CIMA Paper P2 Advanced Management Accounting Ian Kusano and Nathi Thela
2 Chapter The Modern Business Environment 1
Learning Objectives Lead A1: Evaluate techniques for analysing and managing costs for competitive advantage Component A1b): Evaluate Total Quality Management techniques -The impacts of just-in-time (JIT) production, the theory of constraints and total quality management on efficiency, inventory and cost. -The benefits of JIT production, total quality management and theory of constraints and the implications of these methods for decision in the contemporary manufacturing environment. -Kaizen costing, continuous improvement and cost of quality reporting. -Process re-engineering and the elimination of non-value adding activities and reduction of activity costs. 2
Introduction to the Modern Business Environment “To compete successfully in today’s highly competitive global environment companies are making customer satisfaction an overriding priority, adopting new management approaches, changing their manufacturing systems and investing in new technologies. These changes are having a significant influence on management accounting systems.” Colin Drury in Cost and Management Accounting 3
Session Content The Global Environment Cost Planning and Logistics New Management • Cost Reduction Supply chain Approaches • • The value chain management Just in time • • • Value analysis Outsourcing Total quality • • Life cycle Gain sharing management • costing Theory of • Target costing constraints In this chapter we explore how the modern production system has changed, and in the following chapters we examine how costing has adapted to this and created new ways to calculate a product's production cost. 4
Characteristics of the Modern Environment Global environment • Operate in World Economy • Global customers and competition and sourcing • International regulations Flexibility • Customers have far greater choice than ever before • Huge increase in demand for new, cutting edge innovative products • Customers are demanding ever improving levels of service in cost, quality, reliability and delivery. • Customers demand flexibility As a consequence of this: • Many companies now have very diverse product ranges, with a high level of tailor made products and services; • Product life cycles have dramatically reduced, often from several years to just a few months. 5
Characteristics of the Modern Environment Employee Empowerment 1. To ensure this flexibility, managers need to empower their employees to make decisions quickly , without reference to more senior managers. 2. By empowering employees and giving them relevant information they will be able to respond faster to customers 3. Management accounting systems are moving from providing information to managers to monitor employees to providing information to employees to empower them to focus on continuous improvement . 6
Just-in-Time The emphasis of JIT is on produce or procure products or components as they are required by a customer or for use, rather than for inventory. 1. JIT Production 2. JIT Purchasing • Push vs Pull system Supplier to Production to Consumers Consumers to Production to Suppliers Toyota System • In a full JIT system virtually no inventory is held, that is no raw material inventory and no finished goods inventory is held, but there will be a small amount of WIP, say one tenth of a day’s production. 7
Just-in-Time To successfully adopt or implement JIT, the following is required: • labour force must be versatile • Production processes must be grouped by product line • infallible information system • A ‘get it right first time’ approach and an aim of ‘zero defects’. • Strong supplier relationships. 8
Total Quality Management TQM is the general name given to programmes which seek to ensure that goods are produced and services supplied of the highest quality . - Originates from Japan, its behind the success of many Japanese businesses. Two basic principles: - Get it right first time – prevention costs are lesser than correction costs. - zero defects and 100% quality - Continuous improvement – dissatisfied with the status quo. 9
Continuous Improvement and Cost of Quality There are two approaches to CI: • Kaizen Costing and Target Costing Quality costs are divided into compliance costs (or ‘conformance costs’) and costs of failure to comply (‘ nonconformance costs’) . • Prevention costs - costs of ensuring that defects do not occur in the first place. • Appraisal costs - are connected with measuring conformity with requirements and includes • Internal failure costs – includes reworking costs; costs of scrap; correction costs • External failure costs – there are several measurable costs for external failure i.e. Marketing costs associated with failed products & loss of goodwill. 10
Example 1: Costs of Quality X Ltd is a manufacturing company. Its monthly quality costs are made up as follows: $ Costs re-inspecting previously faulty finished goods 5,700 after reworking them Costs of scrap 12,000 Costs of calibrating and measuring testing equipment 8,500 Costs of inspecting incoming material 1,000 Costs of conducting supplier capability surveys 2,000 Classify the above costs into the four components of costs of quality? 11
Example 2: Costs of Quality Quality control costs can be categorised into internal and external failure costs, appraisal costs and prevention costs. In which of these four classifications would the following costs be included? • The cost of a customer service team • The cost of equipment maintenance • The cost of operating test equipment 12
Commitment to Quality For TQM to bring about improved business efficiency and effectiveness it must be applied throughout the whole organisation. It begins at the top with the managing director, the most senior directors and managers who must demonstrate that they are totally committed to achieving the highest quality standards. Middle management must ensure that the efforts and achievements of their subordinates receive appropriate recognition, attention and reward. This helps secure everyone’s full involvement – which is crucial to the successful introduction of TQM. 13
Successful implementation of TQM • Total commitment throughout the organisation. • Get close to their customers to fully understand their needs and expectations. • Plan to do all jobs right first time. • Agree expected performance standards with each employee and customer. • Implement a company-wide improvement process. • Continually measure performance levels achieved. • Measure the cost of quality mismanagement and the level of firefighting. • Demand continuous improvement in everything you and your employees do. • Recognise achievements. • Make quality a way of life. 14
Quality Circles • Is a team of four to twelve people usually coming from the same area who voluntarily meet on a regular basis to identify, investigate, analyse and solve work-related problems. • They present their solutions to management and is then involved in implementing and monitoring the effectiveness of the solutions. • The problems that quality circles tackle may not be restricted to quality of product or service topics, but may include anything associated with work or its environment. 15
The role of Management Accounting • Management accounting systems can help organisations achieve their quality goals by providing a variety of reports and measures that motivate and evaluate managerial efforts to improve quality – including financial and nonfinancial measures. • Traditionally, the management accounting systems focused on output, not quality. • Nonfinancial measures include: -Number of defects at inspection expressed as a percentage of the number of units completed. -Number of customer complaints. -Number of defectives supplied by suppliers. -Time taken to respond to customer requests. 16
Throughput Accounting Throughput = Sales Revenue Less Direct Material Cost • Aim to maximise throughput • Fully utilise bottlenecks 17
Goldratt and Cox’s 5 steps 1. Identify bottlenecks 2. Exploit bottlenecks 3. Subordinate to bottlenecks 4. Elevate bottlenecks 5. If break a bottleneck return to step 1 18
Accounting Measures Throughput Per Unit Return Per Hour = Time on Bottleneck Total Factory Costs Cost Per Hour = Total Time on Bottleneck = Return Per Factory Hour T A Ratio Cost Per Factory Hour 19
Example 3: Throughput Accounting X Limited manufactures a product that requires 1.5 hours of machining. Machine time is a bottleneck resource, due to the limited number of machines available. These are 10 machines available, and each machine can be used for u to 40 hours per week. The product is sold for $85 per unit and the direct material cost per unit is $42.50. total factory costs are $8,000 each week. Calculate 1. The return per factory hour 2. The TPAR. 20
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