Strategic Cost

Management

Parts V-VII

Part V: Total Quality Management and Just-in-Time

Approach

Terminologie
s:

• ​Continuous Improvement – ​the continual search for ways to increase the overall
efficiency and productivity of activities by reducing waste, increasing quality, and managing
costs.
• ​Total Quality Management (TQM) – ​a management system for a customer-focused organization
that involves all employees in continual improvement. It uses strategy, data, and effective
communications to integrate the quality discipline into the culture and activities of the organization.
• ​Lean Accounting – ​to provide information to managers that supports their waste reduction efforts
and to provide financial statements that better reflect overall performance, using both financial and
nonfinancial information.
• ​Enterprise Risk Management (ERM) approach – ​a formal way for managerial accountants to
identify and respond to the most important threats and business opportunities facing the
organization.
• ​Just-in-Time approach – ​maintains that goods should be pulled through the system by present
demand rather than being pushed through on a fixed schedule based on anticipated demand.

Key
points:

Total Quality
Management

Continuous improvement is fundamental for establishing excellence. A philosophy of TQM, in

which manufacturers strive to create an environment that will enable workers to manufacture perfect
(zero-defect) products, has replaced the “acceptable quality” attitudes of the past. This emphasis on
quality has also created a demand for a managerial accounting system that provides information
about quality, including quality cost measurement and reporting for both manufacturing and service
industries.

8 principles of
TQM:

1.
Customer-focused
The customer ultimately determines the level of quality. No matter what an organization does to
foster quality improvement – training employees, integrating quality into the design process, or
upgrading computers or software – the customer determines whether the efforts were worthwile. 2.
Total employee involvement
 All employees participate in working toward common goals. Total employee commitment can only be
obtained after fear has been driven from the workplace, when empowerment has occurred, and when
management has provided the proper environment. High-performance work systems integrate
continuous improvement efforts with normal business operations. Self-managed work teams are one
form of empowerment. 3. ​Process-centered
A fundamental part of TQM is a focus on process thinking. A process is a series of steps that take
inputs from suppliers (internal or external) and transforms them into outputs that are delivered to
customers (internal or external). The steps required to carry out the process are defined, and
performance measures are continuously monitored in order to detect unexpected variation. 4.
Integrated system
Although an organization may consist of many different functional specialties often
organized into vertically structured departments, it is the horizontal processes
interconnecting these functions that are the focus of TQM. Every organization has a
unique work culture, and it is virtually impossible to achieve excellence in its products and
services unless a good quality culture has been fostered. Thus, an integrated system
connects business improvement elements in an attempt to continually improve and
exceed the expectations of customers, employees, and other stakeholders.
5. ​Strategic and systematic
approach
A critical part of the management quality is the strategic and systematic approach to achieving an
organization’s vision, mission, and goals. This process, called strategic planning or strategic
management, includes the formulation of a strategic plan that integrates quality as a core
component. 6. ​Continual improvement
A large aspect of TQM is continual process improvement. It drives an organization to be both
analytical and creative in finding ways to become more competitive and more effective at meeting
stakeholder expectations. 7. ​Fact-based decision making
In order to know how well an organization is performing, data on performance measures are
necessary. TQM requires that an organization continually collect and analyse data in order to
improve decision making accuracy, achieve consensus, an allow prediction based on past history. 8.
Communications
During times of organizational change, as well as part of day-to-day operation,
effective communications plays a large part in maintaining morale and in motivating
employees at all levels. Communications involve strategies, method, and
timeliness.

Example of
TQM:

In response to increasing customer complaints regarding its laptop computer repair process,
Toshiba formed an alliance with UPS in which UPS picks up the broken laptop, Toshiba fixes it, and UPS
returns the repaired laptop to the customer. In order for this alliance to work effectively, both Toshiba and
UPS require relevant managerial accounting information regarding the cost of existing poor quality and
efforts to improve future quality.

Just-in-Time Approach
(JIT)
 JIT is a principle used in a manufacturing settings. Each operation produces only what is
necessary to satisfy the demand of the succeeding operation. The material or subassembly arrives just
in time for production to occur so that demand can be met. The hallmark of JIT is to reduce all
inventories to very low levels.

JIT scenario example:

McDonald’s

When a customer orders a hamburger, it is taken from the warming rack. When the number of
hamburgers gets too low, the cooks cook more hamburgers. Customer demand pulls the materials
through the system.

