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MANAGEMENT ACCOUNTING (VOLUME II) - Solutions ManualCHAPTER 27MANAGING ACCOUNTING INA CHANGING ENVIRONMENTI. Questions The American Heritage Dictionary defines quality as “1. a characteristic or attribute of something; property; a feature. 2. the natural or essential character of something. 3. excel...

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MANAGEMENT ACCOUNTING (VOLUME II) - Solutions Manual

CHAPTER 27 MANAGING ACCOUNTING IN A CHANGING ENVIRONMENT

I.

Questions 1. The American Heritage Dictionary defines quality as “1. a characteristic or attribute of something; property; a feature. 2. the natural or essential character of something. 3. excellence; superiority.” Quality for a product or service can be defined as a “product or service that conforms with a design which meets or exceeds the expectations of customers at a price they are willing to pay.” 2. Procter & Gamble defines TQM as “the unyielding and continually improving effort by everyone in an organization to understand, meet, and exceed the expectations of customers.” Typical characteristics of TQM include focusing on satisfying customers, striving for continuous improvement, and involving the entire workforce. TQM is a continual effort and never completes. Global competition, new technology, and ever-changing customer expectations make TQM a continual effort for a successful firm. 3. The core principles of TQM include (1) focusing on satisfying the customer, (2) striving for continuous improvement, and (3) involving the entire work force. 4. Continuous improvement (Kaizen) in total quality management is the belief that quality is not a destination; rather, it is a way of life and firms need to continuously strive for better products with lower costs. In today’s global competition, where firms are forever trying to outperform the competition and customers present ever-changing expectations, a firm can never reach the ideal quality standard and needs to continuously improve quality and reduce costs to remain competitive. 5. The Institute of Management Accountants (IMA) believes an effective implementation of total quality management will take between three and five years and involves the following tasks: Year 1

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Chapter 27 Managing Accounting in a Changing Environment

• • • • •

Create a quality council and staff Conduct executive quality training programs Conduct quality audits Prepare gap analysis Develop strategic quality improvement plans

Year 2 • • •

Conduct employee communication and training programs Establish quality teams Create measurement systems and set goals

Year 3 • • •

Revise compensation / appraisal / recognition systems Launch external initiatives with suppliers Review and revise

6. Reward and recognition are the best means of reinforcing the emphasis on TQM. Moreover, proper reward and recognition structures can be very powerful stimuli to promote TQM. Efforts and progress will most likely be short-lived if no change is made to the compensation / appraisal / recognition systems to make them in line with the objectives of the firm’s TQM. 7. The purposes of conducting a quality audit are to identify strengths and weaknesses in quality practices and levels of a firm’s quality and to help the firm identify the target areas for quality improvements. 8. A gap analysis is a type of benchmarking that includes analyzing the differences in practices between the firm and the best-in-class. The objective of gap analyses is to identify strengths, weaknesses, and target areas for quality improvement. 9. Some examples of costs associated with cost of quality categories are: Prevention costs: Training costs such as instructors’ fees, purchase of training equipment, tuition for external training, training wages and salaries; salaries for quality planning and executions, cost of preventive equipment, printing and promotion costs for quality programs, awards for quality. Appraisal costs: Costs of raw materials, work-in-process, and finished goods inspections.

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Managing Accounting in a Changing Environment Chapter 27

