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B405F Advanced Management Accounting. Revision. Lecture 11. Five-Step Decision Process. Gathering information Making predictions Choosing an alternative Implementing the decision Evaluating performance. The Meaning of Relevance.

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five step decision process
Five-Step Decision Process
  • Gathering information
  • Making predictions
  • Choosing an alternative
  • Implementing the decision
  • Evaluating performance
the meaning of relevance
The Meaning of Relevance
  • Relevant costs and relevant revenues are expected future costs and revenues that differ among alternative courses of action.
  • Sunk costs are irrelevant because they are past costs.
  • Common fixed costs are irrelevant because they are non-differential costs.
quantitative and qualitative relevant information
Quantitative and Qualitative Relevant Information
  • Quantitative factors are outcomes that are measured in numerical terms:
    • Financial
    • Nonfinancial
  • Qualitative factors are outcomes that cannot be measured in numerical terms:
    • Nonfinancial
one time only special order
One-Time-Only Special Order
  • Decision criteria:

Accept the order if the revenue differential is greater than the cost differential.

make or buy decision
Make or Buy Decision
  • Opportunity costs are not recorded in formal accounting records since they do not generate cash outlays.
  • These costs also are not ordinarily incorporated into formal reports.
product mix decisions under capacity constraints
Product-Mix Decisions Under Capacity Constraints
  • Decision criteria: Aim for the highest contribution margin per unit of the constraining factor.
  • When multiple constraints exist, optimization techniques such as linear programming can be used in making decisions.
equipment replacement
Equipment Replacement
  • The book value of existing equipment is irrelevant since it is neither a future cost nor does it differ among any alternatives (sunk costs never differ).
decisions and performance evaluation
Decisions and Performance Evaluation
  • Managers often behave consistent with their short-run interests and favor the alternative that yields best performance measures in the short run.
  • When conflicting decisions are generated, managers tend to favor the performance evaluation model.
  • Top management faces a challenge – that is, making sure that the performance-evaluation model of subordinate managers is consistent with the decision model.
time horizon of pricing decisions
Time Horizon of Pricing Decisions
  • Two key differences when pricing for the long run relative to the short run:
  • Costs that are often irrelevant for short-run pricing decisions (fixed costs) are often relevant in the long run.
  • Profit margins in long-run pricing decisions are often set to earn a reasonable return on investment.
alternative long run pricing approaches
Alternative Long-Run Pricing Approaches
  • Market-based
  • Cost-based (also called cost-plus)
target price is
Target Price is...
  • the estimated price for a product (or service) that potential customers will be willing to pay.
  • The target price, calculated using customer and competitors inputs, forms the basis for calculating target costs.
target costs
Target Costs
  • Target sales price per unit
  • Target operating income per unit
  • Target cost per unit
implementing target pricing and target costing
Implementing Target Pricing and Target Costing
  • Steps in developing target prices and target costs:
  • Develop a product that satisfies the needs of potential customers.
  • Choose a target price.
  • Derive a target cost per unit.
  • Perform value engineering to achieve target costs.
value added costs
Value-Added Costs
  • A value-added cost is a cost that customers perceive as adding value, or utility, to a product or service:
  • Adequate memory
  • Pre-loaded software
  • Reliability
  • Easy-to-use keyboards
nonvalue added costs
Nonvalue-Added Costs
  • A nonvalue-added cost is a cost that customers do not perceive as adding value, or utility, to a product or service.
  • Cost of expediting
  • Rework
  • Repair
cost incurrence and locked in costs
Cost Incurrence and Locked-in Costs

Cumulative

Costs per unit

Locked-in

Cost Curve

Cost

Incurrence

Curve

Value Chain

Functions

Manufacturing

Mktg., Dist.,

& Cust. Svc.

