20-1 using accounting for quality and cost management chapter 20 1 st
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20-1
USING ACCOUNTING FORQUALITY AND COST
MANAGEMENT
CHAPTER 20CHAPTER 20
1st1st
20-2
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
20-3
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
.
20-5
Internal failure costs are due to defects discovered before delivery to customers. Scrap materials Rework Reinspection Lost sales resulting
from late deliveries
CostReport
Cost of QualityCost of QualityTexas Instruments ApproachTexas Instruments Approach
20-6
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
Cost of QualityCost of QualityTexas Instruments ApproachTexas Instruments Approach
20-7
Cost of prevention
and appraisal
Internaland external failure costs
Cost of QualityCost of QualityTexas Instruments ApproachTexas Instruments Approach
Objective
Zero defectswhile minimizing
all four qualitycost categories
20-8
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
20-9
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
20-10
The Quality Is Free ConceptThe Quality Is Free Concept
Greatercustomer
satisfaction
Qualityproducts
andservices
Increasedbusiness
andprofits
20-11
Methods to IdentifyMethods to IdentifyQuality ProblemsQuality Problems
Control charts
Pareto diagrams
Cause andeffect analysis
20-12
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
746
20-13
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
20-14
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
20-15
In conventional system, materials are
“pushed” through assembly process.
In JIT system, materials are “pulled”
through assembly process by
customers’ needs.
Just-In-Time (JIT) Inventory Just-In-Time (JIT) Inventory
20-16
Complete partsjust in time for
assembly into products
Receive materialsjust in time for
production
Receivecustomer
ordersComplete products
just in time toship to customers
Scheduleproduction
Just-In-Time (JIT) Inventory Just-In-Time (JIT) Inventory
20-17
Relationship Between JIT andRelationship Between JIT andTotal Quality ManagementTotal Quality Management
Less warehousespace needed
Reducedinventory
carrying costs
Reduced riskof obsoleteinventory
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Relationship Between JIT andRelationship Between JIT andTotal Quality ManagementTotal Quality Management
More rapidresponse to
customer orders
Greatercustomer
satisfaction
Higher qualityproducts
Less warehousespace needed
Reducedinventory
carrying costs
Reduced riskof obsoleteinventory
20-19
Relationship Between JIT andRelationship Between JIT andTotal Quality ManagementTotal Quality Management
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.
20-20
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
20-21
Impact of Just-in-Time on Impact of Just-in-Time on Accounting ProceduresAccounting Procedures
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
20-22
JIT accounting entries
Impact of Just-in-Time on Impact of Just-in-Time on Accounting ProceduresAccounting Procedures
20-23
Backflush entry if inventory remains unsold or in process
Impact of Just-in-Time on Impact of Just-in-Time on Accounting ProceduresAccounting Procedures
20-24
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.
20-25
Let’s change the subject!Let’s change the subject!
20-26
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
20-27
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
20-28
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-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.
Methods Used forMethods Used forActivity-Based CostingActivity-Based Costing
A cost driver is a factor that causes, or “drives,” an
activity’s cost.
20-29
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. Compute a cost rate per cost driver unit or
transaction. Assign costs to products as follows:
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. 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
20-30
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
20-31
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
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.
20-32
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
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
Note that this concept is identical to that used to calculate the predetermined
overhead rate in Chapter 18.
20-33
At this point, we need to look at an example to illustrate the concepts.
Activity-Based CostingActivity-Based CostingExampleExample
.
20-34
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.
