Accounting 4100 Cost Accounting Systems

What is a cost?

A cost is a sacrifice or giving up of resources for a particular purpose. Costs are frequently measured by the monetary units that must be paid for goods and services

What is a cost management system?

A collection of techniques that identify how management decision affect costs.

Cost Object (objective)

Anything for which a separate measurement of costs is desired
Examples: Customers, service, departments, processing orders, products

Product Costs

Product costs are costs identified with goods produced or purchased for resale. They first become part of inventory on hand, and become expenses by COGS only when sold.

Period Costs

Period costs are deducted as expenses during the current period without going through an inventory stage. Most of them are reported as selling and administrative expenses.
Examples: R&D, advertising, and sales

Unallocated Costs

Some costs lack an identifiable relationship to a cost object. Often it is best to leave such costs unallocated like Pepsi and FX hedging, R&D, lawsuit settlement. An unallocated cost for one company may be an allocated cost or even a direct cost for another. These unallocated costs are recorded but not assigned to any cost object

Two Processes in Cost Accounting System

1. Cost accumulation: Collecting costs by some "natural" classification, e.g. job, process, material, labor

2. Cost assignment: Tracing costs to one or more cost object

Prime Costs include

Direct Materials and Direct Labor

(direct costs)

Conversion Costs

Direct Labor and Manufacturing Overhead

Manufacturing overhead

Includes all costs associated with the production process that the company cannot trace to the manufactured goods in an economically feasible way.
Example: Depreciation, property taxes, supplies, and insurance

Cost Allocation

Assigns indirect costs to cost objects, in proportion to the cost object's use of a particular cost allocation base

What is a cost allocation base?

It is some measure of input or output that determines the amount of cost to be allocated to a particular cost object.

Predetermined Overhead Rate (POHR)

Used to apply overhead to jobs is determined before the period begins

POHR = (Budgeted total manufacturing overhead cost for the coming year) / (Budgeted total units in the allocation base for the coming period)

The denominator is the cost driver

What is the Cost Driver?

Unit of activity that changes activity cost

Why use normal costing if it isnt GAAP?

-Allows you to make accounting entries before end of period due to predetermined OH rate

-Smoothout fluctuations in OH costs assigned to products/jobs/services due to uneven activity andor OH costs

-Provides information for estimating costs for bidding on jobs or budgeting

Activity Based Costing

Method that measures the cost and performance of process-related activities and cost objects. Assigns cost to activities based on their use of resources, and assigns cost to cost objects based on their use of activities.

Recognizes the casual relationship of cost drivers to activities

When should a company use ABC?

-When indirect costs are significant in proportion to direct costs.
- When goods are complex requiring many inputs and processes
-Complex low volume products are profitable while standard high volume products arent
-When different departments believe costs are assigned inaccurately
-Introduction of new model results in higher sales, profits, but an overall income decline
-The company has not changed its costing system in spite of major changes in operation

What are some disadvantages of ABC?

-Difficult to gather information

-Expensive to update a system

-Not GAAP, so two systems needed

-Can be a hard sell that benefits > costs

ABC Steps

1. Identify and classify the activities related to the company's products or services

2. Estimate the cost of each activity identified in step 1

3. Calculate a cost-driver rate for each activity

4. Assign activity costs to products using the cost driver rate

Objectives of Lean Enterprise

-Serve Customers

-Increase Capacities

-Accelerate Bottom and Top Line Growth

Lean Principles

4 Different Value Streams

1. Value: Lean defines Value from the customers standpoint

2. Flow and Pull: Maximize Flow -> Triggered by pull of customers

3. Empowerment: Information and authority to act when needed

4. Perfection: 100% quality; unbroken flow

Value Stream Management

In Value Stream Management you must redefine the unit into value streams, which look like:
-Reorganize into value stream teams

-Map the processes

-Organize into production cells which is often U-Shaped to promote efficient exchange

-Engage in continuous improvement

Traditional Organizations

In traditionally managed organizations the majority of operating decisions is made by managers. So the hierarchal requires 'responsibility' reporting with costs, revenue, profit, and investment centers

In lean-managed organizations...

Majority of operating decisions made by value stream members and cell teams - not necessarily functional managers.

Cross functional structure requires information organized differently

In lean principles, Value is one of them. How is value added in manufacturing and service?

