Costing and the Value Chain

Chapter 19

PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA
McGraw-Hill/Irwin Copyright 2012 The McGraw-Hill Companies, Inc.

The Value Chain

The value chain is the set of activities and resources necessary to create and deliver products and services valued by customers.

R&D and Design

Suppliers and Production

Distribution and Marketing

Customer Service

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International Financial Reporting Standards and the Value Chain

Differences between U.S. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) may be value chain related. Examples: IFRS requires some R&D activities to be capitalized while GAAP requires them to be expensed.

Companies, operating in both the U.S. and in countries where IFRS is the accepted standard, may need to file financial reports that meet both IFRS and GAAP standards.
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Value- and Non-Value-Added Activities

Value-added activities add to products or services desirability in customers eyes.

Identify

Non-valueadded activities

Eliminate

Non-value-added activities add cost without additional desirability, and can be eliminated without reducing quality or performance.
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Value- and Non-Value-Added Activities

Activities

Analysis and Classification Non-valueAdded Activities

Reduce or Eliminate

ValueAdded Activities
Continually Evaluate and Improve
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Value-Added Activities
Value-added activities enhance the value of products and services in the eyes of the customer while meeting goals of the business.

I love them!

Designing to customer specification

Processing for just-in-time delivery to customers Competent customer service
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Non-Value-Added Activities
Non-value-added activities use resources without providing value to customers.

Material and other inventory storage Moving parts and materials in the factory

Get rid of them!

Waiting for work

Inspection Creating scrap and rework

Product design without customer input

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Activity-Based Management
Whats the difference between activity-based costing and activity-based management?

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Activity-Based Management
We use Activity-based costing to: 1. Identify activities. 2. Create associated activity cost pools. 3. Identify an activity measure. 4. Create the cost per unit of activity. Activity-based management focuses on managing the activities to reduce costs.

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Activity-Based Management Across the Value Chain

Chart activities needed
to meet customer expectations.

Use ABC to determine

cost of activities.

Classify all activities

as value-added or non-value-added.

Improve value-added
activities and eliminate non-value-added activities.
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ABC: a Subset of Activity-Based Management

Activity-Based Management
Identify activities Create cost pools Identify activity measures ABC
A

Determine cost per unit of activity

Collect external benchmark information

Analyze activities for non-value added activities

Manage activities
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The Target Costing Process

Driven by the customer.

Focused on design.

Target costing is aimed at the earliest stages of new product and service development. Focused simultaneously on profit and cost planning. Consideration given to the entire value chain.
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Components of the Target Costing Process

Establishing the Target Price
Concept development Target price Planning and market analysis Profit margin Target cost

Attaining the Target Cost

Production design and value engineering

Production and continuous improvement

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Components of the Target Costing Process

Price
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Components of the Target Costing Process

Developing target prices and target costs requires four steps:
Develop products
that satisfy customer needs.

Target price
Profit margin = Target cost

Set target price using

competitors prices and customers perceived value for product.

Use value engineering

to find least costly combination of resources to meet customer needs.
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Life-Cycle Product Target Costing and Pricing

Product
discontinued and customer support ends

Research,
design, and development

Lifecycle costing
Production

Marketing

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Life-Cycle Product Target Costing and Pricing

Product
discontinued and customer support ends
Pricing must generate revenue to cover costs of all phases of product life cycle.

Research,
design, and development

Marketing

Production

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Characteristics of the Target Costing Process

Involve entire value
chain in reducing costs while satisfying customer needs.

An understanding of
relationships between process components and costs is critical.

products functional characteristics to the A

customer are emphasized.
A primary
objective is reducing development time.

ABC is used to
determine changes that will reduce costs.
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Just-In-Time Inventory Procedures

Receive customer orders
Schedule production Complete products just in time to ship to customers

Receive materials just in time for production

Complete parts just in time for assembly into products

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Just-In-Time Inventory Procedures

Less warehouse space needed Reduced inventory carrying costs

Reduced risk of obsolete inventory

With reduced inventories, quality must be emphasized to avoid production delays and late deliveries.
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Just-In-Time Inventory Procedures

Less warehouse space needed Reduced inventory carrying costs More rapid response to customer orders

Reduced risk of obsolete inventory

Higher quality products

Greater customer satisfaction

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JIT Characteristics Across the Value Chain

Demand-Pull Production Driven by customer orders and customer quality expectations

On-time delivery to customers

Factory Goals Continuously Reduce: Inventory Wait time Downtime Customer delivery time Defects Continuously Increase Quality Employee cross training Teamwork Process design efficiencies Equipment reliability

Supplier Relations On time delivery High quality inputs Strong partnership Few suppliers Long-term contracts Minimize paperwork

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JIT, Supplier Relationships, and Product Quality

Successful implementation of a JIT system requires: A limited number of suppliers who will make on-time deliveries of quality materials.

Quality that is designed-in and

manufactured-in rather than inspected-out.

A well-trained flexible work force. An efficient plant layout.

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Measures of Efficiency in a JIT System

Production Started Goods Shipped

Process Time + Inspection Time + Storage and Waiting Time + Move Time Cycle Time

Only the process time is value-added time.

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Measures of Efficiency in a JIT System

Production Started Goods Shipped

Process Time + Inspection Time + Storage and Waiting Time + Move Time Cycle Time Manufacturing Efficiency = Ratio

Value-added time Cycle time

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Measures of Efficiency in a JIT System

If cycle time goes up, costs may go up, and delivery time may go down.

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Total Quality Management and the Value Chain

Quality products and services Increased business volume

Greater customer satisfaction

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Components of the Cost of Quality

Prevention costs
Inspection of materials upon delivery Inspection of production process Equipment inspection

Employee training

Appraisal costs
Finished goods inspection Field testing of products
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Components of the Cost of Quality

Internal failure costs defects
discovered before delivery to customers
Scrap materials Rework Reinspection of rework
Cost Report

Lost sales resulting from late deliveries

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Components of the Cost of Quality

External failure costs defects
discovered after delivery to customers
Warranty repairs Product liability Marketing costs to improve product image Lost sales due to poor product quality
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Components of the Cost of Quality

Cost of prevention and appraisal

Internal and external failure costs

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Components of the Cost of Quality

Ultimate Objective:

Cost of prevention and appraisal

Zero defects while minimizing all four quality cost categories

Internal and external failure costs

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Components of the Cost of Quality

External and Internal Failure
Total Cost of Quality

Cost of Quality

Prevention and Appraisal

Direction of recent trend in industry High Quality

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Low Quality

BOARDS AND MORE, INC Quality Cost Report For The Quarter Ended September 30, 2011 Amount Prevention Costs: Training Maintenance Quality planning Appraisal Costs: Material inspections Equipment inspections Supplier relations Testing Internal Failure Costs: Rework Downtime Scrap External Failure Costs Warranty Lost sales Repairs Total $ 12,000 10,000 8,000 6,000 2,000 4,000 5,000 5,000 7,000 8,000 4,500 20,000 6,500 $ Total % of Sales

30,000

3.2%

17,000

1.8%

20,000

2.1%

31,000 98,000

3.3% 10.4%
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Productivity and Quality

Traditional managerial accounting systems may emphasize production quotas and cost minimization.
Managers often find that emphasis on quality also increases productivity.

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Ethics, Fraud, and Corporate Governance

To increase the accuracy and reliability of financial statements, the Sarbanes-Oxley Act requires public companies, and separately their auditors, to issue a report on the effectiveness of their internal control structures.

Because a companys value chain typically engages in transactions recorded in accounting records, the internal control structure must take into account the reliability of the entire value chain.
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End of Chapter 19

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