Activity-Based CostingActivity-Based CostingExampleExample
20-35
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
Activity-Based CostingActivity-Based CostingExampleExample
(Overhead Allocation)
20-36
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 = $50 per hour
Activity-Based CostingActivity-Based CostingExampleExample
(Overhead Allocation)
20-37
Traditional Costing
Deluxe RegularModel Model
Direct Material 150$ 112$ Direct Labor 16 8 Manufacturing Overhead
Total Unit Cost
Activity-Based CostingActivity-Based CostingExampleExample
20-38
Traditional Costing
Deluxe RegularModel Model
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$
Activity-Based CostingActivity-Based CostingExampleExample
20-39
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
Activity-Based CostingActivity-Based CostingExampleExample
20-40
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
Activity-Based CostingActivity-Based CostingExampleExample
20-41
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
Activity-Based CostingActivity-Based CostingExampleExample
20-42
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
Activity-Based CostingActivity-Based CostingExampleExample
++++
====
20-43
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
Activity-Based CostingActivity-Based CostingExampleExample
20-44
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
Activity-Based CostingActivity-Based CostingExampleExample
20-45
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
Activity-Based CostingActivity-Based CostingExampleExample
20-46
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$
Activity-Based CostingActivity-Based CostingExampleExample
20-47
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
Activity-Based CostingActivity-Based CostingExampleExample
AB C
20-48
Costs Assigned to Products: Deluxe Model $720,000 ÷ 5,000 units = $144 per unit Regular Model $1,280,000 ÷ 40,000 units = $32 per unit
Deluxe RegularModel Model
Direct MaterialsDirect LaborManufacturing Overhead 144 32 Total Unit Cost 310$ 152$
Activity-Based CostingActivity-Based CostingExampleExample
AB C
20-49
Costs Assigned to Products: Deluxe Model $720,000 ÷ 5,000 units = $144 per unit Regular Model $1,280,000 ÷ 40,000 units = $32 per unit
Deluxe RegularModel Model
Direct Materials 150$ 112$ Direct Labor 16 8 Manufacturing Overhead 144 32 Total Unit Cost 310$ 152$
Activity-Based CostingActivity-Based CostingExampleExample
AB C
These amounts did notchange as a result of
using ABC.
20-50
Summary
Deluxe RegularModel Model
Activity-based Costing 310$ 152$ Traditional Costing 246 160
Activity-Based CostingActivity-Based CostingExampleExample
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.
20-51
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
Deluxe RegularModel Model
Activity-based Costing 310$ 152$ Traditional Costing 246 160
Activity-Based CostingActivity-Based CostingExampleExample
Comparison
20-52
Can you see how different allocationmethods might lead management
to make different decisions?
Summary
Deluxe RegularModel Model
Activity-based Costing 310$ 152$ Traditional Costing 246 160
Activity-Based CostingActivity-Based CostingExampleExample
Comparison
20-53
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
20-54
ABC is likely to result in cost reductions. Focus is on activity analysis. Cost reduction usually requires a change
in activities.
ABC is likely to result in cost reductions. Focus is on activity analysis. Cost reduction usually requires a change
in activities.
Activity-Based CostingActivity-Based CostingFinal ObservationsFinal Observations
Co
sts
20-55
ABC is likely to result in cost reductions. Focus is on activity analysis. Cost reduction usually requires a change
in activities. Activity-based costing concepts and
methods are also applicable to marketing and administrative activities.
ABC is likely to result in cost reductions. Focus is on activity analysis. Cost reduction usually requires a change
in activities. Activity-based costing concepts and
methods are also applicable to marketing and administrative activities.
Activity-Based CostingActivity-Based CostingFinal ObservationsFinal Observations
20-56
ABC is likely to result in cost reductions. Focus is on activity analysis. Cost reduction usually requires a change
in activities. Activity-based costing concepts and
methods are also applicable to marketing and administrative activities.
Accountants implementing activity-based costing may experience opposition to change.
ABC is likely to result in cost reductions. Focus is on activity analysis. Cost reduction usually requires a change
in activities. Activity-based costing concepts and
methods are also applicable to marketing and administrative activities.
Accountants implementing activity-based costing may experience opposition to change.
Activity-Based CostingActivity-Based CostingFinal ObservationsFinal Observations
20-57
THE ENDTHE ENDWe finished just in time!
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