(FIN MAN); CHAPTER 12 (MAN) COST MANAGEMENT FOR JUST-IN-TIME ENVIRONMENTS DISCUSSION QUESTIONS 1. Just-in-time processing is a philosophy that focuses on reducing time, cost, and poor quality within manufacturing processes. The result of these efforts is a reduction in inventory levels. 2. Move time and wait time in inventory are examples of non-value-added lead time. 3. A product-oriented layout can be designed to minimize materials movements and reduce (or eliminate) setup time. As a result, a product-oriented layout should have a shorter lead time than a process-oriented layout. 4. Long setup times lead to large production runs (batch sizes) in order to amortize the cost of the setup. Large batch sizes result in larger inventories, which in turn lead to long wait times. Thus, long setup times can lead directly to long lead times. 5. Pull or make to order manufacturing requires the manufacturer to build product only as it is needed for actual customer orders. As a result, finished goods, work in process, and materials inventories are minimized. Make to order manufacturing requires a high degree of flexibility and insignificant setup costs. 6. Product defects can cause additional costs and unpredictability in the process in the form of scrap, rework, record keeping, and inspection. In addition, product defects can cause a process to shut down, because there is very little work in process inventory to keep the next (downstream) operations running. Thus, a just-in-time manufacturer would wish to eliminate the negative consequences of product defects. 7. With supply chain management, long-term relationships are established with suppliers and customers to improve quality, cost, and delivery. Traditional relationships are usually focused on reducing price through supplier or customer competitive bidding. Thus, the traditional supplier and customer relationship can be very short-term oriented (until a better deal comes along). 8. A just-in-time environment will result in fewer (or no) work in process control points. As a result, there are no in-process transactions into and out of work in process inventory locations throughout the process. The just-in-time cost accounting system, termed backflush accounting, pulls cost from completed production, rather than pushes through the plant, using materials requisitions or production orders. 9. The raw and in process inventory account combines the materials and work in process inventories because the materials are often introduced directly into the process. Thus, the materials are not recorded in a separate materials account before being introduced to work in process because there is no materials inventory. 27-1
DISCUSSION QUESTIONS (Concluded) 10. Direct labor and indirect labor activities become combined in a just-in-time environment. Employees perform both direct and indirect labor tasks. In addition, direct labor can be a small part of the cost of producing product. As such, the direct labor is included as overall conversion cost (much like in a process cost system). 11. A Pareto chart shows the totals of a particular attribute for a number of categories. The categories are ranked and displayed left to right, so that the largest total is on the left and the smallest total is on the right. In this way, management can quickly identify important problems. 12. Non-value-added activities are activities that are viewed as unnecessary from the customer s perspective. These activities are generally considered wasteful and are candidates for elimination through process improvements. 13. The cost of a process can be improved by improving processing methods or eliminating unnecessary or wasteful work. 27-2
PRACTICE EXERCISES PE 27 1A (FIN MAN); PE 12 1A (MAN) a. Value-added lead time 28 min. (16 min. + 12 min.) Non-value-added lead time: Total within-batch wait time 1,092 (16 min. + 12 min.) (40 1) Move time 15 Total lead time 1,135 min. 28 min. b. Value-added ratio: = 2.5% 1,135 min. PE 27 1B (FIN MAN); PE 12 1B (MAN) a. Value-added lead time 19 min. (11 min. + 8 min.) Non-value-added lead time: Total within-batch wait time 1,881 (11 min. + 8 min.) (100 1) Move time 15 Total lead time 1,915 min. 19 min. b. Value-added ratio: = 1.0% 1,915 min. PE 27 2A (FIN MAN); PE 12 2A (MAN) b. Smaller batch sizes c. Employee involvement d. Less wasted movement of material and people PE 27 2B (FIN MAN); PE 12 2B (MAN) a. Production pace matches demand d. Receive raw materials directly to manufacturing cells 27-3
PE 27 3A (FIN MAN); PE 12 3A (MAN) a. Raw and In Process Inventory* 175,500 Accounts Payable 175,500 *$270 per unit 650 units b. Raw and In Process Inventory* 70,560 Conversion Costs 70,560 *[($819,000 1,950 hours) (16 min. 60 min.)] = $112 per unit; $112 630 units = $70,560 c. Finished Goods Inventory* 238,750 Raw and In Process Inventory 238,750 *($270 + $112) 625 units PE 27 3B (FIN MAN); PE 12 3B (MAN) a. Raw and In Process Inventory* 68,250 Accounts Payable 68,250 *$65 per unit 1,050 units b. Raw and In Process Inventory* 12,000 Conversion Costs 12,000 *[($144,000 1,800 hours) (9 min. 60 min.)] = $12 per unit; $12 1,000 units = $12,000 c. Finished Goods Inventory* 75,460 Raw and In Process Inventory 75,460 *($65 + $12) 980 units 27-4
PE 27 4A (FIN MAN); PE 12 4A (MAN) Cost of Quality Report Quality Cost Classification Quality Cost Percent of Total Quality Cost Percent of Total Sales Prevention $126,000 63% 12.6% Appraisal 30,000 15% 3.0% Internal failure 28,000 14% 2.8% External failure 16,000 8% 1.6% Total $200,000 100% 20.0% PE 27 4B (FIN MAN); PE 12 4B (MAN) Cost of Quality Report Percent of Percent of Quality Cost Classification Quality Cost Total Quality Cost Total Sales Prevention $288,000 32% 9.6% Appraisal 108,000 12% 3.6% Internal failure 54,000 6% 1.8% External failure 450,000 50% 15.0% Total $900,000 100% 30.0% PE 27 5A (FIN MAN); PE 12 5A (MAN) Inspection activity before improvement: $360,000 60,000 units = $6 per unit Inspection activity after improvement: Revised inspection cost (30% 60,000 units) $6 per unit = $108,000 Revised inspection cost per unit $108,000 60,000 units = $1.80 per unit PE 27 5B (FIN MAN); PE 12 5B (MAN) Inspection activity before improvement: $68,000 16,000 units = $4.25 per unit Inspection activity after improvement: Revised inspection cost 3,200 inspections $4.25 per unit = $13,600 Revised inspection cost per unit $13,600 16,000 units = $0.85 per unit 27-5
