Transcript Quality, Time, and the Theory of Constraints Chapter 19 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster 19 - 1

Quality, Time, and the
Theory of Constraints
Chapter 19
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
19 - 1
Learning Objective 1
Explain the four cost categories
in a cost-of-quality program.
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Two Aspects of Quality
Actual
Performance
Design
Specifications
Conformance
Quality
Failure
Customer
Satisfaction
Quality of
Design
Failure
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Costs of Quality
Prevention costs
Appraisal costs
Internal failure costs
External failure costs
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Costs of Quality Example
Vegas Photo Corporation made 10,000
photocopying machines last year.
Vegas Photo determines the costs of quality
of its photocopying machines using a 7-step
activity-based costing approach.
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Costs of Quality (Steps 1 and 2)
Step 1
Identify cost objects.
10,000 photocopying
machines
Step 2
Identify the direct costs
of quality of the products.
No direct costs of
quality
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Costs of Quality (Step 3)
Step 3
Select the cost-allocation bases to use for
allocating indirect costs of quality to the products.
Information on the total
• Prevention
quantities of each of these
• Appraisal
cost-allocation bases used
• Internal failure
in all of Vegas operations
• External failure
is not provided.
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Costs of Quality (Step 4)
Step 4
Identify the indirect costs of quality
associated with each cost-allocation base.
Information about total (fixed and variable)
costs is not provided.
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Costs of Quality (Step 5)
Step 5
Compute the
rate per unit.
Inspection hours is one
cost-allocation base.
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Costs of Quality (Step 5)
Prevention costs:
Design engineering (R&D) $80 per hour
Process engineering (R&D) $60 per hour
Appraisal costs:
Inspection (Manufacturing) $40 per hour
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Costs of Quality (Step 5)
Internal failure costs:
Rework (Manufacturing)
$100 per hour
External failure costs:
Customer support (Marketing)
$ 50 per hour
Transportation (Distribution)
$240 per load
Warranty repair (Customer Service) $110 per hour
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Costs of Quality (Step 6)
Step 6
Compute the indirect costs of quality
allocated to the product.
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Costs of Quality (Step 6)
Prevention costs:
Design engineering (R&D)
20,000 hours
Process engineering (R&D)
22,500 hours
Appraisal costs:
Inspection (Manufacturing) 120,000 hours
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Costs of Quality (Step 6)
Internal failure costs:
Rework (Manufacturing)
50,000 hours
External failure costs:
Customer support (Marketing)
6,000 hours
Transportation (Distribution)
1,500 loads
Warranty repair (Customer Service) 60,000 hours
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Costs of Quality (Step 6)
What is the total cost for design engineering?
20,000 hours × $80 = $1,600,000
What is the total cost for inspection?
120,000 hours × $40 = $4,800,000
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Costs of Quality (Step 6)
Cost of Quality and
Value Chain Category
Prevention costs:
Design engineering (R&D)
Process engineering (R&D)
Total
Appraisal costs:
Inspection
Total Costs
$1,600,000
1,350,000
$2,950,000
$4,800,000
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Costs of Quality (Step 6)
Cost of Quality and
Value Chain Category
Internal failure costs:
Rework (Manufacturing)
Total Costs
$5,000,000
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Costs of Quality (Step 6)
Cost of Quality and
Value Chain Category
Total Costs
External failure costs:
Customer support (Marketing)
$ 300,000
Transportation (Distribution)
360,000
Warranty repair (Customer Service) 6,600,000
Total
$7,260,000
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Costs of Quality (Step 7)
Step 7
Compute the total costs of quality of the product.
Prevention costs
Appraisal costs
Internal failure costs
External failure costs
Total
$ 2,950,000
4,800,000
5,000,000
7,260,000
$20,010,000
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Learning Objective 2
Use three methods to
identify quality problems.
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Techniques Used to Analyze
Quality Problems
1. Control charts
2. Pareto diagrams
3. Cause-and-effect
diagrams
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Control Charts
On the basis of experience, Vegas decides
that any observation outside the arithmetic
mean  ± 2 standard deviations
should be investigated.
