Cost Management For Just-in-Time Environments: Principles of Managerial Accounting

Cost Management for Just-in-Time
Environments
11e
Principles of Managerial Accounting
Chapter 12
Prepared by: C. Douglas Cloud
Professor Emeritus of Accounting
Pepperdine University
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
Reeve Warren Duchac
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Learning Objectives
1. Describe just-in-time manufacturing practices.
2. Apply just-in-time practices to a
nonmanufacturing setting.
3. Describe the implications of just-in-time
manufacturing on cost accounting and
performance measurement.
4. Describe and illustrate activity analysis for
improving operations.
Learning Objective 1
Describe just-in-
time
manufacturing
practices.
LO 1
Just-in-Time Practices
 Just-in-time processing (JIT), sometimes called
lean manufacturing, is a philosophy that focuses
on reducing time and cost and eliminating poor
quality.
LO 1
Just-in-Time Practices
LO 1
Reducing Inventory
 Just-in-time (JIT) manufacturing views inventory
as wasteful and unnecessary. As a result, JIT
emphasizes reducing or eliminating inventory.
 Under traditional manufacturing, inventory often
hides underlying production problems.
 JIT manufacturing attempts to solve and remove
production problems.
LO 1
Reducing Inventory
LO 1
Reducing Lead Time

 Lead time, sometimes called throughput time, is a
measure of the time that elapses between starting a
unit of product and completing the unit of product.
The lead time can be classified as one of the
following:
 Value-added lead time, which is the time spent in
converting raw materials into a finished unit of product.
 Non-value-added lead time, which is the time spent while
the unit of product is waiting to enter, or being moved to,
the next production process.
LO 1
Reducing Lead Time
LO 1
Reducing Lead Time

 The value-added ratio is computed as follows:
Value-Added Lead Time

Value-Added Ratio =
Total Lead Time
LO 1
Reducing Lead Time
55 5 35 10 5 10
min. min. min. min. min. min.
click only
once 120 minutes
LO 1
Reducing Lead Time

The material in Exhibit 2 (previous slide) arrived
at 2:00 o’clock and was delivered to the customer
at 4:00 o’clock, or 120 minutes later. Value was
added in only 45 of these minutes. The value-
added ratio is calculated as follows:
Value-Added Ratio =
Total Lead Time
45 minutes
Value-Added Ratio = = 37.5%
120 minutes
LO 1
Reducing Setup Time

 A setup is the effort spent preparing an operation
or process for a production run. If setups are long
and costly, the batch size (number of units) for
the related production run is normally large.
 Large batch sizes allow setup costs to be spread
over more units and, thus, reduce the cost per
unit.
 Exhibit 3 (next slide) shows the relationship
between setup times and lead time.
LO 1
Reducing Setup Time
LO 1
Reducing Setup Time

A product can be manufactured in Process X or
Process Y as follows:
LO 1
Reducing Setup Time
(continued)
LO 1
Reducing Setup Time
LO 1
Reducing Setup Time

 The lead time for Process Y is longer because
each unit has to wait its “turn” while other
units in the batch are processed. It takes a unit
five minutes for each operation—four minutes
waiting and one minute in production.
 The wait time is called within-batch wait time.
The total within-batch wait time is calculated
as follows:
(Total Time to Perform

Total Within-Batch Wait Time =
Operations) x (Batch Size –
1)
LO 1
Reducing Setup Time

The total within-batch wait time for Process Y is
12 minutes, as computed below.
(Total Time to Perform
Total Within-Batch Wait Time =
Operations) x (Batch Size –
1)
Total Within-Batch Wait Time = (1 +1 + 1) minutes x (5 – 1)
Total Within-Batch Wait Time = 12 minutes
LO 1
Reducing Setup Time

The value-added ratio for Process Y is 20%, as
computed below.
Value-Added Ratio =
Total Lead Time
3 minutes
Value-Added Ratio = = 20%
15 minutes
LO 1
Reducing Setup Time

Automotive Components Inc. manufactures
engine starters as follows:
LO 1
Reducing Setup Time

