STUDY UNIT SEVEN

COST MANAGEMENT CONCEPTS

Financial Management
accounting accounting

-concerned principally with reporting to external users, -concerned principally with reporting to internal users.

-follow GAAP -Not required follow GAAP

-financial statements produced. -produce reports that improve organizational decision
Making
-has a historical focus.
-has future-oriented.

Cost accounting supports both financial and management accounting. Information about the cost of resources
acquired and consumed by an organization underlies effective reporting for both internal and external users.

A cost is defined by the

IMA in two senses:

In management accounting: a measurement in In financial accounting, the sacrifice measured by the

monetary terms of the amount of resources used price paid or required to be paid to acquire goods or
for some purpose. services.

A cost object Any object to which costs can be attached.

A cost driver The basis used to assign costs to a cost object.

Direct costs Indirect costs

Costs that can be associated with a particular cost Costs that cannot be associated with a particular cost object
object in an economically feasible way in an economically feasible way

Cost pool An account into which a variety of similar cost elements with a common cause are accumulated.

Common costs Another notable type of indirect cost. A common cost is a cost incurred for the benefit of more
than one cost object.

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 Manufacturing Nonmanufacturing
Cost cost

-Direct materials -Selling (marketing) expenses (sales personnel

salaries, advertising)
-Direct labor
-Administrative expenses (executive salaries,
-Manufacturing overhead (Indirect materials-Indirect
depreciation on the headquarters building)
labor-Factory operating costs,)

Prime cost DM+DL Conversion cost DL+MOH

Product costs Capitalized as part of finished goods inventory. (DM.DL)

Period costs Expensed as incurred

Relevant Range The limits within which per-unit variable costs remain constant
and fixed costs are not changeable.

Variable Costs Direct function of production volume. They increase when production grows and
decrease when production shrinks (DM, DL VOH)

Variable cost Fixed Costs

Per unit: Remains constant in the short run Per unit: varies indirectly with the activity level
regardless of the level of production.
In total, vary directly and proportionally with In total, remain unchanged in the short run regardless of
changes in volume. production level

Mixed Combine fixed and variable elements, e.g., rental expense on a car that carries a flat
(Semivariable) fee per month plus an additional fee for each mile driven
Costs Two methods of estimating mixed costs are in general use:
1) regression method: Y=a+bx
2) high-low method Cost at highest activity level-cost at lowest level
Variable portion of mixed cost =
Driver at highest activity level-Driver at lowest level

Marginal Cost Relevant range

The cost incurred by a one-unit increase in the All costs are variable in the long run.
activity level of a particular cost driver. Investment in new, more productive equipment results
- Marginal cost remains constant across the in higher total fixed costs but may result in lower total
relevant range. and per-unit variable costs.

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 Controllable Noncontrollable
COST COST

Those that are directly influenced at a given Those that a particular manager does not have the
level of managerial authority within a given Authority to change.
time period.
- Controllability is determined at different
levels of the organization.

Avoidable costs Committed

costs
Those that may be eliminated by not engaging in Arise from holding property, plant, and equipment.
an activity or by performing it more efficiently.

Incremental cost Differential cost

The additional cost inherent in a given decision. The difference in total cost between two decisions.

Engineered costs Discretionary costs

Those having a direct, observable, quantifiable cause- Those characterized by an uncertainty in the
and-effect relationship between the level of output and degree of causation between the level of output
the quantity of resources consumed. and the quantity of resources consumed

Outlay costs/ explicit Opportunity cost/ implicit cost

Require actual cash disbursements The maximum benefit forgone by using a scarce resource
for a given purpose and not for the next-best alternative

Economic cost Imputed costs

The sum of explicit and implicit costs. Those that should be involved in decision making even
though no transaction has occurred that would be routinely
recognized in the accounts, a type of opportunity cost.

Relevant costs Sunk costs Historical cost

Those future costs that will vary Costs either already paid or The actual (explicit) price paid for an
depending on the action taken irrevocably committed to incur. asset
Because they are unavoidable

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 Normal spoilage Abnormal spoilage

-the spoilage that occurs under normal operating -spoilage that is not expected to occur under normal.
conditions - Abnormal spoilage is typically treated as a period
- Treated as a product cost. cost

Rework Scrap Waste

-End products that do not meet -Raw material left over from the - Raw material left over from the
standards of salability but can be production cycle but still usable for production cycle for which there is
brought to salable condition with purposes other than those for which no further use.
additional effort. it was originally intended.

Carrying costs The costs of storing or holding inventory

Transferred-in costs Those incurred in a preceding department and received in a subsequent department

Value-adding costs The costs of activities that cannot be eliminated without reducing the quality,
responsiveness, or quantity of the output

Stock out costs The opportunity costs of missing a customer order

Normal capacity Practical capacity Theoretical (ideal) capacity

The long-term average level of The maximum level at which output The maximum capacity assuming
activity that will approximate is produced efficiently. It allows for continuous operations with no
Demand over a period that includes unavoidable delays in production holidays
seasonal for maintenance

Actual costing Normal costing Extended normal costing

-Recording of product costs based on - applies overhead on the basis of a Extends the use of normalized
actual (1) cost of materials, (2) cost of budgeted rate and DL&DM Actual. rates to direct material and
labor, and (3) overhead incurred. - compensates for the fluctuations in direct labor, so that all three
- The most accurate method of unit cost inherent in actual costing. major input categories use
accumulating costs. - The difference is immaterial between normalized rates.
- The least timely. budgeted overhead and actual
-Disadvantage: prepared after overhead it should be allocated to
production period. cost of goods sold
- Large fluctuations arise from period - The difference is material it should
to period. be prorated between cost of goods
sold, work-in process, and finished
goods inventories

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 Standard costing Flexible budgeting

-a system designed to alert management when the -the calculation of the quantity and cost of inputs
actual costs of production differ significantly from that should have been consumed given the
budgeted. achieved level of production.
-Standard costs are predetermined, attainable unit -Flexible budgeting supplements the static budget,
costs. A standard cost is not just an average of past which is the company’s best projection of the
costs, but an objectively determined estimate of what a resource consumption and levels of output that will
cost should be. be achieved for an upcoming period.
-tends to simplify recordkeeping. -The static and flexible budgets are compared to the
-Lower than using actual cost. actual results and the differences are calculated.
-Used with Job order-process costing system. These differences are referred to as variances.
-If the difference between budget OVH and actual OVH
is immaterial, it should be allocated to cost of goods
sold, if it material it should be prorated between costs
of goods sold, work-in process, and finished goods
inventories.

