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Lean Accounting,
Costs of Quality &
Target Costing

Oleh: Suyanto, MBA., Dipl. Res.

Contents

Value versus Supply Chain


Costs Associated with Goods for Sale
Cost of Quality
Target Costing
Lean Accounting

Supply vs Value Chain

Supply vs Value Chain


Key success factors:
- Cost and efficiency
- Quality
- Time
- Innovation

Costs Associated with Goods for Sale


Ordering costs

Stockout costs

Carrying costs

Purchasing costs

Costs of Quality
Shrinkage Costs

Cost of Quality
Quality meets/exceeds customer expectations:
Performance, Aesthetics, Serviceability, Features,
Reliability, Durability, Quality of conformance &
Fitness for use
Zero defects versus defective product
Cost of quality
Costs of conformance (control activities) : the costs
incurred to produce a quality product or service
Costs of nonconformance (failure activities): the costs
incurred to correct defects in a product or service.

Cost of Quality

Control Activities

Observable CQ
- Recorded in AIS

Failure Activities
Hidden CQ
- Multiplier
Method
- Market Research
Method
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Reporting Quality Costs

Rule of thumb: 2-4% of sales

THINK!!!
Reduce costs of quality,
Improve quality

Analysis of Quality Costs

Conformance vs
Non-conformance!
-Avoid non-conformance?
-Avoid External Failure?
-Why?

Case 1
Internal reports on quality at the EMCAP Publishing Company
generated the following information for the Trade Division for the
first three months of the year:
Total sales $60,000,000
Costs of quality:
Prevention $
Appraisal
Internal failure
External failure

523,000
477,000
1,360,000
640,000

Compute the following:


a.
b.
c.
d.

Total costs of quality as a percentage of sales


Ratio of costs of conformance to total costs of quality
Ratio of costs of nonconformance to total costs of quality
Costs of nonconformance as a percentage of total sales
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Case 2

1.
2.
3.

Which company is most likely to succeed in the competitive


marketplace?
Which company has serious problems with its products quality?
What do you think will happen to the total costs of quality for each
company over the next five years? Why
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Target Costing
Pricing method designed to enhance a companys ability
to compete, especially in markets for new or emerging
products,
Procedures:
1. identifies the price at which a product will be
competitive in the marketplace
2. defines the desired profit to be made on the product
3. computes the target cost for the product by
subtracting the desired profit from the competitive
market price.

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Why?
1. gives managers the ability to control or dictate
the costs of a new product at the planning
stage of the products life cycle.
2. enables managers to analyze a products
potential before they commit resources to its
production.

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Comparison of Price Decision Timing

Target Price Desired Profit = Target costs?


Costs + Profit = Price?

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Case 3: Esemka Ltd


Esemka Ltd. is considering a new MPV car and
must make a go or no-go decision when its
planning team meets tomorrow. Market research
shows that the unit selling price that would be
agreeable to potential customers is Rp130
million, and the companys desired profit is 25
percent of target cost. The design engineers
preliminary estimate of the products design,
production, and distribution costs is Rp110
million per unit. Using target costing, determine
whether the company should market the new
product.
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Case 4: Elsinore Company

Router (R) and Tablet (T)


Market price: R=$320-380, T=$750-850
Target price: R=$300, T=$725
Profit: 25% of total unit cost
Cost information (ABC):
Material handling ($)
parts cost
Production
($)
Product delivery ($)
Projected unit demand
Direct material cost ($)
Purchased parts cost ($)
Manufacturing labor
Hours
Hourly labor rate ($)

1.30 per dollar of direct material and purchased


3.50 per machine hour
24 (R)
30 (T)
26,000
18,000
25
65
15
45
2.6
12

4.8
15

3.4
14

8.2
16

Assembly labor
Hours
Hourly labor rate ($)

Machine hours

12.8

28.4
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Questions
1. Find the target cost per unit
2. Find the projected unit cost
3. Make a decision

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Lean Manufacturing
Competitive environment:
Needed to exercise better control, reduce costs,
and become more efficient.
Successful firm: preservation of market share,
stable growth, and continuation of efficient
production

Needed an approach designed to eliminate


waste & maximize customer value.

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Basic Concepts of Lean Manu


Dont try to focus on a few lean tools and
methodologies

1.
2.
3.
4.
5.
6.
7.
8.

Simple is better.
The quality of the product or service is critical to customer
satisfaction.
The work environment must emphasize continuous improvement.
Maintaining large inventories wastes resources and may hide poor
work.
Activities or functions that do not add value to a product or service
should be eliminated or reduced.
Goods should be produced only when needed.
Workers must be multiskilled and must participate in eliminating
waste.
Building and maintaining long-term relationships with suppliers is
important.
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Dimension of Lean Manufacturing


Delivering the right product

Right quantity
Right quality (zero defect)
At time needed
At lowest possible cost

A cost reduction strategy that redefines activities


performed

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The Lean Thinking Model

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Just in Case - JIC


Inventories of raw materials are maintained just in case some
items are of poor quality or a key supplier is shut down by a strike.
Subassembly parts are manufactured and stored just in case they
are needed later in the manufacturing process.
Finished goods are completed and stored just in case unexpected
and rush customer orders are received.
push approach, raw materials and subassembly parts are
pushed through each process.

