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Lecture 11

AYB225 - Lecture 11 Notes

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Queensland University of Technology

LECTURE 11 – INTRODUCTION TO STRATEGIC MANAGEMENT ACCOUNTING Deficiencies of Traditional Management Accounting  Thus far covered cost accounting – referred to as traditional management accounting techniques.  Commonly acknowledged limitations of traditional management accounting and the ‘new’ techniques that have resulted include: o Traditional systems were set up in a direct-labour-intensive manufacturing environment. Consequently, using overhead allocations based on direct-labour (or other volume-related bases) in a highly automated environment leads to inaccurate, non-representative product costs, and potentially bad business decisions. The problem is exacerbated because in an automated environment overhead is typically a higher percentage of manufacturing cost than in a traditional environment. (Activity based costing and management) o Product costs have included manufacturing costs only. A wider view recognises that much of the product's cost occurs in the design and development stage, and further that additional expense here can lead to savings in other areas. (Activity based costing, life-cycle costing, value-chain analysis) o The requirements of external reporting have dominated management accounting in the past. While it is still necessary to provide information for inventory valuation, in addition relevant information for decision-making is needed. (Cost concepts such as opportunity costs, relevant costs, marginal costs) o Management accounting in the past has been reactive. A firm made a decision to produce a product, and the management accountant was then called on to provide the costing for that product. In today's competitive environment, it is necessary for management accounting to take a more proactive role. Consequently, the strategic role of the management accountant is becoming increasingly important as the accountant provides management with information to enable the firm gain a sustainable competitive advantage. (Target costing, strategic cost management focus, marketing issues) o In the past, management accounting systems have focused on cost control (as evidenced by the emphasis placed on variance analysis). Today's systems still include cost control via traditional measures such as variance analysis, but also emphasise the reduction and elimination of non-value adding costs. (Value added, customer profitability analysis, total quality management, continuous improvement, business process re-engineering, just-in-time inventory) o Traditionally performance evaluation has focused on accounting measures, e.g. return on investment; achieving favourable variances etc. These accounting measures are primarily of interest to the principal stakeholder, viz. the owners/shareholders. While bottom-line profit is still important, it is recognised that there is a need to focus on other critical success factors for the firm (such as quality, customer satisfaction etc.) Consequently for certain decisions, non-financial indicators are required in addition to financial measures. (Non-financial performance indicators, balanced scorecards, benchmarking, best practice) o Past management accounting information systems have focused on accumulating data internal to the firm. The challenge in today's global market and highly competitive environment is to be able to supplement internal data with data from external sources (market-related information, customer information, competitor information). o Almost exclusive focus on manufacturing firms. The majority of accountants will be working in non- manufacturing firms, and consequently techniques need to be adapted to the service industry. Value Engineering  Value engineering includes value chain analysis, and involves analysing products, processes and costs with the objective of changing the way firms do things, and therefore reducing cost while at the same time maintaining customer satisfaction. o It is important that any changes should not remove activities (and therefore costs) resulting from what customers value, therefore value engineering revolves around the concept of value-added and non- value added activities and costs.  A feature of the “target costing” technique. Value Chain Analysis  An analysis of the firm's value chain provides potential for cost reduction. A firm gains competitive advantage is by performing all value chain functions (not just the production function, which has been the focus of most weeks of the course) more efficiently than its competitors.  Furthermore, analysis of the value chain also yields cost reduction opportunities relating to: o Linkages in the chain. For example, spending more in the design stage may mean savings greater than that amount in later stages. o The extended value chain. Strategies can be extended back to suppliers (e.g. setting contracts for supply of materials), or forward to customers (not just customer service, which is part of the value chain, but consulting customers in advance of production to find out what they value). o Re-engineering the way things are done. For example, instead of transporting A to B, move B to A. (Business process re-engineering) Value-added and non-value added  A value added activity is an activity which, if eliminated, would reduce the worth of a product or service to the customer. The activity adds value for the customer, and the customer is willing to pay for the activity.  