1. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Chapter 18 1

2. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 2 Develop activity-based costs (ABC) Use activity-based management (ABM) to achieve target costs Describe a just-in-time (JIT) production system, and record its transactions Use the four types of quality costs to make decisions

3. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Develop activity-based costs (ABC) 1 1 3

4. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. More accurate method to attach costs to products Refines the way indirect costs are allocated to production Focuses on costs incurred by each production activity Activity costs become the building blocks for allocating costs to products and services Each activity has its own cost driver 4

5. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Activity-based costing Divides production process into activities Assigns costs to products based on how much the product USES those activities Cost drivers Activity that drives the cost to being accumulated Examples Quality inspections–number of inspections Warranty Services–number of service calls Shipping–number of pounds 5

6. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Traditional system Uses a plant-wide manufacturing overhead allocation rate 6

7. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. ABC system Uses a separate allocation rate for each activity 7

8. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 8

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10. Under traditional system: The gross profit for specialty DVD is $20 per DVD—five times as high as the $4 gross profit for the Excel DVD Management may decide to produce more specialty DVDs Under ABC: Costs are more accurate 10

11. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Day, Corp. is considering the use of activity-based costing. The following information is provided for the production of two product lines: Day plans to produce 400 units of Product A and 375 units of Product B. 1. Compute the ABC indirect manufacturing cost per unit for each product. 11

12. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 1.The indirect manufacturing cost for Product A is: 2.The indirect manufacturing cost for Product B is: 12 $81.50 $342.40 AB Set-up530.00 x 20 =$10,600530.00 x 180 =$95,400 Machine Maintenance 13.75 x 1,600 =22,00013.75 x 2,40033,000 32,600128,400 Divide by # units÷ 400÷ 325 Cost per unit$81.50342.40 Setup = $106,000 / 200 = $530.00 per set-up Maintenance = $55,000 / 4000 = $13.75 per machine hour

13. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Use activity-based management (ABM) to achieve target costs 2 2 13

14. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Uses ABC to make decisions Increase profits while meeting customer needs Types of decisions: Pricing and product mix Provides a more accurate cost of products Determines the profitability of products Cutting cost 14

15. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 15 Loss versus Profit

16. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Reevaluating activities to reduce costs Requires cross-functional teams Marketers—identify customer needs Engineers—design more efficient products Accountants—estimate costs Setting sales prices based on target prices Targeting what customers are willing to pay 16

17. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Cost-based: Full cost + Desired profit Sales Price Target based: Target price - Desired profit Target Cost 17

18. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Consider all production costs: Direct materials Direct labor Allocated manufacturing overhead Plus all nonmanufacturing costs (operating expenses): Administrative Selling expenses To determine target costs and target profits. 18

19. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Target Cost Full Cost Assemble team to: Cut costs, given current production process Redesign the production process to further cut costs 19

20. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Company decides to redesign setup to reduce the setup cost per batch Estimated total cost saving is $160,000 Number of batches stay the same 20

21. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Revised Cost 21

22. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Accel, Corp., makes two products: C and D. The following data have been summarized: Indirect manufacturing cost information includes the following: The company plans to manufacture 150 units of each product. 1. Calculate the product cost per unit for Products C and D using activity-based costing. 22 Product CProduct D Direct materials cost per unit$ 700$ 2,000 Direct labor cost per unit300100 Indirect manufacturing cost per unit?? ActivityAllocation RateProduct CProduct D Setup$1,500/per setup38 setups75 setups Machine maintenance$ 12/per hour1,400 hours4,000 hours

23. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 23 CD Set-up1,500.00 X 38 =$57,0001,500.00 X 75 =$112,500 Machine Maintenance 12.00 X 1,400 =16,80012.00 X 4,000 =48,000 73,800160,500 Divide by # units÷ 150 Cost per unit$4921,070.00 Product CProduct D Direct materials cost per unit$ 700$ 2,000 Direct labor cost per unit300100 Indirect manufacturing cost per unit4921,070 Product cost per unit$ 1,492$ 3,170

24. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. In Short Exercise 18-5, Accel Corp. desires a 25% target profit after covering all costs. 1. Considering the total costs assigned to the Products C and D in S18-5, what would Accel have to charge the customer to achieve that profit? 24 Product CProduct D Direct materials cost per unit$ 700$ 2,000 Direct labor cost per unit300100 Indirect manufacturing cost per unit4921,070 Product cost per unit$ 1,492$ 3,170 Total costs divided by (100% - target profit) = $1,492 ÷ 0.75 = $ 1,989.33 Total costs divided by (100% - target profit) = $3,170 ÷ 0.75 = $ 4,226.67

25. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Describe a just-in-time (JIT) production system, and record its transactions 3 3 25

26. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Materials purchased and goods completed “just in time” for delivery Deliveries are small and frequent Suppliers must guarantee a defect rate close to zero Finished goods inventories are kept to a minimal amount Reduces company’s cost to store and insure inventory Minimizes investment the company has in its inventories Lowers risk of the inventory becoming obsolete or unsalable 26

27. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Production completed in work cells Area where resources are readily available Employees work in a team without supervision Goods completed in small batches that are inspected for quality As completed products move out, suppliers deliver more materials Traditional systems Production moves to various departments Work must be moved, between departments wasting time and money 27

28. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 28

29. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Lost sales if materials do not arrive on time or if the materials are of poor-quality Strong relations with vendors of quality materials essential Some JIT companies have small inventories of critical materials 29

30. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Also called “backflush costing” Starts with completed products and then assigns manufacturing costs to units sold and inventory 30 TraditionalJust-in-Time Recording production activity Build costs as products move through three inventory accounts Record costs when units are completed Inventory accounts Materials inventory Work in process Finished goods Raw and in-process inventory Finished goods Manufacturing costs Direct materials Direct labor Manufacturing overhead Direct materials Conversion costs

31. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. JIT does not use a separate Work in process inventory account Only two inventory accounts: Raw and in-process inventory Finished goods inventory 31

32. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 32 Consider the following characteristics of either a JIT production system or a traditional production system. a.Products are produced in large batches. b.Large stocks of finished goods protect against lost sales if customer demand is higher than expected. c.Suppliers make frequent deliveries of small quantities of raw materials. d.Employees do a variety of jobs, including maintenance and setups as well as operating machines. 1. Indicate whether each is characteristic of a JIT production system or a traditional production system. Traditional JIT

33. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 33 Consider the following characteristics of either a JIT production system or a traditional production system. e.Machines are grouped into self-contained production cells or production lines. f.Machines are grouped according to function. For example, all cutting machines are located in one area. g.The final operation in the production sequence “pulls” parts from the preceding operation. h.Each employee is responsible for inspecting his or her own work. i.Management works with suppliers to ensure defect-free raw materials. JIT Traditional JIT

34. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Use the four types of quality costs to make decisions 4 4 34

35. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. JIT more vulnerable to production shutdowns Critical element–defect free direct materials Solution Monitor activities to improve quality and eliminate defects and waste Total Quality Management (TQM) Goal of continuous improvement Well-designed products reduce inspections, rework, and warranty claims Design and build quality into the product Research & development investments can generate savings in marketing and customer service 35

36. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 1.Prevention costs—spent to avoid poor-quality goods or services 2.Appraisal costs—spent to detect poor-quality goods or services 3.Internal failure costs—incurred when the company detects and corrects poor-quality goods or services before delivery to customers 4.External failure costs—spent after the company delivers poor-quality goods or services 36

37. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Prevention costs occur in the R&D stage of the value chain Appraisal and internal failure costs occur in production External failure occurs in customer service or results from lost sales due to an unhappy customer Prevention much cheaper than external failure Deciding whether to adopt a new quality program involves comparing costs versus benefits 37

38. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. How to decide: Classify each cost into one of the four categories Total the estimated cost per category Total estimated cost reductions Decide whether to undertake or not Costs versus benefits Quality costs can be hard to measure: Measure in nonfinancial terms Number of customer complaints Volume of incoming customer-service phone calls 38

39. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 39

40. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Sammy, Inc. manufactures motor scooters. Consider each of the following examples of quality costs. 1. Preventive maintenance on machinery. 2. Direct materials, direct labor, and manufacturing overhead costs incurred to rework a defective scooter that is detected in-house through inspection. 3. Lost profits from lost sales if company’s reputation was hurt because customers previously purchased a poor-quality scooter. 4. Costs of inspecting raw materials, such as chassis and wheels. 1. Indicate which of the following quality cost categories each example represents. ● P Prevention costs ● A Appraisal costs ● IF Internal failure costs ● EF External failure costs 40 P IF EF A

41. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Sammy, Inc., manufactures motor scooters. Consider each of the following examples of quality costs. 5. Working with suppliers to achieve on-time delivery of defect-free raw materials. 6. Cost of warranty repairs on a scooter that malfunctions at customer’s location. 7. Costs of testing durability of vinyl. 8. Cost to re-inspect reworked scooters. 1. Indicate which of the following quality cost categories each example represents. ● P Prevention costs ● A Appraisal costs ● IF Internal failure costs ● EF External failure costs 41 P EF A IF

42. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Activity-based costing (ABC) focuses on activities. The costs of those activities become the building blocks for measuring (allocating) the costs of products and services. The total production process and the related costs are divided among the various production activities. A cost driver for the activity is identified, and a rate per activity is calculated. The costs are then allocated to individual products based on the amount of products’ USE of each activity. 42

43. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Activity-based management (ABM) uses activity-based costs to make decisions that increase profits while meeting customer needs. Most companies adopt ABC to get better product costs for pricing and product-mix decisions. However, they often benefit more by cutting costs. Target pricing takes the sales price and subtracts desired profit to determine the target cost of manufacturing. 43

44. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. ABC and value engineering work together to re-evaluate activities with the goal of reducing manufacturing overhead costs to meet the target cost. By reducing costs, companies can maintain desired profit levels. Just-in-time (JIT) systems streamline manufacturing and accounting by developing relationships with suppliers, resulting in no need for the company to maintain large supplies of raw materials on hand. Defect-free raw materials arrive JIT to the work cell for production. 44

45. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Because of the more efficient production process, the accounting is streamlined to match it. Only two inventory accounts need to be kept—Raw and in- process inventory and Finished goods inventory. Labor and overhead are tracked in a temporary account—Conversion costs—where they are allocated to products as they are completed. The four types of quality related costs are prevention, appraisal, internal failure, and external failure costs. Quality improvement programs that reduce internal and external failure costs by more than the increased cost to prevent or appraise the product are smart total quality management decisions. 45

46. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 46

47. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 47 Copyright All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.