Variable/ direct costing Absorption, full costing

-Used for internal purposes. Sales - For external reporting purposes Sales
-fixed overhead treated as -the fixed overhead treated as
Period cost. -COGS A product cost. -COGS
-Product cost includes DM -Product cost thus includes DM
Only the variable portion DL All manufacturing costs, DL
Of manufacturing costs. VOH -Absorption cost of goods sold VOH
-Fixed manufacturing VS . Is subtracted from sales to arrive FOH .
Costs are considered Contribution margin At gross margin Gross margin
Period costs and are - fixed OVH -S&A expenses are subtracted - Total S&A expenses
Thus expensed as incurred. Fixed S&A expenses To arrive operating cost. Operating income
-Variable-basis cost of Operating income
Goods sold and the
Variable portion of S&A expenses are subtracted from
sales to arrive at Contribution margin.

Note that ending finished goods inventory will differ between the two methods due to the different treatment of fixed
production costs.

The two methods have varying effects on operating income.

-When everything produced during a period is sold that period, the two methods report the same operating income.
-when production exceeds sales, operating income is higher under absorption costing than it would be under
variable costing.
-when production is less than sales, operating income is higher under variable costing than it would be under
absorption costing

Effects on Income and Ending Inventory

-The value of ending inventory is never higher under variable costing than it is under absorption costing.
-Income and inventory levels will differ whenever sales and production differ.
-Variable costing will show a higher income in periods when inventories decline and will show a lower income when
inventory increase because all fixed costs are being subtracted on the income statement.
-
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 STUDY UNIT EIGHT

COST ACCUMULATION SYSTEMS

Job-Order Costing Process Costing

Use Concerned with accumulating costs by specific job Use It is applicable to relatively homogeneous
when producing products with individual characteristics. products that are mass produced on a continuous basis.
Accumulation of Costs
-Units should be dissimilar enough to warrant the special
recordkeeping and made for specific customer. - The accumulation of costs is by department rather
Steps than by project.
- As in job-order costing, the physical inputs required for
1- receipt of a sales order the production process are obtained from suppliers.
2- The sales order is approved, and a production order - Direct materials actually used by the first department in
is issued. the process are added to WIP for that department.
3- Costs are recorded by classification on a job-cost - Conversion costs used by the first department, are
sheet such as direct materials, added to WIP for that department.
4- estimated overhead rate is necessary - The products can move from one department to the next
If overhead applied > overhead control mean overapplied (from Department A to Department B).
If overhead applied < overhead control mean underapplied - If a standard costing system is used, standard costs are
5- When a job order is completed, all the costs are applied before transfer from WIP to finished goods.
transferred to finished goods. - When processing is finished in the last department, all
the costs are transferred to finished good.
Spoilage. - As products are sold, the costs are transferred to cost of
Normal spoilage is treated as a product cost while abnormal goods sold
spoilage is treated as a period cost.
Spoilage.
1- Normal spoilage: is the amount expected in the As with job-order costing, the cost of a normal level of
ordinary course of production. spoilage is left in cost of goods sold;
If the normal spoilage is worthless, it should be discarded. - Recognizing the loss resulting from abnormal spoilage
No journal entry will be made. under process costing is a multi-step process
If the normal spoilage can be sold, its value should not be 1- The manufacturer establishes inspection points, that is,
included in the cost of the good units produced the places in the production process where those goods
2- Abnormal spoilage: is spoilage over the amount not meeting specifications are pulled from the process.
expected in the ordinary course of production. 2- The loss is equal to the number of units of abnormal
Abnormal spoilage costs are expensed spoilage multiplied by the department’s equivalent-units
If the abnormal spoilage is worthless, it should be costs, whether weighted-average or FIFO.
discarded.
If the abnormal spoilage can be sold, it should be sold.

Rework

Consists of unacceptable units that can be repaired and

sold as acceptable units.
Scrap
Leftover material with no attached cost and low sales
value. It may be recognized as revenue
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 Equivalent Units of Some units remain unfinished at the end of the period. For each department to account
Production adequately for costs attached to its unfinished units.
Unit transferred +ending WIP = beginning WIP + unit started
Units started and completed = Unit transferred- beginning WIP

Weighted-average method First-in, first-out (FIFO) method

The beginning WIP is treated as if it is started and Work done in the current period on units in
completed during the current period. beginning WIP are included in the calculation.

Equivalent Units of Production – Materials

Materials can be added at the beginning

- Beginning WIP: treated as 100% complete and will Beginning WIP: will not produce EUP in the
produce EUP in the current period even though current period since materials were added in the
materials were added in the previous period.100% previous period.0%
- Units started and completed are always 100% complete with respect to direct materials.
-Units in ending WIP are 100% complete with respect to direct materials when materials
are all added at the beginning of the production process.