R&D and

Design

cost plus pricing
Cost-Plus Pricing
  • The general formula for setting a cost-based price is to add a markup component to the cost base.
  • Cost base $X Markup component Y Prospective selling price $X + Y
life cycle budgeting
Life-Cycle Budgeting
  • The product life-cycle spans the time from original research and development, through sales, to when customer support is no longer offered for that product.
  • A life-cycle budget estimates revenues and costs of a product over its entire life.
predicted costs
Predicted Costs
  • Many of the production, marketing, distribution and customer service costs are locked in the R&D and design stage.
  • Life-cycle budgeting facilitates value engineering at the design stage before costs are locked in.
strategy
Strategy
  • Strategy specifies how an organization matches its own capabilities with the opportunities in the marketplace to accomplish its objectives
  • A thorough understanding of the industry is critical to implementing a successful strategy
the balanced scorecard
The Balanced Scorecard
  • The balanced scorecard translates an organization’s mission and strategy into a comprehensive set of performance measures.
  • The balanced scorecard does not focus solely on achieving financial objectives.
  • It highlights the nonfinancial objectives that an organization must achieve in order to meet its financial objectives.
aligning the balanced scorecard to strategy
Aligning the Balanced Scorecard to Strategy
  • Different strategies call for different scorecards.
  • What are some of the financial perspective measures?
  • Operating income
  • Revenue growth
  • Cost reduction is some areas
  • Return on investment
aligning the balanced scorecard to strategy1
Aligning the Balanced Scorecard to Strategy
  • What are some of the customer perspective measures?
  • Market share
  • Customer satisfaction
  • Customer retention percentage
  • Time taken to fulfill customers requests
aligning the balanced scorecard to strategy2
Aligning the Balanced Scorecard to Strategy
  • What are some of the internal business process perspective measures?
  • Innovation Process
  • Manufacturing capabilities
  • Number of new products or services
  • New product development time
  • Number of new patents
aligning the balanced scorecard to strategy3
Aligning the Balanced Scorecard to Strategy
  • Operations Process
  • Yield
  • Defect rates
  • Time taken to deliver product to customers
  • Percentage of on-time delivery
  • Setup time
  • Manufacturing downtime
aligning the balanced scorecard to strategy4
Aligning the Balanced Scorecard to Strategy
  • Post-sales service
  • Time taken to replace or repair defective products
  • Hours of customer training for using the product
aligning the balanced scorecard to strategy5
Aligning the Balanced Scorecard to Strategy
  • What are some of the learning and growth perspective measures?
  • Employee education and skill level
  • Employee satisfaction scores
  • Employee turnover rates
  • Information system availability
  • Percentage of processes with advanced controls
features of a good balanced scorecard
Features of a Good Balanced Scorecard
  • Tells the story of a firm’s strategy, articulating a sequence of cause-and-effect relationships: the links among the various perspectives that describe how strategy will be implemented
  • Helps communicate the strategy to all members of the organization by translating the strategy into a coherent and linked set of understandable and measurable operational targets
features of a good balanced scorecard1
Features of a Good Balanced Scorecard
  • Must motivate managers to take actions that eventually result in improvements in financial performance
  • Limits the number of measures, identifying only the most critical ones
  • Highlights less-than-optimal tradeoffs that managers may make when they fail to consider operational and financial measures together
balanced scorecard implementation pitfalls
Balanced Scorecard Implementation Pitfalls
  • Managers should not assume the cause-and-effect linkages are precise: they are merely hypotheses
  • Managers should not seek improvements across all of the measures all of the time
  • Managers should not use only objective measures: subjective measures are important as well
balanced scorecard implementation pitfalls1
Balanced Scorecard Implementation Pitfalls
  • Managers must include both costs and benefits of initiatives placed in the balanced scorecard: costs are often overlooked
  • Managers should not ignore nonfinancial measures when evaluating employees
  • Managers should not use too many measures
evaluating strategy
Evaluating Strategy
  • Strategic Analysis of Operating Income – 3 parts:
    • Growth Component – measures the change in operating income attributable solely to the change in the quantity of output sold between the current and prior periods
    • Price-Recovery Component – measures the change in operating income attributable solely to changes in prices of inputs and outputs between the current and prior periods
    • Productivity Component – measures the change in costs attributable to a change in the quantity of inputs between the current and prior periods
revenue effect analysis
Revenue Effect Analysis

