BREAKING DOWN Managerial Accounting

Managerial accounting encompasses all fields of accounting aimed at informing

management of business operation metrics. Budgets are also extensively used
as a quantitative expression of the business’s plan of operation. Individuals in
managerial accounting utilize performance reports to note deviations of actual
results from budgets.

Just-in-time (JIT) purchasing is a cost accounting strategy where you

purchase the minimum amount of goods to meet customer demand.
Say you decide to approach your supplier about moving to a JIT
purchasing arrangement. The supplier needs to deliver smaller
shipments more frequently. You request a price quote based on new,
different levels of purchasing activity. Compare the financial impact of
your current purchasing system with a JIT purchasing system.

JIT PURCHASING COSTS IN COST

ACCOUNTING
Say you manage a large chain of sporting-goods stores. You’re
considering the impact of JIT purchasing for many products. At the
moment, you’re evaluating baseball bats.

Here’s some information regarding baseball bat purchases:

 Purchasing costs: The cost per baseball bat is $100 for both
your current purchasing method and JIT purchasing.

 Ordering costs: The cost per order is $150 for both purchasing
methods.
  Opportunity costs: Company management has decided on an
8 percent required rate of return on investment. That 8 percent
rate applies to any use of capital, including inventory purchases.
This is the minimum return that the company expects from the
money it has invested. If this return is not achieved, there are
likely better alternatives for the company’s cash.

 Average inventory: Average inventory is defined as the

average value of inventory during a certain time period. Average
inventory is (beginning inventory + ending inventory) ÷ 2.
Currently, your average inventory is 10 percent of annual sales,
or 2,000 bats. Under JIT, your average inventory will decline to
200 units.

 Carrying costs: You also incur costs for insurance and storage.
Carrying costs total $15 per unit.

This table compares your current purchasing costs with JIT

purchasing costs.
Current Purchasing Costs versus JIT Purchasing Costs

Total Costs Current JIT

Purchasing costs Cost Units

$100/unit 20,000 $2,000,000 $2,000,000

Ordering costs Cost Orders

 $150/order 20 $3,000

$150/order 200 $30,000

Opportunity costs Cost Inventory

8% rate $100/unit 2,000 $16,000

8% rate $100/unit 200 $1,600

Other carry costs Cost Inventory

$15/unit 2,000 $30,000

$15/unit 200 $3,000

Total costs $2,049,000 $2,034,600

JIT purchasing saves you $14,400 in costs ($2,049,000 current costs

less $2,034,600 JIT purchasing costs).

Using JIT purchasing, the number of orders increases from 20 to 200.

Purchase ordering costs increase from $3,000 to $30,000.

The opportunity cost multiplies the 8 percent rate x $100 unit cost x
the average inventory. Note that the average inventory for your current
process is 2,000 units; so, the opportunity cost for your current
purchasing system is much higher than with JIT ($16,000 versus
$1,600).
Carrying costs are $15 per unit. When you cut the average inventory
with JIT, you also reduce carrying costs ($30,000 current versus
$3,000 JIT).

JIT STOCKOUT COSTS IN COST

ACCOUNTING
Before you decide on JIT purchasing, consider other costs. Stockout
costs weren’t included in the table. Those costs are more difficult to
quantify.

The financial impact of a stockout is hard to pin down, but you can
develop some data. You can probably identify individual stockout
situations. Your store managers can track customers who ask for out-
of-stock items. The total stockout cost would be the number of
customers requesting an out-of-stock product multiplied by the cost
you incur to get them the product.

This table shows that the ordering cost is $150 per order. All suppliers
give their clients a cost quote for placing small, last-minute orders.
Now this is a different cost for a different service.

Say that the minimum cost for any order is $30. As stockouts occur,
you place last-minute orders for small amounts — sometimes two
bats, sometimes ten. You estimate a stockout cost per item of $5 per
bat.

You forecast 50 customer orders placed when bats are out of stock.
The total stockout cost would be $5 per unit x 50 orders = $250.
You can’t quantify the opportunity cost of future lost business due to
stockouts. Sure, you may be able to “save the order” by ordering the
product when it’s out of stock. The customer gets the product, but not
as soon as he or she wanted it. That experience may mean that he or
she will do business somewhere else going forward.

TQM was developed by William Deming, a management consultant whose work

had great impact on Japanese manufacturing. While TQM shares much in
common with the Six Sigma improvement process, it is not the same as Six
Sigma. TQM focuses on ensuring that internal guidelines and process standards
reduce errors, while Six Sigma looks to reduce defects.

What's Total Quality Management?

BREAKING DOWN Total Quality Management - TQM
Total Quality Management (TQM) is a structured approach to overall
organizational management. The focus of the process is to improve the quality of
an organization's outputs, including goods and services, through continual
improvement of internal practices. The standards set as part of the TQM
approach can reflect both internal priorities and any industry standards currently
in place. Industry standards can be defined at multiple levels, and may include
adherence to various laws and regulations governing the operation of the
particular business. Industry standards can also include the production of items
to an understood norm, even if the norm is not backed by official regulations.

Primary Principles of Total Quality Management

Special emphasis is put on fact-based decision making, using
performance metrics to monitor progress. High levels of organizational
communication are encouraged, for the purpose of maintaining employee
involvement and morale.

Industries Using Total Quality Management

While TQM originated in the manufacturing sector, its principles can be applied to
a variety of organizations. With focus on long-term change over short-term goals,
it is designed to provide a cohesive vision for systemic change. With this in mind,
 total quality management is used in many industries, including, but not limited to,
manufacturing, banking and finance, and medicine.

