Management Accounting:
A Road of Discovery
Management Accounting:
A Road of Discovery
James T. Mackey
Michael F. Thomas
Presentations by:
Roderick S. Barclay
Texas A&M University - Commerce
James T. Mackey
California State University - Sacramento
© 2000 South-Western College Publishing
Chapter 11
How do we begin the improvement
process?
Total quality management and
continuous improvement
Key Learning Objectives
1.Discuss total quality
management’s three critical
success factors of quality,
service, and cost.
2.Define the four quality costs and
create a cost of quality report.
3. Explain how to identify valueadded and nonvalue-added
activities, and how continuous
improvement with kaizen
costing supports TQM.
4. Calculate the inefficiency and
cost created by nonvalue-added
activities.
5. Prepare a fishbone diagram and
Pareto chart, and discuss the
need for 2nd generation ABC in
eliminating quality problems.
6. Identify ways to motivate a
TQM mentality.
The Objective of Good Management

The objective is to maintain and add value to
the enterprise.
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As competition increases, we can increase value
by decreasing our costs or differentiating products
to add greater customer value.
The only truly sustainable competitive advantage
is the ability to learn and improve faster than the
competition.
We want to do things that add value for the
marketplace and do these things as efficiently as
possible.
Part II
Definition of Quality —
Measuring value created in the
eyes of the customer
Quality of Design



Quality of design is the fit between the
customers wants and the goods or services
we provide.
This means we design products with
customers in mind.
For example, both the Geo and the Mercedes
are quality products but they may not both be
quality designs for the same customer.
Total Quality Management (TQM)

This is a philosophy that focuses on
 Better product quality (Quality of
Conformance).
 Commitment to customer service (Service).
 Minimize total costs (Cost).
Linking Value to Operational Conformance

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Quality of Conformance means the product meets its
specifications.
 It has the characteristics the company promises.
Service means the company does what it’s supposed
to do for the customer.
Cost for the customer means all costs incurred by the
product throughout the customer’s value chain.
A value-focused strategy must consider all three
because only current costs and revenues are
measured.
Value is determined by both current and future
cashflows.
Nonfinancial measures are lead indicators of future
cashflows
Part III
The Role of Management
Accounting in TQM
Management Accounting’s Role in TQM



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Influence change by measuring the costs of
current quality activities.
Determine the activities adding value to our
products (or services) AND THOSE NOT
ADDING VALUE.
Provide relevant cost information for
proposed changes.
Monitor and report the financial impact of
quality programs.
Changing the Corporate Culture


Use Cost of Quality (COQ) reporting.
The objectives of COQ reports are:


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Changing the corporate culture.
Reporting the money spent on quality failures.
Identifying the cost of quality activities.
Identifying the relationships between conformance
costs and nonconformance costs.
Tracking the changes over time.
Total Quality Management vs. Traditional
Management
Conformance


The Traditional View is that as conformance costs
increase, the nonconformance cost savings decrease.
Therefore at some point increasing spending on
quality is not justified.
The TQM view is that savings from increasing quality
always justify the cost.

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We need to consider the long-term strategic value of
zero defect products,
The advantages for automation when defects are
eliminated, and
The incremental savings to current and future
product lines over many years.
Part IV
Cost of Quality
Juran’s COQ Relationships
Failure
Costs
Appraisal and
Prevention Cost
0
% of Conformance
95%
•Costs versus benefits — an efficient level of inefficiency (scientific
management).
•Long-Term strategic value exceeds the costs of prevention (TQM
management).
The Four Classifications of COQ

Quality Conformance activities.

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Prevention costs are the monies spent to stop
quality failures from happening.
Appraisal costs are the monies spent to identify
failures that have happened.
Quality Nonconformance activities.


Internal failure costs are monies spent due to
failures before the products reach the customer.
External failure costs are monies spent and
value lost due to failures in the hands of the
customers.
Costs of Quality Examples

Prevention cost examples:


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New equipment to improve quality and prevent
problems.
Training in new methods to improve quality and
prevent problems.
Rewards to motivate high quality.
ISO certification.
Technical support to suppliers.
Preventive maintenance.
More Costs of Quality Examples

Appraisal cost examples:

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Inspection of materials.
Process inspection within each activity.
Final inspection of finished products.
Test equipment.
More Costs of Quality Examples

Internal failure cost examples:

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Scrapping bad materials.
Reworking subassemblies.
Reworking finished products.
Rejecting defective products.
Retesting reworked components or finished
products.
More Costs of Quality Examples

External failure cost examples:

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Warranty work.
Product replacements.
Recalls.
Product liability insurance, legal fees, etc.
Handling customer complaints.
Lost sales and customers.
Reporting the Costs of Quality

Review, analyze and discuss Exhibit 11-3, p.
397, which provides an example of one
method of preparing a Cost of Quality Report.
Trend Reports
$ 1 ,0 0 0
Cost ($000)
$800
$600
E x t e rn a l fa ilu re s
In t e rn a l fa ilu re s
A p p ra is a l
$400
P re ve n t io n
$200
$0
1
2
3
T im e P e rio d s
4
5
Lost Sales and Customers

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The treatment of this issue varies from
company to company. It is subjective (soft)
data and does not comply with GAAP (hard
data) concepts.
Estimates of both current and future losses in
value are required.
Determination of these costs requires a very
thorough understanding of the business and
its customers.
Measuring Value to External Consumers
— Examples

Critical success
factors
Quality

Management accounting system
measures

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Service

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Cost

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Number of warranty claims
Average number of warranty claims per
home
Ratio of customer testimonials to homes
sold
Time to approval for sales contracts
Time to approval for loan agreements
Warranty work time to completion
Sales price variance using competition’s
prices
Warranty cost as a percentage of profit
per house
Costs of quality reports
Part V
Process Value Analysis (PVA) &
Activity-Based Management (ABM)
Measuring Customer Value

Identify value adding and nonvalue adding
activities.

