITION THAT CHARACTERIZES
TODAY’S TECHNOLOGY MARKETPLACE. SUPPLIERS THAT GUARANTEE COST SAVINGS
AND TOPLINE IMPROVEMENT CAN COMMAND A PRICE PREMIUM IN THE MARKETPLACE.
SUCH RISK SHARING AGREEMENTS ARE ATTRACTIVE TO CUSTOMERS BECAUSE THEY
REDUCE THE BUSINESS RISK AND COST ASSOCIATED WITH IMPLEMENTING NEW
TECHNOLOGIES, SYSTEMS, AND SERVICES.
• FACTORS SUCH AS IDENTIFICATION OF COMMON GOALS FOR SUCCESS, MUTUAL
INTERDEPENDENCE AND TRUST BETWEEN PARTIES, A CLEARLY SET AGREEMENT,
COMMITMENT TOWARDS CONTINUOUS IMPROVEMENT, OPEN BOOK ACCOUNTING ETC.
ARE SIGNIFICANT FOR THE SUCCESS OF A GAIN SHARING AGREEMENT
THROUGHPUT ACCOUNTING
• OBJECTIVE: MAXIMIZE THE THROUGHPUT
• THROUGHPUT ACCOUNTING BELIEVES THE FOLLOWING 3 CONCEPTS:
• ALL COSTS EXCEPT FOR MATERIAL IS FIXED
• STOCK MINIMIZATION: EVEN THOUGH THROUGHPUT ACCOUNTING BELIEVES IN LIMITED RESOURCES IT ARGUES
THAT THE BOTTLENECK RESOURCE HAS TO HAVE A BUFFER STOCK
• COST CONTROLS & ADDRESSING THE BOTTLENECKS WILL IMPROVE THE THROUGHPUT & PROFITABILITY
• STEP 1: IDENTIFY THE BOTTLENECK CONSTRAINT.
• STEP 2: CALCULATE THE THROUGHPUT CONTRIBUTION PER UNIT FOR EACH PRODUCT.
• STEP 3: CALCULATE THE THROUGHPUT CONTRIBUTION PER UNIT OF THE BOTTLENECK
• RESOURCE FOR EACH PRODUCT.
• STEP 4: RANK THE PRODUCTS IN ORDER OF THE THROUGHOUT CONTRIBUTION PER UNIT OF
• THE BOTTLENECK RESOURCE.
• STEP 5: ALLOCATE RESOURCES USING THIS RANKING AND ANSWER THE QUESTION
If the TA ratio is greater than 1 the product is viable. Therefore should be continued.
However, if the TA ratio is less than 1 the product is not viable.
Therefore the process should be revisited or discontinued.
 QUESTION 2

THE FOLLOWING DATA RELATES TO TWO PRODUCTS MANUFACTURED BY DJ LTD

THE FIRM HAS 80,000 BOTTLENECK HOURS AVAILABLE EACH PERIOD.
TOTAL FACTORY COSTS AMOUNT TO $128,000 IN THE PERIOD.

PRODUCT X Y
SELLING PRICE PER UNIT $15 $20
DIRECT MATERIAL COST PER UNIT $10 $11
MAXIMUM DEMAND (UNITS) 25,000 30,000
TIME REQUIRED ON THE BOTTLENECK (HOURS PER UNIT) 2 6

REQUIRED:
CALCULATE THE OPTIMUM PRODUCT MIX AND THE MAXIMUM PROFIT.
CALCULATE THE THROUGHPUT ACCOUNTING RATIO FOR EACH PRODUCT
 QUESTION 4
SM MAKES TWO PRODUCTS, Z1 AND Z2. ITS MACHINES CAN ONLY WORK ON ONE PRODUCT AT A TIME. THE TWO
PRODUCTS ARE WORKED ON IN TWO DEPARTMENTS BY DIFFERING GRADES OF LABOUR. THE LABOUR
REQUIREMENTS FOR THE TWO PRODUCTS ARE AS FOLLOW

Z1 Z2

DEPARTMENT 1 12MIN 16MIN

DEPARTMENT 2 20MIN 15MIN

THERE IS CURRENTLY A SHORTAGE OF LABOUR AND THE MAXIMUM TIMES AVAILABLE EACH DAY IN DEPARTMENTS 1
AND 2 ARE 480 MINUTES AND 840 MINUTES, RESPECTIVELY.

THE CURRENT SELLING PRICES AND COSTS FOR THE TWO PRODUCTS ARE SHOWN BELOW:

Z1 Z2

SELLING PRICE $50 $65

-DIRECT MATERIAL $10 $15

-DIRECT LABOUR $10.40 $6.20

-VARIABLE OVERHEAD $6.40 $9.20

-FIXED OVERHEAD $12.80 $18.40

 1. CALCULATE THE MAXIMUM NUMBER OF EACH PRODUCT THAT COULD BE
PRODUCED EACH DAY, AND IDENTIFY THE LIMITING FACTOR/BOTTLENECK.

2.USING TRADITIONAL CONTRIBUTION ANALYSIS, CALCULATE THE „PROFIT-

MAXIMISING‟ OUTPUT EACH DAY, AND THE CONTRIBUTION AT THIS LEVEL OF
OUTPUT.

3. USING A THROUGHPUT APPROACH, CALCULATE THE „THROUGHPUT-

MAXIMISING‟ OUTPUT EACH DAY, AND THE THROUGHPUT CONTRIBUTION‟ AT
THIS LEVEL OF OUTPUT.