Materials can be added evenly throughout the process

- Beginning WIP: treated as 100% complete and will - Beginning WIP: we are looking for the amount
produce EUP in the current period even though completed in the current period, we subtract the
materials were added in the previous period. completion percentage from 100%. This will give us the
percentage completed in the current period. 70% (100%
– 30%)
- Units started and completed are always 100% complete with respect to direct materials.
- Units in ending WIP will be complete based on the completion percentage
Materials added at a specific time during production
- Beginning WIP: If the point at which materials are added occurs during the current period,
Beginning WIP will produce EUP.
- Units started and completed are always 100% complete with respect to direct materials.
-Ending WIP: - If the point at which materials are added occurred during the current period,
ending WIP will produce EUP for the current period.
-If the point at which materials are added occurs during the next period, ending WIP will not
produce EUP for the current period
Equivalent Units of Production – Conversion Costs
Since conversion costs are generally added throughout the process,
- Beginning WIP: treated as 100% complete and will - Beginning WIP: we are looking for the amount
produce EUP in the current period even though completed in the current period, we subtract the
materials were added in the previous period. completion percentage from 100%. This will give us the
percentage completed in the current period. 70%
(100% – 30%)

- Units started and completed are always 100% complete with respect to direct materials.
- Units in ending WIP will be complete based on the completion percentage

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Traditional (Volume-Based) Costing System

-The inaccurate averaging or spreading of indirect costs over products or service units that use different
amounts of resources is sometimes called peanut-butter costing.
-Peanut-butter costing results in product-cost cross-subsidization, the condition in which the miscosting
of one product causes the miscosting of other products.
-The peanut-butter effect of using a traditional, can be summarized as follows:
1- Direct labor and direct materials are traced to products 2-single pool of indirect costs
3-Indirect costs from the pool are assigned using an allocative (rather than a tracing) procedure, such as
using a single overhead
-Traditional-based systems were appropriate when direct costs were the bulk of manufacturing costs
-
ACTIVITY-BASED COSTING
- (ABC) is a response to the significant increase in indirect costs resulting from the rapid advance of
technology.
-Under ABC, indirect costs are attached to activities that are then rationally allocated to end products.

STEPS
Step one: indirect costs (activity analysis classification) activities are classified in hierarchy according to the level of
the production process at which they take place

1-unit level activity .IN DL, IN DM, inspection 2-Batch-level activities (machine setup, batch quality)

3-product sustaining activities (product design, product testing

4-faclity sustaining activities (utilities, rent, maintenance, deprecation, security, safety

Step two assign resources of costs; the indirect costs are mapped into the resources that have been identified.

1-Material handling: IND M, IND L 2- quality &inspection: inspection, batch quality

3-product: product design, product testing. 4-machinig: utilities, maintenance, deprecation, machine setup

5: facility management: security, safety, insurance, rent

Step three accumulate the cost of resource in multi pools: once the resources have been identified, the costs of
resources are accumulated accordingly.

Step four identify the resource driver: once the resource and costs accumulated, the resource driver are identified
at entire entity.

Resource driver’s 1-Material handling: No. of production Units 2-- quality &inspection: No. of inspection

3- product: No. of production units 4-machinig: utilities, machine hours

5-facility management: square footage

Step five calculate cost per resource driver: the dollar amount of resources per resource driver

Accumulate the cost of resource in multi pools / identify the resource driver Exp.- quality &inspection/ No. of
inspection

Step six identify the cost driver: in this step the cost driver actually consumed by the activity is determined.

Square footage be discard.

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Step seven allocate resource costs to final cost object: the final step in enacting an ABC is allocated the ABC cost
objects.
 Process Value Analysis

-determination of which activities that use resources are value-adding or nonvalue-adding and how the
latter may be reduced or eliminated.
A value-adding activity A nonvalue-adding activity
-contributes to customer satisfaction or meets a -does not make such a contribution. It can be
Need of the entity. eliminated, reduced, or redesigned without impairing
-The perception is that it cannot be omitted without the quantity, quality.
a loss of the quantity, quality

-Activity-based management (ABM): The linkage of product costing and continuous improvement of
processes.

Advantages of Activity-Based Costing Disadvantages of Activity-Based Costing

- An advantage of ABC is that product -Cost of implementation -the increased time
costing is improved, making for better decision -effort needed
making. -maintain a separate accounting system to
-The process value analysis performed as capture resource costs
part of ABC provides information for eliminating -design and implement drivers and cost pools.
or reducing nonvalue-adding activities. -Initial costs are quite high, and continuing costs
-The real benefits of ABC occur when a of application can also be significant.
company has a high level of fixed costs and -if a company has a low level of fixed costs or
produces a wide variety of products with widely produces a single product, there is little to no
varying levels of production. advantage in using ABC.
-may not conform with GAAP;

LIFE-CYCLE COSTING

A life-cycle approach to budgeting estimates a product’s revenues and expenses over its entire sales life cycle.

The product life cycle has five phases:

Introduction Maturity
Research and Growth Decline stage
development Few competitors Sales growth
Number of
Competitors’increase
Profits Low declines
No sales (not peak), cost competitors’
slow sales growth decreases
high costs reductions maximize Competitors
numerous.

Value chain for a manufacturer

R&D Product Manufacturing Marketing & Customer

design distribution service

Upstream cost Downstream cost

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 Potential Benefits

-emphasizes the relationships among costs incurred at different value-chain stages

-Life-cycle costing highlights the potential for cost reduction activities during the upstream phase and
minimize downstream Costs of the value chain.

Whole-life cost Whole life cost equal life cycle cost plus after purchased cost

Target costing and target pricing.

-A firm may determine that market conditions require that a product sell at a given target price.
-Target costing is the practice of calculating the price for a product by adding the desired unit profit margin to the
total unit cost.

Value engineering

-a means of reaching targeted cost levels.

-Value engineering is a systematic approach to assessing all aspects of the value chain cost buildup for a product.
-The purpose is to minimize costs without reducing customer satisfaction
-For this purpose, distinguishing between value-adding and nonvalueadding activities is useful.

Internal and External Reporting Effects

For internal management accounting purposes, the For external financial statement purposes, costs during
costs (such as R&D) that result in marketable the upstream phase and downstream must be
products represent a life-cycle investment and must expensed in the period incurred
be capitalized.

Evaluating Management

The overall advantage of life-cycle costing is that it provides a better measure for evaluating the performance of
product managers.

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 STUDY UNIT NINE
COST ALLOCATION TECHNIQUES

Joint (common) costs Separable costs By-products

-those costs incurred before -those incurred beyond - one or more products of relatively small total value
the split-off point the split-off point - produced simultaneously from a common
-they are not traceable - they can be identified manufacturing process
Include DM, DL, MOH... they with a particular joint -Do the benefits of further processing and bringing
are not separately product them to market exceed the costs
identifiable, they must be - they can be allocated Selling price – Additional processing costs –
allocated to the individual to a specific unit of Selling costs NRV
joint products. output -If NRV zero or negative should be discarded as
scrap.
-If it material, they are capitalized in a separate
inventory account.
-If it immaterial, not recognized until the time of sale
-it do not receive an allocation of joint costs.

