CHAPTER 16
LEAN ACCOUNTING, TARGET COSTING, AND THE
BALANCED SCORECARD
QUESTIONS FOR WRITING AND DISCUSSION
1. Lean manufacturing is an approach de-
signed to eliminate waste and maximize
customer value. It is characterized by deli-
vering the right product, in the right quantity,
with the right quality (zero-defect) at the ex-
act time the customer needs it and at the
lowest possible cost.
2. The five principles of lean thinking are: (1)
Precisely specify value by each particular
product; (2) Identify the "value stream" for
each product; (3) Make value flow without
interruption; (4) Let the customer pull value
from the producer; and (5) Pursue perfec-
tion.
3. Two types of value streams are the order
fulfillment value stream and the new product
value stream. The order fulfillment value
stream focuses on providing current prod-
ucts to current customers. The new product
value stream focuses on developing new
products for new customers.
4. A value stream may be created for every
product; however, it is more common to
group products that use common processes
into the same value stream. One way to
identify the value streams is to use a simple
two-dimensional matrix, where the activi-
ties/processes are listed on one dimension
and the products on a second dimension.
5. The key factors in being able to produce low
volume products with great variety are lower
setup times and cellular manufacturing. Re-
ducing setup times and using manufacturing
cells eliminates considerable wait and move
time so that cycle time is dramatically re-
duced.
6. Demand-pull means producing only the
products when needed and in the quantities
needed. Demand-pull systems re-
duce/eliminate WIP and finished goods in-
ventories. Inventories are the most signifi-
cant source of waste in a manufacturing
firm.
7. Eight sources of waste are: (1) Defective
products; (2) Overproduction of goods not
547
needed; (3) Inventories of goods awaiting fur-
ther processing or consumption; (4) Unneces-
sary processing; (5) Unnecessary movement
of people; (6) Unnecessary transport of goods;
(7) Waiting; and, (8) The design of goods and
services that do not meet the needs of the cus-
tomer.
8. A focused value stream is dedicated to one
product. It includes all the activities and
steps necessary to produce, deliver, and
service the product after it is sold. The re-
sources, people, and equipment to accom-
plish this are all exclusive to the value
stream, making all the costs directly tracea-
ble to the product produced by the value
stream.
9. Facility costs are assigned using a fixed cost
per square foot( (total cost/total square feet).
If a value stream uses less square feet, it
receives less cost. Thus, the purpose of this
assignment is to motivate value stream
mangers to find ways to occupy less space.
As space is made available, it can be used
for new product lines or to accommodate in-
creased sales
10. Units shipped are used to discourage the
production of excess inventories. It also en-
courages the reduction and elimination of
existing finished goods inventories. The unit
cost increases if more units are produced
than sold. The unit cost decreases if are
shipped than units produced.
11. If the products in the value stream are quite
similar, then the average cost will approx-
imate the actual unit product cost. If the
product mix is relatively stable over time,
then the average unit cost can be a good
signal of overall changes in efficiency within
the value stream.
12. Value streams often have excess capacity.
In certain decisions, such as make or buy or
accept or reject special orders, the change
in profitability is the key factor in assessing
which way to go. In these cases, knowledge
 of individual product cost is not needed and,
in fact, may be misleading.
13. The lean control system uses a Box Score-
card that compares operational, capacity,
and financial metrics with prior week perfor-
mances and with a future desired state.
Trends over time coupled with the expecta-
tion of achieving some desired state in the
near future is the means used to motivate
constant performance improvement. Thus,
the lean control approach uses a mixture of
financial and nonfinancial measures for the
value steam. The future desired state re-
flects targets for the various measures. Op-
erational, nonfinancial measures are also
used at the cell level.
14. Life-cycle costing is measuring the costs
associated with a product for its entire life
cycle. Life-cycle management is managing
the activities during the development stage
to ensure the lowest total life-cycle cost.
Budgeting life-cycle costs can help managers
adjust the activities during the development
stage; furthermore, comparing actual life-
cycle costs with budgeted costs should ena-
ble managers to improve life-cycle cost
management in the future using the feed-
back from actual results.
15. Target costing is a cost management me-
thod that is used to reduce costs to a level
that reflects a product’s functions and mar-
ket demands and management’s return re-
quirements. Costs are reduced to target by
product and process redesign activities.
Product redesign is aided by reverse engi-
neering and value analysis.
16. The Balanced Scorecard translates an or-
ganization’s vision and strategy into opera-
tional objectives and measures for four
perspectives: financial, customer, process,
and learning and growth.
17. A strategy is the process of choosing the
market and customer segments, identifying
the critical internal processes, and selecting
the individual and organizational capabilities
548
needed for the process, customer, and fi-
nancial objectives.
18. Lag measures reflect what has happened.
Lead measures reflect what may happen.
19. A testable strategy is a set of linked objec-
tives aimed at an overall goal that can be
restated into a sequence of cause-and-effect
hypotheses.
20. Double-loop feedback is information that
deals with both the effectiveness of strategy
implementation and the validity of the as-
sumptions underlying the strategy.
21. The three strategic themes of the financial
perspective are revenue growth, cost reduc-
tion, and asset utilization.
22. The five core objectives of the customer
perspective are market share, customer re-
tention, customer acquisition, customer sa-
tisfaction, and customer profitability.
23. The long-wave of value creation means
anticipating the emerging and potential
needs of customers and creating new prod-
ucts and processes to satisfy those needs.
The short-wave of value creation is produc-
ing and delivering existing products to cus-
tomers.
24. Cycle time is the length of time required to
produce one product; velocity is the number
of units that can be produced in a given pe-
riod of time.
25. Manufacturing cycle efficiency is a ratio
computed by dividing the processing time by
the sum of processing time, move time, in-
spection time, and waiting time. The ideal is
to increase efficiency by reducing the nonva-
lue-added times of moving, inspection, and
waiting.
26. Three objectives of the learning and growth
perspective are increase employee capabili-
ties; increase motivation, empowerment,
and alignment; and increase information
systems capabilities.
 EXERCISES

16–1

1. e 8. a
2. d
3. b
4. e
5. b
6. c
7. e

16–2

Value Streams:

A&D: All common processes

B&E: All common processes
C: Different from all other products

16–3

1. Departmental times:

Processing time (10 × 30*) 300 minutes

Wait and move time 53 minutes
Total time 353 minutes

*The sum of the unit production times for each department

2. Cellular times:

Unit Elapsed time

First 30 minutes
Second 40
Third 50
. .
. .
Tenth 120 minutes

If the cell is continuously producing then the time is 100 minutes (10 × 10)

549
16–3 Continued

3. Time saved = 353 – 120 = 233 minutes (253 minutes for the continuous case)
= 233/10 = 23.3 minutes per unit (25.3 for continuous)

16–4

1. 60 minutes/10 = 6 units per hour is the current production rate (10 minutes is
the bottleneck time—for the first department.

