© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Costing and the Value Chain Chapter 18

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin R & D and Design Suppliers and Production Distribution and Marketing Customer Service The value chain is the set of activities and resources necessary to create and deliver products and services valued by customers. The Value Chain—Focus on Core Operations

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Non-value-added activities add cost without additional desirability, and can be eliminated without reducing quality or performance. Value-added activities add to product or service desirability in customers’ eyes. IdentifyEliminate Non-value- added activities Value and Non-value-Added Activities

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Analysis and Classification Activities Value and Non-value-Added Activities Non-value- Added Activities Reduce or Eliminate Value- Added Activities Continually Evaluate and Improve

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Examples of non-value- added activities are: Storage of materials, work-in-process, or finished goods. Moving parts and materials in the factory. Waiting for work. Inspection. Get rid of them! Non-value-Added Activities

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin What’s the difference between activity-based costing and activity-based management? Activity-Based Management — Drive Out Costs

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Activity-based management focuses on managing activities to reduce costs. Activity-based costing establishes relationships between overhead costs and activities. Activity-Based Management — Drive Out Costs

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Analyze activities Collect benchmark information Determine cost per unit of activity Identify activity measures Create cost pools Identify activities Activity-based costing Activity-based management ABC: a Subset of Activity-Based Management

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin  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. Activity-Based Management and the Value Chain

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Let’s move along to a new topic. The Target Costing Process — Creating Customer Satisfaction

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Focused on design. Consideration given to the entire value chain. Focused simultaneously on profit and cost planning. Driven by the customer. Target costing is aimed at the earliest stages of new product and service development. The Target Costing Process — Creating Customer Satisfaction

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Concept development Planning and market analysis Production design and value engineering Production and continuous improvement Target price Profit margin Target cost Establishing the Target Price Attaining the Target Cost The Target Costing Process

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Price Major Influences on Target Pricing

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin  Develop products that satisfy customer needs.  Set target price using competitors’ prices and customers’ perceived value for product.  Target price – Profit margin = Target cost  Use value engineering to find least costly combination of resources to meet customer needs. Developing target prices and target costs requires four steps: Components of the Target Costing Process

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Life- cycle costing  Research, design, and development  Production  Marketing  Product discontinued and customer support ends Life-Cycle Product Costing and Pricing

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Pricing must generate revenue to cover costs of all phases of product life cycle.  Research, design, and development  Production  Marketing  Product discontinued and customer support ends Life-Cycle Product Costing and Pricing

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin  Involve entire value chain in reducing costs while satisfying customer needs.  An understanding of relationships between process components and costs is critical.  A product’s functional characteristics to the customer are emphasized.  A primary objective is reducing development time.  ABC is used to determine changes that will reduce costs. Characteristics of Target Costing Processes

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Let’s move along to another topic. Just-in-time (JIT) Inventory Procedures

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Complete products just in time to ship to customers. Complete parts just in time for assembly into products. Schedule production. Receive customer orders. Receive materials just in time for production. Just-In-Time (JIT) Inventory

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin 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. Relationship Between JIT and Total Quality Management (TQM)

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin More rapid response to customer orders Greater customer satisfaction Higher quality products Less warehouse space needed Reduced inventory carrying costs Reduced risk of obsolete inventory Relationship Between JIT and Total Quality Management (TQM)

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin  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. Successful implementation of a JIT system requires: JIT, Supplier Relationships, and Product Quality

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Manufacturing Cycle Time Process Time + Inspection Time + Storage and Waiting Time + Move Time ProductionS tarted Goods Shipped Only the process time is value-added time. Measures of Efficiency in a JIT System

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Manufacturing Cycle Time Process Time + Inspection Time + Storage and Waiting Time + Move Time ProductionS tarted Goods Shipped Manufacturing Efficiency Ratio Value-added time Manufacturing cycle time = Measures of Efficiency in a JIT System

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin If cycle time goes up, costs may go up, and service and quality may go down. Measures of Efficiency in a JIT System

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Let’s move to the last topic in the chapter. Total Quality Management and the Value Chain

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Greater customer satisfaction Quality products and services Increased business volume Why is Quality Important?

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin  Prevention costs  Inspection of materials upon delivery  Inspection of production process  Equipment inspection  Employee training  Appraisal costs  Finished goods inspection  Field testing of products  Prevention costs  Inspection of materials upon delivery  Inspection of production process  Equipment inspection  Employee training  Appraisal costs  Finished goods inspection  Field testing of products Components of the Cost of Quality

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin  Internal failure costs – defects discovered before delivery to customers  Scrap materials  Rework  Reinspection of rework  Lost sales resulting from late deliveries  Internal failure costs – defects discovered before delivery to customers  Scrap materials  Rework  Reinspection of rework  Lost sales resulting from late deliveries Cost Report Components of the Cost of Quality

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin  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  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 Components of the Cost of Quality

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Cost of prevention and appraisal Internal and external failure costs Components of the Cost of Quality

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Cost of prevention and appraisal Internal and external failure costs Ultimate Objective: Zero defects while minimizing all four quality cost categories. Components of the Cost of Quality

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Prevention and Appraisal External and Internal Failure Total Cost of Quality Low QualityHigh Quality Cost of Quality Direction of recent trend in industry. Components of the Cost of Quality

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Traditional managerial accounting systems may emphasize production quotas and cost minimization. Managers often find that emphasis on quality also increases productivity. Productivity and Quality

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin I’m managing some quality time in a value-added activity. End of Chapter 18