P2

Price Recovery Component

Q2

Growth Component

P1

Q1

cost effect analysis
Cost Effect Analysis

Q2

Productivity Component

P2

Price Recovery Component

Q

Growth Component

P1

Q1

the management of capacity
The Management of Capacity
  • Managers can reduce capacity-based fixed costs by measuring and managing unused capacity
  • Unused Capacity is the amount of productive capacity available over and above the productive capacity employed to meet consumer demand in the current period
analysis of unused capacity
Analysis of Unused Capacity
  • Two Important Features:
    • Engineered Costs result from a cause-and-effect relationship between output and the resources used to produce that output
    • Discretionary Costs have two parts:
      • They arise from periodic (annual) decisions regarding the maximum amount to be incurred
      • They have no measurable cause-and-effect relationship between output and resources used
managing unused capacity
Managing Unused Capacity
  • Downsizing (Rightsizing) is an integrated approach of configuring processes, products, and people to match costs to the activities that need to be performed to operate effectively and efficiently in the present and future
  • Because identifying unused capacity for discretionary costs is difficult, downsizing, or otherwise managing this unused capacity, is also difficult.
customer profitability profiles
Customer-Profitability Profiles
  • Customer profitability reports often highlight that a small percentage of customers contribute a large percentage of operating income.
  • It is important that companies devote sufficient resources to maintaining and expanding relationships with these key contributors to profitability.
other factors in evaluating customer profitability
Other Factors in Evaluating Customer Profitability
  • Likelihood of customer retention
  • Potential for sales growth
  • Long-run customer profitability
  • Increases in overall demand from having well-known customers
  • Ability to learn from customers
sales volume variance
Sales Volume Variance

aMi

Sales Mix

aQ

bMi

Sales Quantity

bQ

BCMi

aX

Market Share

aZ

BCM

Market Size

bX

bZ

purposes of cost allocation
Purposes of Cost Allocation
  • There are four essential purposes of cost allocation:
  • To provide information for economic decisions
  • To motivate managers and other employees
  • To justify costs or compute reimbursement
  • To measure income and assets for reporting to external parties
cost allocation criteria
Cost Allocation Criteria

Cost

Allocation

by Ability

to Bear

How many resources

are consumed by the

cost object?

Cost

Allocation

by Cause

and Effect

The ability for the cost object to absorb additional cost given reasonable profit margin

Cost Object

Cost

Allocation

by Benefit

Received

User

How many benefits

are received by the user

from using the cost object?