Joint Cost Allocation

physical-measure-based Market-based approaches (on a monetary basis.)

approach(physical
measure)
physical-unit method sales-value at split- estimated NRV constant-gross-margin
off method method percentage NRV method
-Allocates joint production - 1) Revenues from - same sales-value at - Determine the overall gross-
costs to each product separate product split-off method margin percentage.
based on their relative /total revenues for all -The significant - Subtract the separable costs
proportions of the measure separate product. difference is that, to arrive at the joint cost
selected. EXP.Revenues from under the estimated amount
- Advantages (a) ease of separate NRV method, all $145,000 – $100,000 – $7,000 =
use and (b) having 300x$ 70 =21,000 separable costs $38,000
objective criteria for the Total revenues=145000 necessary to make the - Subtract the appropriate
allocation of the joint costs 2) The amount before product salable are gross margin from the final
- limitations it treats low- split off x the result subtracted before the sales value of each product to
value products that are from upper equation. allocation is calculate total costs for that
large in size as if they were 100000x(21000/145000) Made product.
valuable EXp. 21,000-1000=20000. $38,000 ÷ $145,000 = 26.21%
100000x(20000/138000) $ 21,000 – ($ 21,000 × 26.21%)

Components of Manufacturing Overhead

Indirect materials Tangible inputs to the manufacturing process that cannot be traced.
Indirect labor human labor connected with the manufacturing process that cannot be traced
Factory operating costs utilities, real estate taxes, insurance, depreciation

Variable overhead costs indirect materials, indirect labor, utilities, and depreciation expense under any
method that ties depreciation to the level of output( short run)
Fixed overhead costs real estate taxes, insurance, and depreciation expense under any method
not related to the level of output(long run) 11 | P a g e
 The estimates made of the total
amounts of overhead
Overhead application rate:
=
Estimate of the total quantity of each
allocation base that will be expended

Estimates of the total quantity of each allocation base can be based off different capacity levels.

Normal capacity Practical capacity Theoretical (ideal) capacity

The long-term average level of The maximum level at which output the maximum capacity assuming
activity that will approximate is produced efficiently. It continuous
demand over a period that includes allows for unavoidable delays in operations with no holidays,
seasonal, cyclical, and trend production for maintenance, downtime, etc.
variations holidays, etc.

Departmental Plant-Wide Rates

-A more accurate method is the use of -This method has the benefit of simplicity
departmental rates. -Some production departments may be labor-intensive while
others are Machine-intensive. In these cases, the use of a
single driver for applying overhead to every phase of the
production results in the miscosting of products.
-Less effective control, and less efficient operations

-Calculating new overhead application no more often than annually.

Actual costing Normal costing Extended normal costing

DM Actual Actual Budgeted

DL Actual Actual Budgeted
MOH Actual Budgeted Budgeted

During the budget period, actual overhead costs are accumulated in the control accounts as they are incurred.

At the end of the period, overhead is applied to work-in-process based on the actual level of the driver

-Overapplied overhead: when product costs are overstated because the Activity level was higher than
expected-Actual overhead costs were lower than expected.
-Underapplied overhead: when product costs are understated because the Activity level was lower than
expected or Actual overhead costs were higher than expected.
-If the amount of over- or underapplied overhead is considered immaterial, it can be closed to COGS.
-If the amount of over- or underapplied overhead is considered material, it should be allocated based on
the relative values of WIP, finished goods, and COGS.

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 ALLOCATING SERVICE DEPARTMENT COSTS

Four criteria are used to allocate costs

1-Cause and effect should be used if possible.

2-Benefits received is the most frequently used alternative when a cause-and-effect relationship cannot be
determined.
3- Sometimes mentioned in government contracts but appears to be more of a goal than an objective
allocation base. Management judgment is used to determine fairness.
4-Ability to bear (based on profits) is usually unacceptable because of its dysfunctional effect on
managerial motivation.
The three methods of service department allocation in general use (for internal reporting)
Direct - The simplest.
Method - Service department costs are allocated directly to the producing departments without regard
for services rendered by service departments to each other.
EXP. page No.194
Step -Under the step (or step-down) method, some of the costs of services rendered by service
(Step- departments are allocated to each other EXP. page No.195.
Down) -The service departments are allocated in order, from the one that provides the most service
Method to other service departments down

Reciprocal
Method
The most
accurate
method

dual-rate method single-rate method

Use two bases to allocate the overhead cost of Use one bases to allocate the overhead cost of service
service department to operating department department to operating department

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 STUDY UNIT TEN
SUPPLY CHAIN MANAGEMENT

JUST-IN-TIME INVENTORY

-Modern inventory planning favors the just-in-time (JIT) model.

-JIT views inventory as a liability and limits output to the demand of the subsequent operation.
-Reductions in inventory levels result in less money invested in idle ‫غير مستخدمة‬assets.
-Reduction of storage space requirements, lower inventory taxes, pilferage, and obsolescence risks.
-JIT is a reaction to the trends of global competition and rapid technological progress.
-High inventory levels often mask production problems but if only have enough parts are made for the subsequent
operation, however, any defects will immediately halt production.
-The focus of quality control under JIT shifts from the discovery of defective to the prevention of quality problems.
Objectives
-Higher productivity, reduced order costs as well as carrying costs, faster and cheaper setups, shorter
manufacturing cycle times, better due date performance, improved quality, and more flexible processes
- The ultimate goal is increased competitiveness and higher profits.
Features
- JIT is a pull system; i.e., items are pulled through production by current demand.
- Demand-driven production allows inventory levels to be minimized.
- Decrease in the number of suppliers.
- Buyer-supplier relationships are facilitated by electronic data interchange (EDI), a technology that allows the
supplier access to the buyer’s online inventory management system.
Effects on Operations
- Lower inventory levels associated with a JIT (lean) system is elimination of the need for certain internal controls.
- JIT also may eliminate central receiving areas, hard copy receiving reports, and storage areas.
- Manufacturing lead time is reduced.
- Production setup costs and times per lot are reduced.
- The quality of parts provided by suppliers is verified by use of statistical controls rather than inspection of incoming
goods.
Implementing JIT
1) Manufacturing is reorganized around what are called manufacturing cells
-In a conventional plant layout, each department or function operates specialized machines that perform one task.
All work moves from department to department.
- In a cellular layout, each cell is a miniature manufacturing plant ‫مصنع مصغر‬. Cells are sets of machines, often
grouped in semicircles, that produce a given product or product family.
2) Each worker in a cell must be able to operate all machines.
3) A cellular organization requires workers to operate as effective teams, so employee empowerment is crucial in a
JIT inventory or lean production system.