EXERCISES Ex. 27 1 (FIN MAN); Ex. 12 1 (MAN) The CEO must not have been listening very closely at the conference. Just-in-time is not primarily an inventory reduction method. Just-in-time is a process improvement philosophy that focuses on reducing time, cost, poor quality, and uncertainty from a process. Large inventories are merely a symptom of poorly designed processes. Thus, the CEO s statement is naive. The company must first remove the reasons for inventory. These causes are poor quality, large setup times, unreliable equipment, poor employee relationships, poor layout design (process focus), and poor supplier relationships. When these are improved, then the inventory level can be reduced, lead times can be shortened, and the company can begin pull manufacturing. If the employees follow the CEO s orders without making the process improvements, the plant will likely suffer reduced productivity. In addition, the CEO has not provided the training or action plan for moving to just-in-time. The CEO has only commanded that it be done. This will create anxiety in the workforce, and it is not consistent with employee involvement. Ex. 27 2 (FIN MAN); Ex. 12 2 (MAN) This is an actual situation facing the U.S. apparel industry. Warren Featherbone and other U.S.-based apparel manufacturers are discovering the strategic power of just-in-time. Rather than competing with the offshore manufacturers on price, these companies are providing smaller quantities with much faster delivery. The retailer is able to order and receive goods in smaller, more frequent batch sizes. As a result, the retailer is able to move with fashion trends much more quickly. For example, if a particular style is proving popular, the domestic manufacturer can immediately produce and deliver more of this item. The offshore operation manufactures in batch sizes that are too large and too far away to respond quickly. In addition, the retailer does not have to commit significant inventory to unknown fashion trends when purchasing from the local company. As a result, the retailer is able to avoid markdowns on slow-moving goods. Markdowns represent the second largest cost to retailing operations (next to cost of merchandise sold). The retailer must make large order commitments to the offshore manufacturer. If the product eventually proves to be disappointing in the market, the retailer has no choice but to incur severe markdowns to move the excess inventory. Because of significant benefits, the retailer will be willing to pay a higher cost for manufactured items from the domestic company. The German and Italian apparel industries are positioning themselves in this way. 27-6
Ex. 27 3 (FIN MAN); Ex. 12 3 (MAN) Piecework compensation is a characteristic of a traditional manufacturing philosophy that is inconsistent with just-in-time. Under just-in-time, workers are viewed not just as laborers but as valuable assets of the company. The company wants workers to also bring their minds to the job. Thus, workers should be compensated for contributing to process improvements, for training themselves to work other jobs in the cell, and for managing themselves. This might involve an hourly rate system plus bonus incentives. Piecework payments would not pay workers for these contributions because the pay arrangement is a very simple produce for pay arrangement. Moreover, piecework encourages workers to make product, regardless of whether there is demand for the product. Workers do not get paid for idle time, so they will continue to work and build inventory. However, under pull manufacturing, the cell will work only if there is demand. If there is no demand, the cell employees should work in other cells or work on improving themselves or the process. Piecework compensation is very inconsistent with this philosophy. Employees should not be penalized just because the cell is operating at a slower pace (or is shut down) due to decreases in demand. The employee has no control over the demand placed on the cell. Management does not need to be concerned about proper motivation to work. Under pull manufacturing, the garment will be pulled through the cell. A slow employee will slow the whole output of the cell. The other employees will either help the slow employee or encourage the employee to catch up with the pace of the cell. Ex. 27 4 (FIN MAN); Ex. 12 4 (MAN) Management is incorrect in stating that the direct labor time is equal to the lead time. The lead time also includes the wait time and other non-value-added time required to make the product. The different batch sizes create within-batch wait time for each unit. Thus, the lion, which is made in batch sizes of 40 units, has assembly lead time of 480 minutes (40 units 12 minutes per unit). Of this amount, only 12 minutes are value-added. The remaining 468 minutes (39 units 12 min.) are non-value-added within-lot wait time. The bear has assembly lead time of 60 minutes (5 units 12 minutes per unit). Of this amount, 12 minutes are value-added. The remaining 48 minutes (4 units 12 min.) are non-value-added within-lot wait time. 27-7
Ex. 27 5 (FIN MAN); Ex. 12 5 (MAN) a. Long setup times have two negative consequences. First, a long setup time consumes valuable machine capacity that could be used for productive purposes. Second, a long setup time results in large production batch sizes to recover the economic cost of the setup. As a result, a long setup will result in a large production batch, which increases work in process inventory, which increases lead time. Large work in process inventory commits working capital that could be used for other purposes. Long lead times reduce the company s ability to respond to changes in customer demand. b. One obvious improvement would be to limit the trips to the tool room to one round trip, rather than two. However, even this could be improved upon by changing the location of the fixtures. Changing the location of the fixtures could significantly reduce the lathe setup time. Instead of using a tool room to control the fixtures, the appropriate fixtures for the lathe