allocating costs of a supporting department to operating departments
Allocating Costs of a Supporting Department to Operating Departments
  • Supporting (Service) Department – provides the services that assist other internal departments in the company
  • Operating (Production) Department – directly adds value to a product or service
allocation method tradeoffs
Allocation Method Tradeoffs
  • Single-rate method is simple to implement, but treats fixed costs in a manner similar to variable costs
  • Dual-rate method treats fixed and variable costs more realistically, but is more complex to implement
allocation bases
Allocation Bases
  • Under either method, allocation of support costs can be based on one of the three following scenarios:
    • Budgeted overhead rate and budgeted hours
    • Budgeted overhead rate and actual hours
    • Actual overhead rate and actual hours
  • Choosing between actual and budgeted rates: budgeted is known at the beginning of the period, while actual will not be known with certainty until the end of the period
budgeted versus actual rates
Budgeted versus Actual Rates
  • Budgeted rates let the user department know in advance the cost rates they will be charged.
  • Users are better equipped to determine the amount of the service to request.
  • Budgeted rates also help motivate the manager of the supplier department to improve efficiency.
budgeted versus actual usage allocation bases
Budgeted versus Actual Usage Allocation Bases
  • When budgeted usage is the allocation base, user divisions will know in advance their allocated costs.
  • This information helps the user divisions with both short-run and long-run planning.
  • The main justification given for the use of budgeted usage to allocate fixed costs relates to long-run planning.
allocating support departments costs
Allocating Support Departments Costs
  • Three methods are widely used to allocate the costs of support departments to operating departments:
  • Direct allocation method
  • Step-down method
  • Reciprocal method
allocating common costs
Allocating Common Costs
  • Common Cost – the cost of operating a facility, activity, or like cost object that is shared by two or more users at a lower cost than the individual cost of the activity to each user
  • Two methods for allocating common cost are:
  • Stand-alone cost-allocation method
  • Incremental cost-allocation method
joint cost basics
Joint-Cost Basics
  • Joint costs are the costs of a single production process that yields multiple products simultaneously.
  • Industries abound in which a single production process simultaneously yields two or more products.
joint products and byproducts
Joint Products and Byproducts

Main Products

Joint Products

Byproducts

High

Low

Sales Value

approaches to allocating joint costs
Approaches to Allocating Joint Costs
  • The two basic approaches to allocating joint costs are:
  • Approach 1: Allocate costs using market-based data such as revenues.
  • Approach 2: Allocate costs in some physical measure-baseddata such as weight or volume.
allocating joint costs
Allocating Joint Costs
  • Approach 1:
  • The sales value at splitoff method
  • The estimated net realizable value (NRV) method
  • The constant gross-margin percentage NRV method
constant gross margin percentage nrv method
Constant Gross-Margin Percentage NRV Method
  • Step 1: Compute the overall gross-margin percentage.
  • Step 2: Use the overall gross-margin percentage and deduct the gross margin from the final sales values to obtain the total costs that each product should bear.
  • Step 3: Deductthe expected separable costs from the total costs to obtain the joint- cost allocation.
comparison of methods
Comparison of Methods
  • Why is the sales value at splitoff method widely used?
  • It is objective.
  • It does not anticipate subsequent management decisions on further processing.
  • It uses a meaningful common denominator.
  • It is simple.
irrelevance of joint costs for decision making
Irrelevance of Joint Costs for Decision Making
  • No techniques for allocating joint-product costs should guide decisions about whether a product should be sold at the splitoff point or processed beyond splitoff.
accounting for byproducts
Accounting for Byproducts
  • Although byproducts have much lower sales value than do joint or main products, the presence of byproducts can affect the allocation of joint costs.
  • Byproduct accounting methods differ on whether byproducts are recognized in the financial statements at the time of production or the time of sale.
production method
Production Method

Sales Method

Revenue MP Only MP + BP

COGS

Total Cost – BP NRV

Total Cost

EI (MP)

COGS

EI

COGS

Total EI = EI (MP) + EI (BP)

operation costing
Operation Costing

Job-costing

Systems

Operation Costing System

Process-costing

Systems

  • A hybrid costing system of customized manufacturing (job-order) and mass production (process) systems
  • Produce batches of similar products with each batch being a variation of one design.
operation costing1
Operation Costing
  • The production system is a sequence ofoperations or processes that a product must go through.
  • All products may not go through all of the processes

