Tail of two cities only

A-B-Cstrategic tool, not an accounting system

Vaidya--UBS

VFMTODAY’S CUSTOMER WANTS

ActivitiesActivitiesCreate outcomes

andconsume resources

Create outcomes and

consume resources

VALUE-ADDED ACTIVITIESenhance the value of products

and services in the eyes of the customer while meetingthe goals of the organization

VALUE-ADDED ACTIVITIESenhance the value of products

and services in the eyes of the customer while meetingthe goals of the organization

NON-VALUE-ADDED ACTIVITIES

do not contribute to customerperceived value

NON-VALUE-ADDED ACTIVITIES

do not contribute to customerperceived value

The Importance Of Customer Value

Most likelysources of non-

value-addedactivity

Most likelysources of non-

value-addedactivity

• Producing to build up inventory• Waiting time for processing• Time and effort to move to processing• Producing defective products of services

Non-Value Added Activities

The test for value added activitiesThe test for value added activities

“Would the organization be more likely to reach its goal by

performing that activity?”

“Would the organization be more likely to reach its goal by

performing that activity?”

“Would an external customer encourage

the organization to do more of the activity?”

“Would an external customer encourage

the organization to do more of the activity?”

Identifying Value-Added Activities

A revolution is transforming the manufacturing industry

• The growth of international competition• The breakneck pace of technological innovation• Startling advances in computerized system

Created a new playing field where some have emerged

as World-class producers, while others have fallen by the wayside

A-B-C

Vaidya--UBS

Conventional Vs Activity Based Costing

A case in point: Material Purchasing Department

Conventional Accounting based information:Cost Categories Annual Cost (Rs. ‘000)

Employees’ Remuneration 94,200Telephone 4,400Travel & Entertaining 7,100Computer Cost 6,200Rent 8,300Administrative Overheads 6,200

TOTAL 126,400

• What does information tell us about purchasing function?

• What decisions or actions can a manager take based on this information ? Vaidya--UBS

Cost Department: Purchasing

ACTIVITIES COST DRIVERS

Process Requisitions Numbers of requisitions

Expedite Orders Number of urgent orders

Process Receipts Paper work required

COST DRIVER ANALYSIS

Vaidya--UBS

Activity Based Costing MethodPurchasing Activities %of Annual Cost time (Rs.’000)

Process requisitions Clarify details 13% 16,430Prepare Specifications 2% 2,530Obtain quotations 1% 1,265Vender queries 3% 3,790Negotiate &select vender 1% 1,265Generate orders 5% 6,320Generate change orders 11% 13,900 36% 45,500

Vender queries 6% 7,590Chase late orders 4% 5,055Amend for changed quantities 9% 11,375Process urgent supplies/ stockouts 10% 12,640 29% 36,660

ABCM provides a much clearer picture of how time is spent and opportunities for improvement

13% of time is spent on clarifying requisition and 11% time is spent on processing changed orders.How much time and money could be saved if they were right at first time?Only 1% time is spent on negotiating and selecting vendors .Could quality delivery and cost of materials be improved by spending more time here.

10% of time is spent on urgent orders.Would better planning reduce time here and enable smother operations?

Vaidya--UBS

Process ReceiptsChecking goods received 1% 1,265Follow -up of short deliveries 8% 10,110Follow -up backorders 2% 2,530Cancel orders no longer required 1% 1,265Prepare reports and administration 23% 29,070 35% 44,240 100% 126,400

23% of time is spent on reports and administration Is this all necessary? Can this time be spent more productively?

Vaidya--UBS

Aerotech corporation:

A TALE OF TWO CITIES

(Phoenix and Bakersfield Plants)

a case study in Cost management

AEROTECH CORPORATION ---a case in point

Aerotech corporation: a tale of two citiesPRODUCT: printed circuit boards used in aircraft radar and

LOCATION: Phoenix plant (more than 20 years) Bakersfield plant (recently added)

TWO DIFFERENT SCENARIOS : Phoenix plant utilizes a traditional plant layout and production processes where as Bakersfield employs the latest in advanced manufacturing technology

