Chapter
18
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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
and
Design
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Suppliers
and
Production
Distribution
and
Marketing
Customer
Service
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Value and Non-value-Added
Activities
Value-added activities add to product or service
desirability in customers’ eyes.
Identify
Non-valueadded
activities
Eliminate
Non-value-added activities add cost without
additional desirability, and can be eliminated
without reducing quality or performance.
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Value and Non-value-Added
Activities
Activities
Analysis and
Classification
Non-valueAdded
Activities
ValueAdded
Activities
Reduce or
Eliminate
Continually Evaluate
and Improve
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Non-value-Added Activities
Examples of non-valueadded activities are:

Storage of materials,
work-in-process, or
finished goods.

Moving parts and
materials in the factory.

Waiting for work.

Inspection.
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Get rid
of them!
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Activity-Based Management —
Drive Out Costs
What’s the difference between
activity-based costing and
activity-based management?
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Activity-Based Management —
Drive Out Costs
Activity-based costing
establishes relationships
between overhead
costs and activities.
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Activity-based management
focuses on managing
activities to reduce costs.
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ABC: a Subset of
Activity-Based Management
Identify
activities
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Create
cost
pools
Identify
activity
measures Determine
cost per unit
of activity
Collect
benchmark
information
Analyze
activities
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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.
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The Target Costing Process —
Creating Customer Satisfaction
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along to a
new topic.
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The Target Costing Process —
Creating Customer Satisfaction
Driven by the
customer.
Focused
on design.
Target costing is aimed at the earliest stages
of new product and service development.
Focused
simultaneously
on profit and
cost planning.
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Consideration
given to the
entire
value chain.
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The Target Costing Process
Attaining the
Target Cost
Establishing the
Target Price
Production
design and
value
engineering
Concept
development
Target
price
Planning
and market
analysis
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Profit
margin
Target
cost
Production
and
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
that satisfy
customer needs.
 Target price
– Profit margin
= Target cost
Set target price using
Use value engineering
competitors’ prices and
customers’ perceived
value for product.
to find least costly
combination of resources
to meet customer needs.
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Life-Cycle Product
Costing and Pricing
Product
discontinued
and customer
support ends
Marketing
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Research,
design, and
development
Lifecycle
costing
Production
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Life-Cycle Product
Costing and Pricing
Product
discontinued
and customer
support ends
Marketing
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Research,
Pricing must
generate revenue
to cover costs
of all phases
of product
life cycle.
design, and
development
Production
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Characteristics of
Target Costing Processes
Involve entire value
An understanding of
chain in reducing
costs while satisfying
customer needs.
relationships between
process components
and costs is critical.
A product’s functional characteristics to the
customer are emphasized.
A primary
ABC is used to
objective is reducing
development time.
determine changes
that will reduce costs.
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Just-in-time (JIT)
Inventory Procedures
Let’s move
along to
another
topic.
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Just-In-Time (JIT) Inventory
Receive
customer
orders.
Complete products
just in time to
ship to customers.
Schedule
production.
Receive materials
just in time for
production.
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Complete parts
just in time for
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
of obsolete
inventory
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With reduced inventories, quality must
be emphasized to avoid production
delays and late deliveries.
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Relationship Between JIT and
Total Quality Management (TQM)
Less warehouse
space needed
More rapid
response to
customer orders
Reduced
inventory
carrying costs
Reduced risk
of obsolete
inventory
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Higher quality
products
Greater
customer
satisfaction
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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.
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Measures of Efficiency
in a JIT System
ProductionS
tarted
Goods
Shipped
Process Time + Inspection Time +
Storage and Waiting Time + Move Time
Manufacturing Cycle Time
Only the process time is value-added time.
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Measures of Efficiency
in a JIT System
ProductionS
tarted
Goods
Shipped
Process Time + Inspection Time +
Storage and Waiting Time + Move Time
Manufacturing Cycle Time
Manufacturing
Efficiency =
Ratio
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Value-added time
Manufacturing cycle time
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Measures of Efficiency
in a JIT System
If cycle
time
goes up,
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costs may
go up, and
service and
quality may
go down.
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Total Quality Management
and the Value Chain
Let’s move
to the last
topic in
the chapter.
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Why is Quality Important?
Quality
products
and
services
Increased
business
volume
Greater
customer
satisfaction
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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
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Components of the Cost of Quality
 Internal failure costs – defects discovered
before delivery to customers

Scrap materials

Rework

Reinspection of rework

Lost sales resulting
from late deliveries
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Cost
Report
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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
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Components of the Cost of Quality
Cost of
prevention
and appraisal
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Internal
and external
failure costs
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Components of the Cost of Quality
Ultimate Objective:
Cost of
prevention
and appraisal
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Zero defects
while minimizing
all four quality
cost categories.
Internal
and external
failure costs
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Components of the Cost of Quality
Cost of Quality
External and
Internal Failure
Total Cost
of Quality
Direction of
recent trend
in industry.
Prevention
and Appraisal
Low Quality
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High Quality
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Measuring and Reporting the Cost of Quality
Prevention Costs:
Training
Maintenance
Quality planning
Appraisal Costs:
Material inspections
Equipment inspections
Supplier relations
Testing
Internal Failure Costs:
Rework
Downtime
Scrap
External Failure Costs
Warranty
Lost sales
Repairs
Total
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Amount
Total
$ 12,000
10,000
8,000
$ 30,000
3.2%
6,000
2,000
4,000
5,000
17,000
1.8%
5,000
7,000
8,000
20,000
2.1%
31,000
$ 98,000
3.3%
10.4%
4,500
20,000
6,500
% of Sales
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Productivity and Quality

Traditional managerial
accounting systems may
emphasize production
quotas and cost
minimization.

Managers often find that
emphasis on quality also
increases productivity.
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End of Chapter 18
I’m managing some
quality time in a
value-added activity.
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