1. 13 - 1 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Strategy, Balanced Scorecard, and Strategic Profitability Analysis Chapter 13

2. 13 - 2 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Learning Objective 1 Recognize which of two generic strategies a company is using.

3. 13 - 3 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster What is Strategy? Strategy describes how an organization matches its own capabilities with the opportunities in the marketplace to accomplish its overall objectives.

4. 13 - 4 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster What is Strategy? What is the focus of industry analysis? Competitors Potential entrants into the market Equivalent products Bargaining power of customers Bargaining power of input suppliers

5. 13 - 5 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Basic Strategies 1. Product differentiation 2. Cost leadership

6. 13 - 6 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Implementation of Strategy Management accountants design reports to help managers track progress in implementing strategy.

7. 13 - 7 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster The Balanced Scorecard The scorecard measures an organization’s performance from four perspectives: 1. Financial 2. Customer 3. Internal business processes 4. Learning and growth

8. 13 - 8 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Learning Objective 2 Identify what comprises reengineering.

9. 13 - 9 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Reengineering Reengineering is the fundamental rethinking of business processes delivery to achieve improvements in critical measures of performance such as cost, quality, service, speed, and customer satisfaction.

10. 13 - 10 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Reengineering Example Customers needs identified Purchase order issued Production scheduled Manufacturing completed Finished goods to inventory Quantities to be shipped matched against purchase order Shipping documents sent to Billing Department Invoice issued Customer payment follow up Dallas Co. order delivery system:

11. 13 - 11 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Reengineering Example The following was determined: Frequently, there is a long waiting time before production begins in the manufacturing department. Sometimes items are held in inventory until a truck is available for shipment.

12. 13 - 12 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Reengineering Example If the quantity shipped does not match the number of items requested by the customer, a special shipment must be scheduled. Dallas discovered that the many transfers across departments slowed down the process and created delays. A multifunctional team reengineered the order delivery process.

13. 13 - 13 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Reengineering Example A customer relationship manager is responsible for each customer. Dallas will enter into long-term contracts with customers specifying quantities and prices. The customer relationship manager will work with the customer and manufacturing to specify delivery schedules one month in advance.

14. 13 - 14 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Reengineering Example The schedule of customer orders will be sent electronically to manufacturing. Completed items will be shipped directly from the manufacturing plant to customer sites. Each shipment will automatically trigger an invoice to be sent electronically to the customer.

15. 13 - 15 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Learning Objective 3 Present the four perspectives of the balanced scorecard.

16. 13 - 16 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Perspectives of Performance 1. Financial 2. Customer 3. Internal business process 4. Learning and growth

17. 13 - 17 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Financial Perspective Objective: Increase shareholder value Measures: Increase in operating income

18. 13 - 18 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Financial Perspective Initiatives: Target Performance Actual Performance Manage costs and unused capacity Build strong customer relationships $2,000,000 $3,000,000 6% Build strong customer relationships $2,100,000 $3,420,000 6.48%

19. 13 - 19 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Customer Perspective Objectives: Increase market share Measures: Market share in communication networks segment Customer satisfaction survey Increase customer satisfaction

20. 13 - 20 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Customer Perspective Initiatives: Target Performance Actual Performance Identify future needs of customer Identify new target customer segments 6% 7 90% give top two ratings Increase customer focus of sales organization 7% 8 87% give top two ratings

21. 13 - 21 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Internal Business Process Perspective Objectives: Improve manufacturing quality and productivity Measures: Yield On-time delivery Meet specified delivery dates

22. 13 - 22 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Internal Business Process Perspective Initiatives: Target Performance Actual Performance Identify problems and improve quality Reengineer order delivery process 78% 92% 79.3% 90%

23. 13 - 23 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Learning and Growth Perspective Objectives: Align employee and organization goals Measures: Employee satisfaction survey Improvements in process controls Improve manufacturing processes

24. 13 - 24 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Learning and Growth Perspective Initiatives: Target Performance Actual Performance Employee participation and suggestion program to build teamwork Organize R&D/ manufacturing teams to modify processes 80% of employees give top two ratings 5 88% of employees give top two ratings 5

25. 13 - 25 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Aligning the Balanced Scorecard to Strategy Different strategies call for different scorecards. What are some of the financial perspective measures? Operating income Revenue growth Cost reduction is some areas Return on investment

26. 13 - 26 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Aligning the Balanced Scorecard to Strategy What are some of the customer perspective measures? Market share Customer satisfaction Customer retention percentage Time taken to fulfill customers requests

27. 13 - 27 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Aligning the Balanced Scorecard to Strategy What are some of the internal business perspective measures? Innovation Process: Manufacturing capabilities Number of new products or services New product development time Number of new patents

28. 13 - 28 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Aligning the Balanced Scorecard to Strategy Operations Process: Yield Defect rates Time taken to deliver product to customers Percentage of on-time delivery Setup time Manufacturing downtime

29. 13 - 29 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Aligning the Balanced Scorecard to Strategy Post-sales service: Time taken to replace or repair defective products Hours of customer training for using the product

30. 13 - 30 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Aligning the Balanced Scorecard to Strategy What are some of the learning and growth perspective measures? Employee education and skill level Employee satisfaction scores Employee turnover rates Information system availability Percentage of processes with advanced controls

31. 13 - 31 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Pitfalls When Implementing a Balanced Scorecard What pitfalls should be avoided when implementing a balanced scorecard? 1. Don’t assume the cause-and-effect linkages to be precise. 2. Don’t seek improvements across all measures all the time. 3. Don’t use only objective measures on the scorecard.