Vaidya--UBS

Traditional “Push” ManufacturingComputer Manufacturer

Forecast Sales Order components

Prepare Production Schedule

Begin Production in Anticipation of Sales

Make sales from finished

goods inventory

Store Inventory

JIT “Pull” ManufacturingComputer Manufacturer

Customer places an order

Create Production Order

Generate component requirements

Production begins as parts arrive

Goods delivered just in time

Components are ordered

PRODUCTION PROCES

1. SEQUENCING2. AUTO-INSERTION3. HAND-INSERTION4.WAVE SOLDERING5. WASH/DRY6.HAND-INSERTION7. BED NAILS8.BURN-IN9. PACKAGING

Vaidya--UBS

Aerotech Corporation’s Phoenix Plant

Shipping

Receiving

Inspection

Raw

Material &

Parts

Storage

Purchasing

&

Inventory

Control

Production

Scheduling

Sales &

Marketing

Finished goods Storage

1. Axial leadSequencing

Work in ProgressStorage

2. Auto-insertion


3. Hand-insertion

Work-in-ProgressStorage

4. Wave Soldering

9. Packaging

Work in Progress

Storage

8. Burn-in-Testing

Work in Progress

Storage

7. Bed-of-Nails

Testing


6. Hand-insertion

Work in Progress

Storage

5. Wash/Dry

Work in Progress

Storage

Maintenance and Custodial

Qua lity Control

Design Engineer ing

Industrial Engineering

Elec tronic Data Processing

Plant Manager and Staff Accounting Personnel

Aerotech Corporation’s Bakerfield Plant

Shipping

Receiving

Inspection

Raw Material

& Parts

Storage

Purchasing

And

Inventory

Control

Sales

And

Marketing

Finished Goods Storage Packaging

Work

Center

Burn-in

Testing

Work

Center

Production

Scheduling

Personnel

Plant Manager

and

Staff

Maintenance

And Custodial

Quality

Control

Engineering

Design

Computer

Center

Accounting

TRADITIONAL , VOLUME-BASED PRODUCT COSTING SYSTEM

Basic production and cost data:

Mode I Mode II Mode IIIBoards Boards Boards

Production unit 10,000 20,000 4,000Production runs 1 run of 10000 4 runs of 5000 each 10 runs of 400 each

Direct material 50 90 20 (raw boards and components)

Direct labour* 3 hours per board 4 hours per board 2 hours per board

Setup time* 10 hours per run 10 hours per run 10 hours per run

Machine time 1 hour per board 1.25 hours per board 2 hours per board

* direct labour and setup labour cost 20 per hour, including fringe benefits

Vaidya--UBS

PRODUCT COST FROM TRADITIONAL, VOLUME-BASED PRODUCT-COSTING SYSTEM


Direct material 50 90 20 (raw boards and components)

Direct labour* 60 (3hr.@20 ) 80 (4hr.@20 ) 40 (2hr.@20)

Manufacturing overhead* 99 (3 hrs. @33 ) 132 (4 hrs. @33) 66 (2 hrs. @33)

TOTAL 209 302 126Calculation of predetermined- overhead rate:

Budgeted manufacturing overhead----------------------------------------------------- 3894000Direct Labou, budgeted hours :

Mode I : 10000 units*3 hours 30000 ModeI I : 20000 units*4 hours 80000 Mode III : 4000 units*2 hours 8000 TOTAL HOURS 118000Predetermined overhead rate:Budgeted overhead/Budgeted direct labour hours = 3894000/118000 = 33 Per Hour

Vaidya--UBS


Target and Actual Selling Prices :

Production Cost under Traditional 209 302 126volume-based System

Target selling Price 261.25 377.50 157.50 (cost* 125%)

Actual selling price 261.25 328.00 250.00

Vaidya--UBS

12 3

Stage one of A-B-C : Identification of Activity Cost Pool

OVERHEAD COSTSTotal budgeted cost = 3894000

ACTIVITYCOSTPOOL

MachineryCost Pool 1212600

SetupCost Pool

3000

Engineering Cost Pool

700000

FacilityCost Pool

507400

UNITLEVEL

BATCHLEVEL

PRODUCTION-SUSTAININGLEVEL

FACILITYLEVEL

Receiving and Inspection Cost Pool200000

Material-Handling Cost Pool600000

Quality-Assurance Cost Pool421000

Packing and Shipping Cost Pool 250000

Vaidya--UBS

1.A-B-C : Machinery Cost Pool

Maintenance

Depreciation

Computer Support

Lubrication

Electricity

Calibration

Machinery Cost PoolTotal budgeted cost =1212600

Total budgeted machinery cost/Total budgeted machine hours = 1212600/43000 machine hours