Batch A

Operation 1

Materials

Finished

Goods

Inventory

Operation 3

Batch B

Operation 2

Batch C

accounting for operation costing
Accounting for Operation Costing
  • Separate WIP for each operation (or process).
  • As the product moves between operations, debit receiving operation's WIP, credit sending operation's WIP.
  • Direct materials are traced directly to each batch (or order).
  • Conversion costs are accumulated by operation. A single average conversion cost is then applied to units that go through the operation, regardless of which batch they belong to.
spoilage rework and scrap terminology
Spoilage, Rework and Scrap Terminology
  • There are three types of costs that arise as a result of defects:
  • Spoilage (損壞品)
  • Rework (重製品)
  • Scrap (剩餘物資)
  • Some amount of spoilage, rework, or scrap appears to be an inherent part of many production processes.
abnormal spoilage
Abnormal Spoilage
  • Abnormal spoilage costs are written off as losses of the accounting period in which detection of the spoiled units occurs.
  • Companies record the units of abnormal spoilage and keep a separateLoss from Abnormal Spoilage account.
fifo spoilage
FIFO: Spoilage
  • The FIFO method of process costing keeps costs in the beginning inventory separate from the costs in the current period when determining the costs of good units (which includes a normal spoilage amount) and the costs of abnormal spoilage.
job costing spoilage or rework
Job Costing: Spoilage or Rework
  • Normal spoilage or rework can be assigned to a specific job or, if common to all jobs, as part of manufacturing overhead.
  • Abnormal spoilage or rework is written off as a cost of the period.
recognizing scrap
Recognizing Scrap
  • Scrap, if material in dollar amount, is recognized in the accounting records either at the time of its sale or at the time of its production.
  • Scrap, if immaterial, is often recognized asother revenuesat time of sale.
recognizing material scrap at time of sale
Recognizing Material Scrap at Time of Sale

Recognizing sale of scrap specific to Job #10:

  • Cash or Accounts Receivable 300 Work-in-Process (Job #10) 300

Recognizing sale of scrap common to all jobs:

  • Cash or Accounts Receivable 300 Manufacturing Overhead Control 300
recognizing material scrap at time of production
Recognizing Material Scrap at Time of Production

Recognizing scrap specific to Job #10is returned to the storeroom:

  • Materials Control 300 Work-in-Process (Job #10) 300

Recognizing scrap common to all jobsis returned to the storeroom:

  • Materials Control 300 Manufacturing Overhead Control 300
the financial perspective costs of quality
The Financial Perspective: Costs of Quality
  • The costs of quality (COQ) refer to costs incurred toprevent, or costs arising as a result of, the production of a low-quality product.
  • These costs focus on conformance quality and are incurred in all business functions of the value chain.
the financial perspective costs of quality1
The Financial Perspective: Costs of Quality
  • Prevention costs--costs incurred in precluding the production of products that do not conform to specifications.
  • Appraisal costs--costs incurred in detecting which of the individual units of products do not conform to specifications.
the financial perspective costs of quality2
The Financial Perspective: Costs of Quality
  • Internal failure costs--costs incurred by a nonconforming product detected before it is shipped to customers.
  • External failure costs--costs incurred by a nonconforming product detected after it is shipped to customers.
cost of quality exclusions
Cost of Quality Exclusions
  • Opportunity Costs resulting from poor quality:
    • Contribution Margin and Income forgone from lost sales
    • Lower Prices
  • Excluded due to estimation difficulties and being unrecorded as to the financial accounting records
nonfinancial measures
Nonfinancial Measures
  • Nonfinancial measures of customer-satisfaction
  • Nonfinancial measures of internal performance
  • Measures of learning and growth
evaluating quality performance
Evaluating Quality Performance
  • Advantages of Financial COQ measures:
    • Financial measures are helpful to evaluatetradeoffs among prevention costs, appraisal costs, and failure costs.
    • Financial COQ measures assist in problem solving by comparing different quality-improvement programs and setting priorities for achieving maximum cost reduction.
    • COQ provides a single, summary measure of quality performance.
evaluating quality performance1
Evaluating Quality Performance
  • Advantages of nonfinancial measures of quality:
    • Nonfinancial measures of quality are often easy to quantify and understand.
    • Nonfinancial measures direct attention tophysical processes and hence focus attention on the precise problem areas that need improvement.
control charts
Control Charts