could be located at the lathe operation. In this case, the operator would not need to walk to a tool room and retrieve and replace fixtures (along with paperwork). Rather, the operator would have the tools required for a setup right at the lathe location. In this situation, the company would trade off somewhat less control over fixtures for faster setup time. Many companies are eliminating tool rooms for just this reason. These companies are finding that tool room control is not necessary if tools are stored at a designated location near the point of use (i.e., they won t be lost or stolen if they have a visible storage point). An intermediate solution is to retain the tool room and have the operator make only one trip to the tool room to return the old fixture and retrieve the new one. c. Turn off machine and remove fixture from lathe 10 minutes Clean lathe 15 Install new fixture and turn on machine 10 Total setup time 35 minutes* * Plus time for replacing and retrieving a tool at a point of use. 27-8
Ex. 27 6 (FIN MAN); Ex. 12 6 (MAN) Traditional Philosophy Value-Added Non-Value- Total Time Added Time Time Processing time 1 14 14 Within-batch wait time 2 616 616 Move time 5 5 Total 14 621 635 Value-added ratio: 14 minutes 635 minutes = 2.2%, rounded 1 Total process time per unit: Milling 6 minutes Finishing 8 Total 14 minutes 2 Within-batch wait time: Multiply the process time by the remaining units in the batch (waiting their turn) 14 minutes (45 1 units) = 616 minutes Just-in-Time Philosophy Value-Added Non-Value- Total Time Added Time Time Processing time 1 14 14 Within-batch wait time 2 42 42 Move time 0 0 Total 14 42 56 14 minutes Value-added ratio: = 25.0% 56 minutes 1 Total process time per unit: Milling 6 minutes Finishing 8 Total 14 minutes 2 Within-batch wait time: Multiply the process time by the remaining units in the batch (waiting their turn) 14 minutes (4 1 units) = 42 minutes 27-9
Ex. 27 7 (FIN MAN); Ex. 12 7 (MAN) Present Approach Value-Added Non-Value- Total Time Added Time Time Processing time 1 30 30 Within-batch wait time 2 1,170 1,170 Move time 3 40 40 Total 30 1,210 1,240 Value-added ratio: 30 minutes 1,240 minutes = 2.4%, rounded 1 Total process time per unit: Process Step 1 6 minutes Process Step 2 10 Process Step 3 6 Process Step 4 8 Total 30 minutes 2 Within-batch wait time: Multiply the process time by the remaining units in the batch (waiting their turn): 30 minutes (40 1 units) = 1,170 minutes 3 Move time: 5 moves (from raw materials to finished goods) 8 minutes = 40 minutes Proposed Approach Value-Added Non-Value- Total Time Added Time Time Processing time 1 30 30 Within-batch wait time 2 120 120 Move time 3 10 10 Total 30 130 160 Value-added ratio: 30 minutes 160 minutes = 18.8%, rounded 1 Total process time per unit: Process Step 1 6 minutes Process Step 2 10 Process Step 3 6 Process Step 4 8 Total 30 minutes 2 Within-batch wait time: Multiply the process time by the remaining units in the batch (waiting their turn) 30 minutes (5 1 units) = 120 minutes 3 Move time: 5 moves 2 minutes = 10 minutes 27-10
Ex. 27 8 (FIN MAN); Ex. 12 8 (MAN) a. and b. Non- Elapsed Time (a) 1:00 PM Activity Arrives at doctor office Value-Added Time Value-Added Time (b) 1:30 Waits in waiting room (5 6 min.) 30 min. 1:45 Waits in examining room 15 1:55 Nurse takes readings 10 min. 2:15 Waits in examining room 20 2:30 Doctor performs diagnosis 15 2:40 Waits to pay for services 10 2:45 Walks to pharmacy 5 3:15 Waits to fill prescription (6 5 min.) 30 3:20 Prescription is filled 5 3:35 Drives home 15 Total 50 min. 105 min. Edwards arrives home at 3:35 p.m. b. Of the total elapsed time of 155 minutes, 105 minutes is non-value-added time. Value-Added Lead Time c. Value-Added Ratio = = Total Lead Time 50 min. (50 min. + 105 min.) = 32% d. The doctor requires patients to wait in order to increase the productivity of the office. The patients represent the work in process inventory of the office, while the physician and nurses are the critical productive resources. The clinical staff remains productive because there is always a supply of patients to serve. The physician never loses productive minutes providing patient care by waiting for a patient. Unfortunately, the physician s productivity comes at the cost of the patient. The patients must wait for the nurse and physician before being served. Additional causes of patient waiting are due to variation in the patient service delivery process. If there are uncertainties or variation in service requirements, such as some patients needing more time with the doctor and others needing less, then the amount of work in process will tend to increase in order to buffer the throughput of the office. Likewise, doctors being called out for emergencies causes disruption in the patient flow in the office. 27-11
Ex. 27 9 (FIN MAN); Ex. 12 9 (MAN) a. The Japanese supply chain model is one based on long-term arrangements and partnership. The Japanese automobile manufacturers want their suppliers to be financially healthy because they rely on them for innovation. The Big Three automakers, in contrast, are only concerned about getting the best short-term price from their suppliers. The article seems to imply that the longer-term benefits from partnership are being ignored by the Big Three. As a result, they are willing to view their supplier relationships as temporary until the next best price comes along. b. These suppliers support the Japanese system because it provides for winwin opportunities, whereby the customer and the supplier can both be successful. The suppliers are concerned about their margins being squeezed down to the point that they will be unable to maintain financial viability and/or provide the level of supplier service that will be demanded in the long-term under the conventional Big Three supplier model. Suppliers are also concerned about the uncertainty of temporary or short-term contracts. Such demand volatility can add risk and cost to the supplier s business over time. c. Supply chain management is often beneficial to the customer. However, the customer may have to trade off between short-term and longer-term benefits. For example, supply chain management provides the supplier the financial incentives to invest in process and product innovation, invest in supply chain collaboration (such as EDI, RFID, and Internet collaboration), and to share best practices, such as just-in-time principles, across business entities. Such investments provide the customer access to new technologies, new ideas, more efficient processes, and ultimately lower costs and higher value for all parties involved in the supply chain. 27-12