Just-in-case -traditional inventory planning views inventory as an asset.

-the next operation will always have parts to work with
Lean manufacturing
- expands the concept of JIT. It focus on accomplishing more with fewer resources providing customers with what
they want, and meeting their expectations.
- Five principles of lean manufacturing
a) Value: identifying the features of the product.
b) Value stream requires (1) examining every process within the production of a product, (2) identifying processes
that add value, (3) removing processes (if possible) that do not add value.
c) Flow and pull incorporates designing the production process to be capable of maximizing the flow of the
product initiated by the pull of customer.
d) Empowerment provides each employee with the knowledge and authority to make valuable and timely
decisions in order to (1) add customer value and (2) eliminate waste from the process. 14 | P a g e
e) Perfection focuses on making incremental improvement in each process.
 Role of - Kanban is (Japanese term) one of the many elements in the JIT.
Kanban - Kanban means ticket. Control the flow of production or parts so that they are produced or
obtained in the needed amounts at the needed times.
- When a worker sees a kanban, the card or ticket acts as authorization to release inventory to the
next step.
- U.S. companies have been used, computerized information systems have been used for many
years, they reluctant to give up their computers in favor of the essentially manual kanban system.

ENTERPRISE RESOURCE PLANNING

- Short-range (tactical or operational) plans must be converted into specific production targets for finished goods.
- The raw materials going into the creation of these end products must be carefully scheduled for delivery.

- Master production schedule (MPS). The yearly/quarterly/monthly numbers and styles of finished goods called
for in the demand forecasts included in the operational plans must be turned into specific dates for completion
and availability for shipment to the customer

Materials Requirements Planning (MRP)

-A computerized system for moving materials through a production process according to a predetermined schedule.
-enables a company to efficiently fulfill the requirements of the MPS.
-Overriding goals of MRP are the arrival of the right part, in the right quantity, at the right time.
-MRP is a push system; i.e., the demand for raw materials is driven by the forecasted.
-MRP, in effect, creates schedules of when items of inventory will be needed in the production departments.
-If parts are not in stock, the system automatically generates a purchase order on the proper date.
-The timing of deliveries is vital to avoid both production delays and a pileup of raw materials inventory.
-The MRP system consults the bill of materials (BOM), a record of which (and how many) subassemblies go into
the finished product.
-Lead time is the amount of time between when a process starts and when it is completed.
- Some benefits of MRP are
1) Reduced idle time 2) Lower setup costs
3) Lower inventory carrying costs 4) Increased flexibility in responding to market changes

Manufacturing Resource Planning (MRP II)

MRP II is a closed-loop manufacturing system that integrates all facets of a manufacturing business, including
production, sales, and inventories, schedules, and cash flows.
- The same system is used for both the financial reporting and managing operations.
Because manufacturing resource planning encompasses materials requirements planning, MRP is a component
of an MRP II system.

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 Traditional Enterprise Resource Planning (ERP)

- MRP is a common function contained in ERP.

- An ERP system allows a company to determine what hiring decisions might need to be made or whether a
company should invest in new capital assets.
-The traditional ERP system is one in which subsystems share data and coordinate their activities.
-The traditional ERP system are internal to the organization. Thus, they often are called back-office functions. The
information produced is principally intended for internal use by the organization’s managers.
- Because ERP software is costly and complex, it is usually installed only by the largest enterprises.
-The tremendous variety of forms that information systems can take and the diverse needs of users.
- Separate financial and nonfinancial systems have the increased potential to experience 1) Different reporting
results 2) Inefficiencies 3) A lack of standardized purchasing among departments.
- ERP connects all functional financial and non-financial subsystems (human resources, the financial
accounting system, production, marketing, distribution, purchasing, receiving, order processing, shipping, etc.) and
also connects the organization with its suppliers and customers.
The advantages of developing a traditional ERP system
-The linked subunits in the organization not only to redesign and improve their processes but also to conform to one
standard.
- An organization may wish to undertake a reengineering project before choosing ERP software. The project should
indicate what best practices already exist in the organization’s processes. This approach may be preferable for a
unique enterprise in a highly differentiated industry.
-The processes reflected in the ERP software may differ from the organizations. In this case, the better policy is
usually to change the organization’s processes.
Customizing the ERP software is expensive and difficult, and it may result in bugs and awkwardness when adopting
upgrades.
The disadvantages of traditional ERP are its extent and complexity, which make customization of the software
difficult and costly
Current Generation of ERP (ERP II)
-The current generation of ERP software (ERP II) has added front-office functions, which provide the capability
for smooth (and instant) interaction with the business processes of external parties such as customers, suppliers,
shareholders or other owners, creditors, and strategic allies.
-ERP II system has the following interfaces with its back-office functions:
1) Supply-chain: management applications for an organization focus on relationships extending from its suppliers
to its final customers A) supply chain is part of a linked chain of multiple organizations
B) This chain stretches from the producers of raw materials, to processors of those materials,
C) Supply chain management involves a two-way exchange of information (customer may be able to track the
progress of its order and supplier may be able to monitor the customer’s inventory.
D) An advanced planning and scheduling system may be an element of a supply chain management application
for a manufacturer. It controls the flow of material and components within the chain
2) Customer relationship management applications extend to customer service, finance-related matters, sales, and
database creation and maintenance A) Integrated data is helpful in better understanding customer needs.
3) Partner relationship management applications connect the organization not only with such partners as
customers and suppliers but also with owners, creditors, and strategic allies.
Advantages of a Current ERP System
1) Lower inventory costs 2) Better management of liquid assets
3) Reduced labor costs and greater productivity 4) Enhanced decision making
5) Elimination of data redundancy, centralization of data, and protection of data integrity
6) Avoidance of the costs of other means of addressing needed IT changes 7) Increased customer satisfaction
8) More rapid and flexible responses to changed circumstances 9) More effective supply chain management
10) Integration of global operations 11) Standardization and simplification of the decision-making process
Disadvantages of a Current ERP System
1) Losses from an unsuccessful implementation, 2) Purchasing hardware, software, and services
3) Data conversion from legacy systems to the new integrated system 4) Training
5) Design of interfaces and customization 16 | P a g e
6) Software maintenance and upgrades
7) Salaries of employees working on the implementation
Challenges

