MANAGEMENT
ACCOUNTING
WEEK 9
OVERVIEW – CHAPTER 11
Operations & accounting
 The value chain
 Manufacturing v. services
 Standard costs
 Capacity utilization, spare capacity and product
mix

OPERATIONS & ACCOUNTING

Operations is the function
that produces the goods or
services to satisfy demand
from customers


purchasing,
manufacturing,
distribution and logistics
Four aspects of the
operations function:
quality, speed,
dependability and
flexibility - each has cost
implications

Slack et al.


What is the cost of spare
capacity?
What product/service mix
should be produced where
there are capacity
constraints?
VALUE CHAIN
Figure 11.1: Porter’s Value Chain
Firm Infrastructure
Support
activities
Human Resource Management
Technology Development
Procurement
Primary
activities
Inbound
Logistics
Operations
Outbound
Logistics
Copyright Porter 1985. Competitive Advantage New York: Free Press
Margin
Marketing
& Sales
Service
VALUE CHAIN
- PORTER

‘a collection of activities that
are performed to design,
produce, market, deliver, and
support its product … A firm’s
value chain and the way it
performs individual activities
are a reflection of its history,
its strategy, its approach to
implementing its strategy, and
the underlying economics of
the activities themselves’
 Porter


Costs should be assigned
to the value chain but
accounting systems can
get in the way of
analysing those costs
 Hierarchical
departments v. value
processes
The cost drivers of each
value activity should be
analysed to enable
comparisons with
competitor value chains
Figure 11.2 The manufacturing process and its relationship to accounting
INPUTS
CONVERSION PROCESS
OUTPUTS
Custom
Batch
Continuous
Raw materials
Work-in-progress
+
Labour
+
Equipment, facilities, space, etc.
Bill of Materials
Components & quantities
Labour Routing
processing steps & times
Which are priced to become
Standard costs
Finished goods
PRODUCTION METHODS

Custom


Batch


Unique, single products
A quantity of the same goods produced at the same
time ( a production run)
Continuous (or process)

Continuous production process of the same,
indistinguishable goods
MANUFACTURING V. SERVICES
 Inventory



Raw materials
Finished goods
Work in progress

Job costing
 Costing
methods
Bill of materials
 Labour routing


Process costing
SERVICES
Differences
Intangibility, heterogeneity, simultaneity and
perishability
 Types
 Professional services
 Mass services (transport, retail)
 Service shop (banks, hotels)

Fitzgerald et al.
Professional service equal to customised or batch
manufacturing; mass service with continuous
manufacture; and service shop as a batch-type process


- Slack et al.
STANDARD COSTS
Anticipated or budget cost for a unit or batch of
units
 Standard quantities multiplied by ‘standard’
costs: the current/ anticipated purchase prices for
materials and labour rates of pay

Materials, labour & overhead
 Expressed per unit

STANDARD COSTS
Printing of 5,000 copies of a text book.
The costing system shows that:
Materials (paper, ink, etc.)
$12,000
Labour for printing
$20,000
Overhead allocated
$10,000
Total Job Cost
$42,000
Cost per text book ($42,000/5,000 copies)
$8.40
CAPACITY UTILIZATION & THE COST OF
SPARE CAPACITY
Utilization of capacity is a key performance
driver

Accounting traditionally equates the cost of
using resources with the cost of supplying
resources


Unused capacity


Reduce the supply of resources or
Increasing the quantity of activities


Kaplan & Cooper
Activity-based costing
cost of resources supplied – cost of resources
used = cost of unused capacity
COST OF SPARE CAPACITY




Cost of resources supplied
– cost of resources used =
cost of spare capacity
10 staff @ $30,000
Cost driver is 2,000
transactions per person
(capacity)
Cost of resources supplied
10 x $30,000 = $300,000