The development of JIT produced the

following:

1. Identification and Elimination of the 7 Categories of Manufacturing

Waste:
• Overproduction: The manufacture of excess
product.
• Waiting: Delays in the flow of production.
• Transportation: Unnecessary moving of product between
processes.
• Inappropriate Processing: Overly expensive
equipment.
• Excessive Inventory: Resources wasted through costs of
storage.
• Unnecessary Motion: Resources wasted in unnecessary physical
work.
• Defects: Wastes of time and money in inspecting and quarantining
inventory.

2. The "Kanban" System: Otherwise known as the "Supermarket Method," this system uses
product
control cards to automate reordering of only the quantities of parts needed to carry on with
production.
To successfully implement JIT, an organization requires advanced technologies and the highly
trained personnel to use them, flexible resources, reliable suppliers, steady production, high quality
machines that do not break down and can be set up quickly, and organizational discipline. Many
companies meet these demands, while many others fall short. Just-in-Time is a concept that is
easier explained than executed.
Advantages of
JIT

This model has the potential to dramatically reduce waste, lower costs and improve profitability.
Organizations that avoid the seven categories of waste can operate with leaner staffs, less space and
fewer resources. Because they reduce their investments in inventory, they have more capital available for
investment and growth. The financials of JIT companies are far more attractive to investors, who can see
that they are organizationally better managed, more efficient and capable of producing outsize returns on
investments. This results in inflows of capital that enable more growth and expansion to continue the
cycle. The manufacturing organizations you know best, from Coke to Toyota rely heavily on JIT.

Disadvantages of
JIT

JIT is highly complex and requires expertise and skills that many organizations do not have. It
requires precise predictive and planning capabilities in all operations, from manufacturing to sales. It is
also somewhat dependent on the ability of organizations to control for variables like inclement weather,
delayed shipments, or labor strikes or shortages.
The model has many interdependencies that raise risk levels if something should go wrong. For
example, relying on untimely suppliers can jeopardize all of the steps in the process that follow, whereas
having more inventory on hand mitigates this risk. Suppliers may be affected by natural disasters,
unavailability of raw materials or management shakeups. Or they may go out of business.
Some raw materials and supplies may have fluctuating availability, which may not work within
the JIT model. Larger organizations have the financial power to form exclusive agreements with
suppliers to ensure tight controls, but many smaller organizations are vulnerable to suppliers' mistakes.
Despite some of its risks, the upside of Just-in-Time is so strong that its application is
becoming more widespread -- and smaller organizations are increasingly embracing the concept.

Part VI: The Balanced

Scorecard

The ​Balanced Scorecard ​is a strategic management system that defines a strategic-based
responsibility accounting system. The Balanced Scorecard translates an organization’s mission and
strategy into operational objectives and performance measures into four perspectives. These
measures, once developed, become the means for articulating and communicating the strategy of the
organization to its employees and managers. The measures also serve the purpose of aligning
individual objectives and actions with organizational objectives and initiatives.
A. Financial Perspective
The financial perspective establishes the long- and short-term financial performance objectives. The
financial perspective is concerned with the global financial consequences of the other three perspectives.
Thus, the objectives and measures of the other perspectives must be linked to the financial objectives.
The financial perspective has three strategic themes: revenue growth, cost reduction, and asset utilization.
These themes serve as the building blocks for the development of specific operational objectives and
measures.
Objective Measures ​Revenue Growth: ​Increase the number of new products Create new applications
Develop new customers and markets Adopt a new pricing strategy
Cost Reduction: ​Reduce unit product cost Reduce unit customer cost Reduce distribution channel cost
Asset Utilization: I​ mprove asset utilization
Percentage of revenue from new products Percentage of revenue from new applications Percentage of
revenue from new sources Products and customer profitability
Unit product cost Unit customer cost Cost per distribution channel
Return on investment Economic value added
1. Revenue Growth
Several possible objectives are associated with revenue growth. Among these possibilities are the
following: increase the number of new products, create new applications for existing products, develop
new customers and markets, and adopt a new pricing strategy. Once operational objectives are known,
performance measures can be designed. For example, possible measures for the above list of objectives
(in the order given) are percentage of revenue from new products, percentage of revenue from new
applications, percentage of revenue from new customers and market segments, and profitability by
product or customer.
2. Cost Reduction
Reductions in the cost per unit of product, per customer, or per distribution channel are examples of cost
reduction objectives. The appropriate measures are obvious: the cost per unit of the particular cost
object(s). Trends in these measures will tell whether the costs are being reduced or not. For these
objectives, the accuracy of cost assignments is especially important. Activity-based costing can play an
essential measurement role, especially for selling and administrative costs— costs not usually assigned to
cost objects like customers and distribution channels.
3. Asset Utilization
Improving asset utilization is the principal objective. Financial measures such as return on investment and
economic value added are used.
B. Customer Perspective
The customer perspective is the source of the revenue component for the financial objectives. This
perspective defines and selects the customer and market segments in which the company chooses to
compete.
Objective Measures
Core: reputation
Increase market share Market share (percentage of market)
Increase customer Percentage growth of business from
retention existing customers Percentage of
repeating customers Number of new
customers Ratings from customer
Increase customer surveys Customer profitability
acquisition Increase
customer satisfaction Price Postpurchase costs
Increase customer Ratings from customer
profitability surveys Percentage of
Customer Value:: returns On-time delivery
Decrease price Decrease percentage Aging Schedule
postpurchase costs Improve Ratings from customer
product functionality Improve surveys
product quality Increase
delivery reliability
1. Core Objectives and
Measures
Improve product image and