The total within-batch wait time is 936 minutes,
as computed below:
The total lead time is 985 minutes, as computed

below:
LO 1
Reducing Setup Time

Based on the data in the preceding slides, the
value-added ratio is approximately 2.4%, as
computed below:
Value-Added Ratio =
Total Lead Time
(7 + 9 + 8) minutes
Value-Added Ratio =
985 minutes
Value-Added Ratio = 2.4% (rounded)
LO 1
Reducing Setup Time

Automotive Components can increase its value-
added ratio by:
 reducing setups so that the batch size is one
unit (termed one-piece flow), and
 moving the Machining, Assembly, and Testing
operations closer to each other so that the
move time can be reduced.
EE 12-1
12-1
12-1
PE 12-1A, PE 12-1B
LO 1
Emphasizing Product-Oriented Layout

 If the manufacturing process is organized around
a product, it is called a product-oriented layout
(or product cells).
 If the manufacturing process is organized around
a process, it is called a process-oriented layout.
LO 1
Emphasizing Product-Oriented Layout

 Just-in-time normally organizes manufacturing
around products rather than processes.
Organizing work around products reduces:
1. Moving materials and products

between processes
2. Work in process inventory
3. Lead time
4. Production costs
LO 1
Emphasizing Employee Involvement

 Employee involvement is a management
approach that grants employees the responsibility
and authority to make decisions about operations
by:
1. Organizing employees into product cells.
2. Cross-training employees to perform any

operation within the product cell.
LO 1
Emphasizing Pull Manufacturing

 Producing items only as they are needed by the
customer is called pull manufacturing (or make to
order).
 A system that accomplishes pull manufacturing is
often called kanban (Japanese for “cards”).
Electronic cards or containers signal production
quantities to be filled by the preceding operation.
LO 1
Emphasizing Pull Manufacturing

 In contrast, the traditional approach is to
schedule production based on forecasted
customer requirements. This principle is called
push manufacturing (or make to stock).
LO 1
Emphasizing Zero Defects

 Just-in-time manufacturing attempts to eliminate
poor quality. Poor quality creates:
1. Scrap
2. Rework required to fix the product
3. Disruption in the production process
4. Dissatisfied customers
5. Warranty costs and expenses
LO 1
Emphasizing Zero Defects

 Six Sigma was developed by Motorola
Corporation and consists of five steps:
 Define
 Measure
 Analyze
 Improve
 Control
 These five steps form the acronym DMAIC.
LO 1
Emphasizing Supply Chain Management
 Supply chain management coordinates and

controls the flow of materials, services,
information, and finances with suppliers,
manufacturers, and customers.
LO 1
 To enhance the interchange of information

between suppliers and customers, supply chain
management often uses:
 Electronic data interchange (EDI), which uses
computers to communicate
 Radio frequency identification devices (RFID),
which are electronic tags (chips) placed on or
embedded within products that can be read by radio
waves that allow instant monitoring of product
location
LO 1
 Enterprise resource planning (ERP) systems,

which are used to plan and control internal and supply
chain operations
EE 12-2
Apply just-in-time
practices to a
non-
manufacturing
setting.
LO 2
JIT for Nonmanufacturing Processes
(continued)
LO 2
LO 2
Describe the
implications of just-in-
time manufacturing on
cost accounting and
performance
measurement.
LO 3
Accounting for JIT Manufacturing

 In just-in-time manufacturing, the accounting
system has the following characteristics:
 Fewer transactions. There are fewer transactions to
record, thus simplifying the accounting system.
 Combined accounts. All in-process work is combined
with raw materials to form a new account, Raw and
In Process (RIP) Inventory.
LO 3
Accounting for JIT Manufacturing