2. 10 minutes; the bottleneck sets the production rate

3. The minimum unit production time for any process within the cell must be 6
minutes. Thus, ways must be found to reduce the processing time for Mixing,
Heating, and Tableting to 6 minutes. Process redesign and product redesign
are possible ways to reduce the times.

16–5

1. Materials, people, equipment and other resources are dedicated to value

streams as far as possible. In some case, there may not be enough specialized
resources for each value stream. For example, the quality engineer is spread
out over several value streams. A portion of his salary (0.40 × $75,000 =
$30,000) would be assigned to the value stream. Facility costs are assigned by
obtaining a cost per square for the entire facility ($900,000/100,000 = $9.00 per
square foot) and then multiplying this by the square feet occupied by the value
stream: $9.00 × 10,000 = $90,000. This amount would be added to the
$1,800,000, to bring the total value stream cost to $1,890,000. If the MP3 value
stream could find a way to occupy less space (say 7,000 square feet) and do
the same tasks, they would receive an cost assigned of $63,000 ($9 ×
7,000).Thus, there is an incentive to use no more space than necessary. Thus,
the purpose of this assignment is to motivate value stream mangers to find
ways to occupy less space. As space is made available, it can be used for
new product lines or to accommodate increased sales.

2. The recommended size of a value stream is between 25 and 150 employees.

3. The most likely option to be exercised is to cross-train Mary so that she can
function in quality control, eliminating the need for the quality engineer to
share time with more than one value stream. It also allows productive use of
available capacity and will not increase the cost of the MP3 value stream, and
in fact, may decrease the cost when the partial services of the value engineer
are eliminated.

550
4. Unit cost = $1,890,000/20,000 units = $94.50 per unit. This cost is very accurate
because virtually all of the costs are assigned using direct tracing. Causal
tracing is used for facility costs and quality engineering. Thus, this cost is a
good efficiency measure for the MP3 value stream and tracking it over time
will provide a measure of changes in efficiency.

16–6

1. First, calculate activity rates:

Cell: Driver is conversion time (in minutes):

$9,600/(600+1800) = $4 per minute

Engineering: Driver is Engineering hours:

$3,400/80 = $42.50 per eng. hr.

Testing: Driver is testing hours:

$3,000/80 = $37.50 per test hour

Next, calculate product costs:

Model A Model B
Cell:
$4 × 600 $ 2,400.00
$4 × 1,800 $ 7,200.00
Engineering:
$42.50 × 15 637.50
$42.50 × 65 2,762.50
Testing:
$37.50 × 25 937.50
$37.50 × 55 2,062.50
Total $3,975.00 $12,025.00
Units 50 150
Unit cost (cost/units) $79.50 80.17

2. Average cost = $16,000/200 = $80. The average cost approximates the ABC
costs with very little error, suggesting that the two value stream products are
quite similar.

551
16–7

1.
Week 1
Sales (90 @ $40) $3,600
Cost of goods sold (90 @$20) (1,800)
Gross profit $1,800

Week 2
Sales (100 @ $40) $4,000
Cost of goods sold (100 @$20) (2,000)
Gross profit $2,000

Week 3
Sales (90 @ $40) $3,600
Cost of goods sold (90 @$20) (1,800)
Gross profit $1,800

2.

Week 1: Average cost = Value stream cost/units shipped

= $1,800/90 = $20
Week 2: Average cost = Value stream cost/units shipped
= $1,800/100 = $18
Week 3: Average cost = Value stream cost/units shipped
= $1,800/90 = $20

The average cost decreased with a drop in inventories and increased with an in-
crease in inventories. The signal is consistent with the objective of reducing in-
ventories.

3.

Week1:

Sales (90 @ $40) $3,600

Materials (450)
Conversion cost (1,350)
Value stream profit $1,800
Change in inventory 0
Gross profit $1,800

Week 2:

552
Sales (100 @ $40) $4,000
Materials (450)
Conversion cost (1,350)
Value stream profit $2,200
Change in inventory (200)
Gross profit $2,000

Week 3:

Sales (90 @ $40) $3,600

Materials (500)
Conversion costs (1,500)
Value stream profit $1,600
Change in inventory 200
Gross profit $1,800

The value stream profit is highest in week 2 and lowest in week 3. The profit va-
riability is directly tied to the ability of the stream to produce on demand. In
weeks 1 and 2, inventories are stable or decreasing. In week 3, the stream slipped
and produced more than demanded and so profits decreased. The change in in-
ventory adjustment brings the value stream to the traditional measurement. When
the value stream achieves the ability to produce on demand, the two incomes will
be the same and any changes income will be from reductions in waste other than
inventories.

16–8

1. Seven nonfinancial measures (4 operational and three capacity)

2. Time-based: on-time delivery and dock to dock days; quality-based: first-
time through; efficiency: units sold per person and average cost. Lean
firms compete on the basis of these three dimensions. They strive to
supply the right quantity at the right price at the right quality at the time the
customer wants the product. To supply the quantity needed at the time
needed mandates shorter cycle times. Quality mandates zero defects and
lower prices mean that a lean firm must reduce its costs and become more
efficient.
3. The planned state sets targets for the various financial and nonfinancial
measures and thus encourages continuous and innovative improvements.
4. The value stream (processes within the value stream) possess a certain
amount of capacity based on resources employed. Value-added us of the
resources is productive use; using resources to produce waste is nonpro-
ductive use. Thus, all nonvalue-added activities are non-productive use of

553
 value-stream capacity. As waste is reduced, resources become available
for other productive uses.
5. As quality, time, and efficiency increase, we would eventually expect all of
this to convert into financial gains. Typically, what happens is that elimina-
tion of waste is first expressed as available capacity. Financial gains are
realized when the available capacity is either reduced by reducing re-
sources needed or they are used elsewhere for other productive purposes.

