5-47 ABC and TOC Discuss the similarities and differences between activity-based costing and the theory

of constraints, as well as situations in which one approach might be preferable to the other. 5-48 Cycle time efficiency and JIT Walker Brothers Company is considering installing a JIT manufacturing system in the hope that it will improve its overall processing cycle efficiency. Data from the traditional system and estimates for the JIT system are presented here for their Nosun Product: TIME CATEGORY TRADITIONAL SYSTEM JIT SYSTEM Storage 4 hours 1 hour Inspection 40 minutes 5 minutes Moving 80 minutes 20 minutes Processing 2 hours 75 minutes a. Calculate processing cycle efficiency (PCE) under the traditional and JIT systems for the Nosun product. b. Strictly based on your PCE calculations above, should Walker Brothers implement the JIT system? Explain. 5-50 Relevant Costs: dropping a product Merchant Company manufactures and sells three models of electronic printers. Ken Gail, president of the company, is considering dropping model JT484 from its product line because the company has experienced losses for this product over the past three quarters. The following product-level operating data have been compiled for the most recent quarter: CATEGORY TOTAL JT284 JT384 JT484 Sales $1,000,000 $500,000 $200,000 $300,000 Variable costs ___600,000 __300,000 __100,000 __200,000 Contribution margin $400,000 $200,000 $100,000 $100,000 Fixed costs: Rent $50,000 $25,000 $10,000 $15,000 Depreciation 60,000 30,000 12,000 18,000 Utilities 40,000 20,000 5,000 15,000 Supervisors 50,000 15,000 5,000 30,000 Maintenance 30,000 15,000 6,000 9,000 Administrative __100,000 __30,000 __20,000 __50,000 Total fixed costs _$330,000 $135,000 _$58,000 $137,000 Operating income (loss) $70,000 $65,000 $42,000 ($37,000) In addition, the following information is also available: Factory rent and depreciation will not be affected by a decision to drop model JT484. Quarterly utility bills will be reduced from $40,000 to $31,000 if JT484 is dropped. Supervision costs for JT484 can be eliminated if dropped. The maintenance department will be able to reduce quarterly costs by $7,000 if JT484 is dropped. Elimination of JT484 will make it possible to eliminate two administrative staff positions with combined salaries of $30,000 per quarter.

a. Should Merchant Company eliminate JT484? b. Merchants sales manager believes that it is important to continue to produce JT484 to maintain a full product line. He expects the elimination of JT484 will reduce sales of the remaining two products by 5% each. Will this information change your answer to (a)? Explain. 5-51 Quality improvement programs and cost savings Garber Valves Company manufactures brass valves meeting precise specification standards. All finished valves are inspected before packing and shipping to customers. Rejected valves are returned to the initial production stage to be melted and recast. Such rework requires no new materials in casting but requires new materials in finishing. The following unit cost data are available:

COSTS CASTING FINISHING INSPECTION PACKAGING Direct materials $225 $12 $0 $8 $245 Direct labor 84 121 24 16 245 Variable support 122 164 30 20 336 Fixed support __63 ___89 ___16 __10 __178 $494 $386 $70 $54 $1,004

TOTALS

As a result of a quality-improvement program, the reject rate has decreased from 6.4% to 5.1% and the number of rejects has decreased by (6.4%-5.1%) x (10,000) units. Improvements in reject rates have also led to a decrease in work-in-process inventory from $386,000 to $270,000. Inventory carrying costs are estimated to be 15% per year. Estimate the annual cost savings as a result of the quality improvement. 5-56 Facilities layout One aspect of facilities layout for McDonalds is that when customers come into the building, they can line up in one of several lines and wait to be served. In contrast, customers at Wendys are asked to stand in one line that snakes around the front of the counter and to wait for a single server. a. What is the rational for each approach? b. Which approach do you favor from (1) a customers perspective and (2) managements perspective? Explain. 5-59 Preparing a cost-of-quality report The following information shows last years quality-related costs for the Renwal Company: ITEM AMOUNT Quality engineering $500,000 Warranty claims 2,345,000 Product liability lawsuits 4,500,000 Research of customer needs 75,000 Maintenance of test equipment 350,000 Returned products 1,200,000 Rework costs 1,200,000 Quality training 125,000 Process control monitoring 1,000,000 Inspection of and testing of incoming materials 400,000

Repair costs in the field 850,000 Statistical process control 250,000 Product recalls 2,000,000 Waste 700,000 Net cost of scrap 635,000 Product quality audits 475,000 Downtime due to defects 125,000 Supplier certification 90,000 Total sales for the year was $100,000,000 a. Prepare a cost-of-quality report grouping costs into prevention, appraisals, internal failure, and external failure. Also show costs as a percent of sales. b. Interpret the data and make recommendations to Renwals management.

5-47 Both the theory of constraints and activity-based costing support aspects of process improvement and improved profitability, but differ in many other respects. The theory of constraints emphasizes the short-run optimization of throughput contribution, and downplays operating costs (except direct materials) because they are viewed as difficult to alter in the short-run. Consequently, analyses of activities and cost drivers are not conducted as they are in activity-based costing. Proponents of activity-based costing take a long-term perspective in which managers can alter capacity resources. Therefore, it is viewed as beneficial to produce accurate cost information by tying actual resources consumed to cost objects, such as products, services, channels, and customers. The theory of constraints and activity-based costing might conceivably be used together. 5-48 (a) PCE in minutes under the traditional system equals [120/(120 + 80 + 240 + 40)] = [120/480] = 0.25. PCE under the JIT system equals [75/(75 + 20 + 60 + 5)] = [75/160] = 0.47. Based on the calculations above, Walker Brothers should implement the JIT system since the processing cycle efficiency is almost double that of the traditional system (0.47 vs. 0.25). Impact of dropping JT484 on operating income: Reduction in contribution margin $100,000

(b)

5-50 (a)

Cost savings: Utilities Supervision Maintenance Administrative Decrease in operating income Therefore, JT484 should not be eliminated. (b)

(9,000) (30,000) (7,000) (30,000) $24,000

No, the decision to retain JT484 will only be reinforced by the sales managers comments.