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Value adding activities (VA) are identified by the
characteristics the customers (internal or external)
value.
In a value chain, each subsequent activity is the
customer of the previous activity.
Any change in a VA activity should only be made
after consulting the affected customers.
Nonvalue adding activities (NVA) should be
eliminated (if possible) or minimized.
Performance Measures

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Performance measures should be based upon
value measures of quality, service, and cost.
Exhibit 11-6, p. 401, follows to illustrate
potential performance measures for external
customers.
Exhibit 11-7, p. 401, also follows to illustrate
potential performance measures for internal
customers.
Measuring Value to External Consumers
— Examples

Critical success
factors
Quality

Management accounting system
measures



Service



Cost



Number of warranty claims
Average number of warranty claims per
home
Ratio of customer testimonials to homes
sold
Time to approval for sales contracts
Time to approval for loan agreements
Warranty work time to completion
Sales price variance using competition’s
prices
Warranty cost as a percentage of profit
per house
Costs of quality reports
Measuring Value to Internal Consumers —
Packing measures for Shipping

Critical success
factors
Quality

Management accounting system
measures


Service

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
Cost

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Amount of damage during shipment due
to poor packaging materials
Extra time required in shipping because of
poorly packaged components
Time waiting to load houses and
packaged components
Time waiting for packaging materials
Time to approval for loan agreements
% of boxes not adequately labeled
Cost of rework or replacement for
damage caused during shipment
Extra cost from time trying to find
building site (due to poor directions,
maps, etc.)
ABM vs. ‘Management by the Numbers’

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Management by the numbers using management by
exception examines the outcome of work done.
Activities are only indirectly measure by cost data.
Activities are the sources of cost consumption.
Activities need to be managed — not costs.
It is more efficient to manage activities to maximize
value rather than managing costs.
Well-managed activities result in higher quality
products, better customer service, and lower costs.
Management by the number is not an attempt to
understand the root causes of, or elimination of,
nonvalue adding activities.
Continuous Improvement (Kaizen) Costing


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TQM makes incremental changes on a
continuing basis — Continuous Improvement
(CI).
Kaizen (which means continuous
improvement in Japanese) costing means we
are continuously changing cost standards.
Employee training and empowerment is
crucial.
The Relationship Between Target and
Kaizen Standard Costs
$130
Cost per unit
$120
$110
$100
Target cost
$ 90
$ 80
Introduction
Growth
Maturity
Life cycle stages
Decline
Part VI
Measuring the Impact of
NVA Costs
Illustrations

The next few slides demonstrate the
evaluation of and impact of Nonvalue Added
activities.
PVA for Framing Walls — Activity 3.2
Process 3: Manufacturing
Steps in Activity 3.2
Classification
1. Requisition lumber (2 x 4 studs) from WIP
Nonvalue-added
2. Process material requisition form (check for
materials availability, schedule forklift and driver)
Nonvalue-added
3. Forklift driver picks up lumber from stock yard
Nonvalue-added
4. Forklift driver delivers lumber to Assembly
Nonvalue-added
5. Stack according to when and where it is used
Nonvalue-added
6. Set up jigs to hold walls in place
Nonvalue-added
7. Lay down 12 2x4s for bottom of walls in the jigs
Value-added
8. Measure and mark for location of wall studs
Value-added
9. Get nails and brackets from inventory
Nonvalue-added
10. Pick up each 8’ 2x4 wall stud and set on the mark
Value-added
11. Nail the stud in place using 90o angle brackets
Value-added
Lead Time Efficiency (LTE) Ratio
Process 3: Manufacturing
Activity 3.2: Wall assembly (framing)
LTE Value =
Value-added time
Value-added + Nonvalue-added time
=
4 hours
4 + 12 hours
=
25%
Activity Cost Table



Review and analyze Exhibit 11-12, p. 409.
Notice the time spent on Nonvalue-added
activities and the costs involved.
In this case we cannot eliminate all of the
nonvalue-added costs. However, the cost
table does provide us relevant information
and indicates that we may be able to increase
efficiency and thereby reduce costs.
Part VII
Improving VA Activities —
Identifying the Core Problems
Fishbone Diagrams
Basic Fishbone Diagram Model
Causes
Results
See Exhibit 11-13, p. 411 for a completed fishbone diagram.
Pareto Charts
$1,000
$900
$800
$700
100%
80%
$600
$500
60%
$400
$300
$200
40%
20%
$100
$0
0%
Benchmarking


Benchmarking is the practice of comparing
our activities to similar activities from ‘best
practices’ companies. The activities do not
have to be identical as to their goals, just
similar as to their activities.
Benchmarking may be accomplished using
data from internal activities in our own
organization.
TQM Problems and Prescriptions
Reasons why TQM
initiatives fail:

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Incongruent
organizational culture
Reward system does not
support TQM
The search for a quick fix
Recommendations

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TQM becomes a formula
rather than a philosophy

Top management must be committed
Top management cannot dictate that
TQM will happen
Employees must be empower to do it
Reward employees for TQM activities
Use easy to understand measures
TQM must start with value chain
process and activities
Change from a department focus to an
activity focus
Develop employee excitement for
TQM