16–9

1. Desired profit = $50 × 1,500,000 = $75,000,000

2. Projected profit = ($150 × 1,500,000) $225,000,000 − $180,000,000 =

$45,000,000

3. Target cost = $150 – $50 = $100

Need to reduce costs by $20 per unit ($180,000,000 ÷ 1,500,000 = $120/unit;
$120 – $100 = $20/unit) or $30,000,000 ($20 × 1,500,000) for the target to be
met.
Three methods are available: reverse engineering, value analysis, and
process improvement. The first two methods are concerned with reducing
costs by improving product design. Reverse engineering may reveal more ef-
ficient design features that can be exploited, while value analysis should
show which product functions are worth keeping and which ones are worth
dropping or changing. Process improvement puts the company into the realm
of process value analysis where the emphasis is selecting only those activi-
ties that add value and eliminating the ones that do not.

4. It would be wise to include postpurchase costs in design decisions. Reducing

postpurchase costs reduces customer sacrifice and, therefore, increases cus-
tomer value, creating a potential competitive advantage for a company. In-
cluding postpurchase costs in target costs makes less sense because post-
purchase costs are incurred by the customer and not by the company.

554
16–10

1. If (a) employees are trained to improve their soldering capabilities, (b) the
manufacturing process is redesigned, and (c) the right suppliers are selected,
then the number of defective units produced will decrease; if the number of
defective units produced decreases, then customer satisfaction will increase;
if customer satisfaction increases, then market share will increase; if market
share increases then sales will increase; if sales increase, then profits will in-
crease.

2.
Profits Revenues
FINANCIAL
Increase Increase

Customer Market
CUSTOMER Satisfaction Share
Increases Increases

Supplier Defects Redesign

PROCESS Selection Decrease Process

Soldering
INFRASTRUCTURE Training

555
16–10 Concluded

3. Each consequence of the if-then sequence (the “then” outcome) can be

tested to see if the outcome is as expected. For example, if workers are
trained to solder better, do defects actually decrease? If defects decrease, do
we observe an increase in customer satisfaction? Does market share then in-
crease? Thus, the consequences are observable but only if they are meas-
ured. Of course, it should be mentioned that not only must outcomes be
measured but also those factors that lead to the outcomes (the performance
drivers). Was the process redesigned? How many hours of soldering training
are needed, and were they provided? Were suppliers selected so that we now
have a higher-quality circuit board? Note also that the number of defects acts
as both a lag measure and a lead measure. First, it measures the outcome for
training, supplier selection, and process redesign. Second, it also drives cus-
tomer satisfaction (which must be measured by surveys).
Targets indicate the amount of performance driver input and the improvement
expected. For example, the company may budget 100 hours of soldering
training, 300 hours of supplier evaluation, and two new process changes, and
then expect a 50 percent reduction in the number of defects (the outcome).
Suppose that the outcome is only a 10 percent reduction in defects. Compar-
ing the 50 percent to the 10 percent reduction achieved reveals a problem.
Double-loop feedback provides information regarding both the validity of the
strategy and the effectiveness of implementation. If the targeted levels were
not achieved for the performance drivers, then it is possible that the outcome
was not achieved because of an implementation problem. If, however, the tar-
geted levels of the performance drivers were achieved, then the problem
could lie with the strategy itself. Maybe training to solder better has little to do
with reducing defects (it may not be as much of a problem as thought). Or,
perhaps the current suppliers are not really a root cause for the production of
defects.

556
16–11

a. Customer, Nonfinancial, Objective, External, Lag (Lead)

b. Process, Nonfinancial, Objective, External, Lag (Lead)
c. Financial, Financial, Objective, Internal, Lag (Lead)
d. Financial, Financial, Objective, External, Lag (Lead)
e. Learning and growth, Nonfinancial, Subjective, Internal, Lead
f. Process, Financial, Objective, Internal, Lag (Lead)
g. Customer, Nonfinancial, Subjective, External, Lead (lag)
h. Process, Nonfinancial, Objective, External, Lag (Lead)
i. Learning and growth, Nonfinancial, Subjective, Internal, Lead
j. Customer, Nonfinancial, Objective, External, Lead (Lag)
k. Financial, Financial, Objective, External, Lag (Lead)
Note: Attempting to place measures in lead and lag categories will likely pro-
voke some discussion. Lead indicators make things happen—they are the
things that enable outcome measures to be achieved. Many—if not all—
measures may act as both lead and lag indicators. Pure lead measures are
most likely to be found in the learning and growth category, whereas pure lag
measures are most likely in the financial perspective category. It is very diffi-
cult to classify measures as lead or lag without knowing the underlying strat-
egy. This is an important message of the exercise. For example, on-time deli-
very is both a lead and lag measure. As a lead measure, it may signal an in-
crease in customer satisfaction as on-time delivery improves. On the other
hand, it may act as an outcome measure for a manufacturing cycle time
measure (as cycle time decreases, then on-time delivery increases). As a
second example, consider unit product cost. This is a lag indicator (e.g., a re-
sult of improving process efficiency), but it can also serve as a lead indicator
(e.g., if a unit cost reduction leads to a price decrease which, in turn, leads to
an increase in market share).

557
16–12

1. Theoretical rate = $1,350,000/300,000

= $4.50 per minute
Theoretical conversion cost per unit = $4.50 × 15
= $67.50

2. Applied conversion cost per unit = $4.50 × 20 = $90

Note: 60/3 = 20 minutes used per unit

3. An incentive exists to reduce product cost by reducing cycle time. For exam-
ple, current cycle time is 20 minutes per unit. If cycle time could be reduced
to 15 minutes per unit, conversion costs would be reduced from $90 per unit
to $67.50 per unit, reducing the unit product cost by $22.50. Reducing cycle
time increases the ability to meet deliveries on time as well as increasing the
ability of the firm to respond quickly to customer demands.

