Costing

and the
Value Chain

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 The Value Chain—Focus
on Core Operations
The value chain is the set of activities and
resources necessary to create and deliver
products and services valued by customers.

R&D Suppliers Distribution

Customer
and and and
Service
Design Production Marketing

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Value and Non-value-Added
Activities
Activities

Analysis and
Classification
Non-value- Value-
Added Added
Activities Activities
Reduce or Continually Evaluate
Eliminate
McGraw-Hill/Irwin and Improve
© The McGraw-Hill Companies, Inc., 2002
 Non-value-Added Activities
Examples of non-value-
added activities are: Get rid
 Storage of materials,
work-in-process, or
of them!
finished goods.
 Moving parts and
materials in the factory.
 Waiting for work.
 Inspection.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Activity-Based Management —
Drive Out Costs perbedaan

Activity-based costing
establishes relationships Activity-based management
between overhead focuses on managing
costs and activities. activities to reduce costs.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 ABC: a Subset of
Activity-Based Management
Identify Ac
ti vit
activities y-b
Create ase
cost dm
pools an
Identify ag
em
Ac activity en
ti v i t
ty-b measures Determine
ase cost per unit
dc
ost of activity
in g Collect
benchmark
information
Analyze
activities

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Activity-Based Management
and the Value Chain
Chart activities needed
to meet customer
expectations.
Use ABC to determine
cost of activities.
Classify all activities
as value-added
or non-value-added.

Improve value-added
activities and eliminate
non-value-added activities.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 The Target Costing Process —
Creating Customer Satisfaction

Driven by the Focused

customer. on design.

Target costing is aimed at the earliest stages

of new product and service development.

Focused Consideration
simultaneously given to the
on profit and entire
cost planning. value chain.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 The Target Costing Process
Attaining the
Target Cost
Establishing the
Target Price
Production
design and
Concept value
development engineering
Target Profit Target
price margin cost
Planning Production
and market and
analysis continuous
improvement

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 Major Influences on Target Pricing

Price

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 Components of the
Target Costing Process
Developing target prices and target
costs requires four steps:

Develop products  Target price

that satisfy – Profit margin
customer needs. = Target cost

Set target price using Use value engineering

competitors’ prices and to find least costly
customers’ perceived combination of resources
value for product. to meet customer needs.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Life-Cycle Product
Costing and Pricing

Product Research,
discontinued design, and
and customer development
support ends
Life-
cycle
costing
Marketing Production

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Life-Cycle Product
Costing and Pricing

Product Research,
discontinued design, and
and customer development
support ends Pricing must
generate revenue
to cover costs
of all phases
of product
life cycle.
Marketing Production

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Characteristics of
Target Costing Processes
Involve entire value An understanding of
chain in reducing relationships between
costs while satisfying process components
customer needs. and costs is critical.

A product’s functional characteristics to the

customer are emphasized.

A primary ABC is used to

objective is reducing determine changes
development time. that will reduce costs.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Just-In-Time (JIT) Inventory
Receive
customer Complete products
orders. just in time to
ship to customers.

Schedule
production.

Receive materials Complete parts

just in time for just in time for
production. assembly into products.

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 Relationship Between JIT and
Total Quality Management (TQM)

Less warehouse
space needed

Reduced
inventory
carrying costs

Reduced risk With reduced inventories, quality must

of obsolete be emphasized to avoid production
inventory delays and late deliveries.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Relationship Between JIT and
Total Quality Management (TQM)

Less warehouse
space needed More rapid
response to
customer orders
Reduced
inventory
carrying costs

Greater
Reduced risk Higher quality
customer
of obsolete products
satisfaction
inventory
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 JIT, Supplier Relationships,
and Product Quality
Successful implementation of a JIT system requires:
 A limited number of suppliers who will
make on-time deliveries of quality
materials.
 Quality that is “designed-in” and
“manufactured-in” rather than
“inspected-out”.
 A well-trained flexible work force.
 An efficient plant layout.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Measures of Efficiency
in a JIT System
ProductionS Goods
tarted Shipped

Process Time + Inspection Time +

Storage and Waiting Time + Move Time

Manufacturing Cycle Time

Only the process time is value-added time.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Measures of Efficiency
in a JIT System
ProductionS Goods
tarted Shipped

Process Time + Inspection Time +

Storage and Waiting Time + Move Time

Manufacturing Cycle Time

Manufacturing
Value-added time
Efficiency =
Ratio Manufacturing cycle time
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Measures of Efficiency
in a JIT System

If cycle costs may service and

time go up, and quality may
goes up, go down.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Why is Quality Important?

Quality
Increased
products
business
and
volume
services

Greater
customer
satisfaction
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Components of the Cost of Quality
 Prevention costs
 Inspection of materials upon delivery
 Inspection of production process
 Equipment inspection
 Employee training
 Appraisal costs
 Finished goods inspection
 Field testing of products

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Components of the Cost of Quality
 Internal failure costs – defects discovered
before delivery to customers
 Scrap materials
 Rework
 Reinspection of rework
Cost
 Lost sales resulting Report

from late deliveries

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Components of the Cost of Quality
 External failure costs – defects discovered
after delivery to customers
 Warranty repairs
 Product liability
 Marketing costs to
improve product image
 Lost sales due to poor
product quality

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Components of the Cost of Quality

Ultimate Objective:

Zero defects
Cost of while minimizing Internal
prevention all four quality and external
and appraisal cost categories. failure costs

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Components of the Cost of Quality
External and
Internal Failure Total Cost
of Quality
Cost of Quality

Direction of
Prevention recent trend
and Appraisal
in industry.

Low Quality High Quality

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Measuring and Reporting the Cost of Quality
Amount Total % of Sales
Prevention Costs:
Training $ 12,000
Maintenance 10,000
Quality planning 8,000 $ 30,000 3.2%
Appraisal Costs:
Material inspections 6,000
Equipment inspections 2,000
Supplier relations 4,000
Testing 5,000 17,000 1.8%
Internal Failure Costs:
Rework 5,000
Downtime 7,000
Scrap 8,000 20,000 2.1%
External Failure Costs
Warranty 4,500
Lost sales 20,000
Repairs 6,500 31,000 3.3%
Total $ 98,000 10.4%

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Productivity and Quality

 Traditional managerial
accounting systems may
emphasize production
quotas and cost
minimization.
 Managers often find that
emphasis on quality also
increases productivity.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002