= 28.20 per machine hour

Mode I28.20*1=28.20

Mode II28.20*1.25

=35.25

Mode III28.20*2= 56.40

Activity costpool

Various Overhead Costsrelated to machinery

Calculation ofpool rate

Cost assignment :pool rate per machine hour*

machine hours per unit

STAGEONE

STAGE TWO

Vaidya--UBS

2. A-B-C : Setup Cost Pool

Setup cost poolTotal budgeted cost = 3000

Total budgeted setup cost/Total planned production runs = 3000/15 runs = 200 per run

Mode I 200 per run/10000

units per run=.02 per run

Mode II200 per run/5000

units per run=.04 per unit

Mode III200 per run/400 units

per run=.50 per unit

Activity costpool

Calculation of totalsetup cost


Cost assignment :pool rate per setup/

units per production run

STAGEONE

STAGE TWO

Total budgeted setup cost= (10 hrs. per setup) (20 per hour) (15 production runs)

Vaidya--UBS

3. A-B-C : Machinery Cost Pool

Maintenance

Depreciation

Computer Support

Lubrication

Electricity

Calibration

Machinery Cost PoolTotal budgeted cost =1212600

Total budgeted machinery cost/Total budgeted machine hours = 1212600/43000 machine hours

= 28.20 per machine hour

Mode I28.20*1=28.20

Mode II28.20*1.25

=35.25

Mode III28.20*2= 56.40

Activity costpool

Various Overhead Costsrelated to machinery


Cost assignment :pool rate per machine hour*

machine hours per unit

STAGEONE

STAGE TWO

Vaidya--UBS

4. A-B-C : Engineering Cost Pool

Engineer’s salary

Engineering supplies

Engineering software

Depreciation onengineering equipment

Engineering Cost PoolTotal budgeted cost =700000

Total budgeted engineering cost = 700000

Mode I25%*700000/10000

units =17.50 per unit

Mode II45%*700000/20000

units=15.75 per unit

Mode III30%*700000/4000

units=52.50 per unit

Activity costpool

Various Overhead Costsrelated to engineering

Allocation to product lines based on

proportion of engineeringtransactions

Cost assignment :cost allocated to each product

line / no. of units of each product

STAGEONE

STAGE TWO

25% oftransactions

45% oftransactions

30% oftransactions

Vaidya--UBS

5.A-B-C : Facility Cost Pool

Plant depreciation

Plant management

Plant maintenance

Property taxes

Insurance

Security

Facility Cost PoolTotal budgeted cost =507400

Total budgeted facility cost/Total budgeted direct labour hours 507400 / 118000

= 4.30 per direct labour hour

Mode I4.30 per direct labourhour * 3 hr. per unit

=12.90 per unit

Mode II4.30per direct

labour hour * 4 hr.

=17.20 per unit

Mode III4.30 per direct labourhour * 2 hr. per unit

=8.60 per unit

Activity costpool

Various Overhead Costsrelated to facilities andand general operations


Cost assignment :pool rate per direct labour

hour * direct labour per unit

STAGEONE

STAGE TWO

Vaidya--UBS

PRODUCT COST FROM ACTIVITY-BASED-COSTING SYSTEM :


DIRECT MATERIAL 50.00 90.00 20.00DIRECT LABOUR 60.00 80.00 40.00MACHINERY--(a) 28.20 35.25 56.40SETUP --(b) .02 .04 .50ENGINEERING --© 17.50 15.75 52.50FACILITY --(d) 12.90 17.20 8.60RECEIVING AND INSPECTION--(e) 1.20 2.40 35.00MATERIAL HANDLING--(f) 4.20 9.00 94.50QUALITY ASSURANCE--(g) 8.42 8.42 42.10PACKAGING AND SHIPPING--(h) 1.00 3.75 41.25