Manufacturing:
-"Value Adding" Changes the value of an item with drilling, assembling, painting, cutting
-"Non Value Adding" consumes time and money (but is not value-added) with sorting, counting, expediting, checking, stacking.

Service:
-"Value Adding" helps satisfy a customers needs through greeting, completing, cleaning, delivering
-"Non-Value Adding" consumes time and money (but does not satisfy need) with checking, asking, fixing, apologizing, re-doing.

In lean principles, what is the 'Push' versus 'Pull'

Push:
The traditional production push makes big batches cheaper due to less downtown with fewer setups, lower purchase price with bulk orders, fewer moves of material, and bulk deliveries to customers. It is a production based on forecast (e.g. GM and Ford in 1980s)

Pull:
The Demand Pull which is a one piece flow and produces to customer order rather than bulk and producing due to forecast

In lean principles, Empowerment requires:

-Training

-Clear understanding of goals/strategy

-Authority (Cell and Value Stream Teams)

-Accountability

-Widespread access to information across and within functions

In Lean Principles, what is the Perfection Aspect?

It involves 100% quality and an unbroken flow. It serves at the pull of the customer rather than the push.

-With Lean, the work is never done and is a continuous striving for improvement.
-Visual Management (e.g. Kanban Board which is what tyler taked about)
-Standardized work processes
-Tools to identify waste and improve processes
-Availability of information WHEN it is needed and in usable form
-NO WORK IN PROCESS (WIP)

5 S's for Visual Control

-Sort
-Straighten
-Shine
-Standardize
-Sustain
-Safety

Why 5 S's?

-To eliminate the waste that results from "uncontrolled" processes
-To gain control on equipment, material, and inventory placement and position
-Apply control techniques to eliminate erosion of improvements
-Standardize improvements for maintenance of critical process parameters

After a system goes through the 5 S's what comes after?

Clear Aisles, Color-Coded areas, Slogans and Banners, no work in process

In a lean environment performance measures should:

-Reflect the principles of lean thinking

-Drive improvement of value stream results

-Control adherence to standards in cells

-Link cells and value streams to corporate strategies and goals

Cell/Process Measures

1. Day-by-the-hour production

2. First Time Through (FTT)

3. WIP-to-Standard work in progress (SWIP)

4. Operational Equipment Effectiveness (OEE)

1. Day-by-the-hour Production

A. Track's cell's success on Takt Time (Takt Time is the Maximum time needed to meet a customers demand)

B. Purpose of measure is to focus on maintaining consistent output in line with rate of customer demand, To provide IMMEDIATE feedback if there is a problem, and to gather data about problems to facilitate learning.

Takt Time

Available Production Time / Customer Demand

A company manufactures high quality radios. The AVERAGE customer demands 635 units per day. The factory works two shifts of 7.5 hours each. What is the Takt Time?

Available Production Time / Customer Demand

so...

(7.5 x 2 x 60 x 60) / 635 = 85 seconds per unit

The numerator takes into account the two shifts and converts the hours into seconds

2. First Time Through (FTT)

A. Purpose - determine whether the cell is making products right the first time through

B. Production efficiency measure

C. Shows % of product made in the cell without any need for rework, repair or scrap

D. (Total units processed - Rejects or Reworks) / (Total units processed)

3. WIP-to-Standard work in progress (SWIP)

A. Purpose: show inventory levels in the cells

B. Minimum materials in-process needed in order to produce standard output

C. Measure: (Total Inventory in the Cell / Standard Cell Inventory)

4. Operational Equipment Effectiveness (OEE)

A. Purpose: to track the ability of a machine to make product on time and to the right quality

B. Must track: Downtime, production rate, and first time through

C. Measure: (Availability x Perfect Efficiency x Quality)

Traditional way of thinking vs Lean way of thinking

Traditional:
-Departments (silos)
-Batch Production (Push)
-Production Push System
-Management makes all decisions
-Controlled by transaction reporting
-Standard costing system
-Reduce per unit costs

Lean:
-Value Streams
-Single piece flow
-Pull System from customer demand
-Empowered teams make most decisions
-Controlled by visuals on plant floor
-Value stream costing
-The process is WHAT COUNTS

Lean Accounting vs. Accounting for Lean

Often used synonymously but more formally:
-Lean Accounting: Accounting department uses same Lean tools as production department

-Accounting for Lean: Create accounting information system that is consistent with lean production

