Discussion in Accounting

UNIVERSITY OF SAINT LOUIS-TUGUEGARAO
School of Business Administration and Accountancy, 2013-2014

Junior Philippine Institute of Accountants
MEMORY AID IN MANAGEMENT ADVISORY SERVICES
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CHAPTER 16:
Quality-Based Production Process Management
(JIT, Backflush Costing, Activity-Based Costing, etc.)
☛Total Quality Management (TQM) Methodology and Tools – Use of appropriate

 is an approach that seeks to improve methodology and tools ensures that non-
quality and performance which will meet conformance incidents are identified, measured and
or exceed customer expectations. This can responded to consistently.
be achieved by integrating all quality-
related functions and processes Continuous Improvement – Companies should
throughout the company. TQM looks at the continuously work towards improving manufacturing
overall quality measures used by a and quality procedures.
company including managing quality design
and development, quality control and Company Culture – The culture of the company
maintenance, quality improvement, and should aim at developing employees ability to work
quality assurance. TQM takes into account together to improve quality.
all quality measures taken at all levels and
involving all company employees. Employee Involvement – Employees should be
encouraged to be pro-active in identifying and
☛Principles of TQM addressing quality related problems.
 TQM can be defined as the management of
initiatives and procedures that are aimed ☛The Cost of TQM
at achieving the delivery of quality  Many companies believe that the costs of
products and services. A number of key the introduction of TQM are far greater
principles can be identified in defining than the benefits it will produce. However
TQM, including: research across a number of industries has
costs involved in doing nothing, i.e. the
Executive Management – Top management should direct and indirect costs
act as the main driver for TQM and create an of quality problems, are far greater than
environment that ensures its success. the costs of implementing TQM.
 The American quality expert, Phil Crosby,
Training – Employees should receive regular training wrote that many companies chose to pay
on the methods and concepts of quality. for the poor quality in what he referred to
as the “Price of Nonconformance”. The
Customer Focus – Improvements in quality should costs are identified in the Prevention,
improve customer satisfaction. Appraisal, Failure (PAF) Model.
Decision Making – Quality decisions should be made A. Prevention costs are associated with the design,
based on measurements. implementation and maintenance of the TQM
Management Advisory Services (MAS) Committee: Hazeleen Martinez; Jimmy Joe Miranda; Cliff Mark Confidente;
102 Corina Bariuan; Kristina Gaddon; Rizalyn Taguibao ;Niῆo Rey Mangupag; Marjhon Maramag; Leo Jay Labasan
Adviser: Mary Queen Ramos, CPA
system. They are planned and incurred before actual D. External failure costs occur when the products or
operation, and can include: services fail to reach quality standards, but are not
 Product Requirements – The setting detected until after the customer receives the item.
specifications for incoming materials, These can include:
processes, finished products/services.  Repairs – Servicing of returned products or
 Quality Planning – Creation of plans for at the customer site.
quality, reliability, operational, production  Warranty Claims – Items are replaced or
and inspections. services re-performed under warranty.
 Quality Assurance – The creation and  Complaints – All work and costs associated
maintenance of the quality system. with dealing with customer’s complaints.
 Training – The development, preparation Returns – Transportation, investigation and
and maintenance of processes. handling of returned items.
B. Appraisal costs are associated with the vendors ACTIVITY BASED COSTING SYSTEM
and customers evaluation of purchased materials
and services to ensure they are within specification. ☛BROAD AVERAGING OR “PEANUT-BUTTER
They can include:
COSTING”
 Verification – Inspection of incoming
 describes a costing approach that uses
material against agreed upon specifications.
broad averages for assigning (or spreading,
 Quality Audits – Check that the quality
as in spreading peanut butter) the cost of
system is functioning correctly.
resources uniformly to cost objects when
 Vendor Evaluation – Assessment and
the individual products or services, in fact,
approval of vendors.
use those resources in non-uniform ways.
Failure costs can be split into those resulting from

Product undercosting – a product consumes a high
internal and external failure.
level of resources but is reported to have a low cost
per unit.
C. Internal failure costs occur when results fail to
Product overcosting – a product consumes a low
reach quality standards and are detected before
level of resources but is reported to have a high cost
they are shipped to the customer. These can include:
per unit.
 Waste – Unnecessary work or holding
Product-cost cross-subsidization – if a company
stocks as a result of errors, poor
overcosts one of its products, it will overcost at least
organization or communication.
one of its other products.
 Scrap – Defective product or material that
cannot be repaired, used or sold.
☛COSTING SYSTEM REFINEMENT – making changes
 Rework – Correction of defective material
to a simple costing system that reduces the use of
or errors.
broad averages for assigning the cost of resources to
 Failure Analysis – This is required to
cost objects and provides better measurement of
establish the causes of internal product
the costs of overhead resources used by different
failure.
cost objects.
An activity-based approach refines a ☛FOUR DECISIONS FOR WHICH ABC