 Combined accounts. Direct labor is combined with
other costs to form a new account titled Conversion
Costs.
 Nonfinancial performance measures. Nonfinancial
performance measures are emphasized.
 Direct tracing of overhead. Indirect labor is directly
assigned to product cells; thus, less factory overhead
is allocated to products.
LO 3
Fewer Transactions
 The accounting system for just-in-time
manufacturing is simplified by eliminating the
accumulation and transfer of product costs by
departments. This type of accounting is termed
backflush accounting.
LO 3
Combined Accounts
Anderson Metal Fabricators, a manufacturer of
metal covers for electronic test equipment, has an
annual budgeted conversion cost of $2,400,000
and 1,920 planned hours of production. The cell
conversion cost rate is determined as follows:
Budgeting Conversion Cost
Cell Conversion Cost Rate =
Planned Hours of Production
$2,400,000
Cell Conversion Cost Rate = = $1,250 per hr
1,920 hours
LO 3
Combined Accounts
Assume that Anderson Metal’s cover product cell

is expected to require 0.02 hour of manufacturing
time per unit. Thus, the conversion cost for the
cover is $25 per unit, as shown below.
Conversion Cost for Manufacturing Cell Conversion Cost
= ×
Cover Time Rate
= 0.02 hours × $1,250
= $25 per unit
LO 3
Combined Accounts
1. Steel coil is purchased for producing 8,000
metal covers. The purchase cost was $120,000,
or $15 per unit.
Raw and In Process Inventory 120,000
Accounts Payable 120,000
To record materials purchases.
AAseparate
separate
Raw
RawMaterials
Materials
account
account is
isnot
not
used.
used.
LO 3
Combined Accounts
2. Conversion costs are applied to 8,000 covers at
a rate of $25 per cover.
Conversion Costs 200,000
To record applied conversion
costs of the medium-cover line.
The
TheRaw
Rawand
and In
In Process
Process
Inventory
Inventoryaccount
account isisused
used
to
toaccumulate
accumulatethetheapplied
applied
conversion costs..
conversioncosts
LO 3
Combined Accounts
3. All 8,000 covers were completed in the cell.
Finished Goods Inventory 320,000
To transfer the cost of
completed units to finished
goods. Materials
Materials
($15
($15xx8,000
8,000units)
units) $120,000
$120,000
Conversion
Conversion
This is a backflush transaction
($25
This is a backflush transaction($25xx8,000
8,000units)
units) 200,000
200,000
because the raw and in process
because the raw and in process Total $320,000
Total $320,000
inventory account balance is
inventory account balance is zero zero
after
afterthe
thetransfer.
transfer.
LO 3
Combined Accounts
4. Of the 8,000 units completed, 7,800 were sold
and shipped to customers at $70 per unit.
Accounts Receivable 546,000
Sales 546,000
To record sales.
Cost of Goods Sold 7,800

7,800 ×× $70
$70
312,000
Finished Goods Inventory 312,000
To record cost of goods sold.
7,800
7,800 ×× $40
$40
EE 12-3
LO 3
Nonfinancial Performance Measures

 A nonfinancial measure is operating information
that has not been stated in dollar terms. Examples
include:
1. Lead time
2. Value-added ratio
3. Setup time
4. Number of production line stops
5. Number of units scrapped
6. Deviations from scheduled production
7. Number of failed inspections
Describe and
illustrate activity
analysis for
improving
operations.
LO 4
Activity Analysis
 An activity analysis determines the cost of
activities based on an analysis of employee effort
and other records. An activity analysis can be
used to determine the cost of:
 Quality
 Value-added activities
 Processes
LO 4
Costs of Quality
 Prevention costs are costs of preventing defects
before or during the manufacture of the product
or delivery of services.
 Appraisal costs are costs of activities that detect,
measure, evaluate, and inspect products and
processes to ensure that they meet customer
needs.
(continued)
LO 4
Costs of Quality
 Internal failure costs are costs associated with
defects discovered before the product is delivered
to the consumer.
 External failure costs are costs incurred after
defective products have been delivered to
consumers.
LO 4
Costs of Quality
LO 4
Costs of Quality
 Exhibit 7 (next slide) shows the relationship
between the costs of quality. The internal and
external failure costs decline with increases in the
percentage of good units produced.
LO 4
Costs of Quality
LO 4
Quality Activity Analysis
LO 4
Pareto Chart of Quality Costs