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Just in Time - JIT


A lean operation embraces the just-in-time (JIT) operating
philosophy.
Requires that all resourcesmaterials, personnel, and facilitiesbe
acquired and used only as needed to create value for customers.
A JIT environment reveals waste and eliminates it by adhering to
the principles:
Minimum Inventory Levels
Quick Setup and Flexible Work Cells
A Multiskilled Work Force
High Levels of Product Quality
Effective Preventive Maintenance
Pull-Through Production
Backflush Costing (lean operation)
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JIT

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Source: Weygandt et al. (2012)

Direct vs Indirect Costs

Why?

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Backflush Costing
Track cost flows through
the production
process as the product
is made.

1.Accumulated in CGS
2.Flushed back into the
appropriate inventory
accounts.

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La-Z-Boy
1. Purchased $20,000 of direct materials on
account.
2. Used all of the direct materials in production
during the month.
3. Incurred direct labor costs of $8,000.
4. Applied $24,000 of overhead to production.
5. Completed units costing $51,600 during the
month.
6. Sold units costing $51,500 during the month.
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Backflush Costing

Track cost flows through


the production
process as the product
is made.

1.Accumulated in CGS
2.Flushed back into the
appropriate inventory
accounts.

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Case 5
For work done during August, Plush Furniture Company,
incurred direct materials costs of $123,450 and conversion
costs of $265,200. The company employs a just-in-time
operating environment and backflush costing. At the end of
August, it was determined that the Work in Process
Inventory account had been assigned $980 of costs, and
the ending balance of the Finished Goods Inventory
account was $1,290. There were no beginning inventory
balances.
How much was charged to the Cost of Goods Sold account
during August? What was the ending balance of the Cost
of Goods Sold account?
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Practical Insight
Toyota Production System (Shigeo Shingo and
Taaichi Ohno)
World-class manufacturing
Just-in-time (JIT) manufacturing and purchasing

Fords lean enterprise sys-tem, minus:


did not properly value employees
was not structured to deal with product variety

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ABM versus Lean ABS

Source: Value Based Systems: ABM and Lean, 2011


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Case 6
Couch Potato, Inc., produces futon mattresses.
The company recently changed from a traditional
production environment to just-in-time work cells.
Would you recommend the use of ABM/ABC or
backflush costing for tracking product costs?
Explain your choice.

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Value Streams

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Thank You !

Any comment or question


ssuy@ugm.ac.id

Case 7
A company manufactures pottery products. One of its value streams
produces three prod-ucts: X, Y, and Z. Each pottery product goes
through two cells sequentially: shaping and firing. Each cell has
implemented lean manufacturing and has a team of people and equipment fully dedicated to the cell. The time the products spend in each
cell is as follows:
The cost of materials for each product is $5. Total conversion cost
(labor and overhead) of the value stream is $22 per production hour.

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Case 7

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VALUE STREAM: Definition

Is all activities, both value-added


& non-value-added, required to
bring product group or service from
starting point to finished product in
hands of customer.

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VALUE STREAM
Types of value streams

Order fulfillment
New product

Value stream activities

Non-value-added

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Activities avoidable in the short run


Unavoidable activities due to current technology
or production method

Value added

MANUFACTURING CELL: Definition

Contains all operations in close


proximity that are needed to
produce a family of products.

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LEAN ACCOUNTING: A Comparison

Traditional cost management systems may


not be compatible with Lean Accounting.
Lean Accounting makes product costs
more simple & direct. More labor and
overhead costs are assigned to products
through direct tracing rather than
allocation.

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FOCUSED VALUE STREAMS


Are more simple & accurate in product costing
Have limitations
Initially, labor costs may be difficult to assign if
people are employed in several value streams
Labor costs should assigned proportionately

Are organized around a family of products

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VALUE STREAM DECISIONS


May lead to
Short term decisions
May not reflect long term consequences

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PERFORMANCE MEASUREMENT: A
Comparison

Lean accounting replaces standard cost


system measurements with a Box
Scorecard that compares a) operational,
b) capacity, & c) financial metrics with
prior week performances. A mixture of
financial & nonfinancial measures are
used.

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What are product life cycle


& life cycle costs?

Product life cycle is the time a


product exists from conception
to abandonment. Life cycle
costs are all costs associated
with a product for its life cycle.

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VALUE CHAIN: Definition

Is the set of activities required


to design, develop, produce,
market, and service a product.

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When are most costs


incurred?

During the development stage.


stage
This is also the time costs
should best be managed.

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TARGET COSTING
Uses 1 of 3 methods
Reverse engineering
Tearing down a competitors product to
discover design features that create cost
reductions

Value analysis
Attempting to assess the value placed on
product functions by customers

Process improvement

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