16–13

1. Velocity (theoretical) = 360,000/60,000 = 6 speakers per hour

Cycle time (theoretical) = 60 minutes/6 speakers = 10 minutes per speaker

2. Conversion cost rate = $720,000/(60,000 × 60) = $0.20 per minute

Assignment per unit (theoretically) = $0.20 × 10 minutes = $2.00 or
$720,000/360,000 = $2.00

3. Applied conversion cost = $0.20 × 40 minutes = $8.00

MCE = Theoretical time/Actual time = 10/40 = 0.25

4. Wasted time = 40 – 10 = 30 minutes; Cost = $0.20 × 30 minutes = $6.00

558
 PROBLEMS

16–14

1. Pizza: (3 × 30) + (7 × 30) = 300 slices/10 slices per pizza = 30 pizzas

Root beer: (3 × 30) + (2 × 30) = 150 glasses/5 glasses = 30 pitchers
Salads: (1 × 60) = 60 bowls.

2. Pizza ($10 × 30) $300

Root beer ($3 × 30) 90
Salad ($2 × 60) 120
Total cost $510

Average lunch cost = $510/60 = $8.50

3. Group (value stream) A:

Pizza: (3 × 30) = 90 slices/10 slices per pizza = 9 pizzas

Root beer: (3 × 30) = 90 glasses/5 glasses = 18 pitchers
Salads: (1 × 30) = 30 bowls

Pizza ($10 × 9) $ 90
Root beer ($3 × 18) 54
Salad ($2 × 30) 60
Total cost $204

Average lunch cost = $204/30 = $6.80

Group B:
Pizza: (7 × 30) = 210 slices/10 slices per pizza = 21 pizzas
Root beer: (2 × 30) = 60 glasses/5 glasses = 12 pitchers
Salads: (1 × 30) = 30 bowls.

Pizza ($10 × 21) $210

Root beer ($3 × 12) 36
Salad ($2 × 30) 60
Total cost $306

Average lunch cost = $306/30 = $10.20

Placing customers into groups based on similar consumption patterns is analog-

ous to placing products in value streams based on usage of similar processes.
Assigning all the costs to the groups that relate to the groups is analogous to as-
signing to dedicating people, equipment and resources to a value stream.

559
16-14 Concluded

Calculating cost per lunch customer is analogous to calculating a cost per unit of
product produced.

ABC cost is based on causal relationships:

Cost per slice of pizza = $10/10 = $1 per slice

Cost per glass of root beer = $3/5 = $0.60
Cost per bowl of salad = $2.00

Cost per customer A type (3,3,1) = ($1 × 3) + ($0.60 × 3) + ($2 × 1) = $6.80

Cost per customer B type (7,2,1) = ($1 × 7) + ($0.60 × 2) + ($2 × 1) = $10.20

The focused value stream produces accurate product costing assignments.

16-15
1.

Group (Light Eaters) A:

Pizza: (2 × 15) + (3 × 15) = 75 slices/10 slices per pizza = 8 pizzas

Root beer: (2 × 15) + (3 × 15) = 75 glasses/5 glasses = 15 pitchers
Salads: (1 × 30) = 30 bowls.

Pizza ($10 × 8) $ 80
Root beer ($3 × 15) 45
Salad ($2 × 30) 60
Total cost $185

Average cost $185/30 = $6.17

ABC cost is based on causal relationships:

Cost per slice of pizza = $10/10 = $1 per slice

Cost per glass of root beer = $3/5 = $0.60
Cost per bowl of salad = $2.00

Cost per A1 type (2,2,1) = ($1 × 2) + ($0.60 × 2) + ($2 × 1) = $5.20

Cost per A2 type (3,3,1) = ($1 × 3) + ($0.60 × 3) + ($2 × 1) = $6.80

560
16-15 Concluded

Group (Heavy Eaters) B:

Pizza: (6 × 15) + (7 × 15) = 195 slices/10 slices per pizza = 20 pizzas

Root beer: (3 × 15) + (2 × 15) = 75 glasses/5 glasses = 15 pitchers
Salads: (1 × 30) = 30 bowls.

Pizza ($10 × 20) $200

Root beer ($3 × 15) 45
Salad ($2 × 30) 60
Total cost $305

Average cost $305/30 = $10.17

ABC cost is based on causal relationships:

Cost per slice of pizza = $10/10 = $1 per slice

Cost per glass of root beer = $3/5 = $0.60
Cost per bowl of salad = $2.00

Cost per B1 type (6,3,1) = ($1 × 6) + ($0.60 × 3) + ($2 × 1) = $9.80

Cost per B2 type (7,2,1) = ($1 × 7) + ($0.60 ×2) + ($2 × 1) = $10.20

Using the ABC costs as a benchmark, the Group B value stream is a better si-
milarity grouping than Group A. The groups are analogous to value streams
and the assignment of pizza, root beer, and salads to each group is analogous
to the assignment and dedication of people, equipment, and resources to val-
ue streams. The costing analogies are obvious.

2. The extra capacity created by this reduction is 1 × 30 = 30 slices of pizza and

1 × 30 = 30 glasses of root beer. The four guest program will require (5 × 2) +
(6 × 2) = 22 slices of pizza and (2 × 2)+ (1 × 2) = 7 glasses of root beer. No addi-
tional cost is required (relative to the original arrangement) for pizza and root
beer; however, four extra salads would be needed and would cost an extra
$8.00 or $2.00 per guest. In a manufacturing environment, as waste is elimi-
nated from the value streams, extra capacity exists. This extra capacity can
be used productively to increase value-stream profitability. For example, a
special order may be offered and if there is unused capacity in the value
stream, the only extra cost may be the cost of materials. Thus, if the price is
above the cost of materials, then accepting the order will increase value-
stream profitability (in the short run)

16–16

561
1. The operational performance measures that improved for the first six months
all have to do with improving time-based performance. On-time delivery and
dock-to-dock days showed dramatic improvements, reflecting the increased
ability of the firm to produce on demand. From the capacity measures, we see
that the ability to produce on demand has created additional available capacity
in the value stream. For the second six months, the focus has been on improv-
ing quality. FTT improved form 60% to 90 %, a dramatic increase in quality. For
example, eliminating scrap may explain why the materials cost dropped, giv-
ing the increase in ROS that did occur. The improvements have eliminated
waste and increased the amount of available capacity. The implications are
profound. The company can produce higher quality products more much more
rapidly. This will enable the company to produce the kind of products de-
manded by customers, in the quantities needed, and delivered when they need
them. This should begin to translate into increased sales and improved finan-
cial performance. The stage is now set.