- Implementation of ERP may take years and cost millions. (Poor implementation may cause the project to fail)
1) Do strategic planning and to organize a project team.
2) Choose ERP software and a consulting firm.
3) Preimplementation (The length of the process design phase is a function of the extent of Reengineering
And Customization of the software and data conversion may be delayed moreover The ERP system and its
interfaces must be tested.)
4) Implementation (“going live”) is not the final step. Follow-up is necessary to monitor the activities of
employees who have had to change their routines.
5) Training should be provided during implementation

Outsourcing -management or day-to-day execution of an entire business function by a Third-party service

provider.
- Outsourcing enables a company to focus on its core business rather than having to be
concerned with marginal activities.
- Business process outsourcing is the outsourcing of back office and front office functions
-Benefits of outsourcing reliable service, reduced costs, avoidance of the risk of
obsolescence, and access to technology. Limitations include dependence on an outside party
and loss of control over a necessary function
Insourcing - the transfer of an outsourced function to an internal department of a company

Cosourcing - Performance of a business function by both internal staff and external resources.

THEORY OF CONSTRAINTS

1) (TOC) is a system to improve human thinking about problems. 2) The basic premise of TOC is by focusing on
the slowest part of the process. 3) The slowest part of the process is called the constraint.
The steps in a TOC analysis

Identify the Constraint -The bottleneck operation can usually be identified as the one where work-in-
process backs up the most.
A more sophisticated approach is to analyze available resources, and determine
which phase has negative slack time
Determine the Most - short-term profit maximization
Profitable Product Mix -maximizing the contribution margin through the constraint, called the throughput
Given the Constraint Margin or throughput contribution.
- To make the most profitable use of the bottleneck operation, managers may need
to produce the product with the highest throughput margin per unit.
- Throughput margin(supervariable costing) = Sales – Direct materials
-When there are multiple products, the crucial factor in determining the optimal
product mix throughput margin per hour.
-The available time in the bottleneck operation is first devoted to the product with the
highest throughput margin per hour, then to the other products in descending order
until the company is unable to meet additional demand
Maximize the flow through - managed using the drum-buffer-rope (DBR) system.
the constraint.( short run) - The drum is the bottleneck operation - The buffer is a minimal amount of work-in-
process input to the drum - The rope is the sequence of activities including the
bottleneck operation that must be coordinated to avoid inventory buildup.
Increase capacity at the - encourages a manager to make the best use of the bottleneck operation
constraint.
Redesign the - reengineer the entire process.
manufacturing process for - The firm should take advantage of new technology, product lines requiring too
greater flexibility and much effort should be dropped.
speed(The long-term) - Value engineering is useful for this purpose because it explicitly balances product
Cost and the needs of potential customers 17 | P a g e
 Capacity Planning

-capacity is an element of strategic planning that is closely related to capital budgeting.

-effective capacity cost management requires:

i. In short run, optimizing capital decisions and the effective flexible use of investments that have already been made.
ii. Maximizing the value of delivered to customers.
iii. Helping minimize the requirement for the future investment.
iv. Supporting effective matching with the resource and current and future market opportunities.
v. Closing any gap between market demand and a firm’s capacities.
vi. Eliminate waste in short run, intermediate ,and long run
vii. Providing useful cost information.
viii. Estimating capacity level for future periods.

*Capacity level influences product costing, pricing decisions, and financial statements.
Excess capacity Has a cost, having excess capacity means that a company with either have to charge
higher prices for its products or report lower income on its financial statements.
Full capacity Have a cost in the form of opportunity costs. A company that could generate additional
sales if it had more capacity needs to address whether the acquisition of additional
capacity is warranted.

Capacity level & expansion

 Determining whether to expand capacity is a major strategic decision because of the capital required, the difficulty
of forming accurate expectations, and the long timeframe of the lead times and the commitment. The key
forecasting problems are long-term demand and behavior of competitors. The key strategic issue is avoidance of
industry overcapacity.
 Capacity expansion is also referred to as market penetration because it involves increasing the amount of an
existing product in an existing market.
 Under capacity in a profitable industry tends to be a short-term issue. Profits ordinarily lure additional
investors. Overcapacity tends to be a long-term problem because firms are more likely to compete intensely
rather than reverse their expansion

Capacity expansion Steps

 The firm must identify the options in relation to their size, type, degree of vertical integration (if
any), and possible response by competitors.
 The second step is to forecast demand, input costs, and technology developments. The firm must
be aware that its technology may become obsolete or that future design changes to allow
expansion may or may not be possible. Moreover, the expansion itself may put upward pressure
on input prices.
 The next step is analysis of competitors to determine when each will expand
 Using the foregoing information, ‫طبقا للمعلومات السابقة‬the firm predicts total industry capacity and
firms’ market shares.
 The final step is testing for inconsistencies.‫فحص و دراسة سريعه‬

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 STUDY UNIT ELEVEN
BUSINESS PROCESS IMPROVEMENT

VALUE-CHAIN ANALYSIS

-To remain on the market, a product must provide value to the customer and a profit to the seller.
1) Customers assign value to a product. The producer can affect the customers’ perception of value by
differentiating the product and lowering its price.
2) The producer’s profit is the difference between its costs and the price it charges for the product.

Value-Added and Nonvalue-Added Activities

-A value-added activity increases the value of a product or service to the customer.