Once the customers and segments are defined, then core objectives and measures are
developed. Core objectives and measures are those that are common across all organizations.
There are five key core objectives: increase market share, increase customer retention, increase
customer acquisition, increase customer satisfaction, and increase customer profitability.
Possible core measures for these objectives, respectively, are market share (percentage of the
market), percentage growth of business from existing customers and percentage of repeating
 customers, number of new customers, ratings from customer satisfaction surveys, and individual
and segment profitability. Activity-based costing is a key tool in assessing customer profitability.
Notice that customer profitability is the only financial measure among the core measures. This
measure, however, is critical because it emphasizes the importance of the right kind of
customers. What good is it to have customers if they are not profitable? The obvious answer
spells out the difference between being customer focused and customer obsessed.

2. Customer Value

In addition to the core measures and objectives, measures are needed that drive the creation of
customer value and, thus, drive the core outcomes. For example, increasing customer value
builds customer loyalty (increases retention) and increases customer satisfaction. Customer value
is the difference between realization and sacrifice, where realization is what the customer
receives and sacrifice is what is given up. Realization includes such things as product
functionality (features), product quality, reliability of delivery, delivery response time, image, and
reputation. Sacrifice includes product price, time to learn to use the product, operating cost,
maintenance cost, and disposal cost. Recall that the costs incurred by the customer after
purchase are called postpurchase costs.

The attributes associated with the realization and sacrifice value propositions provide the basis
for the objectives and measures that will lead to improving the core outcomes. The objectives for
the sacrifice value proposition are the simplest: Decrease price and decrease postpurchase
costs. Selling price and postpurchase costs are important measures of value creation.
Decreasing postpurchase costs decreases customer sacrifice and, thus, increases customer
value. Increasing customer value should favorably impact most of the core objectives. Similar
favorable effects can be obtained by increasing realization. Realization objectives, for example,
would include the following: improve product functionality, improve product quality, increase
delivery reliability, and improve product image and reputation. Possible measures for
these objectives include, respectively, feature satisfaction ratings, percentage of returns, on-time delivery
percentage, and product recognition rating. Of these objectives and measures, delivery reliability will be
used to illustrate how measures can affect managerial behavior, indicating the need to be careful in the
choice and use of performance measures. Any of these measures would be appropriate for assessing and
improving value stream performance.
C. ​Internal(Process) Perspective
Processes are the means for creating customer and shareholder value. Thus, the process perspective
entails the identification of the processes needed to achieve the customer and financial objectives. To
provide the framework needed for this perspective, a process value chain is defined. The process value
chain is made up of three processes: the innovation process, the operations process, and the postsales
process.
The ​innovation process ​anticipates the emerging and potential needs of customers and creates new
products and services to satisfy those needs. It represents what is called the long-wave of value creation.