A non-value-added activity increases the time spent producing the product, creates additional cost, but does not increase the worth of the product to the customer. o Elimination of the activity means that costs would decrease without affecting the market value or the quality of the product. Lecture Example Determine whether the following activities from the clothes-dryer assembly product line are value-added or non-value added. (a) Time-consuming moving of component parts from warehouse to assembly line. (b) Assembling the tumbler unit. (c) Expediting materials to the door-assembly area because of stock-balance error. (d) Assembling the dial-presentation component. (e) Inserting the owner's manual and instruction guide in the dryer package. (f) Reworking faulty latches on doors. (g) Testing the operating capabilities of the assembled unit. (h) Packaging the clothes dryer in a breakage-resistant box. Costs of Quality  Measurement of quality in traditional systems has focused on items such as: o the planning and control of production costs (variance analysis) o accounting for spoilage (which assumes that some level of spoiled product is acceptable and consistent with efficient production, and aims to control abnormal spoilage).  Some of today's firms strive for total quality management (TQM) production, which says that the only acceptable level of spoilage is zero. Costs of Quality  There are four costs of quality for a firm: (1) prevention costs (2) appraisal costs (3) internal failure costs (4) external failure costs  A cost advantage is sought by a TQM firm based on the principle that prevention costs are less than correction costs. In other words, costs incurred in the prevention stage will be more than compensated for by savings in the costs of failure. o TQM firms will be hoping to see the amounts spent in the four areas above decreasing as the firm moves from (1) to (4) to the ultimate stage when the only cost incurred is (1).  The employment of quality as a strategic tool for competitive advantage involves recognition of issues such as the following: o Expenditure on prevention costs has not been attractive in the past because of the short-term focus of traditional systems. Cost-savings lag cost-increases sometimes by lengthy periods. o Actual costs of poor quality in the past are probably higher than is recognised because of the multiplier effect on external failure costs. The firm may know the amount of goods that had to be replaced, but do not know how much lost custom has resulted because dis-satisfied customers o Firms may be slow to change because of the funds already committed to "fixing" the problem (eg. inspection systems, reworking etc.). Short-term profitability can be improved by incurring costs in the wrong area, ie. by continuing to "fix" rather than "prevent". Continuous Improvement  A TQM environment is characterised by "continuous improvement". o For example, a firm may start its quality improvement by focusing on problem areas - "on time delivery". Initially the firm will select performance measures to address that problem. The measure may be "percentage of on-time deliveries", and the target may be "70%". As things improve, the target moves higher (now "95%"). o Once on-time delivery is improved, we change our focus. Lecture Example Classify the following costs as prevention, appraisal, internal failure or external failure. a) Line inspection b) Normal spoilage identified c) Design engineering d) Returned goods e) Product testing equipment f) Customer problems and complaints g) Rework of faulty products prior to sale h) Preventive maintenance i) Product liability claims j) Incoming materials inspection k) Breakdown maintenance l) Product testing labour m) Training n) Warranty repair o) Supplier evaluations Reduction Inventory – Just in Time Inventory Systems  With the new focus on cost leadership and value-adding, firms are realising that holding inventory is frequently a "non-value-added" activity and cost. Therefore cost can be reduced by reducing inventory, or in the extreme case, as under JIT, eliminating it altogether.  A JIT system implies that physical material moves along the production line only in response to customer orders, rather than being pushed into production only to be stored in warehouses. It is sometimes called a "demand pull" system.  Firms sit somewhere on a continuum from “just in case” to 100% “just in time”, with various number of inventory accounts. o “Just in case” firms will have Materials, WIP and FG. Others will combine their Materials and WIP into a “RIP account” (raw materials in process). Others will have a FG account, and still others at the extreme may have “none of the above”, i.e. only produce to order, so the job can be immediately expensed. Life Cycle Costing  Better decision-making will occur, resulting in potential cost reduction, by considering the life-cycle costs of the product rat
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