Ex. 27 10 (FIN MAN); Ex. 12 10 (MAN) Quickie s team approaches are very different from using a manager to hire and evaluate employees. First, the input of many individuals goes into the hiring decision. In this way, the viewpoints of a variety of people are brought into the decision. Moreover, the new hire needs to fit with the culture of the team. Team-based hiring can produce a higher probability of having an effective team member by having a good fit. A possible concern is the team hiring only people that are like themselves. The peer evaluation may be more effective than the supervisor evaluation, since the team may be more familiar with the team member s input to the goals of the team. In addition, it will be difficult to hide unwanted behavior from the team. Team members work with each other every day and may best be able to evaluate performance. A concern would arise if the team members are not trained in making evaluations. The process should be helpful and not threatening to the employee. Team-based evaluation practices increase employee involvement. Employees have input into decisions that affect the team, rather than having these decisions handed down to them. This should increase the amount of empowerment and job satisfaction enjoyed by the team members. Ex. 27 11 (FIN MAN); Ex. 12 11 (MAN) Shield Insurance Company should adopt just-in-time principles in its claims payment operations. Management should first consider changing the layout for this process. Instead of processing the claims payments through three different departments that are organized by process, the company could design claims payment cells that are organized around different types of insurance products or customers. For example, a cell could be created for all marine insurance. The cell would have data input, claims audit, and claims adjustment personnel all located together (co-located) to process marine insurance claims. This would reduce the move time between the departments considerably. In addition, the claims batches should be reduced. If the claims were processed one or two at a time in a product-focused cell, then payments might be possible on the same day that the claim is submitted, rather than 10 days later. Thus, as claims came into the cell, they would be worked on. This would be an example of pull manufacturing (scheduling). The cell is activated by work (demand for claim payments). The work is pulled through each process step in the cell until a check is delivered to the insurance customer. Claims payment software can also aid the process by transmitting claim information on electronic forms over an Intranet, rather than using paper forms. Note to Instructors: Insurance companies, such as Aetna and Mutual Benefit Life, are actually employing just-in-time principles in their claims payment and insurance application processes. 27-13
Ex. 27 12 (FIN MAN); Ex. 12 12 (MAN) a. The present Grill Rite service delivery system is an example of a push system. Special orders are pushed through the system. The order is placed at the beginning of the process and the hamburger is cooked, dressed, and then delivered to the inventory of finished hamburgers placed under the hot lamps. Customers are sold burgers from this finished goods inventory. Under this system, the customer wait time would be small only if the customer ordered a standard burger from the inventory. If the customer placed a special order, then he or she would have to wait for the complete cook and dress cycle to be completed. b. A new system could be designed so that a custom order is introduced after cooking the burger, rather than prior to cooking. In this way, hamburgers are made to order without the use of finished goods inventory. Under this process, assume a customer ordered a hamburger with ketchup and pickles only. The order would be received at the dressing station. Here, a food preparer would take a hamburger off the grill and place ketchup and pickles on the burger using materials at the dressing station (termed point-of-use materials). The hamburger that is pulled from the grill would create a signal (the space on the grill) for a new hamburger to be placed on the grill. In this way, hamburgers that are cooking do not have orders assigned to them. Rather, they are available to be pulled by the food preparer to satisfy customer orders. Under this system, the lead time for cooking the hamburger is eliminated from the customer wait time. The customer has only to wait for the burger to be dressed. The attractiveness of this approach is that customers can have the burgers their way without using finished goods inventory to provide fast response. A variation on this answer is to have plain hamburgers pulled directly off the grill by the customer order (as above) but place the dressing stations among the customers (similar to Fuddruckers). In this way, the customers dress their own burgers after purchasing them. Note to Instructors: You may recognize that the first system described in this exercise is similar to the method invented by McDonald s, while Wendy s used the second method. McDonald s recently indicated that it was switching its method to work more like Wendy s because of its superior service characteristics. You might also note that Dell s manufacturing strategy is very similar to Wendy s. It produces computers to order using pull signals. This allows Dell to build the computer to a user specification yet still deliver it within a matter of days. 27-14
