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ch11.pptxChapter 11
Operating Decisions
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© 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 978XXXXXXXXXX, Chapter X
Overview
The Operations function
Manufacturing
Services
Cost of spare capacity
Capacity utilization and product mix under limited capacity
Operating decisions & relevant costs
Supply chains, total cost of ownership & supplier cost analysis
The cost of quality and environmental cost management
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© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
Operations
Operations is the function that produces the goods or services to satisfy demand from customers, including
purchasing, manufacturing, distribution and logistics
Separation of ‘front office’ (customer facing) from ‘back office’ (support) functions in professional/financial services, etc.
Relates to production of products or services
Five aspects of operations: quality, speed, dependability, flexibility & cost
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© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
Value chain
‘a collection of activities that are performed to design, produce, market, deliver, and support its product … A firm’s value chain and the way it performs individual activities are a reflection of its history, its strategy, its approach to implementing its strategy, and the underlying economics of the activities themselves’
Porter (1985)
Primary & support activities - all have costs – Porter called these ‘cost drivers’
© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
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Value chain & accounting
Value chain and margin:
Costs incurred in value-adding activities must be able to be reflected in price customers are willing to pay with a sufficient margin
Primary & support activities that do not add value, or that customers are unwilling to pay for
© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
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Manufacturing
© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
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Accounting for production of products
Job costing
Bill of materials
Labour routing
Overhead
Process costing
Bill of materials
Conversion costs
Types of inventory:
Raw materials
Work in progress
Finished goods
(See Chapter 8: Accounting for Inventory)
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© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
Production methods
Custom
Unique, single products
Batch
A quantity of the same goods produced at the same time ( a production run)
Continuous (or process)
Continuous production process of the same, indistinguishable goods
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© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
Accounting for production of services
Differences
Intangibility, heterogeneity, simultaneity and perishability of services – no inventory
Types of services:
Professional services (consultants, lawyers)
Mass services (transport, retail)
Service shop (banks, hotels)
Fitzgerald et al. (1991)
Professional service compared with customised or batch manufacturing; mass service with continuous manufacture; and service shop with a batch-type process
Slack et al. (2014)
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© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
Standard costs
Standard quantities of materials and labour hours multiplied by the current/ anticipated purchase prices for materials and labour rates of pay
Budget cost for a product or batch
Usually expressed per unit
Derived from total product or batch cost divided by quantity of finished goods or services produced
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© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
Standard cost illustration
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© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
Operations & accounting
What is the cost of spare capacity?
What product/service mix should be produced where there are capacity constraints?
What are the costs that are relevant for operational decisions?
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© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
Capacity utilization & the cost of spare capacity
Utilization of capacity is a key performance driver
Accounting traditionally equates the cost of using resources with the cost of supplying resources
Identifying unused capacity
cost of resources supplied – cost of resources used = cost of unused capacity
Eliminating unused capacity
Reduce the supply of resources or
Increasing the quantity of activities
Kaplan & Cooper (1998)
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© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
Cost of spare capacity
Cost of resources supplied – cost of resources used = cost of spare capacity
10 staff @ $30,000
Cost driver is 2,000 transactions per person (capacity)
Cost of resources supplied 10 x $30,000 = $300,000
Standard cost per transaction is $300,000/20,000 = $15 per transaction
Actual 18,000 transactions
Cost of resources used 18,000 x $15 = $270,000
Cost of unused capacity = 300,000 – 270,000 = $30,000
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© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
Capacity utilization & product mix
Capacity utilization
Maximising profitability by selecting the optimum product/service mix
Capacity as the limiting factor
Ranking of product/services
Contribution per unit of limiting factor
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© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
Capacity utilization and product mix
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© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
Contribution per unit of limiting factor
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© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
Optimum capacity utilisation
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© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
Theory of constraints
Bottleneck defines capacity Goldratt & Cox (1986)
Throughput contribution
= sales revenue – cost of materials
Assumes all other costs are fixed
Ranking of product/services
Throughput contribution per unit of bottleneck resource
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© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
Throughput contribution
© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
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Operating decisions & relevant costs
Relevant costs are those that are relevant to a particular decision.