2. The constant sales per person coupled with constant total sales, suggest that
the head count has not been reduced. More resources are available for use by
the value stream as reflected by the increase in available capacity. The fact
that financial performance has not improved dramatically is likely attributable
to the fact the company is maintaining the same level of resources in the value
stream. Eliminating these resources is one way to improve financial perfor-
mance. However, a more preferable approach is to find ways to use them pro-
ductively. New products and expanded production (which may occur because
of increased quality and improved cycle time) are much better ways of improv-
ing financial performance.

3. Accepting the order only promises a contribution of $10,000 or an ROS of 10%,

using the traditional standard cost. However, the value stream has 50% avail-
able capacity, suggesting that the order could easily be accepted (the value
stream is currently producing $800,000 of sales output) without causing any
increase in the conversions cost already being incurred. The only incremental
cost would be the materials cost of $30,000. Thus, value stream profitability
would increase by $70,000 and sales by $100,000. ROS = $330,000/900,000 =
36.67%, a hefty increase in ROS from this one order.

562
16–17

1. 2007 2008
a. 192,000/80,000 = 2.4/hour (velocity) 2.4/hour
60/2.4 = 25 minutes (cycle time) 25 minutes
b. 152,000/80,000 = 1.9/hour (velocity) 176,000/80,000 = 2.2/hour
60/1.9 = 32 minutes* (cycle time) 60/2.2 = 27 minutes*
c. N/A ($20 – $10)/$20 = 50%
d. 152,000/80,000 = 1.9 176,000/80,000 = 2.2
e. 20,000/200,000 = 10% 16,000/200,000 = 8%
f. N/A ($200 – $250)/$250 = (20%)
g. N/A (6 – 3)/6 = (50%)
h. 9,000/152,000 = 5.9%* 4,000/176,000 = 2.3%*
i. 4,000/152,000 = 0.026/unit* 16,000/176,000 = 0.091/unit*
j. 200 hours 800 hours
k. $300 $280
l. 2 × 40 = 80 6 × 40 = 240
m. ($300 × 4,000)/($300 × 152,000) ($280 × 16,000)/($280 × 176,000)
= 2.63%* = 9.1%*
n. 20% 176,000/780,000 = 22.6%**
o. N/A [($280 × 176,000) – ($300 ×
152,000)]/($300 × 152,000) = 8.1%*
*Rounded
**152,000 ÷ 20% = 760,000 + 20,000 = 780,000

563
16–17 Continued

2. Strategic Objectives Measures

Financial:
Reduce unit cost Unit cost
Develop new customers New customers per unit sold
Increase total revenues Percentage change in revenues

Customer:
Reduce customer Price/Unit
sacrifice Postpurchase costs
Increase customer Number of new customers
acquisition
Increase market share Percentage of market

Process:
Decrease process time Cycle time/Velocity
Decrease defective units Number of defects
Number of scrapped units
Decrease inventory Days of inventory

Learning and Growth:

Increase employee Output per hour
capabilities Training hours
Suggestions

All measures have shown improvement over the two-year period. This pro-
vides evidence of the strategy’s viability, assuming that the measures are tied
to the strategy as they appear to be. What is lacking are the targets for the
various measures. Knowing the targets for the two-year period would signifi-
cantly enhance the value of the feedback. It is important to emphasize that
comparing targets to actuals allows for an assessment both of implementa-
tion success and strategy viability (double-loop feedback).

564
16–17 Concluded

3. It is important to understand that one cause can have more than one effect
and that an effect can have more than one cause. Because of this, a strategy
can have several cause-and-effect branches. Based on the available informa-
tion, we can express the strategy as follows:
If training is increased, then employee productivity and participation will in-
crease; if employee productivity and participation increase, then product
quality and process time will improve; if process time decreases and if the
product quality improves, then inventory will decrease and costs will de-
crease (including postpurchase costs); if inventory decreases, then costs will
decrease; if costs decrease, then customer sacrifice decreases (selling prices
and postpurchase costs lowered); if selling prices and postpurchase costs
are lowered, then the number of customers can be increased; if the number of
customers increases, then market share will increase; if market share in-
creases, then revenues will increase.
The measures reveal a lot about the strategy; in fact, if the measures are
properly specified, they should tell the whole story of the strategy. The meas-
ures allow us to infer the strategic objectives and the underlying relationships
of these objectives.
Market share is an example of a measure that acts as both a lead and a lag
measure. It acts as an outcome variable because it is a consequence of other
performance drivers such as selling prices and postpurchase costs, but it is
also a lead measure for revenues. Hours of training is a lead measure only
(for this example), and revenues is a lag measure only.

565
16–18

1. Setup $125,000
Materials handling 180,000
Inspection 122,000
Customer complaints 100,000
Warranties 170,000
Storing 80,000
Expediting 75,000
Total $852,000
Units produced and sold ÷120,000*
Potential unit cost reduction $ 7.10
*$1,920,000/$16 (total cost divided by unit cost)
The consultant’s estimate of cost reduction was on target. Per-unit costs can
be reduced by at least $7, and further reductions may be possible if improve-
ments in value-added activities are possible.

2. Target cost to maintain sales = $14 – $4 = $10

Target cost to expand sales = $12 – $4 = $8
Current cost = $16
Cost reduction to maintain = $16 – $10 = $6
Cost reduction to expand = $16 – $8 = $8

3. Total potential reduction:

$ 852,000 (from Requirement 1)
150,000 (by automating)
$1,002,000
Units ÷ 120,000
Unit savings $ 8.35
Costs can be reduced by at least $7, enabling the company to maintain cur-
rent market share. Further, if all the nonvalue-added costs are eliminated,
then the cost reduction needed to increase market share is also possible.