Internal failure costs: Scrap, rework, loss due to downgrades, reinspection costs, and loss due to work interruptions. External failure costs: Sales returns and allowance due to quality deficiency, warranty cost, and canceled sales orders due to quality deficiency. 10. Prevention costs rise during the early years of implementing TQM as the firm engages in education to prepare its employees and in the planning and promotion of the quality program. Appraisal costs will also likely rise during the early years of TQM, because the firm needs to ensure that quality is actually being achieved. The increase in appraisal cost, however, is most likely to occur at a slower pace than those of the prevention costs because at the beginning of a TQM program there will be substantial increases in quality training and in promotion to raise awareness on the importance of quality. The firm may see some decreases in internal and external failure costs in the early years of implementing a TQM. However, these two costs most likely will remain at about the same level as before during the first several years of TQM. Many firms may actually see internal failure cost rise, because of the higher standard demanded by the TQM or the higher level of employees’ awareness on the critical importance of perfection in every step of the process. As the firm makes progress in TQM, both internal failure and external failure costs should decrease. 11. Costs of conformance are costs incurred to ensure that products or services meet quality standards and include prevention costs and appraisal costs. Internal and external failure costs are costs of non-conformance. They are costs incurred or opportunity costs because of rejection of products or services. 12. Better prevention of poor quality often reduces all other costs of quality. With fewer problems in quality, appraisal is needed because the products are made right the first time. Fewer defective units also reduce internal and external failure costs as the occasion for repairs, rework, and recalls decrease. It is easier to design and build quality in than try to inspect or repair quality in. Theoretically, if prevention efforts are completely successful, there will be no need to incur appraisal costs and there will be no internal failure or external failure costs. In practice, appraisal costs usually do not decrease, partly because management needs to ensure that quality is there

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as expected. Nonconformance costs, however, decrease at a much faster pace than prevention costs increase. 13. The role of management accountants in total quality management includes gathering all relevant quality information, participating actively in all phases of the quality program, and reviewing and disseminating quality cost reports. 14. To meet the challenges of total quality management, management accountants need to have a clear understanding of TQM methodology. They must be able to design, create, or modify information systems that measure and monitor quality and evaluate progress toward total quality as expected of each organizational unit and the total enterprise. 15. Just-in-time (JIT) purchasing is the purchase of goods or materials such that a delivery immediately precedes demand or use. Benefits include lower inventory holdings (reduced warehouse space required and less money tied up in inventory) and less risk of inventory obsolescence and spoilage. 16. The sequence of activities involved in placing a purchase order can be facilitated by use of the Internet. A company can streamline the procurement process for its customers – e.g., having online a complete price list, information about expected shipment dates, and a service order capability that is available 24 hours a day with email or fax confirmation. 17. Just-in-time (JIT) production is a “demand-pull” manufacturing system that has the following features: • • • • •

Organize production in manufacturing cells, Hire and retain workers who are multiskilled, Aggressively pursue total quality management (TQM) to eliminate defects, Place emphasis on reducing both setup time and manufacturing lead time, and Carefully select suppliers who are capable of delivering quality materials in a timely manner.

18. Reengineering is the fundamental rethinking and redesign of business processes to achieve improvements in critical measures of performance such as cost, quality, service, speed, and customer satisfaction. 19. The three main measures used in the theory of constraints are: a. Throughput contribution equal to sales revenue minus direct materials costs. 27-4

Managing Accounting in a Changing Environment Chapter 27

b. Investments (inventory) equal to the sum of materials costs of direct materials inventory, work-in-process inventory and finished goods inventory, research and development costs, and costs of equipment and buildings. c. Other operating costs equal to all operating costs (other than direct materials) incurred to earn throughput contribution. 20. The four key steps in managing bottleneck resources are: Step 1: Recognize that the bottleneck operation determines throughput contribution. Step 2: Search for, and find the bottleneck. Step 3: Keep the bottleneck busy, and subordinate all nonbottleneck operations to the bottleneck operation. Step 4: Increase bottleneck efficiency and capacity. 21. (a) Product warranty costs should be lower because a world-class manufacturer (WCM) will make fewer defectives. (b) Salaries of quality control inspectors should be lower because a WCM will have its workers inspect as they go, rather than having separate inspections. Nor will a WCM inspect incoming materials and components because it will deal only with vendors whose quality has been demonstrated. (c) Amounts paid to vendors for parts and components should be higher because a WCM will not search out the lowest prices, but will seek high-quality components delivered when needed. (d) Wages rates for direct laborers should be higher because a WCM’s workers will multiskilled and should therefore command premium wages. (e) Total supervisory salaries should be lower because a WCM’s workers will not need as much supervision. (f) Warehousing costs should be lower because a WCM will produce as needed and so will not require storage space for materials or finished product. 22. At the final assembly stage in a JIT system, a signal is sent to the preceding workstation as to the exact parts and materials that will be needed over the next few hours for the final assembly of products. Only those parts and materials are provided. The same signal is sent back through each preceding workstation so that a smooth flow of parts and materials is maintained with no buildup of inventories at any point. Thus, all workstations respond to the “pull” exerted by the final assembly stage.