Relevant costs are the future, incremental cash flows that result from a decision
Sunk costs are not relevant
Relevant costs may be opportunity costs
the loss of a future cash flow that takes place as a result of making a particular decision
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© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
Avoidable costs
Relevant costs are avoidable costs.
Unavoidable costs are not relevant because, irrespective of what a decision is, unavoidable costs will still be incurred
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© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
Decisions where relevant costs may be important
Make versus buy: outsourcing decisions
Equipment replacement
Relevant cost of materials in a contract
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© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
Total costs: make v. buy
Fixed costs are not relevant
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© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
Relevant costs: make v. buy
© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
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Equipment replacement
Sunk costs and depreciation are not relevant
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© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
Relevant cost of materials
Material purchased specifically - relevant cost is the purchase price
Material already in stock and used regularly - relevant cost is the replacement price
Material already in stock but surplus - relevant cost is the opportunity cost
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© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
Relevant cost of materials
© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
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Comparison with accounting cost of materials
© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
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Supply chain management
Costs associated with suppliers
Purchase cost of product/service
Purchasing costs – finding suppliers, placing/ receiving orders, making payment etc.
Delivery failure costs – late deliveries, lost production, opportunity costs
Quality failure costs – poor quality, returns, rework, scrap, lost production time, opportunity costs
Inventory holding costs – storage, insurance, handling, obsolescence & damage, financial cost
Compliance costs – auditing supplier arrangements, inspections, relationship management
© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
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Total cost of ownership
© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
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Cost of quality
Total Quality Management (TQM) encompasses design, purchasing, operations, distribution, marketing and administration
Continuous improvement requires a systematic approach to quality management which focuses on customers, re-engineers business processes and ensures that all employees are committed to quality
ISO9000
Statistical Process Control (SPC) involves comprehensive measurement
E.g. Six Sigma & DMAIC
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© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
Cost of quality
The difference between the actual costs of production, selling and after-sales service and the costs that would be incurred if there were no failures during production or usage of product/ services
CIMA definition
Conformance costs
prevention costs such as quality measurement and quality training, the costs of inspection and testing
Non-conformance costs
Cost of waste or rework before the product/service reaches the customer
Warranty claims, discounts and replacement costs after the product/service is in the hands of the customer
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© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
Costs of quality
© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
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Environmental cost management
Importance of corporate social responsibility – impact of costs that are externalised to the organization
Environmental costs
Land, water and air pollution, waste treatment
ISO14000
See chapter 7 for CSR reporting in the Annual Report
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© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
Environmental cost reporting
Prevention costs: to avoid environmental damage (e.g. the cost of equipment to reduce pollution and the training of employees);
Measurement costs, to determine the extent of the organization’s environmental impact (including testing, monitoring and external certification);
Internal failure costs, where remedial action has to be taken (e.g. cleaning up spillages or leakages, or employee health and safety-related damages); and
External failure costs (e.g. penalties incurred for environmental damage).
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© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
Key points
Using accounting to help make operations decisions
Manufacturing and services
Standard costs
Cost of spare capacity
Capacity utilization and product mix with limited capacity: Ranking by contribution per unit
Relevant costs
Make versus buy, equipment replacement, cost of materials
Supply chains
Total cost of ownership & supplier cost analysis
Cost of quality and environmental cost management
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© 2015 John Wiley & Sons Ltd, Accounting for Managers, 5th edition, 9781119002949
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A simple exam is the job cost for the printing of 5,000 copies of a text book. The costing system shows that:
Materials (paper, ink, etc.) €12,000
Labour for printing €20,000
Overhead allocated € 10,000
Total Job Cost € 42,000
Cost per text book (€42,000/5,000 copies) £8.40