The ​operations process ​produces and delivers existing products and services to customers. It begins
​
with a customer order and ends with the delivery of the product or service. It is the short-wave of value
creation.
The ​postsales service process ​provides critical and responsive services to customers after the product
or service has been delivered.
Objective Measures ​Innovation: I​ ncrease the number of new products Increase proprietary products
Decrease new product development time
Operations: I​ ncrease process quality
Increase process efficiency
Decrease process time
Postsales Service: ​Increase service quality Increase service efficiency
Decrease service time
Number of new products vs planned Percentage revenue form proprietary products Time to market (from
start to finish)
Quality costs Output yields Percentage of defective units Unit cost trends Output/input(s) Cycle time and
velocity MCE
First-pass yields Cost trends Output/input Cycle time
1. Innovation Process
Objectives for the innovation process include the following: increase the number of new products, increase
percentage of revenue from proprietary products, and decrease the time to develop new products.
Associated measures are actual new products developed versus planned products, percentage of total
revenues from new products, percentage of revenues from proprietary products, and development cycle
time (time to market).
2. Operations Process
Three operations process objectives are almost always mentioned and emphasized: increase process
quality, increase process efficiency, and decrease process time. Improving quality, efficiency, and
time in processes is basic to lean manufacturing. Furthermore, processes are the source of
value for customers and so making sure that they are performing well on these three
dimensions is critical to being competitive.

a. ​Quality - ​Examples of process quality measures are quality costs, output yields
(good
output/good input), and percentage of defective units (good output/total output). b.
Efficiency - ​Measures of process efficiency are concerned mainly with process cost
and
process productivity. Measuring and tracking process costs are facilitated by
activity-based costing and process value analysis.

Cycle Time and

Velocity

The time to respond to a customer order is referred to as responsiveness. Cycle time and velocity
are two operational measures of responsiveness. Cycle time is the length of time it takes to
produce a unit of output from the time materials are received (starting point of the cycle) until the
good is delivered to finished goods inventory (finishing point of the cycle). Another definition of
cycle time is dock-to-dock time. Dock-to-dock time is the number of days between the time
materials are received at the receiving dock and the time the finished good is shipped from the
shipping dock.19 In a lean firm, there is no finished goods inventory—goods are shipped when
finished. Thus, cycle time is the time required to produce a product (time/units produced). Velocity
is the number of units of output that can be produced in a given period of time (units
produced/time).
Incentives can be used to encourage operational managers to reduce manufacturing cycle time
or to increase velocity, thus improving delivery performance. A natural way to accomplish this
objective is to tie product costs to cycle time and reward operational managers for reducing
product costs. For example, in a lean firm, cell conversion costs can be assigned to products on
the basis of the time that it takes a product to move through the cell. Using the theoretical
productive time available for a period (in minutes), a value- added cost per minute can be
computed.

Value-added cost per minute=Cell conversion costs/Minutes

available

To obtain the conversion cost per unit, this value-added cost per minute is multiplied by the
actual cycle time used to produce the units during the period. By comparing the unit cost
computed using the actual cycle time with the unit cost possible using the theoretical or optimal
cycle time, a manager can assess the potential lfor improvement. Note that the more time it takes
a product to move through the cell, the greater the unit product cost. With incentives to reduce
product cost, this approach to product costing encourages operational managers and cell
workers to find ways to decrease cycle time or increase velocity.

Example: Computing Cycle Time and

Velocity

Cycle time (Time/Units Produced) and velocity (Units Produced/Time) measures the time it takes
for a firm to respond to such things as customer orders, customer complaints, and the
development of new products.

Information
:

A company has the following data for one of its manufacturing

cells:

Maximum units produced in a quarter (3-month period):

200,000 units Actual units produced in a quarter: 160,000 units
Productive hours in one quarter: 40,000 hours

Require
d:

a. Compute the theoretical cycle time (in

minutes). b. Compute the actual cycle time (in
minutes).
c. Compute the theoretical velocity in units per
hour. d. Compute the actual velocity in units per
hour.

Solution
:
a. Theoretical Cycle Time = (40,000 hours)(60 minutes per hour) / 200,000
units
= 12 minutes per unit b. Actual Cycle Time = (40,000
hours)(60 per hour)/160,000 units
= 15 minutes per unit c. Theoretical Velocity = 60 minutes per
hour/ 12 minutes per unit
= 5 units per hour (Or, 200,000 units per quarter/40,0000
hours per quarter = 5 units per hour) d. Actual Velocity = 60 minutes per
hour/ 15 minutes per unit
= 4 units per hour (Or 160,000 units per quarter/40,000 hours per
quarter = 4 units per hour)

Manufacturing Cycle
Efficiency

Another time-based operational measure calculates manufacturing cycle efficiency (MCE) as

follows:

MCE = Processing time/(Processing time + Move time + Inspection time + Waiting

time)

where processing time is the time it takes to convert materials into a finished good. The other
activities and their times are viewed as wasteful, and the goal is to reduce those times to zero. If
this is accomplished, the value of MCE would be 1.0. As MCE improves (moves toward 1.0),
cycle time decreases. Furthermore, since the only way MCE can improve is by decreasing
waste, cost reduction must also follow.