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The “pull” approach just described can be contrasted to the “push” approach used in conventional systems. In a conventional system, inventories of parts and materials are built up—often simply to keep everyone busy. These semi-completed parts and materials are “pushed” forward to the next workstation whether or not there is actually any customer demand for the products they will become part of. The result is large stockpiles of work in process inventories. 23. A number of benefits accrue from reduced setup time. First, reduced setup time allows a company to produce in smaller batches, which in turn reduces the level of inventories. Second, reduced setup time allows a company to spend more time producing goods and less time getting ready to produce. Third, the ability to rapidly change from making one product to making another allows the company to respond more quickly to customers. Finally, smaller batches make it easier to spot manufacturing problems before they result in a large number of defective units. II. Exercises Exercise 1 (Quality Cost Classification) Preventio n Appraisal a. b. c. d. e. f. g. h. i. j. k. l.

Warranty repairs Scrap Allowance granted due to blemish

Internal Failure

External Failure x

x x

Contribution margins of lost sales Tuition for quality courses Raw materials inspections Work-in-process inspection Shipping cost for replacements Recalls Attorney’s fee for unsuccessful defense of complaints about quality Inspection of reworks Overtime caused by reworking

x x x x x x x x x 27-6

Managing Accounting in a Changing Environment Chapter 27 m. n.

Machine maintenance Tuning of testing equipment

x x

Exercise 2 (Cost of Quality Report) Requirements 1 & 2 Bali Company Cost of Quality Report For 2005 and 2006 Cost of Quality Category Prevention costs: Quality manual Product design Appraisal costs: Testing Internal failure costs: Rework Retesting Disposal of defective units External failure costs: Product recalls Field service Total cost of quality

2006 Peso

%

2005 Peso

%

P 40,000 300,000

P 340,000

5.67

P 50,000 270,000

P320,000

5.33

P 80,000

80,000

1.33

P 60,000

60,000

1.00

340,000

5.67

P250,000 90,000 85,000

425,000

7.08

590,000 P1,350,000

9.83 22.50

P200,000 50,000 90,000 P360,000 230,000

P500,000 350,000

850,000 14.17 P1,655,000 27.58

a. There were slight increases in both prevention and appraisal costs from 2005 to 2006. Each of these two cost of quality increased by approximately 0.33 percent of the total sales. These two costs increased by P40,000 over the two years. b. Both internal failure costs and external failure costs decreased substantially in 2006 as compared to those in 2005. The firm experienced a 1.41 percent decrease in internal failure and a 4.34 percent decrease in external failure costs with the total savings of P345,000. The savings was 863 percent of the increases in prevention and appraisal costs. Requirement 3 Among nonfinancial measures the firm may want to monitor are: • • •

The number of defects or the processes yield (ratio of good output to total output) The percentage of defective units shipped to customers to total units of products shipped The number of customer complaints 27-7

Chapter 27 Managing Accounting in a Changing Environment

• • •

Difference between delivery date requested by the customer On-time delivery percentage (total units shipped on or before the scheduled date to the total units shipped) Surveys of customer satisfaction

It should be noted that nonfinancial measures by themselves often have limited meaning. Nonfinancial measures are more informative when trends of the same measure over time are examined. Exercise 3 (Cost of Quality Category) Requirement 1 Costs of Quality Rework Recalls Reengineering efforts Repair Replacements Retesting Supervision Scrap Training Testing of incoming materials Inspection of work in process Downtime Product liability insurance Quality audits Continuous improvement Warranty repairs