Standard cost per
transaction is
$300,000/20,000 = $15 per
transaction
Actual 18,000
transactions
Cost of resources used
18,000 x $15 = $270,000
Cost of unused capacity =
300,000 – 270,000 =
$30,000
CAPACITY UTILIZATION & PRODUCT MIX
Capacity as the limiting factor
 Ranking of product/services


Contribution per unit of limiting factor
CAPACITY UTILIZATION AND PRODUCT MIX
Part F
$150
Part G
$200
Part H
$225
Selling price per
unit
Variable
$50
$80
$40
material cost per
unit
Variable labour
$50
$60
$125
cost per unit
Contribution per
$50
$60
$60
unit
Machine hours
2
4
5
per unit
Estimated sales
2,000
2,000
2,000
demand (units)
Required
4,000
8,000
10,000
machine hours
based on
estimated
demand
OVERALL CAPACITY LIMITATION 10,000 MACHINE HOURS
CONTRIBUTION PER UNIT OF LIMITING
FACTOR
Contribution per
unit
Machine hours
per unit
Contribution per
machine hour
Ranking
(preference)
Part F
$50
Part G
$60
Part H
$60
2
4
5
$25
$15
$12
1
2
3
OPTIMUM CAPACITY UTILISATION
Production
2,000 of Part F @ 2 hours = 4,000 hours.
Contribution
2,000 @ $50 per unit =
$100,000
1,500 @ $60 per unit =
$90,000
Based on the capacity limitation of
10,000 hours, there are 6,000 hours
remaining, so Beaufort can produce ¾
of the demand for Part G (6,000 hours
available/8,000 hours to meet demand)
equivalent to 1,500 units of part G (¾
of 2,000 units).
1,500 of Part G @ 4 hours = 6,000 hours
Maximum contribution
There is no available capacity for Part H.
$190,000
BOTTLENECK CAPACITY
Seating capacity in restaurant = 100 seats
but not all can be served simultaneously
 Bottleneck capacity is ability of kitchen to serve a
maximum of 70 people at the same time

Medium term: increase kitchen capacity or reduce
seating capacity
 Short term: capacity limitation is 70, not 100


Note: in this example waiters are a variable labour
cost, kitchen staff are a fixed labour cost
THROUGHPUT ACCOUNTING

Theory of constraints

Bottleneck defines capacity
Throughput contribution = sales – cost of
materials


All other costs are fixed
Ranking of product/services

Throughput contribution per unit of bottleneck
resource
THROUGHPUT CONTRIBUTION
Selling price per unit
Variable material cost
per unit
Throughput
contribution per unit
Machine hours per unit
Return per machine
hour
Ranking (preference)
Previous ranking
P a rt F
$15 0
$5 0
P a rt G
$200
$80
P a rt H
$225
$40
$10 0
$120
$185
2
$5 0
4
$30
5
$37
1
1
3
2
2
3
ILLUSTRATIVE QUESTIONS
Q 11.2 Maxitank
makes two products.
Its costs are:
Product R
Product S
Selling price
$12
$20
Materials
$4
$11
Labour
hours
2
4
Machine
hours
4
3
Maxitank’s sales are
limited by the bottleneck
(machine) capacity of the
factory. Which of the two
products should be
produced first in order to
maximize the throughput
contribution generated
from the limited capacity?
VARIATION TO Q11.2
Maxitanks’ cost of
labour is now
included:
Product R
Product S
Selling price
$12
$20
Materials
$4
$11
Labour cost
$2
$5
Labour
hours
2
4
Which of the two
products should be
produced first in
order to maximize the
profits generated
from the limited
capacity, taking
material and labour
costs into account?
Q 11.5
Harrison products capacity is 20,000 units per year. Their
results for last year are:
Sales 12,000 units @ $100
Variable costs
Contribution margin
Fixed costs
Profit
$1,200,000
588,000
612,000
245,000
$367,000
Harrison expects its regular sales next year to be 15,000 units. They
also expect fixed costs to increase by $100,000. A foreign distributor
has offered to buy a guaranteed 8,000 units at $95 per unit next
year. Should Harrison accept this offer?