4. Current:
Sales $ 2,160,000 ($18 × 120,000 units)
Costs (1,920,000)
Income $ 240,000

566
16–18 Concluded

$14 price (assumes that current market share is maintained):

Sales $1,680,000 ($14 × 120,000 units)
Costs (918,000) ($7.65* × 120,000 units)
Income $ 762,000
$12 price:
Sales $ 2,160,000 ($12 × 180,000 units)
Costs (1,377,000) ($7.65* × 180,000 units)
Income $ 783,000
*$16 – $8.35 = $7.65
The $12 price produces the greatest benefit.

16–19

1. Current cost per unit = $12,800,000/20,000

= $640
Current profit per unit = $720 – $640
= $80
Target cost (C) to maintain current profit and expand market share:
$624 – C = $80
C = $544

2. Nonvalue-added costs:
Materials (400,000 – 380,000)$21 $ 420,000
Labor (96,000 – 91,200)$12.50 60,000
Setups (6,400 – 0)$75 480,000
Materials handling (16,000 – 0)$70 1,120,000
Warranties (16,000 – 0)$100 1,600,000
Total $3,680,000
Units produced and sold ÷ 20,000
Unit nonvalue-added cost $ 184
Current cost less nonvalue-added cost:
$640 – $184 = $456
This is much less than the target cost of $544 Thus, achieving target cost is
possible. How quickly the cost reductions can be achieved is another matter.
As CEO, I would attempt to reduce the nonvalue-added costs quickly by im-
plementing lean manufacturing methodologies. I would also lower the price to

567
 $624 by year end and seek to take advantage of the increased market share—
even if it meant a short-term reduction in profits.

16–20

1. Good life-cycle costing and life-cycle management require tracing develop-

ment and logistics costs to individual products. The company should aban-
don the traditional distinction of product and period costs. While this distinc-
tion may work well for external reporting, a more comprehensive view is
needed for managerial product costing.
Also, because most of the costs are committed during the development
stage, it is critical that the design engineers know what drives product costs.
An activity-based management system is essential for life-cycle cost man-
agement.

2. Revised income statements:

Product A Product B Total
Sales $ 4,000,000 $5,000,000 $ 9,000,000
Cost of goods sold 2,000,000 2,500,000 4,500,000
Gross margin $ 2,000,000 $2,500,000 $ 4,500,000
Traceable expenses:
R&D (1,200,000) (800,000) (2,000,000)
Marketing (575,000) (575,000) (1,150,000)
Life-cycle income $ 225,000 $1,125,000 $ 1,350,000
Return on sales 5.6% 22.5% 15%
Based on the revised income statements, Product B is an attractive invest-
ment according to the 20 percent criterion.

568
16–20 Concluded

3. The target cost for A is $3,200,000 ($4,000,000 – $800,000); for B it is

$4,000,000 ($5,000,000 – $1,000,000). There is no need to reduce costs for
Product B—it already meets the target cost criterion ($3,875,000 is less than
$4,000,000). Product A, however, does not. Its costs are $3,775,000. Thus,
costs must be reduced by $575,000 ($3,775,000 – $3,200,000).
Activity analysis can help by identifying the activities associated with Product
A and the cost drivers that are associated with these activities. This informa-
tion may help design engineers to redesign Product A so that it does not
consume as many resources over its life cycle. The information may also be
useful in helping redesign the processes used for producing and selling
Product A.
The ability to influence life-cycle costs is primarily available during the devel-
opment stage. More than 90 percent of a product’s costs are committed dur-
ing this stage, and very little can be done to alter the total cost by the time
production begins. Thus, it makes sense to focus on managing activities dur-
ing the development stage.

4. Postpurchase costs can be large and play a significant role in a customer’s

product purchase decision. Boyce Products strives to create a long-term
competitive advantage. Managing activities so that whole-life costs are re-
duced can help achieve this objective. Managers must balance whole-life
costs with other factors such as product performance, reliability, innovative-
ness, and durability.

569
16–21

1. Velocity (theoretical) = 180,000/60,000 = 3 heaters per hour

Cycle time (theoretical) = 60 minutes/3 heaters = 20 minutes per heater

2. Conversion cost rate = $1,800,000/(60,000 × 60) = $0.50 per minute

Assignment per unit (theoretically) = $0.50 × 20 minutes = $10.00, or
$1,800,000/180,000 = $10.00

3. Applied conversion cost = $0.50 × 30 minutes = $15.00

If cell managers are rewarded for lowering product cost, then one way prod-
uct cost can be lowered is by decreasing the time to produce one unit of
product. For example, if the time is decreased from 30 minutes to 25 minutes,
then the conversion cost assigned would be $12.50 ($0.50 × 25), saving $2.50
per unit. Of course as cycle time decreases, delivering on time should also
improve.

4. MCE = Theoretical time/Actual time = 20/30 = 0.67

Wasted time = 30 – 20 = 10 minutes; Cost = $0.50 × 10 minutes = $5.00

5. In the advanced manufacturing environment, firms need to compete on the

basis of time and cost. These measures support these objectives. The goal is
to decrease cycle time (increase velocity) by eliminating nonvalue-added
time. As nonvalue-added time is reduced, MCE increases, and the conversion
cost assigned per unit decreases. Also, as MCE increases, nonvalue-added
time drops, and nonvalue-added costs decrease, yielding a lower-cost prod-
uct.

570
16–22

1. MCE = 45.0/(45.0 + 3.0 + 7.5 + 12.0 + 36.0 + 46.5)

= 0.30

2. Lean improvements improve the manufacturing process by changing the way

things are done—by improving time, quality, and efficiency. This is done by
incremental or dramatic improvements in processes. Rearranging work flow,
reducing scrap and defective units, implementing cellular manufacturing, and
JIT purchasing, are among the approaches taken. Process improvement and
innovation require a thorough understanding of the activities that define the
processes. Identifying the root causes (driver analysis) helps a manager un-
derstand how processes can be improved. Activity analysis adds to this un-
derstanding by identifying activities and assessing their value content. Finally,
performance measures that reflect quality, time, and efficiency are used to
measure progress in improving processes. For example, MCE is a measure of
the value-added content as a percentage of total activity performance. As the
value-added content increases, MCE should increase.