Ex. 27 13 (FIN MAN); Ex. 12 13 (MAN) The production manager probably has some good points. If the accounting system does not change when an organization embraces a just-in-time strategy, then there will likely be complaints. A conventional accounting system needs to have a strong accounting control orientation. Under just-in-time, the accounting system can be designed with much wider transaction control intervals. The company could have a very wide transaction interval such as between purchased parts transacted in and finished goods transacted out. Thus, many transactions into and out of intermediate work in process inventory locations would not be needed. In addition, a raw and in process inventory account would allow the company to eliminate separate raw materials release transactions. Eliminating accounting controls would be foolhardy unless the company has strong visible controls. Otherwise, there is simply too much room for waste and very large unexplained cost variances. Under just-in-time, visible controls such as the amount of inventory, production line stoppages, statistical control charts, or emergency lights replace accounting controls. The direct labor reporting can be eliminated. Under JIT accounting, the direct labor employees are assigned to production cells. Their wages are treated as part of the cell s conversion costs and are not separately traced or reported. The traditional financial measures should be supplemented with nonfinancial measures, such as schedule attainment, lead time, quality, machine uptime (availability), safety, and setup time. The nonfinancial measures can be collected and reported immediately without the need for additional effort to translate the numbers into financial terms. In addition, cost of quality or value-added/non-value-added activity analyses can provide financial information that can be used by the production department manager. 27-15
Ex. 27 14 (FIN MAN); Ex. 12 14 (MAN) Budgeted Cell Conversion $550,000 a. Cost Rate = 2,000 hours = $275 per hour b. Budgeted Cell Conversion Cost per Unit 12 minutes = $275 per hour 60 minutes = $55 per unit c. 1. Raw and In Process Inventory* 128,000 Accounts Payable 128,000 *800 units $160 per unit 2. Raw and In Process Inventory* 44,000 Conversion Costs 44,000 *800 units $55 per unit 3. Finished Goods Inventory* 172,000 Raw and In Process Inventory 172,000 *800 units ($160 + $55) = $172,000 4. Accounts Receivable* 249,600 Sales 249,600 *$780 units $320 per unit Cost of Goods Sold* 167,700 Finished Goods Inventory 167,700 *780 units ($160 + $55) 27-16
Ex. 27 15 (FIN MAN); Ex. 12 15 (MAN) Budgeted Cell Conversion $168,000 a. Cost Rate = 2,100 hours = $80 per hour b. Budgeted Cell Conversion Cost per Unit 12 minutes = $80 per hour 60 minutes = $16 per unit c. 1. Raw and In Process Inventory* 31,500 Accounts Payable 31,500 *900 units $35 per unit 2. Raw and In Process Inventory* 14,400 Conversion Costs 14,400 *900 units $16 per unit 3. Finished Goods Inventory* 44,880 Raw and In Process Inventory 44,880 *880 units ($35 + $16) 4. Accounts Receivable* 90,300 Sales 90,300 *860 units $105 per unit Cost of Goods Sold* 43,860 Finished Goods Inventory 43,860 *860 units ($35 + $16) 27-17
Ex. 27 16 (FIN MAN); Ex. 12 16 (MAN) a. 1. Raw and In Process Inventory* 80,600 Accounts Payable 80,600 *620 units $130 per unit 2. Raw and In Process Inventory* 66,000 Conversion Costs 66,000 *[($66,000 200 hours) (20 min. 60 min.)] = $110 per unit; $110 per unit 600 units = $66,000 3. Finished Goods Inventory* 141,600 Raw and In Process Inventory 141,600 *($130 + $110) 590 units 4. Sales* 244,375 Accounts Receivable 244,375 *$425 per unit 575 units Cost of Goods Sold* 138,000 Finished Goods Inventory 138,000 *($130 + $110) 575 units b. Raw and In Process Inventory, ending balance 1 $5,000 Finished Goods Inventory, ending balance 2 $3,600 1 $80,600 + $66,000 $141,600, or Materials [130 per unit (620 units 600 units)] $2,600 Production [($130 + $110) (600 units 590 units)] 2,400 Total $5,000 2 $141,600 $138,000 = $3,600, or ($130 + $110) (590 units 575 units) = $3,600 27-18
Ex. 27 17 (FIN MAN); Ex. 12 17 (MAN) Pareto Chart of Quality Activities 250000 200000 150000 100000 Dollars 50000 0 Warranty claims Correct shipment errors Disposing scrap Final inspection Processing customer returns Emergency equipment maintenance Employee training Scrap reporting Inspecting incoming materials Preventive equipment maintenance Supplier development 19
Ex. 27 18 (FIN MAN); Ex. 12 18 (MAN) a. Quality Cost Classification ACTIVE MEMORIES INC. Cost of Quality Report Quality Cost Cost Summary Percent of Total Quality Cost Percent of Total Sales Prevention $ 72,000 9% 1.8% Appraisal 120,000 15% 3.0% Internal failure 208,000 26% 5.2% External failure 400,000 50% 10.0% Total $800,000 100% 20.0% 1 2 1 $72,000 $800,000 2 $72,000 $4,000,000 The following classifications were used to develop the cost of quality report: Quality Activities Correct shipment errors Disposing of scrap Emergency equipment maintenance Employee training Final inspection Inspecting incoming materials Preventive equipment maintenance Processing customer returns Scrap reporting Supplier development Warranty claims Total Quality Cost Activity Cost Classification $120,000 External failure 88,000 Internal failure 80,000 Internal failure 40,000 Prevention 80,000 Appraisal 40,000 Appraisal 16,000 Prevention 80,000 External failure 40,000 Internal failure 16,000 Prevention 200,000 External failure $800,000 b. The majority of the company s quality efforts are in correcting quality problems. This is evident by the high percentage of quality costs associated with internal and external failure (76% of total quality costs). The highest cost activities are warranty claims, which indicates significant field failures for the product. Emergency equipment maintenance is an internal failure because it indicates that the company is failing to preventively maintain the equipment. Emergency repairs create significant disruptions and quality problems. 27-20
Ex. 27 19 (FIN MAN); Ex. 12 19 (MAN) CHAPTER 27 Pareto Chart of Quality Activities 140,000 120,000 100,000 Dollars 80,000 60,000 40,000 20,000 0 Replace old technology cable with higher quality cable Replace old technology signal switches with higher quality switches Cable signal testing Re-install service (installed incorrectly the first time) Billing error correction Train employees Repair satellite equipment Respond to customer home repair requests Repair underground cable connections 27-21
