Introduction to Management
Accounting (ACCT2105)
Chapter 4 Activity-Based Costing, Lean
Operations, and the Costs of Quality (Part 2)
Objective 4
Describe lean operations
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Lean Thinking
● Lean thinking is a management Philosophy and a business strategy of
manufacturing without waste.
○ Lowers costs
○ Creates value for customers
○ Increases competitive position
● One key element is to emphasize a short customer response time:
○ The time that elapses between receipt of a customer order and delivery
of the product or service.
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Eight Wastes of Traditional Operations
● Eight wastes that comprise much of the waste found in traditional
organizations:
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Eight Wastes of Traditional Operations
● Defects:
○ Producing defective products or services costs time and money. The
product will either need to be repaired or disposed of. In either case,
resources are wasted.
● Overproduction:
○ Overproduction means that the company is making more product than
needed or making product sooner than it is needed.
○ Traditional manufacturers keep large inventories on hand to buffer against
unexpected high product demand, production slows, or stoppages.
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Eight Wastes of Traditional Operations
● Waiting:
○ Waiting time is wasted time, making customer response time longer.
■ Employees often wait for parts, materials, information, or machine repairs
before continuing tasks.
■ Overproduction leads to WIP inventory waiting in queues for the next process.
● Not utilizing people to full potential:
○ Traditional companies underutilize employees by assuming managers
always know best.
■ Lean thinking emphasizes employee empowerment at all levels, because
employees often have valuable insights on on how their jobs could be done
more efficiently and with less frustration.
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Eight Wastes of Traditional Operations
● Transportation:
○ While some movement of parts, inventory, and paperwork is necessary,
excess transportation wastes equipment, manpower, energy, and time.
○ Causes:
■ Poor plant layout.
■ Large centralized storage cribs.
■ Large batches.
■ Long lead times that require products to be moved elsewhere until the next
production process is ready to begin.
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Eight Wastes of Traditional Operations
● Inventory:
○ Traditional manufacturers maintain large raw materials, WIP, and finished
goods inventories to safeguard against uncertainty (“Just-in-Case” approach).
○ Why are large inventories wasteful?
■ Ties up cash: Companies incur interest expenses from borrowing cash to finance
inventories or forgo other investment opportunities.
■ Hide quality issues, production bottlenecks, and obsolescence.
■ Storage costs: space, shelving, security, IT systems, labor, etc.
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Eight Wastes of Traditional Operations
● Movement:
○ Movement waste refers to excess human motion (e.g., excess bending,
reaching, turning, walking).
○ Causes:
■ Cluttered or unorganized work areas that require search for tools and supplies.
■ Poor facility design that requires excessive walking between areas.
■ Inefficient workstations and work methods where employees must continually
crouch, stretch, bend, and turn to do their tasks.
○ Impacts:
■ Wastes time and reduces efficiency.
■ Signals unsafe work conditions, lowering employee morale and increasing risks
of workers’ compensation claims.
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Eight Wastes of Traditional Operations
● Excess processing:
○ Performing additional production steps or adding features the customer
doesn’t care about.
○ Causes:
■ Customer requirements are not clearly defined.
■ Engineering changes are made without simultaneous process changes.
■ Additional steps are performed to make up for shortfalls in earlier steps.
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Lean Production
● Lean companies often adopt a “just-in-time” (JIT) inventory philosophy, to
eliminate the waste of time and money that accompanies large inventories.
○ JIT focuses on purchasing raw materials just in time for production and
then completing finished goods just in time for customer delivery.
○ Eliminate waste from storing and unstoring raw materials and finished
goods.
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Lean Production
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Lean Production
● Common characteristics of lean production
○ Value stream mapping
○ Production occurs in self-contained cells
○ Broad employee roles
○ 5S workplace organization
○ Point of use storage
○ Continuous flow
○ Pull system
○ Shorter manufacturing cycle times
○ Reduced setup times
○ Smaller batches
○ Emphasis on quality
○ Supply-chain management
○ Backflush costing
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Common characteristics of lean production
● Value stream maps (VSM)
○ A VSM identifies and visually illustrates the flow of materials and
information for products/services, from order receipt to final delivery.
■ A current state VSM illustrates the sequence of activities, communication of
information, time elapsing, and inventory build-up that is currently occurring.
■ After identifying waste within the current state VSM, a company creates a
future state VSM, with waste removed, and use it as a goal for improvement.
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Common characteristics of lean production
● Production occurs in self-contained cells
○ One of the first wastes identified on current state VSMs is the waste of
time, transportation, and movement from poor plant or office layout.
○ Lean companies group the machines in self-contained production cells to
minimize the time and cost of moving parts across the factory.
