MANAGEMENT ACCOUNTING

WEEK 9

OVERVIEW – CHAPTER 11

Operations & accounting The value chain Manufacturing v. services Standard costs Capacity utilization, spare capacity and

product mix

OPERATIONS & ACCOUNTING

Operations is the function that produces the goods or services to satisfy demand from customers purchasing,

manufacturing, distribution and logistics

Four aspects of the operations function: quality, speed, dependability and flexibility - each has cost implications Slack et al.

What is the cost of spare capacity?

What product/service mix should be produced where there are capacity constraints?

VALUE CHAIN

FFiigguurree 1111..11:: PPoorrtteerr’’ss VVaalluuee CChhaaiinn

FFiirrmm IInnffrraassttrruuccttuurree

HHuummaann RReessoouurrccee MMaannaaggeemmeenntt

TTeecchhnnoollooggyy DDeevveellooppmmeenntt

PPrrooccuurreemmeenntt

IInnbboouunndd OOppeerraattiioonnss OOuuttbboouunndd MMaarrkkeettiinngg SSeerrvviiccee LLooggiissttiiccss LLooggiissttiiccss && SSaalleess

SSuuppppoorrtt aaccttiivviittiieess

MMaarrggiinn

CCooppyyrriigghhtt PPoorrtteerr 11998855.. CCoommppeettiittiivvee AAddvvaannttaaggee NNeeww YYoorrkk:: FFrreeee PPrreessss

PPrriimmaarryy aaccttiivviittiieess

VALUE CHAIN- PORTER

‘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

Costs should be assigned to the value chain but accounting systems can get in the way of analysing those costs Hierarchical

departments v. value processes

The cost drivers of each value activity should be analysed to enable comparisons with competitor value chains

FFiigguurree 1111..22 TThhee mmaannuuffaaccttuurriinngg pprroocceessss aanndd iittss rreellaattiioonnsshhiipp ttoo aaccccoouunnttiinngg IINNPPUUTTSS CCOONNVVEERRSSIIOONN PPRROOCCEESSSS OOUUTTPPUUTTSS CCuussttoomm BBaattcchh CCoonnttiinnuuoouuss RRaaww mmaatteerriiaallss WWoorrkk--iinn--pprrooggrreessss FFiinniisshheedd ggooooddss ++ LLaabboouurr ++ EEqquuiippmmeenntt,, ffaacciilliittiieess,, ssppaaccee,, eettcc.. BBiillll ooff MMaatteerriiaallss LLaabboouurr RRoouuttiinngg CCoommppoonneennttss && qquuaannttiittiieess pprroocceessssiinngg sstteeppss && ttiimmeess

WWhhiicchh aarree pprriicceedd ttoo bbeeccoommee

SSttaannddaarrdd ccoossttss

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

MANUFACTURING V. SERVICESInventory

Raw materialsFinished goodsWork in progress

Costing methods Job costing

Bill of materials Labour routing

Process costing

SERVICES Differences

Intangibility, heterogeneity, simultaneity and perishability

TypesProfessional servicesMass services (transport, retail)Service shop (banks, hotels)

Fitzgerald et al. Professional service equal to customised or batch

manufacturing; mass service with continuous manufacture; and service shop as a batch-type process

- Slack et al.

STANDARD COSTS

Anticipated or budget cost for a unit or batch of units

Standard quantities multiplied by ‘standard’ costs: the current/ anticipated purchase prices for materials and labour rates of pay Materials, labour & overhead Expressed per unit

STANDARD COSTS

PPrriinnttiinngg ooff 55,,000000 ccooppiieess ooff aa tteexxtt bbooookk..

TThhee ccoossttiinngg ssyysstteemm sshhoowwss tthhaatt::

MMaatteerriiaallss ((ppaappeerr,, iinnkk,, eettcc..)) $$1122,,000000

LLaabboouurr ffoorr pprriinnttiinngg $$2200,,000000

OOvveerrhheeaadd aallllooccaatteedd $$1100,,000000

TToottaall JJoobb CCoosstt $$4422,,000000

CCoosstt ppeerr tteexxtt bbooookk (($$4422,,000000//55,,000000 ccooppiieess)) $$88..4400

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

Unused capacity Reduce the supply of resources or Increasing the quantity of activities

Kaplan & Cooper Activity-based costing

cost of resources supplied – cost of resources used = cost of unused capacity

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

CAPACITY UTILIZATION & PRODUCT MIX

Capacity as the limiting factor Ranking of product/services

Contribution per unit of limiting factor

CAPACITY UTILIZATION AND PRODUCT MIX

PPaarrtt FF PPaarrtt GG PPaarrtt HH SSeelllliinngg pprriiccee ppeerr uunniitt

$$115500 $$220000 $$222255

VVaarriiaabbllee mmaatteerriiaall ccoosstt ppeerr uunniitt

$$5500 $$8800 $$4400

VVaarriiaabbllee llaabboouurr ccoosstt ppeerr uunniitt

$$5500 $$6600 $$112255

CCoonnttrriibbuuttiioonn ppeerr uunniitt

$$5500 $$6600 $$6600

MMaacchhiinnee hhoouurrss ppeerr uunniitt

22 44 55

EEssttiimmaatteedd ssaalleess ddeemmaanndd ((uunniittss))