32. 13 - 32 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Pitfalls When Implementing a Balanced Scorecard 4. Don’t fail to consider both costs and benefits of initiatives such as spending on information technology and research and development. 5. Don’t ignore nonfinancial measures when evaluating managers and employees. 6. Don’t use too many measures.

33. 13 - 33 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Learning Objective 4 Analyze changes in operating income to evaluate strategy.

34. 13 - 34 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Evaluating the Success of a Strategy Assume the following operating incomes: Year 2003 Year 2004 Revenues: (1,000,000 × $26)$26,000,000 (1,100,000 × $24)$26,400,000 Expenses: Materials 4,050,000 3,631,320 Other 16,000,000 16,000,000 Operating income$ 5,950,000$ 6,768,680

35. 13 - 35 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Evaluating the Success of a Strategy How can the increase in operating income of $818,680 be evaluated? Growth Price recovery Productivity

36. 13 - 36 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Growth Component Assume that for 2003, Dallas produced and sold 1,000,000 units at $26 per unit. During the year 2004, Dallas produced and sold 1,100,000 units at $24 per unit. What is the revenue effect of growth?

37. 13 - 37 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Growth Component Revenue effect of growth component (Actual units of output sold in 2004 Actual units of output sold in 2003) Output price in 2003 (1,100,000 – 1,000,000) × $26 = $2,600,000 F This component is favorable because it increases operating income. = – ×

38. 13 - 38 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Growth Component Cost effect of growth component Actual units of input or capacity that would have been used in 2003 to produce year 2004 output assuming the same input-output relationship that existed in 2003 Actual units or capacity to produce 2003 output Input prices in 2003 = – ×

39. 13 - 39 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Growth Component To produce 1,100,000 units in 2004 compared with the 1,000,000 units produced in 2003 (a 10% increase), Dallas would require a proportional increase in direct materials. Assume that 3,000,000 square centimeters of materials were used to produce the 1,000,000 units in 2003 at a cost of $1.35 per square centimeter.

40. 13 - 40 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Growth Component Assume that manufacturing conversion costs, selling and customer service costs and research and development costs were $16,000,000 and remained stable during 2004. What is the cost effect of the growth component? 3,000,000 × 110% = 3,300,000 centimeters (3,300,000 – 3,000,000) × $1.35 = $405,000 U

41. 13 - 41 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Operating Income and Growth What is the net increase in operating income as a result of growth? Revenue effect of growth component$2,600,000 F Cost effect of growth component 405,000 U Increase in operating income due to growth component $2,195,000 F

42. 13 - 42 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Price-Recovery Component Revenue effect of price-recovery component = (Output price in 2004 – Output price in 2003) × Actual units of output sold in 2004 What is the revenue effect of the price-recovery component? ($24 – $26) × 1,100,000 = $2,200,000 U

43. 13 - 43 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Price-Recovery Component Cost effect of price-recovery component (Input prices in 2004 – Input prices in 2003) Actual units of inputs or capacity that would have been used to produce year 2004 output assuming the same input-output relationship that existed in 2003 Assume that in the year 2004, direct materials costs were $1.31 per square centimeter. = ×

44. 13 - 44 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Price-Recovery Component What is the cost effect of the price-recovery component? ($1.31 – $1.35) × 3,300,000 = $132,000 F What is the total effect on operating income of the price-recovery component?

45. 13 - 45 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Operating Income and Price-Recovery Component Revenue effect of price-recovery component$2,200,000 U Cost effect of price-recovery component 132,000 F Decrease in operating income due to price-recovery component$2,068,000 U

46. 13 - 46 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Productivity Component Productivity component Actual units of inputs or capacity to produce year 2004 output Input prices in 2004 = × Actual units of inputs or capacity that would have been used to produce year 2004 output assuming the same input-output relationship that existed in 2003 –

47. 13 - 47 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Productivity Component Assume that 2,772,000 actual square centimeters of direct materials were used in the year 2004. Actual price was $1.31/square centimeter.

48. 13 - 48 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Productivity Component What is the productivity component of cost changes? (2,772,000 – 3,300,000) × $1.31 = $691,680 F There is a $691,680 increase in operating income due to the productivity component.

49. 13 - 49 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Change in Operating Income Increase in operating income $818,680 Growth component $2,195,000 F Price-recovery component $2,068,000 U Productivity component $691,680 F

50. 13 - 50 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Learning Objective 5 Distinguish between engineered and discretionary costs.

51. 13 - 51 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Engineered Costs Engineered costs result specifically from a clear cause-and-effect relationship between output and the resources needed to produce that output. They can be variable or fixed in the short run.

52. 13 - 52 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Discretionary Costs Discretionary costs have two important features. They arise from periodic (usually yearly) decisions regarding the maximum amount to be incurred. They have no measurable cause-and-effect relationship between output and resources used.

53. 13 - 53 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Relationships Between Inputs and Outputs Engineered costs differ from discretionary costs along two key dimensions: Type of process Level of uncertainty

54. 13 - 54 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Relationships Between Inputs and Outputs Engineered costs pertain to processes that are detailed, physically observable, and repetitive. Discretionary costs are associated with processes that are sometimes called black boxes, because they are less precise and not well understood.

55. 13 - 55 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Learning Objective 6 Identify unused capacity and how to manage it.

56. 13 - 56 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Managing Unused Capacity What actions can management take when it identifies unused capacity? Attempt to eliminate the unused capacity Attempt to use the unused capacity to grow revenue

57. 13 - 57 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster End of Chapter 13