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Control Charts
Defect Rate
Production Line A
 + 2
+ 

- 
 - 2
0 1 2 3 4 5 6 7 8 9 10
Days
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Control Charts
Defect Rate
Production Line B
 + 2
+ 

- 
 - 2
0 1 2 3 4 5 6 7 8 9 10
Days
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Number of Times
Defect Observed
Pareto Diagram
600
500
400
300
200
100
0
Copies are
fuzzy and
unclear
Copies
are too
light/dark
Paper gets
jammed
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Pareto Diagram
As a first step, Vegas analyzes the causes
of the most frequently occurring failure,
fuzzy and unclear copies.
Final Draft of a
Sales Contract
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Cause-and-effect Diagrams
Methods and
Design Factors
Human Factors
Inadequate
supervision
Poor training
New operator
Flawed part design
Incorrect
manufacturing
sequence
Inadequate tools
Incorrect speed
Poor
maintenance
Multiple suppliers
Incorrect specification
Variation in purchased
components
Machine-related
Factors
Materials and
Components Factors
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Learning Objective 3
Identify the relevant costs and
benefits of quality improvements.
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Relevant Costs
Careful analysis of Vegas cause-and-effect
diagram reveals that the frame of the copier
is often mishandled as it travels from the
suppliers’ warehouses to Vegas’ plant.
Mishandling causes the dimensions of the
frame to vary from specifications, resulting
in fuzzy and unclear copies.
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Relevant Costs
Alternative solutions:
Improve the inspection of the frames
immediately upon delivery.
Redesign and strengthen the frames
and the containers used to transport
them to better withstand mishandling
during transportation.
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Relevant Costs
What must management do to evaluate
each alternative?
Additional
Additional
Inspection Cost
Redesign Cost
Difference
$200,000
$230,000
$30,000
Vegas determines the fixed and variable
cost component of each activity involved.
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Relevant Costs
Further Redesigning
Inspection Frames
Relevant savings:
Rework costs
Customer-support costs
Transportation costs
Warranty repair costs
Total
$480,000 $ 640,000
20,000
28,000
45,000
63,000
450,000
630,000
$995,000 $1,361,000
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Comparison
Further
Redesigning
Inspection
Frames
Relevant savings $995,000 $1,361,000
Additional cost
200,000
230,000
Difference
$795,000 $1,131,000
What should Vegas do?
Redesigning the frames provides a $336,000
incremental benefit over further inspection.
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Learning Objective 4
Provide examples of nonfinancial
quality measures of customer
satisfaction and internal
performance.
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Nonfinancial Measures
Nonfinancial measures of customer satisfaction:
• Number of customer complaints
• Defective units as a percentage of total units
shipped to customers
• Percentage of products that experience early
or excessive failure
• On-time delivery rate
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Nonfinancial Measures
Nonfinancial measures of internal performance:
• Number of defects for each product line
• Process yield
(ratio of good output to total output)
• Employee turnover
(ratio of the number of employees who left
the company to the total number of employees)
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Learning Objective 5
Describe the benefits of
financial and nonfinancial
measures of quality.
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Evaluating Quality Performance
Financial measures are helpful to evaluate
trade-offs among prevention costs,
appraisal costs, and failure costs.
Nonfinancial measures help focus attention
on the precise problem areas that need
improvement and also serve as indicators
of future long-run performance.
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Learning Objective 6
Describe customer-response
time and explain why delays
happen and their costs.
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Customer-Response Time
Order is
placed
Order is
received
Order is
set up
Waiting
Time
Receipt
Time
Order is
manufactured
Order is
delivered
Mfg.
Time
Manufacturing
Lead Time
Delivery
Time
Customer-Response Time
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On-Time Performance
On-time performance refers to situations in which
the product or service is actually delivered at
the time it is scheduled to be delivered.
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Time Drivers and Costs of Time
Time drivers
1. Product or service
order uncertainty
2. Bottlenecks due to
limited capacity
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Time Drivers and Costs of Time
Average waiting time equals:
Average number of orders × (Manufacturing time)2
÷
[
Annual machine
capacity
–
Average no. Manufacturing
of orders × time of product
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Time Drivers and Costs of Time
Fredonia uses one machine to convert
steel bars into a special component (SC).
Fredonia expects it will receive 30 orders,
but it could actually receive 10, 30, or 40
orders for the special component.
Each order is for 1,000 units and will take
100 hours of manufacturing time.
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Time Drivers and Costs of Time
The annual capacity of the machine
is 4,000 hours.