Invisibility of Lean

-Improvements are often invisible in accounting. For example: reduced setups, improved productivity, improved lead times, and capacity increases not reflected in short term profits

-Lean improvements may initially lower profits. Lean exposes surplus inventory & WIP's inefficiencies, which makes standard cost per unit rise. This lowers profits for a short period but fixes the problem in the long run

Benefits of Lowering Inventory Levels

-Reduces Variability
-Eliminates Waste
-Streamlines production and material flows
-Provides more accurate information

Lean Improvements

-Move processes to a cell
-Improve insertion and taping process
-Increased quality
-Reduced lot sizes
-Reduced lead time
-Increased on-time deliveries

Standard Costs

-Do not reflect actual costs
-Generally outdated but still widely used
-Do not support continuous improvement
-Focus on variances, rather than process improvement
-Historically based
-Difficult to understand and interpret
-Encourage overproduction to decrease per unit costs

In Traditional Methods, bonuses can be based on ________________ per equivalent TON produced

average (standard) costs

This motivates greater work in processes to inflate the unit calculation and give bigger bonuses

Traditional Accounting Summary (Standard cost, Volume effects, Inventory Effects) of Does and Donts

Does:
-Encourage inventory building

Does NOT:
-Identify waste
-Identify obstacles to flow
-Encourage inventory reduction since inventory is asset
-Provide timely information
-Provide information on lean improvements

What are value streams?

Set of all actions (both value added and no value added) required to bring a specific product or service from raw material through to the customer

Value Stream Costing

Benefits from value stream costing...
-Easy for all to understand
-Provides timely information. A decision and the outcome is much more efficient
-Exposes surplus inventory and capacity not utilized
-Assigns accountability through value stream teams and plant management

What are 3 common value streams?

-Concept to Launch (engineering)
-Order to cash receipts (administrative)
-Raw materials to customer delivery (manufacturing)

Value Stream Mapping

-Links the material and information flows

-Provides common language (Plain English)

-Provides a blueprint for implementation

-Ties together lean concepts and techniques

-Helps you visualize more than the single process

-Follow product or service from beginning to end, and draw a visual representation of every process in the material & information flows

-Map future state of how value should flow

The Current State (of activities in mapping)

-99.9% of throughput time is wasted time and not valued by customer
-Upstream quality issues impose significant downstream costs
-Most managers and many production employees expend significant effort on non-production related activities

The Future State (of activities in mapping)

-Completed in a day with the same team
-Focused on flexibility and a reactive system to adapt to change
-Eliminating waste
-Creating flow
-producing on demand
-Lends itself to small batch production and customization

Potential Downside:
-Stockouts and greater reliance on single supplies
-Labor issues

In order to Implement Change, the critical success factors are...

-Management must embrace and lead organization into lean thinking
-Value stream managers must be empowered and enabled to manage implementations
-Improvements must be panned in detail with the cross functional Kaizen teams
-Successes must be translated to the bottom line and or market share

Effects of Lean Changes

Typical Results:
-Throughput time falls from 44 days to 6 days
-Wasted steps fall from 65 to 27
-Transport distance falls from 5300 to 1100 miles
-Inventories shrink by 90%
-Defects are reduced to the same rate at the start of the process as to the end

Throughput

Rate at which production process generates output

Wrong ways to address inefficiencies

-Programs of the month
-Redundant meetings
-Silo optimization

All activity is divided into two categories:

-Value added (Would the customer be willing to pay?)

-Non Value Added

Lean Thinking uses a stricter definition of value. Lean Value added Criteria is...

Is the customer willing to pay for it?
Does it directly transform?
Is it done right the first time?

If these three questions are not met, it is not considered value.

What is Waste?

Things that customers do not perceive as valuable

D.O.W.N.T.I.M.E.

D.O.W.N.T.I.M.E.

Defects

Overproduction

Waiting

Neglect of Human Talent

Transportation

Inventory

Motion

Excess Processing

Theory of Constraints

Any system can produce only as much as its critically constrained resource

Significance of Bottlenecks

-Maximum speed of the entire process is based on the speed of the slowest operation

-Any process improvements will be wasted unless the bottleneck is relieved. Relieving this is beneficial by leveling the workload which reduces negativity. Decreasing bottlenecks also reduces lead times and promotes competitive advantage across an even playing field.