-A nonvalue-added activity does not increase the value of a product or service to the customer even if this
activity is necessary.
-A direct cost can be specifically associated with a single cost object. Direct costs usually are classified as
either value-added or nonvalue-added

VALUE-CHAIN

-The way depict which every function in a company adds value to the final product.
-A value chain depicts how costs and customer value accumulate along a chain of activities that lead to an
end product or service.
-A value chain consists of the internal processes or activities a company performs:
R&D, design, production, marketing, distribution, and customer service.

Product

Primary R&D Design Manufacturing Marketing Customer

activities &distribution service

HR inventory management
Supporting
activities Contract management

IT plant management

- Primary activities deal with the product directly. Support activities lend aid to the primary activity functions.
- A value chain is a firm’s overall chain of value-creating.
Customer retention is an important objective of value-adding and profit-maximizing processes because the
customer base is a key intangible asset.
- Customer relationship management optimizes customer equity by managing information about individuals
and their “touchpoints” for the purpose of maximizing customer loyalty.

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 Value-Chain Analysis
- Value-chain analysis is a strategic analysis tool that allows a firm to focus on those activities that are
consistent with its overall strategy.
- Value-chain analysis allows a firm to decide which parts of the value chain it wants to occupy and how each
activity then contributes to the firm’s competitive advantage by adding customer value or by reducing costs.
- Value-chain analysis improves the firm’s knowledge of its relations with customers, suppliers, and
competitors.
- The first step in a value-chain analysis is to identify the firm’s value-creating activities.
- The second step is to determine how each value-creating activity can produce a competitive advantage for
the firm by (Identify the firm’s competitive advantage- Identify the ways in which the firm’s value-creating
activities can generate additional customer value- Identify activities that are candidates for cost reduction-
Identify value-adding ways in which the firm’s remaining activities can be linked)
- Value-chain analysis is a team effort.
-
The Supply Chain

- The supply chain is the flow of materials and services from their original sources to final consumers.
- Purchasing is the management function that concerns the acquisition process. It includes choice of vendors,
contract negotiation, the decision whether to purchase centrally or locally, and value analysis.
- Purchase requisitions ultimately result from insourcing vs. outsourcing (make vs. buy) decisions made when
production processes were designed.
- The choice of vendors depends on price, quality, delivery performance, shipping costs, credit terms, and
service
- The purchaser and the vendor are viewed as committed to a partnership involving joint efforts to improve
quality.
- Supply-chain analysis and coordination should extend to all parties in the chain. Such cooperation
counteracts what has been called the bullwhip or backlash effect that occurs when demand variability
increases at each level of the supply chain.
- Retailers face only customer demand variability, but the manufacturer must cope with retailer demand
variability that is greater than customer demand variability because retailers’ purchases vary with additional
factors
- The variability of manufacturer demands on suppliers may be greater than the variability of retailer demands
on manufacturers.
-. Value-chain and supply-chain analysis should be used to meet customer requirements for better
performance regarding such critical success factors as
1) Cost reduction 2) Efficiency 3) Continuous improvement of quality to meet customer needs and wants,
4) Minimization or elimination of defects 5) Faster product development and customer response times, and
6) Constant innovation.

Cost of Value Chain Analysis

- To achieve value chain analysis, a company will need value engineering.

- Value engineering is a means of reaching targeted cost levels, the purpose is to minimize costs without
sacrificing customer satisfaction. (It requires distinguishing between cost incurrence and locked-in costs).
- Cost incurrence is the actual use of resources, but locked-in (designed-in) costs will result in use of resources in
the future as a result of past decisions.
- Life-cycle costing is sometimes used as a basis for cost planning and product pricing.
- Life-cycle costing estimates a product’s revenues and expenses over its expected life cycle.

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 OTHER PROCESS 1. Process Analysis
IMPROVEMENT TOOLS 2. Process Value Analysis.
3. Business Process Reengineering (BPR).
4. Benchmarking
5. Costs of Quality
6. Efficient accounting processes
1-Process Analysis
A. Means of linking a firm’s internal processes to its overall strategy.
B. Types of Processes (Continuous, Batch, Hybrid, Make-to-stock, and Make-to-order).
C. Process Interdependence…. ‫االعتماد المتبادل‬
-The degree of interdependence among the stages in a process is referred to as “tightness.”
-A tight process is one in which a breakdown in one stage brings the succeeding stages to a halt.
-A loose process is one in which subsequent stages can continue working after a breakdown in a previous stage.