22,,000000 22,,000000 22,,000000

RReeqquuiirreedd mmaacchhiinnee hhoouurrss bbaasseedd oonn eessttiimmaatteedd ddeemmaanndd

44,,000000 88,,000000 1100,,000000

OOVVEERRAALLLL CCAAPPAACCIITTYY LLIIMMIITTAATTIIOONN 1100,,000000 MMAACCHHIINNEE HHOOUURRSS

CONTRIBUTION PER UNIT OF LIMITING FACTOR

PPaarrtt FF PPaarrtt GG PPaarrtt HH CCoonnttrriibbuuttiioonn ppeerr uunniitt

$$5500 $$6600 $$6600

MMaacchhiinnee hhoouurrss ppeerr uunniitt

22 44 55

CCoonnttrriibbuuttiioonn ppeerr mmaacchhiinnee hhoouurr

$$2255 $$1155 $$1122

RRaannkkiinngg ((pprreeffeerreennccee))

11 22 33

OPTIMUM CAPACITY UTILISATION

PPrroodduuccttiioonn CCoonnttrriibbuuttiioonn

22,,000000 ooff PPaarrtt FF @@ 22 hhoouurrss == 44,,000000 hhoouurrss.. 22,,000000 @@ $$5500 ppeerr uunniitt == $$110000,,000000

BBaasseedd oonn tthhee ccaappaacciittyy lliimmiittaattiioonn ooff

1100,,000000 hhoouurrss,, tthheerree aarree 66,,000000 hhoouurrss

rreemmaaiinniinngg,, ssoo BBeeaauuffoorrtt ccaann pprroodduuccee ¾¾

ooff tthhee ddeemmaanndd ffoorr PPaarrtt GG ((66,,000000 hhoouurrss

aavvaaiillaabbllee//88,,000000 hhoouurrss ttoo mmeeeett ddeemmaanndd))

eeqquuiivvaalleenntt ttoo 11,,550000 uunniittss ooff ppaarrtt GG ((¾¾

ooff 22,,000000 uunniittss))..

11,,550000 ooff PPaarrtt GG @@ 44 hhoouurrss == 66,,000000 hhoouurrss 11,,550000 @@ $$6600 ppeerr uunniitt == $$9900,,000000

MMaaxxiimmuumm ccoonnttrriibbuuttiioonn $$119900,,000000

TThheerree iiss nnoo aavvaaiillaabbllee ccaappaacciittyy ffoorr PPaarrtt HH..

BOTTLENECK CAPACITY Seating capacity in restaurant = 100 seats

but not all can be served simultaneously Bottleneck capacity is ability of kitchen to

serve a maximum of 70 people at the same time Medium term: increase kitchen capacity or

reduce seating capacity Short term: capacity limitation is 70, not 100

Note: in this example waiters are a variable labour cost, kitchen staff are a fixed labour cost

THROUGHPUT ACCOUNTING Theory of constraints

Bottleneck defines capacity

Throughput contribution = sales – cost of materials

All other costs are fixed Ranking of product/services

Throughput contribution per unit of bottleneck resource

THROUGHPUT CONTRIBUTION

PPaarrtt FF PPaarrtt GG PPaarrtt HH SSeelllliinngg pprriiccee ppeerr uunniitt $$115500 $$220000 $$222255 VVaarriiaabbllee mmaatteerriiaall ccoosstt ppeerr uunniitt

$$5500 $$8800 $$4400

TThhrroouugghhppuutt ccoonnttrriibbuuttiioonn ppeerr uunniitt

$$110000 $$112200 $$118855

MMaacchhiinnee hhoouurrss ppeerr uunniitt 22 44 55 RReettuurrnn ppeerr mmaacchhiinnee hhoouurr

$$5500 $$3300 $$3377

RRaannkkiinngg ((pprreeffeerreennccee)) 11 33 22 PPrreevviioouuss rraannkkiinngg 11 22 33

Product R Product S

Selling price $12 $20

Materials $4 $11

Labour hours

2 4

Machine hours

4 3

ILLUSTRATIVE QUESTIONS

Q 11.2 Maxitank makes two products. Its costs are:

Maxitank’s sales are limited by the bottleneck (machine) capacity of the factory. Which of the two products should be produced first in order to maximize the throughput contribution generated from the limited capacity?

Product R Product S

Selling price $12 $20

Materials $4 $11

Labour cost $2 $5

Labour hours

2 4

VARIATION TO Q11.2

Maxitanks’ cost of labour is now included:

Which of the two products should be produced first in order to maximize the profits generated from the limited capacity, taking material and labour costs into account?

Q 11.5

Sales 12,000 units @ $100 $1,200,000

Variable costs 588,000

Contribution margin 612,000

Fixed costs 245,000

Profit $367,000

Harrison products capacity is 20,000 units per year. Their results for last year are:

Harrison expects its regular sales next year to be 15,000 units. They also expect fixed costs to increase by $100,000. A foreign distributor has offered to buy a guaranteed 8,000 units at $95 per unit next year. Should Harrison accept this offer?