Ergonomics

Arranging the environment to fit the employee. Ergonomics increases performance by reducing delays, fatigue, and injuries. It helps workers through better designed tasks, work stations, controls, displays, tools, lighting.

However, it can be expensive!

Establishing Accountability Examples

-Implement charge back systems where an operating unit is charged with accident costs

-Identify safety goals. First aid #s, workers comp #s, lost production time

Engineering Controls

-Eliminate dangerous tasks or unnecessary movements
-Reduce weights of loads, increase handling capacity of equipment
-Workspace modifications (ergonomics)
-Use handles and easy grip surfaces
-Lift properly, keeping loads close to body

Administrative & Process Controls

-Job orientation, training and follow up
-Implement safety analysis programs that include safety audits and inspections. Have programs provide incentives to reward safety (ex: operating unit w fewest accidents gets a reward)

Decentralized Organizations

>Requires Delegation of decision making authority
>Investors/professional managers; supervisors/subordinates
>The degree of decentralization determined by both industry and management

Decentralization Advantages and Disadvantages

Advantages:
-Better use of local knowledge
-Faster response time
-Better use of top managers time
-Opportunity for local managers to develop leadership skills

Disadvantages:
-More idiosyncratic processes
-Duplicate overhead costs
-Incomplete information
-Higher information integration costs
-Delegated decision making can increase agency costs

Performance Measurement

Firms use performance measures to monitor and control decentralization. These measures identify what managers should be focusing on, they can be used for performance evaluation and feedback, provides variance analysis of actual vs budgeted basis for process improvement

Favorable and Unfavorable Variances

A favorable variance increases operating profits and an unfavorable variance decreases operating profits

Characteristics of effective performance measures:

1. Are consistent with managers decision making authority, the manager can take action and affect outcome
2. Are aligned with firms strategic objectives and incentives
3. Benefits of performance measures exceed costs

Responsibility Accounting

System of internal reporting tailored to specific organizational structures. Measures performance by aggregating costs, profits, and returns at the SUBUNIT level.

Managers are evaluated on achieving results for their given responsibility

Types of Resonsibility Centers

1. Cost: Accountable for costs only. Measured through HR, accounting, legal

2. Revenue: Accountable for revenues only, measured through sales to customer

3. Profit: Accountable for revenues and costs, measured through sale of manufactured goods

4. Investment: Accountable for investments, revenues, and costs. Measured against cost of capital

Incentives are the rewards, both implicit, and explicit, that motivate effort and reward performance. Incentives are often linked to what?

They are linked to responsibility center performance measures

Revenue, Cost, and Profit Measures

1. Can use revenue and cost data from internal information systems (transfer pricing, standard costing)

2. Can also use income data from external reporting system (EBIT, EBITDA)

3. Free Cash Flow

Advantage and Disadvantage to ROI

Advantage: It uses percentages, which allow easy short term comparison with required returns

Disadvantage: Not effective at showing long term costs and benefits (what NPV is good at)

Solution: Use a combination of NPV, ROI, EVA

Net Present Value Model

NPV computes PV of future cash flows using minimum desired rate of return.

The required rate of return (discount rate) is minimum desired rate of return based on the firms cost of capital

Applying the NPV Method

1. Identify amount and timing expected cash inflows and outflows
2. Find PV of each expected cash flows
3. Sum the individual present values

Two major assumptions of the NPV Model

1. A world of certainty that predicted cash flows occur on time
2. There are perfect capital markets so money can be borrowed or loaned at the same interest rate

Internal Rate of Return (IRR) Model

The IRR determines the interest rate at which the NPV is zero

IRR > Minimum desired rate of return, accept project

Residual Income

Excess of net profit over the cost of equity capital

Cost of equity capital is the opportunity cost of the equity invested in the business; also the investors rate fo return

Economic Value Added (EVA)

Similar to residual income approach. Began to be heavily used in the 80s and 90s trademarked by Stern Stewart.

Links Income Statement with Balance Sheet

-It makes adjustments to after-tax income and capital to eliminate accounting distortions
-Directs managers attention to cost of capital
-Promotes investment in research and development

Cost of Debt

Equal to the interest payments made on the debt

Cost of Equity

Return the shareholders could obtain in price appreciation and dividends

What are some challenges of EVA?

Based on accounting income and estimates, not present value of cash flows.

Every EVA center needs its own balance sheet.