D. Bottlenecks…. always the slowest part of the process.

The bottleneck issue only arises when demand for the firm’s product is sufficient to absorb all of the output.
When a production line is running at less than full capacity, bottlenecks can be avoided.
2-Process Value
Analysis
A)-Process value analysis is a comprehensive understanding of how an organization generates its output. It involves
a determination of which activities that use resources are value-adding or nonvalue-adding and how the latter may be
reduced or eliminated.
-This linkage of product costing and continuous improvement of processes is activity-based management (ABM).
ABM redirects and improves the use of resources to increase the value created for customers and other stakeholders
-ABM uses include the following:
1. Strategic analysis: explores various ways a company can create and sustain a competitive advantage
2 Benchmarking
3 Operations analysis seeks to identify, measure, and improve current performance
4 Profitability/pricing analysis assists a company in analyzing the costs and benefits of products
5 Process improvement focuses on identifying the causes of variation, waste, and inefficiency.
-A continuous improvement process (CIP) is an ongoing effort involving management and workers to improve
products, services, or processes
-Kaizen is the Japanese word for the continuous pursuit of improvement in every aspect of organizational operations.
 Key features of Kaizen include the following:
 Improvements are based on many small changes rather than the radical changes.
 Ideas come from the workers themselves, so they are less likely to be radically different and therefore are
easier to implement.
 Small improvements are less likely to require major capital investment than major process changes
 The ideas come from the talents of the existing workforce, as opposed to using research, consultants or–any
of which could be expensive.
 All employees, including management, should continually seek ways to improve their own performance.
 Workers are encouraged to take ownership of their work and can help reinforce teamwork.
 The key features of Kaizen are the more tactical elements of CIP. The more strategic elements include
deciding how to increase the value of the delivery process output to the customer (effectiveness) and how
much flexibility is valuable in the process to meet changing needs.
B) An activity analysis determines what is done, by whom, at what cost in time and other resources, and the value
added by each activity
-A value-added activity is necessary to remain in business
-A value-added cost is incurred to perform a value-added activity without waste.
-A nonvalue-added activity is unnecessary and should be eliminated.
-A nonvalue-added cost is caused by a nonvalue-added activity or inefficient performance of a value-added activity
C) Financial and nonfinancial measures of activity performance address efficiency, quality, and time. The purpose
is to assess how well activities meet customer demands (To satisfy customer needs and wants, activities should be
efficient -Activities should produce defect-free output and that output should be produced in a timely manner)
21 |advantage.
D) Select of value-added activities in each place of the value chain reflects on the firm competitive Page
E) One aspect of process analysis is the management of time, A company that is first in the market with a new product
has obvious advantages.
 3. Business Process Reengineering (BPR)
- BPR is a complete rethinking of how business functions are performed to provide value to customers, that is,
radical innovation instead of mere improvement
-A process is how something is accomplished in a firm. It is a set of activities directed toward the same objective.
-Reengineering is process innovation and core process redesign. Instead of improving existing procedures.
-BPR techniques eliminate many traditional controls. They exploit modern technology to improve productivity and
decrease the number of clerical workers.
-The emphasis shifts to monitoring internal control so management can determine when an operation may be out of
control and corrective action is needed.
-Part of the BPR process involves looking at possible alternatives and determining the cost of those possible
alternatives compared to the costs of maintaining the same processes.
-To do this, the management accountant must determine
a) The cost to reengineer the process, b) The expected savings
-Some desirable alternatives may actually increase total costs.
-the management accountant would determine the savings attributed to possible alternatives compared to
maintaining the same processes.
-After determining the cost and savings of BPR, the company must look at all of its goals and needs overall to
determine if it should invest in a possible alternative

4-Benchmarking

-Benchmarking involves continuously evaluating the practices of best-in-class organizations and adapting
company processes to incorporate the best of these practices.
-Benchmarking is an ongoing process that entails quantitative and qualitative measurement of the difference
between the company’s performance of an activity and the performance by the best in the world.
-The benchmark organization need not be a competitor.
Steps for benchmarking
1. Select and prioritize benchmarking projects.
-An organization must understand its critical success factors and business environment to identify key business
processes and drivers and to develop parameters defining what processes to benchmark
-The criteria for selecting what to benchmark relate to the reasons for the existence
Of a process and its importance to the entity’s mission, values, and strategy
2. organize benchmarking teams
-Team members should have knowledge of the function to be benchmarked good communication skills, teaming
skills, motivation to innovate and to support cross-functional problem solving, and project management skills.
3. The benchmarking team must thoroughly investigate and document internal processes
-The organization should be seen as a series of processes, not as a fixed structure. A process is “a network of
related and independent activities linked by the outputs they exchange.” One way to determine the primary
characteristics of a process is to trace the path a request for a product or service takes through the organization
The benchmarking team must also develop a family of measures that are true indicators of process performance.
4. Researching and identifying best-in-class performance is often the most difficult phase
-The critical steps are setting up databases, choosing information-gathering methods (Internal sources, external
public domain sources, and original research are the possible approaches
5. -The data analysis phase entails identifying performance gaps, understanding the reasons they
Exist, and prioritizing the key activities that will facilitate the behavioral and process changes
6. Leadership is most important in the implementation phase of the benchmarking Process because
The team must be able to justify its recommendations.
7. Benchmarking is a way for a company to learn its strengths and weaknesses by comparison to
Similar companies. Additional benefits of benchmarking include
1) Best practices are identified and defined. 2) Alternative solutions are evaluated.
3) The competitive position is strengthened. 4) The company goals are questioned.
5) More people are held responsible for their performance

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 5. Costs of Quality

-describes four categories of costs of quality: prevention, appraisal, internal failure, and external failure. The
organization should attempt to minimize its total cost of quality.
-Conformance costs include prevention and appraisal, which are both financial measures of internal performance.
1) Prevention attempts to avoid defective output. These costs include preventive maintenance, employee
training, review of equipment design, and evaluation of suppliers. Providing quality training to employees
should reduce all types of quality costs.
2) Appraisal encompasses such activities as statistical quality control programs, inspection, and testing
-Nonconformance costs include costs of internal failure (a financial measure of internal performance) and external failure
costs (a financial measure of customer satisfaction).
1. Internal failure costs occur when defective products are detected before shipment.
a) Examples are scrap, rework, tooling changes, downtime, redesign of products or processes, lost output,
Reinspection and retesting, expediting of operations after delays, lost learning opportunities, and searching
For and correcting problems.
2. The costs of external failure or lost opportunity include lost profits from a decline in market share as
dissatisfied customers make no repeat purchases, return products for refunds, cancel orders, and
communicate their dissatisfaction to others
3. Environmental costs are also external failure costs.

6. Efficient accounting processes

-Improving accounting processes can increase a company’s ability to minimize the costs of these processes while
also maximizing their usefulness
Methods used to make accounting operations more efficient are described below.
-Process walk-throughs involve following a transaction from the initial stage and observing every step in the
financial reporting system until the transaction is recorded in the financial statements.
-Process training enables personnel to learn how to do their jobs more efficiently and creates a motivated, skilled,
and effective workforce through which organizational goals are achieved.
-Identification of waste and over-capacity leads to more efficient accounting operations by eliminating
unnecessary accounting transactions and freeing up accounting personnel.
-Identifying the root cause of errors uncovers issues related to accounting systems, errors by personnel, or issues
with organizational procedures or instructions.
-Reducing the accounting close cycle (fast close) can be accomplished by successfully identifying the root cause
of errors and correcting the problem; hence, speeding up the close process.
-Shared services make accounting operations more efficient by having only one department provide accounting
service for each department, Shared services help standardize processes and accounting technology systems,
Making it easier to track and analyze costs across a company

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