Ex. 27 20 (FIN MAN); Ex. 12 20 (MAN) a. Quality Cost Classification DIGITAL LIGHT INC. Cost of Quality Report Quality Cost Cost Summary Percent of Total Quality Cost Percent of Total Sales Prevention $260,000 1 52% 13.0% Appraisal 70,000 14% 3.5% Internal failure 30,000 6% 1.5% External failure 140,000 28% 7.0% Total $500,000 100% 25.0% 2 1 $260,000 500,000 2 $260,000 $2,000,000 b. DIGITAL LIGHT INC. Value-Added/Non-Value-Added Activity Analysis Category Amount Percent Value-added $330,000 66% Non-value-added 170,000 34% Total $500,000 100% The following classifications were used to develop the reports: Activity Quality Activities Cost Billing error correction $ 50,000 Cable signal testing 70,000 Reinstalling service (installed incorrectly the first time) 55,000 Repairing satellite equipment 30,000 Repairing underground cable connections to the customer 15,000 Replacing old technology cable with higher quality cable 120,000 Replacing old technology signal switches with higher quality switches 95,000 Responding to customer home repair requests 20,000 Training employees 45,000 Total $500,000 Quality Cost Classification External failure Appraisal External failure Internal failure External failure* Prevention Prevention External failure Prevention VA/NVA Non-value-added Value-added Non-value-added Non-value-added Non-value-added Value-added Value-added Non-value-added Value-added * This is an external failure because the underground cable connection needs to be repaired after receiving notification of disrupted service from a customer. 27-22
Ex. 27 20 (FIN MAN); Ex. 12 20 (MAN) (Concluded) c. The reports indicate that Digital Light Inc. s total costs of quality are 25% of total sales. In addition, 52% of the activity cost goes toward prevention activities. As a result, Digital Light is able to avoid high internal and external failure activities. Only 34% of the activities are non-value-added, compared to 66% that are value-added. Although there is some room for improvement, the company appears to be effectively managing its quality activities. 27-23
Ex. 27 21 (FIN MAN); Ex. 12 21 (MAN) a. Activity Cost per Can = b. In this improvement scenario there will 237,000 (300,000 63,000) additional cans processed through the packaging operation. The same number of cans still will be processed by the mixing and filling activities. 1 Activity Cost per Can Additional cost to packaging activity from improved process: Packaging activity cost per can 1 Number of additional cans from $ 0.020 improvement effort 237,000 Additional packaging activity cost $ 4,740 c. Expected activity cost per can after improvement: = Activity Cost per Can = Activity Cost per Can = Activity Cost Number of Completed Cans $600,000 6,000,000 cans Packaging Activity Cost per Can = Packaging Activity Cost Number of Completed Cans Packaging Activity $0.020 per can Cost per Can = $120,000 = 6,000,000 cans Activity Cost Number of Completed Cans $600,000 + $4,740 6,237,000 cans cans The activity cost per can of the new process is improved because the number of cans completed through the mixing and filling process increased by 237,000 cans at a small additional cost of $4,740 in the packaging activity. The mixing and filling activity costs do not change because the improvement only impacts the number of cans processed after the filling activity, not prior to this activity. This solution simplifies by assuming the refrigeration did not require additional activity cost. While not analyzed in this exercise, there are additional savings from less waste of materials from fewer kicks. = = $0.10 per can $0.097 per can 27-24
Ex. 27 22 (FIN MAN); Ex. 12 22 (MAN) a. Percent of Activity Cost Total Process Receiving claim $ 80,000 20% Adjusting claim 240,000 60% Paying claim 80,000 20% Total $400,000 100% The adjusting claim activity is the most significant activity in this process. b. Average process cost per paid claim: $400,000 4,000 claims = $100 per paid claim c. Activity Cost Activity Cost Prior to After Activity Improvement Improvement Receiving claim $ 80,000 $ 92,000 * Adjusting claim 240,000 72,000 ** Paying claim 80,000 80,000 Total $400,000 $244,000 Activity Cost Savings (Cost) $ (12,000) 168,000 0 $156,000 * $80,000 115% ** $240,000 (100% 70%) Note: Sometimes an activity cost within a process will need to increase in order to realize additional benefits in another part of a process, as illustrated here. d. Average process cost per paid claim: $244,000 4,000 claims = $61 per paid claim 27-25
Ex. 27 23 (FIN MAN); Ex. 12 23 (MAN) a. Percent of Activity Cost Total Process Preparing materials request $ 36,000 9% Requesting, receiving, and selecting vendor bids 100,000 25% Preparing purchase order 20,000 5% Preparing receiving ticket 24,000 6% Matching M/R, R/T, and invoice 48,000 12% Correcting reconciliation differences 140,000 35% Preparing and delivering vendor payment 32,000 8% Total process activity cost $400,000 100% Requesting, receiving, and selecting vendor bids and correcting reconciliation differences total 60% of the total process cost. This indicates that these two activities are good candidates for improvement efforts. b. Average process cost per payment: $400,000 20,000 payments = $20 per payment c. Activity Cost Activity Cost Prior to After Activity Improvement Improvement Preparing materials request $ 36,000 $ 36,000 Requesting, receiving, and selecting vendor bids 100,000 25,000 * Preparing purchase order 20,000 20,000 Preparing receiving ticket 24,000 24,000 Matching M/R, R/T, and invoice 48,000 48,000 Correcting reconciliation differences 140,000 35,000 ** Preparing and delivering vendor payment 32,000 32,000 Total process activity cost $400,000 $220,000 Activity Cost Savings $ 75,000 105,000 $180,000 * $100,000 (100% 75%) ** $140,000 (10% 40%) d. Average process cost per paid claim: $220,000 20,000 payments = $11 per payment 27-26