What is the expected manufacturing
time required on the machine?
(100 × 30) = 3,000 hours
What is the average waiting time?
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Time Drivers and Costs of Time
30 × 1002 = 30 × 10,000 = 300,000
300,000 ÷ 2 × [4,000 – (30 × 100)]
300,000 ÷ 2 × (4,000 – 3,000)
300,000 ÷ 2,000
150 hours average waiting time
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Time Drivers and Costs of Time
What is the average manufacturing
lead time for an order?
150 hours of average waiting time
+ 100 hours of manufacturing time
= 250 hours
Suppose that Fredonia is considering
introducing a regular component (RC).
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Time Drivers and Costs of Time
Fredonia expects to receive 10 orders
for RCs (each order for 800 units).
Each order will take 50 hours of
manufacturing time.
The expected demand for special
components will be unaffected.
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Time Drivers and Costs of Time
Assume that introducing RCs would cause
average waiting time to more than double,
from 150 hours to 325 hours.
The average manufacturing lead time for
a special component order becomes
425 hours (325 + 100).
Average manufacturing lead time for a regular
component order is 375 hours (325 + 50).
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Relevant Revenues and
Relevant Costs of Time
The average selling price per order is:
Average
manufacturing
Product
lead time
SC
RC
Less than 300 hours
$22,000 $10,000
More than 300 hours
$21,500 $ 9,600
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Relevant Revenues and
Relevant Costs of Time
Product
SC
Average number of orders
30
Direct material costs per order
$16,000
Inventory carrying costs/order/hour
1.00
RC
10
$8,000
0.50
Should Fredonia introduce RCs?
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Relevant Revenues and
Relevant Costs of Time
Introduce RCs
Expected revenues:
($21,500 × 30) + ($9,600 × 10) = $741,000
Expected variable costs:
($16,000 × 30) + ($8,000 × 10) = $560,000
Expected other costs:
$ 14,625
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Relevant Revenues and
Relevant Costs of Time
How was the $14,625 other costs computed?
(Average manufacturing lead time for SCs
× Unit carrying costs per order for SCs
× Expected number of orders for SCs)
+ (Average manufacturing lead time for RCs
× Unit carrying costs per order for RCs
× Expected number of orders for RCs)
(425 × $1.00 × 30) + (375 × $0.50 × 10) = $14,625
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Relevant Revenues and
Relevant Costs of Time
Do Not Introduce RCs
Expected revenues:
$22,000 × 30 =
Expected variable costs:
$16,000 × 30 =
Expected other costs:
$660,000
$480,000
$ 7,500
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Relevant Revenues and
Relevant Costs of Time
How was the $7,500 other costs computed?
Average manufacturing lead time
for SCs without RCs
× Unit carrying costs per order for SCs
× Expected number of orders for SCs
250 × $1.00 × 30 = $7,500
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Relevant Revenues and
Relevant Costs of Time
Relevant
Introduce
Do Not
Items
RC
Introduce RC
Expected revenues $741,000
$660,000
Expected total costs 574,625
487,500
Difference
$166,375
$172,500
Falcon Works should not introduce
the regular component.
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Learning Objective 7
Apply the three measures
in the theory of constraints.
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Theory of Constraints
The three main measurements in the theory
of constraints are:
1. Throughput contribution equal to revenues
minus direct material costs.
2. Investments equal the sum of material costs
in direct materials inventory, work in process
inventory, finished goods inventory, R&D
costs, and costs of equipment and buildings.
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Theory of Constraints
3. Operating costs equal to all operating costs
(other than direct materials) incurred to earn
throughput contribution.
The objective of TOC is to increase throughput
contribution while decreasing investments
and operating costs.
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Learning Objective 8
Manage bottlenecks.
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Managing Bottlenecks
The four steps in managing bottlenecks are:
1. Recognize that the bottleneck operation
determines throughput contribution
of the system as a whole.
2. Search and find the bottleneck operation by
identifying operations with large quantities
of inventory waiting to be worked on.
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Managing Bottlenecks
3. Keep the bottleneck busy and subordinate
all nonbottleneck operations to the
bottleneck operations.
4. Take actions to increase bottleneck efficiency
and capacity – the objective is to increase
throughput contribution minus the incremental
costs of taking such actions.
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End of Chapter 19
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