3. MCE is a lag measure. To reduce MCE, as indicated in Requirement 2, the

process must be improved. Performance drivers would include hours of qual-
ity training (this should reduce inspection and rework time), suggestions per
employee (this could reveal ways to reduce wait time, for example), and real-
time feedback capabilities (this could decrease wait and storage time).

571
16–23

1. a. Standard-costing-based. Materials price variances may encourage buying

in quantity to take advantage of discounts and thus work against the ob-
jective of zero inventories (storage is a nonvalue-added activity). Also, in
an effort to achieve a favorable variance, a purchasing agent may buy low-
er-priced, lower-quality materials, thus working against the objective of to-
tal quality control (competing on the basis of quality is critical for the ad-
vanced manufacturing environment).
b. Lean-based. Cycle time encourages reduction of the time it takes to pro-
duce products. This is compatible with the pull-through philosophy of JIT
and the objective of on-time delivery. It supports the objective of deliver-
ing goods quickly to customers (time-based competition).
c. Lean-based. This comparison encourages managers to reduce actual
costs to the targeted level. This is compatible with the objective of conti-
nuous improvement. It is also compatible with the objective of delivering a
low-priced, high-quality product to customers, especially since cost reduc-
tion is achieved by eliminating nonvalue-added activities.
d. Standard-costing-based. Materials usage variances may encourage poor
quality or excessive inventory. These outcomes conflict with the objec-
tives of total quality and zero inventory. Also, usage standards allow a cer-
tain amount of inefficiency and tend to support the status quo, working
against the principle of continuous improvement.
e. Lean-based. Trend reports emphasize the objective of continuous im-
provement. The objective is to encourage managers to produce favorable
trends.
f. Standard-costing-based. Traditional performance reports can encourage
excessive inventory, lack of preventive maintenance, and poor quality, all
of which conflict with the objectives of zero inventories, total preventive
maintenance, and total quality. Overreliance on budgetary performance
creates an internal focus, ignoring the very critical external relationships.
g. Lean-based. Benchmarking helps foster change. By identifying the best
practices of competitors, opportunities, as well as the need for increased
efficiency, are noted. This supports the principle of continuous improve-
ment.

572
16–23 Continued

h. Lean-based. Improving delivery performance is compatible with the objec-

tives of continuous improvement, service quality, and pull-through pro-
duction. It also supports the time-based, competitive dimension that is so
important for the advanced environment.
i. Lean-based. Quality measures are virtually ignored by a standard costing
system. Yet, knowing quality performance is fundamental to measuring
and improving quality.
j. Lean-based. Highlighting value-added and nonvalue-added costs is com-
patible with the objectives of absolute efficiency and continuous im-
provement. Costs not reported are costs ignored. Highlighting nonvalue-
added costs encourages managers to reduce and eliminate these costs.
k. Standard-costing-based. Labor efficiency variances can encourage poor
quality and inventories, both of which conflict with the objectives of total
quality and zero inventories. Moreover, with labor becoming a smaller per-
centage of total costs, it is easy to fall into the trap of overemphasizing di-
rect labor, often at the expense of more important areas.
l. Lean-based. If the objective is to reduce days of inventory, then this
measure is compatible with the objective of zero inventories. In this case,
the trend in the measure is important and should be declining.
m. Lean-based. Reducing downtime is compatible with total preventive main-
tenance, zero inventories, and the pull-through philosophy of JIT. As
downtime is reduced, one of the major reasons for carrying inventory is
eliminated.
n. Lean-based. Manufacturing cycle efficiency is compatible with continuous
improvement and elimination of nonvalue-added activities. As nonvalue-
added activities are eliminated, product cost decreases, and cycle time
tends to decrease.
o. Lean-based. The unused capacity measure focuses on activity utilization.
The objective is to increase the unused capacity for nonvalue-added activ-
ities and to reduce or redeploy resource spending to more productive out-
comes. For value-added activities, increasing activity efficiency should al-
so bring about an increase in activity capacity.

573
16–23 Concluded

p. Standard-costing-based. This variance often occurs because of using dif-

ferent mixes of skilled laborers. Thus, it discourages the use of skilled la-
borers in unskilled tasks. Yet, in a JIT environment, for example, one of the
objectives is to be able to use laborers in a variety of tasks. Producing on
demand may mean that highly skilled production workers should not be
producing—in this case, they could be used for such things as cleaning
up and preventive maintenance. This makes the labor rate variance less
useful.
q. Lean-based. Adopting the best practices of other units within the organiza-
tion fosters change and continuous improvement.

2. Operational: b, h, i, l, m, n, and sometimes q

Financial: a, c, d, e, f, g, j, k, o, p, and q
Operational measures use physical measures of performance, thus providing
operational workers feedback in terms that they know and understand. This
allows them to relate to the performance measures in a more meaningful way.
Even so, it is probably a good idea to communicate from time to time the dol-
lar effect of changes in performance. In this way, workers know that their per-
formance can significantly affect the financial well-being of the firm (and, as a
result, their own financial well-being).

3. Strategic-based accounting derives its measures from the mission and strat-
egy of the organization. Thus, the set of measures is strategically linked. The
set of measures expands to cover customer and learning and growth pers-
pectives. The measures are also balanced with particular emphasis on includ-
ing both lead and lag measures. Lead measures are performance drivers and
are the factors that enable improvement of outcome measures. Additional
measures would include such things as customer satisfaction, customer re-
tention, market share, customer acquisition, customer profitability, employee sa-
tisfaction, employee productivity, and availability of real-time information.