costing system by focusing on individual activities as INFORMATION IS USEFUL:
the fundamental cost objects. It uses the cost of 1. Pricing and product mix decisions.
these activities as the basis for assigning costs to 2. Cost reduction and process improvement
other cost objects such as products or services. decisions.
3. Product design decisions.
☛ACTIVITY BASED COSTING (ABC) SYSTEM 4. Decisions for planning and managing
 allocates overhead to multiple activity cost activities.
pools and assigns the activity cost pools to
products by means of cost drivers. ☛LIMITATIONS OF ABC:
1. ABC can be expensive.
Cost driver – a factor that causes a change in the 2. Some arbitrary allocations continue.
cost pool for a particular activity. It is used as a basis
for cost allocation; any factor or activity that has a ☛WHEN TO SWITCH TO ABC – The presence of one
direct cause-effect relationship. or more of the following factors indicates ABC as the
superior costing system:
Activity – any event, action, transaction, or work 1. Product lines differ greatly in volume and
sequence that incurs costs when producing a manufacturing complexity.
product or providing a service. 2. Product lines are numerous, diverse, and
require differing degrees of support
Activity Cost Pool – a “bucket” in which costs are services.
accumulated that relate to a single activity measure 3. Overhead costs constitute a significant
in the ABC system. portion of total costs.
4. The manufacturing process or the number
VALUE-ADDING ACTIVITIES – activities that are of products has changed significantly.
necessary (non-eliminable) to produce the products. 5. Production or marketing managers are
ignoring data provided by the existing
NON-VALUE-ADDING ACTIVITIES – activities that do system.
not make the product or service more valuable to
the customer.
☛HIERARCHY OF ACTIVITY LEVELS
1. Unit-level Activities – are performed each
☛BENEFITS OF ABC:
time a unit is produced.
1. ABC leads to more cost pools. 2. Batch-level Activities – are performed each
2. ABC leads to enhanced control over time a batch is handled or processes,
overhead costs. regardless of how many units are in the
3. ABC leads to better management decisions. batch.
3. Product-level Activities – relate to specific
products and typically must be carried out
regardless of how many batches are run or
units of product are produced or sold.
4. Customer-level Activities – relate to specific Risk 320, 000 Patients served 1, 000
customers. management
5. Organization-level Activities – carried out The hospital provides service in three broad
regardless of which customers are served, categories. The services are listed below with their
which products are produced, how many volume measures for the activity centers.
batches are run, or how many units are Service Professional Square Number
made. Hours Feet of
Patients
☛STEPS FOR IMPLEMENTING ACTIVITY-BASED Surgery 6, 000 1, 200 200
COSTING: Housing 20, 000 12, 000 500
1. Define activities, activity cost pools, and patients
activity measures. Outpatient 4, 000 1, 800 300
2. Assign overhead costs to activity cost pools. care
3. Calculate activity rates.
4. Assign overhead costs to cost objects using
the activity rates and activity measures. REQUIRED:
5. Prepare management reports. Compute the allocation rates for each activity center
and determine the allocated activity center costs to
the three services provided by the hospital.
COMPREHENSIVE PROBLEM
Caleb Georgina Hospital (CGH) has found itself under SOLUTION:
increasing pressure to be accountable for the Professional Salaries: 900, 000 ÷ 30, 000 =30 per
charges it assesses its patients. Its current pricing hour
system is ad hoc, based on pricing norms for the Building Costs: 450, 000 ÷ 15, 000 =30 per sq. ft.
geographical area, and it only explicitly considers Risk Management: 320, 000 ÷ 1, 000 =320 per
direct costs for surgery, medication, and other patient
treatments. CGH’s controller has suggested that the
hospital try to improve its pricing policies by seeking Surgery (6, 000 × 30) + (1, 200 × 30) + (200 × 320) =
a tighter relationship between costs and pricing. This 280, 000
approach would make prices for services less Housing (20, 000 × 30) + (12, 000 × 30) + (500 ×
arbitrary. As a first step, the controller has 320) = 1, 120, 000
determined that most costs can be assigned to one Outpatient Care: (4, 000 × 30) + (1, 800 × 30) + (300
of three cost pools. The three cost pools follow along × 320) = 270, 000
with the estimated amounts and activity drivers.
Activity Center Amount Activity Driver Quantity
Professional 900, 000 Professional 30,000

salaries hours hours
Building costs 450, 000 Square feet 15,000
used square
feet

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UNIVERSITY OF SAINT LOUIS-TUGUEGARAO

School of Business Administration and Accountancy, 2013-2014

☛Total Quality Management (TQM) Methodology and Tools – Use of appropriate

Failure costs can be split into those resulting from

An activity-based approach refines a ☛FOUR DECISIONS FOR WHICH ABC

Activity Center Amount Activity Driver Quantity

Professional 900, 000 Professional 30,000

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