Example: Calculating Manufacturing Cycle

Efficiency

MCE measures the proportion of manufacturing cycle time attributable to value-added

processing. Without waste, the ratio should be equal to 1.0.

Information
:

A company provided the following

information:

Maximum units produced in a quarter (3-month period):

200,000 units Actual units produced in a quarter: 160,000 units
Productive hours in one quarter: 40,000 hours Actual cycle time
= 15 minutes Theoretical cycle time = 12 minutes

Required: a. Calculate the amount of processing time and the amount of

nonprocessing time. b. Calculate MCE
 Solution: a. Processing time is equal to theoretical cycle time. That is, if everything goes
smoothly and there is not
wasted time, it takes 12 minutes to produce one unit. Nonprocessing time, therefore,
must be the difference between actual cycle time (which includes some waste) and
theoretical cycle time.

Processing Time = Theoretical Cycle Time = 12 minutes

Nonprocessing Time = Actual Cycle Time – Theoretical Cycle
Time
= 15 – 12 = 3
minutes
b. MCE = Processing Time/(Processing Time + Nonprocessing Time)
= 12/(12 + 3) = 0.8, or 80%
3. Postsales Service Process
Increasing quality, increasing efficiency, and decreasing process time are also objectives that apply to the
postsales service process. Service quality, for example, can be measured by first-pass yields, defined as
the percentage of customer requests resolved with a single service call. Efficiency can be measured by
cost trends and productivity measures. Process time can be measured by cycle time, where the starting
point of the cycle is defined as the receipt of a customer request and the finishing point is when the
customer’s problem is solved.
D. Learning and Growth Perspective
The learning and growth perspective is the source of the capabilities that enable the accomplishment of
the other three perspectives’ objectives. This perspective has three major objectives: increase employee
capabilities; increase motivation, empowerment, and alignment; and increase information systems
capabilities.
Objective Measures ​Employee Capabilities: I​ ncrease employee capabilities
Motivation: I​ ncrease motivation and alignment
Information Systems Capabilities Increase information systems capabilities
Employee satisfaction ratings Employee productivity (Revenue/Employee) Hours of training Strategic job
coverage ratio (percentage of critical
job requirements filled)
Suggestions per employee Suggestions implemented per employee
Percentage of processes with real-time feedback
capabilities Percentage of customer-facing employees with
online access to customer and product information
1. Employee Capabilities
Three core outcome measurements for employee capabilities are employee satisfaction ratings, employee
turnover percentages, and employee productivity (e.g., revenue per employee). Examples of lead
measures or performance drivers for employee capabilities are hours of training and strategic job
coverage ratios (percentage of critical job requirements filled). As new processes are created, new skills
are often demanded. Training and hiring are sources of these new skills. Furthermore, the percentage of
employees needed in certain key areas with the requisite skills signals the capability of the organization to
meet the objectives of the other three perspectives.
2. Motivation, Empowerment, and Alignment
Employees must not only have the necessary skills, but they must also have the freedom, motivation, and
initiative to use those skills effectively. The number of suggestions per employee and the number of
suggestions implemented per employee are possible measures of motivation and empowerment.
Suggestions per employee provide a measure of the degree of employee involvement, whereas
suggestions
implemented per employee signal the quality of the employee participation. The second measure also
signals to employees whether or not their suggestions are being taken seriously.
3. Information Systems Capabilities
Increasing information system capabilities means providing more accurate and timely information to
employees so that they can improve processes and effectively execute new processes. Measures should
be concerned with the strategic information availability. For example, possible measure include
percentage of processes with real-time feedback capabilities and percentage of customer-facing
employees with online access to customer and product information.
Illustration: Balanced Scorecard for Ashely Hotel
Objective Measure ​Financial Perspective Operating Revenues
Operating Costs
- Total daily operating revenue - Revenue per available room
- Operating expenses relative to budget - Cost per occupant Customer Perspective Customer Satisfaction
Customer Loyalty
- Customer satisfaction ratings - Number of monthly complaints
- Number of new reward club members - Percent of returning guests Internal Perspective Employee
Turnover
Response to Customer Complaint
- Employee turnover rate - Number of employee complaints
- Percentage of complaints receiving
response - Average response time Learning and Growth New Market Identification
Employee and Training Advancement
- Growth in reward club membership for
new demographic segments
- Percentage of employees participating in
training courses - Survey scores pre- and post-training
sessions