Production Line B

m + 2s

m + s

Defect Rate

m

m - s

m - 2s

1 2 3 4 5 6 7 8 9 10Days

pareto diagram
Pareto Diagram

700

Number of Times Defect Observed

500

Copies are fuzzy and unclear

200

Copies are too light/dark

Paper gets jammed

cause and effect diagrams
Cause-and-Effect Diagrams

Methods and

Design Factors

Human Factors

Flawed part design

Incorrect

manufacturing

sequence

Inadequate

supervision

Poor training

New operator

Inadequate tools

Incorrect speed

Poor

maintenance

Multiple suppliers

Incorrect specification

Variation in purchased

components

Machine-related

Factors

Materials and

Components Factors

time as a competitive weapon
Time as a Competitive Weapon
  • Companies need to measure time in order to manage it properly.
  • Two common operational measures of time are:
    • Customer-response time
    • On-time performance
customer response time
Customer-Response Time

Order is

placed

Order is

received

Order is

set up

Order is

manufactured

Order is

delivered

Waiting

Time

Mfg.

Time

Receipt

Time

Manufacturing

Lead Time

Delivery

Time

Customer-Response Time

theory of constraints
Theory of Constraints
  • The objective of TOC is to increase throughput contribution while decreasing investments and operating costs.
  • TOC considers a short-run time horizon and assumes operating costs to be fixedcosts.
theory of constraints1
Theory of Constraints
  • The theory of constraints emphasizes the management of bottlenecksas the key to improving the performance of the production system as a whole.
methods to relieve bottlenecks
Methods to Relieve Bottlenecks
  • Eliminate idle time at the bottleneck operation
  • Process only those parts or products that increase throughput contribution, not parts or products that will remain in finished goods or spare parts inventories
  • Shift products that do not have to be made on the bottleneck operation to nonbottleneck processes, or to outside processing facilities
methods to relieve bottlenecks1
Methods to Relieve Bottlenecks
  • Reduce setup time and processing time at bottleneck operations
  • Improve the quality of parts or products manufactured at the bottleneck operation
costs associated with goods for sale
Costs Associated with Goods for Sale
  • Five categories of costs associated with goods for sale are:
  • Purchasing costs
  • Ordering costs
  • Carrying costs
  • Stockout costs
  • Quality costs
economic order quantity decision model
Economic-Order-Quantity Decision Model

The formula for the EOQ model is:

EOQ =

D = Demand in units for a specified time period

P = Relevant ordering costs per purchase order

C = Relevant carrying costs of one unit in

stock for the time period used for D

considerations in obtaining estimates of relevant costs
Considerations in Obtaining Estimates of Relevant Costs
  • Obtaining accurate estimates of the cost parameters used in the EOQ decision model is a challenging task.
  • What are the relevant incremental costs of carrying inventory?
  • Only those costs of the purchasing company that change with the quantity of inventory held
considerations in obtaining estimates of relevant costs1
Considerations in Obtaining Estimates of Relevant Costs
  • What is the relevant opportunity cost of capital?
  • It is the return forgone by investing capital in inventory rather than elsewhere.
  • It is calculated as the required rate of return multiplied by thosecosts per unit thatvary with the number of units purchased and that are incurred at the time the units are received.
economic order quantity decision model1
Economic-Order-Quantity Decision Model
  • What are the relevant total costs?
  • The formula for relevant total costs(RTC) is: RTC = Annual relevant ordering costs + Annual relevant carrying costs RTC = () × P + () × C = +
  • Q can be any order quantity, not just EOQ.