TOTAL 183.44 261.81 390.85

Vaidya--UBS

COMPARISON OF PRODUCT COSTS FROM ALTERNATIVE PRODUCT COSTING SYSTEMS :


REPORTED PRODUCT COSTS :

TRADITIONAL COSTING SYSTEM 209.00 302.00 126.00ACTIVITY-BASED COSTING SYSTEM 183.44 261.81 390.85

SALES PRICE DATA:

ORIGINAL TARGET PRICE 261.25 377.50 157.50 (based on traditional system)NEW TARGET PRICE 229.30 327.26 488.56(based on A-B-C)ACTUAL SELLING PRICE 261.25 328.0 250.00

Vaidya--UBS

COST DISTORTION UNDER TRADITIONAL PRODUCT-COSTING SYSTEM

Mode Mode II Mode III Board Boards Boards

PRODUCT COST UNDER TRADITIONAL SYSTEM 209.00 302.00 126.00 PRODUCT COST UNDER A-B-C SYSTEM 183.44 261.81 390.85 AMOUNT OF COST DISTORTION PER UNIT 25.56 40.19 (264.85)

Traditiona

system overcostsMode I

by 25.56

Traditiona system

overcostsMode II

by 40.19

Traditiona system

undercostsMode III

by(264.85)

* PRODUCTION VOLUME 10000 20000 4000TOTAL AMOUNT OF COST DISTORTION 255600 803800 (1059400)

SOME OF THESE THREEAMOUNTS IS ZERO

Vaidya--UBS

This traditional material handling operation depicts the non-value-addedactivities of move time, waiting time, and storage time In Phoenix

Identifying non- value added costs in the Phoenix Plant (as suggested by the President of the company)

• Storage : a considerable reduction in storage space and time is both possible and essential

• Waiting : circuit boards should be processed through each operationonly as they are required in the subsequent operation. Thus, the amountof time products spend waiting for the next operation should be virtuallyeliminated

• Moving :The time devoted to moving raw material and work in processis excessive. Ways must be found to reduce the cost of these materialhandling activities

• Inspection : The bed- of- nails and burn-in tests appear to be necessaryand efficiently conducted. Nevertheless, management should continually reassess the need for these inspection operations

• Processing : The manual insertion of components in department 3 and 6• can be performed by robots. The desirability of this change be explored

JIT PRODUCTION AND INVENTORY SYSTEM

PURCHASING

SALES

PRODUCTIONSTAGE I

PRODUCTIONSTAGE II

PRODUCTIONSTAGE III

DEMAND FOR RAW MATERIALS AND PARTS IS SIGNALEDWHEN THERE IS A NEED IN STAGE I FOR MORE INPUTS

DEMAND FOR PRODUCTION ACTIVITY IN STAGE I SIGNALEDWHEN THERE IS A NEED IN STAGE II FOR MORE INPUTS

DEMAND FOR PRODUCTION ACTIVITY IN STAGE II IS SIGNALEDWHEN THERE IS A NEED IN STAGE III FOR MORE INPUTS

DEMAND FOR FINISHED GOODS IS SIGNALED WHEN SALESACTIVITY WARRANTS MORE FINISHED UNITS. THIS TRIGGERS

MANUFACTURING ACTIVITY IN THE FINAL STAGE OF PRODUCTION

Denotes flow of material, parts, partially finished goods, and finished goods,

Denotes a signal that more goods are needed at the next stage of production

( BABERSFIELD PLANT )

COMPARISON OF PRODUCT COST IN PHOENIX AND BAKERSFIELD PLANTS :


PHOENIX 183.44 261.81 390.85(A-B-C S YSTEM)

Vaidya--UBS

BAKERSFIELD 170.60 232.70 341.35(A-B-C SYSTEM)

THANK YOU

Contacts:

Prof.SUBHASH C.VAIDYAUNIVERSITY BUSINESS SCHOOLPANJAB UNIVERSITY, CHANDIGARHE-MAIL:[email protected]

Vaidya--UBS

Business

Tail of two cities only