PROBLEMS Prob. 27 1A (FIN MAN); Prob. 12 1A (MAN) 1. Brite Lite s purchasing policy is very short-sighted. It does not involve developing partnerships with suppliers. Brite Lite should consider changing its arm s length policy and work on building a long-term supply chain strategy with its suppliers. With a supply chain strategy, Brite Lite can begin to consider more than just the price of its glass. It can work with the supplier on quality, responsive delivery, electronic data interchange invoicing, supplier raw materials logistical support, sharing of research and development efforts, and sharing of production schedules, to name a few. The arm s length approach is more costly in the long run, even if it squeezes the last penny out of each supplier. The arm s length approach reduces the possibility of working on issues that go across organizational boundaries (such as electronic data interchange, sharing demand forecasts, or more frequent just-in-time deliveries), which hold the promise of reducing the total delivered cost. 2. The hidden costs beyond the price include the costs associated with the higher inventory required by Mid-State s delivery schedule. These inventory costs include additional space, handling, obsolescence, financing, and materials management costs. These costs were not considered because they are not obvious. They are also difficult to determine. The price is obvious, so it is easy to build a purchasing policy around getting the best price. This policy ignores the additional internal costs of the higher inventory imposed by Mid-State s delivery schedule. These are costs incurred by other parts of the organization, not purchasing. In a functional organization, purchasing would respond by saying that the additional internal inventory costs are not its problem. Those are costs incurred in another manager s responsibility center. Of course, this is part of the problem of such simple low-price bid policies. 3. If the financing costs are 10%, then the additional cost of the inventory could be determined as follows: At the beginning of July, the new shipment of 45,000 pounds arrives. Assuming that the glass supply runs out by the end of the quarter, the average inventory for the quarter is: Beginning of July 45,000 End of September 0 Total 45,000 2 Average pounds in inventory for the quarter 22,500 27-27
Prob. 27 1A (FIN MAN); Prob. 12 1A (MAN) (Concluded) The inventory carrying cost can be estimated as follows: Average pounds in inventory for the quarter 22,500 Price per pound $28 Total inventory investment $630,000 Interest rate per quarter (10% 4) 2.5% Inventory financing cost per quarter $ 15,750 Inventory financing cost per quarter $ 15,750 Number of pounds ordered for the quarter 45,000 lbs. Additional cost per pound (rounded) $ 0.35 /lb. The financing cost is 2.5% of the average quarterly inventory value, or $15,750 per quarter. This translates into an additional 35 per pound ($15,750 45,000 lbs.) purchased during the quarter. Thus, just considering the financing cost by itself makes Cleveland Glass the real low-cost bidder. Note to Instructors: As a point of comparison, the financing cost for Cleveland Glass daily deliveries is less than a cent per pound ($14,100 2.5% = $352.50; $352.50 45,000 lbs. = $0.0078), because the average daily inventory investment would be only $14,100 [500 lbs. $28.2]. (This calculation would be half this amount if it was assumed the average daily inventory was half the daily shipment, or 250 pounds [500 pounds per day 2]). 27-28
Prob. 27 2A (FIN MAN); Prob. 12 2A (MAN) 1. Value-added time: Assembly of PC board 5 min. Stereo assembly 18 Time to inspect one unit 9 Pack and label 8 Total 40 min. Non-value-added time: Wait time: Within-batch wait time PC board assembly (59 5 min.) 295 min. Within-batch wait time final assembly (59 18 min.) 1,062 Within-batch wait time testing (59 9 min.) 531 Within-batch wait time shipping (59 8 min.) 472 Test setup 30 Total wait time 2,390 min. Move time: Move from PC board assembly to final assembly 10 min. Move from final assembly to testing 20 Total move time 30 Total non-value-added time 2,420 min. Total lead time (40 min. + 2,420 min.) Value-Added Ratio = Value-Added Lead Time Total Lead Time 40 min. Value-Added Ratio = = 1.6% 2,460 min. 2,460 min. 2. The existing process is very wasteful. The company could improve the process by changing the layout from a process orientation to a product orientation. Each stereo model could be formed into a production cell. Each cell would have PC board assembly, final assembly, and testing next to each other. In this way, the batch sizes could be reduced significantly. Workers could practice one-at-a-time processing and merely pass a single completed assembly through the cell. The work content would need to be made more balanced before implementing this solution. As a result, the move time and within-batch wait time would be eliminated. The company could also initiate total quality principles. Moving toward zero defects would allow the company to reduce testing activities (and time), and as a result, the setup time for the test area might be eliminated or reduced. 27-29
Prob. 27 3A (FIN MAN); Prob. 12 3A (MAN) Budgeted Cell Conversion $756,000 1. Cost Rate = 2,400 hours = $315 per hour 2. Budgeted Cell Conversion Cost per Unit = $315 per hr. (20 min. 60 min.) = $105 per unit 3. a. Raw and In Process Inventory* 730,000 Accounts Payable 730,000 *7,300 units $100 per unit b. Raw and In Process Inventory* 756,000 Conversion Costs 756,000 *7,200 units $105 per unit c. Finished Goods Inventory* 1,465,750 Raw and In Process Inventory 1,465,750 *7,150 units ($100 + $105) d. Accounts Receivable* 2,800,000 Sales 2,800,000 *7,000 units $400 per unit Cost of Goods Sold* 1,435,000 Finished Goods Inventory 1,435,000 *7,000 units ($100 + $105) 4. Raw and In Process Inventory: $730,000 + $756,000 $1,465,750 = $20,250 Finished Goods Inventory: $1,465,750 $1,435,000 = $30,750 or (7,150 units 7,000 units) ($100 + $105) = $30,750 27-30
Prob. 27 3A (FIN MAN); Prob. 12 3A (MAN) (Concluded) 5. JIT accounting is different from traditional accounting in a number of respects. Most importantly, JIT accounting is simplified and uses minimal control. As a result, the number of transactions are reduced, and the control intervals between adjacent work in process transaction points are widened. In many JIT operations, there are no separate materials or work in process inventories. Rather, purchased materials are charged to an account that combines raw materials and work in process, termed the raw and in process inventory account. Direct labor is frequently eliminated as a cost category and is instead included as a conversion cost of the cell. The cell conversion cost is applied to the raw and in process inventory account. Indirect labor can frequently be assigned to a production cell. As a result, these costs do not need to be allocated, since they are included directly in the cell s conversion cost. Often, nonfinancial performance measures, such as lead time or quality measures, are used to monitor performance. 27-31