Prevention

Appraisal

Internal Failure P 6,000

External Failure P15,000

P 9,000 12,000 12,000 5,000 P18,000 9,000 15,000 7,000 18,000 10,000 9,000 5,000 1,000 15,000

Requirement 2 Total spent by category

P25,000

Requirement 3

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P48,000

P42,000

P51,000

Managing Accounting in a Changing Environment Chapter 27

The company is currently spending the least on preventive costs. They should concentrate their efforts on preventive costs because they prevent poor quality products from being manufactured. By increasing amount spent on prevention, they could reduce spending on the other cost of quality categories. Exercise 4 (Cost of Quality Analysis, Nonfinancial Quality Measures) Requirements 1 and 2 Revenues

Costs of Quality Prevention costs Design engineering Preventive maintenance Training Supplier evaluation Total prevention costs

Appraisal costs Line inspection Product-testing equipment Incoming materials inspection Product-testing labor Total appraisal costs Internal failure costs Scrap Rework Breakdown maintenance Total internal failure costs

2006 P12,500,000 Percentage of Revenues (2) = (1) ÷ Cost P12,500,000 (1)

2005 P10,000,000 Percentage of Revenues (4) = (3) ÷ Cost (3) P10,000,000

P240,000

P100,000

90,000 120,000 50,000

35,000 45,000 20,000

500,000

4.0%

200,000

85,000

110,000

50,000

50,000

40,000 75,000 250,000

20,000 220,000 400,000

2.0%

200,000 135,000

250,000 160,000

40,000

90,000

375,000 27-9

3.0%

500,000

2.0%

4.0%

5.0%

Chapter 27 Managing Accounting in a Changing Environment External failure costs Returned goods Customer support Product liability claims Warranty repair Total costs of quality

145,000 30,000 100,000 200,000 475,000 P1,600,000

3.8% 12.8%

60,000 40,000 200,000 300,000 600,000 P1,700,000

6.0% 17.0%

Between 2005 and 2006, Gabriel’s costs of quality have declined from 17% of sales to 12.8% of sales. The analysis of individual costs of quality categories indicates that Gabriel began allocating more resources to prevention activities – design engineering, preventive maintenance, training and supplier evaluations in 2006 relative to 2005. As a result, appraisal costs declined from 4% of sales to 2%, costs of internal failure fell from 5% of sales to 3%, and external failure costs decreased from 6% of sales to 3.8%. The one concern here is that, although external failure costs have decreased, the cost of returned goods has increased. Gabriel’s management should investigate the reasons for this and initiate corrective action. Requirement 3 Examples of nonfinancial quality measures that Gabriel Corporation could monitor are: a. Number of defective grinders shipped to customers as a percentage of total units of grinders shipped. b. Ratio of good output to total output at each production process. c. Employee turnover. Exercise 5 (Costs of Quality Analysis, Nonfinancial Quality Measures) Requirements 1 and 2 Revenues, Costs of Quality and Costs of Quality as a Percentage of Revenues for Victoria Revenues = P2,000 x 10,000 units = P20,000,000

Costs (1)

Costs of Quality 27-10

Percentage of Revenues (2) = (1) ÷ P20,000,000

Managing Accounting in a Changing Environment Chapter 27

Prevention costs Design engineering (P75 x 6,000 hours) Appraisal costs Testing and inspection (P40 x 1 hour x 10,000 units) Internal failure costs Rework (P500 x 5% x 10,000 units) External failure costs Repair (P600 x 4% x 10,000 units) Total costs of quality

P 450,000

2.25%

400,000

2.00%

250,000

1.25%

240,000

1.20%

P1,340,000

6.70%

Revenues, Costs of Quality and Costs of Quality as a Percentage of Revenues for Vancouver Revenues = P1,500 x 5,000 units = P7,500,000

Costs of Quality Prevention costs Design engineering (P75 x 1,000 hours) Appraisal costs Testing and inspection (P40 x 0.5 x 5,000 units) Internal failure costs Rework (P400 x 10% x 5,000 units) External failure costs 27-11

Costs (1)

Percentage of Revenues (2) = (1) ÷ P7,500,000

P 75,000

1.00%

100,000

1.33%

200,000

2.67%

Chapter 27 Managing Accounting in a Changing Environment

Repair (P450 ...