 Managers want information displayed so that
important problems or issues can be identified
quickly. One method of reporting quality cost
information is the Pareto chart.
 A Pareto chart is a bar chart that shows the totals
of an attribute for a number of ranked categories.
LO 4
Pareto Chart of Quality Costs
LO 4
Cost of Quality Report

 A cost of quality report normally reports the:
1. Total activity cost for each quality cost
classification
2. Percent of total quality costs associated with each
classification
3. Percent of each quality cost classification to sales
LO 4
Cost of Quality Report
EE 12-4
LO 4
Value-Added Activity Analysis

 A value-added activity is one that is necessary to
meet customer requirements.
 A non-value-added activity is not required by the
customer, but occurs because of mistakes, errors,
omissions, and process failures.
LO 4
Value-Added Activity Analysis
LO 4
Process Activity Analysis

 A process is a series of activities that converts an
input into an output. Common business processes
include:
1. Procurement
2. Product development
3. Manufacturing
4. Distribution
5. Sales order fulfillment
LO 4
LO 4

Assume that the cost of a firm’s four activities is
as follows:
If 10,000 sales orders are filled during the current

period, the per-unit process cost is $8 per order
($80,000/10,000 orders).
LO 4
Masters Company determines that only new

customers need to have a credit check. If this
change is made, it is estimated that only 25% of
sales orders would require credit checks. In
addition, by revising the warehouse product
layout, it is estimated that the cost of picking
orders can be reduced by 35%.
LO 4

If 10,000 orders will be filled, the cost savings
from these two improvements are as follows:
EE 12-5
Cost Management for Just-in-Time
Environments
The
The End
End
Prepared by: C. Douglas Cloud
Professor Emeritus of Accounting
Pepperdine University
© 2012 Cengage
permitted Learning. All distributed
in a license Rights Reserved.
with aMay notproduct
certain be copied,
or scanned,
service ororotherwise
duplicated,
on ainpassword-protected
whole or in part, except for for
website useclassroom
as use.

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Cost Management for Just-in-Time

Principles of Managerial Accounting

Reducing Lead Time

Reducing Lead Time

Reducing Lead Time

Value-Added Lead Time

Reducing Lead Time

Reducing Lead Time

Reducing Setup Time

Reducing Setup Time

Reducing Setup Time

Reducing Setup Time

Reducing Setup Time

Reducing Setup Time

(Total Time to Perform

Reducing Setup Time

Total Within-Batch Wait Time = 12 minutes

Reducing Setup Time

Reducing Setup Time

Reducing Setup Time

The total lead time is 985 minutes, as computed

Reducing Setup Time

Reducing Setup Time

Emphasizing Product-Oriented Layout

Emphasizing Product-Oriented Layout

1. Moving materials and products

Emphasizing Employee Involvement

2. Cross-training employees to perform any

Emphasizing Pull Manufacturing

Emphasizing Pull Manufacturing

Emphasizing Zero Defects

Emphasizing Zero Defects

Emphasizing Supply Chain Management

 Supply chain management coordinates and

Emphasizing Supply Chain Management

 To enhance the interchange of information

Emphasizing Supply Chain Management

 Enterprise resource planning (ERP) systems,

JIT for Nonmanufacturing Processes

JIT for Nonmanufacturing Processes

JIT for Nonmanufacturing Processes

Accounting for JIT Manufacturing

Accounting for JIT Manufacturing

Assume that Anderson Metal’s cover product cell

= 0.02 hours × $1,250

= $25 per unit

Cost of Goods Sold 7,800

Nonfinancial Performance Measures

Quality Activity Analysis

Pareto Chart of Quality Costs

Pareto Chart of Quality Costs

Cost of Quality Report

Cost of Quality Report

Value-Added Activity Analysis

Value-Added Activity Analysis

Process Activity Analysis

Process Activity Analysis

Process Activity Analysis

If 10,000 sales orders are filled during the current

Process Activity Analysis

Masters Company determines that only new

Process Activity Analysis

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