Prob. 27 4A (FIN MAN); Prob. 12 4A (MAN) 1. Pareto Chart-Quality Activities 90000 80000 70000 60000 Dollars 50000 40000 30000 20000 10000 0 Correct errors identified by customers (claim, check, application errors) Correct jams Correct scan errors Scan Program scanner Re-run job due to scan reading errors Load Verify scan accuracy via reconciling totals Log-in control codes (for later reconciliation) Verify scanner accuracy with test run 27-32
Prob. 27 4A (FIN MAN); Prob. 12 4A (MAN) (Continued) The following classifications are used in answering (2) and (3): Activity Activity Cost Correcting errors identified by election commission $ 84,000 Correcting jams 66,000 Correcting scan errors 33,000 Loading 15,000 Logging-in control codes (for later reconciliation) 12,000 Program scanner 21,000 Rerunning job due to scan reading errors 18,000 Scanning 30,000 Verifying scan accuracy via reconciling totals 12,000 Verifying scanner accuracy with test run 9,000 Total $300,000 Classification External failure Internal failure Internal failure Not a quality cost Appraisal Not a quality cost Internal failure Not a quality cost Appraisal Prevention 2. Percent of total activity cost for each quality cost (and nonquality cost) classification: Quality Cost Classification Cost of Quality Activity Cost Value-Added/ Non-Value-Added Classification Non-value-added Non-value-added Non-value-added Value-added Value-added Value-added Non-value-added Value-added Value-added Value-added Percent of Total Department Cost Prevention $ 9,000 3% Appraisal 24,000 8% Internal failure 117,000 39% External failure 84,000 28% Not a cost of quality 66,000 22% Total $300,000 100% 27-33
Prob. 27 4A (FIN MAN); Prob. 12 4A (MAN) (Concluded) 3. Percentages of total activity cost that are value- and non-value-added: Activity Percent of Total Cost Department Cost Value-added $ 99,000 33% Non-value-added 201,000 $300,000 67% 100% 4. The department has 67% of its total costs as non-value-added. This is a very significant amount. Internal failure represents 39% of the total costs. This represents significant opportunity for cost savings. In addition, the external failure costs of 28% of the total may understate the true damage caused by external failure. The potential dissatisfaction and political ill will are not accounted for in this analysis. 27-34
Prob. 27 1B (FIN MAN); Prob. 12 1B (MAN) 1. HD Hogg s purchasing policy is very short-sighted. It does not involve developing partnerships with suppliers. HD Hogg should consider changing its arm s length policy and work on building a long-term supply chain strategy with its suppliers. With a supply chain strategy, HD Hogg can begin to consider more than just the price of its frames. It can work with the supplier on quality, responsive delivery, electronic data interchange invoicing, supplier raw materials logistical support, sharing of research and development efforts, and sharing of production schedules, to name a few. The arm s length approach is more costly in the long run, even if it squeezes the last penny out of each supplier. The arm s length approach reduces the possibility of working on issues that go across organizational boundaries (such as electronic data interchange, sharing forecast information, or more frequent just-in-time deliveries), which hold the promise of reducing the total delivered cost. 2. The hidden costs beyond the price include the costs associated with the higher inventory required by Iron Horse Frames delivery schedule. These inventory costs include additional space, handling, obsolescence, financing, and materials management costs. These costs were not considered because they are not obvious. They are also difficult to determine. The price is obvious, so it is easy to build a purchasing policy around getting the best price. This policy ignores the additional internal costs of the higher inventory imposed by Iron Horse Frames delivery schedule. These are costs incurred by other parts of the organization, not purchasing. In a functional organization, purchasing would respond by saying that the additional internal inventory costs are not its problem. Those are costs incurred in another manager s responsibility center. Of course, this is part of the problem of such simple low-price bid policies. 27-35
Prob. 27 1B (FIN MAN); Prob. 12 1B (MAN) (Concluded) 3. If the financing costs are 12%, then the additional cost of the inventory could be determined as follows: At the beginning of July, the new shipment of 4,500 frames arrives. Assuming that the frame supply runs out by the end of the quarter, the average inventory for the quarter is: Beginning of July 4,500 End of September 0 Total 4,500 2 Average frames in inventory for the quarter 2,250 The inventory carrying cost can be estimated as follows: Average frames in inventory for the quarter 2,250 Price per frame $300 Total inventory investment $675,000 Interest rate per quarter (12% 4) 3% Inventory financing cost per quarter $ 20,250 Inventory financing cost per quarter $ 20,250 Number of frames ordered for the quarter 4,500 frames Additional cost per frame $ 4.50 per frame The financing cost is 3% of the average quarterly inventory value, or $20,250 per quarter. This translates into an additional $4.50 per frame ($20,250 4,500 frames) purchased during the quarter. Thus, just considering the financing cost by itself makes Famous Frames the real low-cost bidder. Note to Instructors: As a point of comparison, the financing cost for Famous Frames daily deliveries is 10 per frame ($15,050 3% = $451.50; $451.50 4,500 frames = $0.10), because the average daily inventory investment would be only $15,050 [(50 frames per day) $301]. (This calculation would be half this amount if it was assumed the average daily inventory was half the daily shipment, or 25 frames [50 frames per day 2]). 27-36