QC

2

D

Q

Q 2

DP Q

economic order quantity decision model2
Economic-Order-Quantity Decision Model

10,000

8,000

Annual relevant total costs

Relevant Total Costs (Dollars)

6,000

5,434

Annual relevant ordering costs

4,000

Annual relevant carrying costs

2,000

600

988

EOQ

1,200

1,800

2,400

Order Quantity (Units)

slide97

Reorder Point

988

Reorder Point

Reorder Point

494

Weeks

1

2

3

4

5

6

7

8

Lead Time

2 weeks

safety stock
Safety Stock
  • Safety stock is inventory held at all times regardless of the quantity of inventory ordered using the EOQ model.
  • Safety stock is used as a buffer against unexpected increases in demand or lead time and unavailability of stock from suppliers.
evaluating managers and goal congruence issues
Evaluating Managers and Goal-Congruence Issues
  • Goal-congruence issues can arise when there is an inconsistency between the EOQ decision model and the model used to evaluate the performance of the manager implementing the inventory management decisions.
materials requirement planning mrp
Materials Requirement Planning (MRP)
  • Materials requirements planning (MRP) systems take a “push-through” approach that manufactures finished goods for inventory on the basis of demand forecasts.
  • MRP predetermines the necessary outputs at each stage of production.
  • Inventory management is a key challenge in an MRP system.
just in time production systems
Just-In-Time Production Systems
  • Just-in-time (JIT) production systems take a “demand pull” approach in which goods are only manufactured to satisfy customer orders.
  • Demand triggers each step of the production process, starting with customer demand for a finished product at the end of the process, to the demand for direct materials at the beginning of the process.
major features of a jit system
Major Features of a JIT System
  • The five major features of a JIT system are:
  • Organizing production in manufacturing cells
  • Hiring and retaining multi-skilled workers
  • Emphasizing total quality management
  • Reducing manufacturing lead time and setup time
  • Building strong supplier relationships
benefits of jit systems
Benefits of JIT Systems
  • Benefits of JIT production:
  • Lower carrying costs of inventory
  • Eliminatingthe root causes of rework, scrap, waste, and manufacturing lead time.
performance measures and control in jit production
Performance Measures and Control in JIT Production
  • To manage and reduce inventories, the management accountant must design performance measures to control and evaluate JIT production.
  • What information may management accountants use?
    • Personal observation by production line workers and managers
    • Financial performance measures, such as inventory turnover ratios
performance measures and control in jit production1
Performance Measures and Control in JIT Production
  • What are nonfinancial performance measures of time, inventory, and quality?
    • Manufacturing lead time
    • Units produced per hour
    • Days’ inventory on hand
    • Total setup time for machines/Total manufacturing time
    • Number of units requiring rework or scrap/Total number of units started and completed
backflush costing
Backflush Costing
  • A unique production system such as JIT often leads to its own unique costing system.
  • Organizing manufacturing in cells, reducing defects and manufacturing lead time, and ensuring timely delivery of materials enables purchasing, production, and sales to occur in quick succession with minimal inventories.
backflush costing1
Backflush Costing
  • Where journal entries for one or more stages in the cycle are omitted, the journal entries for a subsequent stage use normal or standard costs to work backward to flush out the costs in the cycle for which journal entries were not made.
trigger points
Trigger Points
  • Stage A: Purchase of direct materials
  • Stage B: Production resulting in work in process
  • Stage C: Completion of a good finished unit or product
  • Stage D: Sale of finished goods
trigger points1
Trigger Points
  • Assume trigger points A, C, and D.
  • This company would have two inventory accounts:
  • Type Account Title 1. Combined materials Inventory: Material and materials in work-in- and In-Process process inventory Control

2. Finished goods Finished GoodsControl

trigger points2
Trigger Points
  • Assume trigger points A and D.
  • This company would have one inventory account:
  • Type Account Title Combines direct materials Inventory inventory and any direct Control materials in work-in-process and finished goods inventories
special considerations in backflush costing
Special Considerations in Backflush Costing
  • Backflush costing does not necessarily comply with GAAP
    • However, inventory levels may be immaterial, negating the necessity for compliance
  • Backflush costing does not leave a good audit trail – the ability of the accounting system to pinpoint the uses of resources at each step of the production process