5-51 Estimated cost savings as a result of the quality improvement: Savings from decrease in reject rate (0.064 0.051) [(494 63 225) + (386 89) + (70 16)] 10,000 Savings from reduction in inventory carrying cost ($386,000 $270,000) 0.15 Total annual savings 5-56 (a) $72,410 $17,400 $89,810

The approach used at McDonalds in which customers wait in several lines is consistent with the push or conventional manufacturing approach. As one comes into McDonalds it is clear that they have been, and are building inventory in each of the specific bins that they use for, lets say, Big Macs, fish sandwiches, regular hamburgers, etc. Having inventory at predefined levels keeps the production process going. The motivation to use the traditional production method is to sustain a certain level of inventory to reduce the time the customer has to wait for an order. Notice in McDonalds that hot lights are used to keep the sandwiches warm. One goal of this approach is that customers perceive that they can get their sandwich very quickly due to the inventory of sandwiches always on hand. On the other hand, Wendys uses more of a pull or JIT system. As you enter into Wendys, notice that you cannot really observe any sandwich inventory building up. The idea in forming one line is that each person has the perception (and often the reality) that each sandwich is made on the spot. This procedure is designed to show

customers how fresh the sandwiches are. The motivation to use a just-in-time approach is to improve the quality of the food and to reduce waste by eliminating the need to throw out food that has been sitting too long. As processing time and setup costs drop, the organization can move closer to just-in-time, reducing the waste and quality problems that arise with batch production. (b) From a customers perspective, it does depend on what one favors. If a customer goes to a fast food restaurant, his or her goal is to get food quickly. On any particular day, the customer may be in a great hurry and wish to run in and run out of a fast food establishment. Having multiple lines at a place like McDonalds may be very appealing as far as the perception of the speed with which one can get a meal (compared to a single line at Wendys). On another day, perhaps having a meal made freshly on the spot, without any warming time under hot lights is more appealing than the speed of getting the food. Of course, one may simply like the taste of one companys hamburgers over anothers.

From managements perspective, apart from taste, competing in selling hamburgers may depend on other variables such as the speed with which an order is filled versus tailoring the production process to individual taste. The traditional push production process can lead to a lot more waste than the JIT system, because if a batch of hamburgers is made and demand drops, the quality of the food deteriorates and often has to be thrown out. However, if the line at Wendys is very long and customers begin to get impatient, the freshness of the food may begin to lose its appeal.

5-59

(a)

Quality Cost Report for Renwal Company Annual Quality Cost Category Cost
Prevention Costs: Quality training Quality engineering Statistical process control Supplier certification Research of customer needs Total Appraisal Costs: Inspection of and testing of in-coming materials Maintenance of test equipment $125,000 500,000 250,000 90,000 75,000 $1,040,000

Percent of
Sales* 0.125% 0.500% 0.250% 0.090% 0.075% 1.040%

$400,000 350,000

0.400% 0.350%

Process-control monitoring Product-quality audits Total Internal Failure Costs: Waste Net cost of scrap Rework costs Downtime due to defectives Total External Failure Costs: Product-liability lawsuits Repair costs in the field Warranty claims Returned products Product recalls Total Total Quality Costs:

1,000,000 475,000 $2,225,000

1.000% 0.475% 2.225%

$700,000 635,000 1,200,000 125,000 $2,660,000

0.700% 0.635% 1.200% 0.125% 2.660%

$4,500,000 850,000 2,345,000 1,200,000 2,000,000 $10,895,000 $16,820,000

4.500% 0.850% 2.345% 1.200% 2.000% 10.895% 16.820%

*Total sales were $100,000,000. (b) The most obvious problem at Renwal is the extremely high externalfailure costs of almost 11%. Since as a norm many companies would like to keep their quality costs below 4% to 5% of sales, Renwal Companys quality costs are out of line. Note in particular that product-liability lawsuits, warranty claims, and product recalls are the biggest externalfailure costs. Renwal must find out why its products seem to be failing in the field.

Renwal should first turn to an analysis of its other quality costs. Quality costs are incurred throughout the total life cycle of a product. If Renwal does not control quality costs early in the research, development, and engineering stage by ensuring good product design, then design problems will lead to increased quality costs later on. At Renwal both prevention and appraisal costs are a relatively small percent of total quality costs (1.04% and 2.225%

respectively). Renwal should consider putting more effort into quality training, quality engineering, and statistical process control. The company should also determine whether to spend more money on appraisal. There could be a problem with Renwals test equipment that would require the company to incur higher maintenance costs. With regard to internal-failure costs, Renwal also apparently incurs a great deal of rework costs. The product seems to require many additional costs that need not be incurred if the company could produce it correctly the first time. Perhaps the production process is at fault, or maybe Renwals workers are not well trained. Note that Renwals quality-related costs are very low at the prevention stage. They increase for the appraisal and internalfailure cost categories. The external failure costs are extremely high. This pattern of quality costs is what most organizations hope to avoid because the highest category of quality costs corresponds to poor quality recognized only after products are in customers hands.
The more desirable quality-cost trend is the reverse of Renwals pattern. That is, organizations desire to have the greatest proportion of quality costs incurred in the prevention stage. By increasing quality training and quality engineering costs during this stage, a company can reduce other quality costs. With the companys products failing less frequently in the customers hands, customer satisfaction should increase and the companys reputation should improve.