574
16–24

1. Theoretical velocity = 30,000/4,000 = 7.5 guns per hour

Theoretical cycle time = 60/7.5 = 8 minutes per gun

2. Actual velocity = 25,000/4,000 = 6.25 guns per hour

Actual cycle time = 60/6.25 = 9.6 minutes per gun

3. MCE = 6.25/7.5 = 0.83. The efficiency of the operation is very high.

4. Budgeted conversion costs = $2,500,000/(4,000 × 60)

= $10.42 per minute*
*Rounded
Theoretical conversion costs per gun = $10.42 × 8 = $83.36
Actual conversion costs per gun = $10.42 × 9.6 = $100.03
Yes. By reducing cycle time, the cost per unit can be reduced. The potential
reduction is as follows:
$100.03 – $83.36 = $16.67 per gun

16–25

1. Strategic Objective Lag Measure Lead Measure

Financial:
Increase profitability ROI —
Increase new customers Percentage of
and markets revenue from
new sources —
Reduce unit cost Unit cost —

Customer:
Increase customer acquisition New customers —
Increase customer satisfaction Survey ratings —
Increase market share Market share —
Increase product quality Returns —
Improve product image
and reputation — Survey ratings

575
16–25 Continued

Strategic Objective Lag Measure Lead Measure

Process:
Improve process quality Quality costs —
Percentage of
defective units Redesign time
Increase quality of Percentage of Engineering
purchased components defective units hours

Learning and Growth:

Increase employee capabilities — Training hours
Job coverage
— ratio
Increase motivation and Suggestions Suggestions per
alignment implemented employee
Increase information system On-time report
capabilities — percentage

2. The if-then sequence strategy representation:

If training and strategic job coverage are improved and if information systems
capability is improved, then employees will increase the number of suggested
improvements; if the number of suggested improvements increases, then the
number implemented will increase; if the number of suggestions implemented
increases, then process quality will increase; if process quality increases and
if the percentage of defective components decreases, then the number of de-
fective units will decrease; if the number of defective units decreases, then
product quality will increase; if product quality increases, then product image
and reputation will improve and then the costs of quality will decrease; if
product image and reputation improve, then customer satisfaction will im-
prove; if customer satisfaction improves then the number of new customers
will increase; if the number of new customers increases, then market share
will increase; if market share increases, then revenues will increase; if reve-
nues increase and if costs of quality are reduced, then profitability will in-
crease.

576
16–25 Continued

FINANCIAL Reduce Increase Increase

Costs Profits Revenues

Market New Customer

Share Customers Satisfaction

CUSTOMER

Product Product
Quality Image

Process Component
PROCESS
Quality Quality

Employee Suggestions Information

LEARNING AND
Capabilities Capabilities
GROWTH

577
16–25 Concluded

3. Evaluation entails or should entail double-loop feedback. Double-loop feed-

back requires information both on the implementation of the strategy and the
viability of the strategy. Implementation effectiveness involves comparing the
actual values of the measures with the targeted values. If the actual values
meet or beat the targeted values for both outcome (lag) measures and per-
formance drivers (lead measures), then effective implementation has oc-
curred. If the actual outcome measures are less than the targeted measures
and the actual lead measures are equal to or greater than the targeted values,
then the viability of the strategy can be questioned. Thus, knowing the expli-
cit targets and actual values would be useful information. However, it is indi-
cated several times that the expected improvements were being realized, indi-
cating both implementation success and strategy viability. The financial out-
comes were also in the right direction.

4. The Balanced Scorecard provides a means for directed continuous improve-

ment. It also links performance measures to the strategy itself and, thus, arti-
culates and communicates the strategy to employees, increasing the chances
of obtaining an alignment of employees’ goals with organizational goals.

5. Using 6 percent, the targeted goal for rework costs was $1,560,000. Since the
actual costs were $1,500,000, the target was met.

6. All but supplier evaluation and training are nonvalue-added activities (inspec-
tion, rework, scrapping units, warranty, sales returns, and customer com-
plaints). The potential savings are $3,410,000 (the total minus the costs of
evaluation and training).

578
 MANAGERIAL DECISION CASE

16–26

1. A more fundamental question is: Is it ethical for management to not under-

take actions to eliminate waste? Should an ethical leader produce a quality
product? To knowingly produce a product that is not able to perform its in-
tended functions seems wrong. To allow resources knowingly to be wasted
seems wrong. These resources are provided by investors and creditors who
expect them to be used productively so that they can be returned along with
an acceptable profit. Thus, an ethical manager would strive to produce quali-
ty products and eliminate waste and to serve customers well. These actions
are compatible with lean manufacturing objectives. If there are ways (and
there are probably other approaches that would work) to accomplish the
same objectives, then it would be hard to say that it is unethical to not use
lean manufacturing—unless lean manufacturing is defined as all methodolo-
gies that will lead to a quality product, minimal waste, and timely service to
customers.
2. Ethical communication is covered by objectivity standards, IV-1 and IV-2 and
the competence standard, I-3. Ethical quality is covered by competence stan-
dards I-I and I-2, and Integrity standards, III-4. Ethical collaboration is covered
to some extent by integrity standards III-1 and II-4. Ethical succession is also
covered to some extent by Competence standard I-1 and Integrity standard III-
4. Ethical tenure is trust-based and in reality requires the full gamut of ethical
standards: competence, confidentiality, integrity, and objectivity. Confiden-
tiality is especially important.
3. The qualities mentioned cover a lot of territory. In fact, the notion of fostering
and developing leadership and surrounding oneself with capable advisors is
an interesting insight into ethical behavior—going beyond the normal view of
ethics. Ethical tenure is the catch-all quality. It might be better labeled as eth-
ical trust since that seems to be the core element. Trust centers on the entire
spectrum of ethical behavior: competence, integrity, confidentiality, and ob-
jectivity. How long someone serves seems to only be an ethical issue if loss
of trust occurs—which seems to mean that the leader is violating some ethi-
cal norm. Ethical quality might be better labeled as ethical stewardship. Man-
agers are entrusted with the resources of others and are expected to use
them wisely and productively. This could be expanded to include products
and processes that are pollution free. One possible addition to the list of ethi-
cal leadership qualities is something that deals with social responsibility. For
example, ethical sustainability may be something many would view as impor-
tant. Using renewable resources instead of nonrenewable resources in pro-
ducing the products arguably is an ethical choice so that future generations
may have access to scarce resources.

579
 RESEARCH ASSIGNMENT

10–27

Answers will vary.

580