These techniques can be applied to all departments within an individual

organization as well. This helps ensure all employees are working toward the
goals set forth for the company, improving function in each area. Involved
departments can include administration, marketing, production and employee
training.

Examples of successful BPR transformations are:

 Cost accounting. A company painfully compiles the cost of finished goods based on each item
included in a production run. A reengineering effort implements the use of backflushing, where
costing is automatic, based on the number of units produced and the bill of materials for the
items produced.
 Accounts payable. A company only pays suppliers after a difficult three-way matching process,
where supplier invoices are compared to receiving documents and purchase orders. A
reengineering effort pays suppliers automatically, based on the number of goods produced in
which their parts are used. Prices paid are based on the authorizing purchase order. No supplier
invoice is needed, or will even be accepted.
 Payroll. A company pays its employees with checks, which requires that checks be sent by
overnight mail to outlying employees, and that employees be contacted later if they have not
cashed their checks. A reengineering project eliminates checks in favor of payroll cards
and ACH electronic payments, thereby eliminating all of the costs associated with checks.
Business Process Reengineering
Examples
The past decade has been very big on change. With new technology being developed at such a
breakneck pace, a lot of companies started carrying out business process reengineering
initiatives. There are a lot of both

There are a lot of both successful and catastrophic business process reengineering examples in
history, one of the most famous being that of Ford.

BPR Examples: Ford Motors

One of the most referenced business process reengineering examples is the case of Ford, an
automobile manufacturing company.

In the 1980s, the American automobile industry was in a depression, and in an attempt to cut
costs, Ford decided to scrutinize some of their departments in an attempt to find inefficient
processes.

One of their findings was that the accounts payable department was not as efficient as it could
be: their accounts payable division consisted of 500 people, as opposed to Mazda’s (their
partner) 5.

While Mazda was a smaller company, Ford estimated that their department was still 5 times
biggerthan it should have been.

Accordingly, Ford management set themselves a quantifiable goal: to reduce the number of
clerks working in accounts payable by a couple of hundred employees. Then, they launched a
business process reengineering initiative to figure out why was the department so overstaffed.

They analyzed the current system, and found out that it worked as follows:

1. When the purchasing department would write a purchase order, they sent a copy to
accounts payable.
2. Then, the material control would receive the goods, and send a copy of the related
document to accounts payable.
3. At the same time, the vendor would send a receipt for the goods to accounts payable.
Then, the clerk at the accounts payable department would have to match the three orders, and if
they matched, he or she would issue the payment. This, of course, took a lot of manpower in the
department.
Old Payable Process

So, as is the case with BPR, Ford completely recreated the process digitally.

1. Purchasing issues an order and inputs it into an online database.

2. Material control receives the goods and cross-references with the database to make sure it
matches an order.
3. If there’s a match, material control accepts the order on the computer.

New payable process

This way, the need for accounts payable clerks to match the orders was completely eliminated.

The theory of constraints

July 03, 2018
The theory of constraints completely contravenes the more traditional view of running a
business, where all operations are optimized to the greatest extent possible. Under the
constraints view, optimizing all operations only means that it is easier to generate
more inventory that will pile up in front of the bottleneck operation, without profits increasing.
Thus, widespread optimization merely leads to the creation of more inventory, rather than more
profits.

Example of a Constrained Operation

A tractor company finds that its bottleneck operation is its paint shop. Painting operations can
only proceed at a certain pace, so the company can only run 25 tractors per day through the
facility. If the company were to produce more engines, the engines would not con tribute to more
tractors being built; there would only be an increase in the number of engines in storage, which
increases the cost of working capital.

The CEO of the company finds that, since the number of tractors produced per day is limited to
25, his next best activity is to cut back production in all other areas if they are producing more
parts than are needed for 25 tractors. Thus, it is better to not optimize in many p arts of the
business, since there is no need for more parts.

Inventory Buffers

As noted earlier, it is critical to ensure that the constrained operation is running at maximum
capacity, all the time. An excellent tool for achieving this goal is to build up an inventory buffer
directly in front of the bottleneck operation. This buffer ensures that any shortfall in the flow of
parts from anywhere upstream of the bottleneck will not impede the process flow through the
constraint. Instead, the inventory buffer will merely fluctuate in size as it is used and then
replenished.

The existence of upstream production problems can also be mitigated by installing extra sprint
capacity in the upstream production areas, as discussed next.

Sprint Capacity
Sprint capacity is an excess amount of production capacity that is assembled in the work
stations that are positioned upstream from the constraint operation. Sprint capacity is needed
when the inevitable production failure occurs, and the flow of parts to the bottleneck is halted.
During this period, the bottleneck instead uses parts from its inventory buffer, which is
therefore depleted. The extra sprint capacity is then used to produce an extra -large quantity of
parts to rebuild the inventory buffer, in preparation for the next period of production downtime.

If there is a large amount of sprint capacity incorporated into a production system, then there is
less need to invest in a large inventory buffer, since the extra capacity can rebuild the buffer in
short order. If there is less sprint capacity, then a larger inventory buffer is needed.

A key point in regard to sprint capacity is that a business should maintain excess capacity in its
upstream work areas, rather than paring down its production capacity to a level that jus t meets
its ongoing needs. This means that selling off what may appear to be excess equipment is not
always a good idea