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Common characteristics of lean production
● Employee Empowerment: Broad Roles and the use of Teams
○ Lean companies focus on employee empowerment to combat the waste of
underutilizing talent.
■ Let employees hold broader roles.
■ Use small teams to identify waste and develop solutions to problems.
■ Institute profit-sharing plans so that employees at all levels are compensated for
improving company performance.
○ Employee empowerment enhances job satisfaction and employee morale.
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Common characteristics of lean production
“a place for everything and
● 5S Workplace Organization everything in its place.”
○ A workplace organization system that keep work cells clean and organized.
○ “5S” stand for:
■ “Sort”, “Set in order”, “Shine”, “Standardize”, and “Sustain”.
○ 5S helps employees quickly locate tools and supplies for maximum
efficiency, reduces defects, enhances workplace safety, and minimizes
unscheduled machine repairs.
● Point-of-use Storage (POUS)
○ A storage system used to reduce the waste of transportation and
movement.
○ In essence, tools, materials, and equipment are stored close to where they
will be used most frequently, rather than in a centralized storage crib.
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Common characteristics of lean production
● Continuous Flow
○ Lean firms align production with demand to reduce the wastes of waiting,
overproduction, and inventory. Takt time is the rate of production needed
to meet customer demand yet avoid overproduction.
■ E.g., A takt time of five minutes for a product line means that one unit needs to
be produced every five minutes.
○ By monitoring takt time, lean firms identify bottlenecks, balance workloads,
avoid inventory build-up, and satisfy customer demand.
● Pull System
○ In lean production systems, a customer order triggers the start of the
production process and “pulls” a batch through production.
■ In traditional production systems, inventory is “pushed” through production
based on forecasted demand.
■ Lean firms must adopt strategies to quickly fulfill customer orders.
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Common characteristics of lean production
● Shorter Manufacturing Cycle Times
○ Lean companies must reduce manufacturing cycle time: the time that
elapses between the start of production and the product’s completion.
■ Most manufacturing cycle time is spent on non-value-added activities.
■ Shorter manufacturing times also protect firms from foreign competitors
whose cheaper products take longer to ship.
● Reduced Setup Times
○ One key factor in manufacturing cycle time is the time required to set
up a machine that is used to manufacture more than one product.
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Common characteristics of lean production
● Smaller Batches
○ Another key factor in manufacturing cycle time is batch size. Lean companies
uses smaller batches because large batch sizes cause wasted wait time.
Manufacturing Cycle Time with a Batch Size of 10
Each unit in this large batch
spends a lot of time waiting.
Manufacturing Cycle Time with a Batch Size of 1
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Common characteristics of lean production
● Emphasis on Quality
○ Lean companies try to produce their products right the first time, every time.
■ No backup stock for waiting customers if production issues arise.
■ Defects in materials and workmanship can slow or shut down production.
○ Lean companies focus on quality at the source.
■ Shift the responsibility for quality adherence to operators at each step in the
value stream, rather than rely on quality assurance personnel to catch errors.
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Common characteristics of lean production
● Supply-Chain management
○ Supply chain management is the information exchange with suppliers and
customers to reduce costs, improve quality, and speed delivery of goods and
services from suppliers, through the company itself, and to end customers.
○ Lean production requires suppliers to deliver defect-free materials on time.
● Backflush Costing
○ Many lean producers use backflush costing, a simplified accounting system
that better mirrors the production and eliminates wasteful bookkeeping.
■ Production costs are not assigned to the units until they are finished or even
sold (avoiding tracking through multiple inventory accounts).
■ At the end of the period, unfinished or unsold products are “flushed” out of Cost
of Goods Sold and placed back to WIP and Finished Goods Inventory.
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Drawbacks to Lean Production Systems
● Vulnerable when problems strike suppliers or distributors.
● Examples
○ Delays in delivery
○ Personnel problems—union strikes
○ Shortage of parts due to recalled products
○ Weather related issues
Lean operation is easier said than
done. If it was so easy to adopt,
Toyota would not continue to have
an advantage over its competitors
for such a long time.
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Sustainability and Lean Thinking
● Similarity: Both seek to reduce waste.
● Differences:
○ Lean operations focus on increasing economic profits, while green practices
aim to increase economic profits, preserve the planet, and improve the lives
of all people touched by the company.
○ Lean operations center on internal operational waste, while green practices
also consider the external waste that may occur because of the product.
● A lean company should be particularly cognizant of all waste that could
harm the planet to be “Lean and Green”.
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Objective 5
Describe and use the cost
of quality framework
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Total Quality Management
● Total Quality Management (TQM): a management philosophy that
focuses on consistently generating high-quality products.
● Goal: Provide customers with superior products and services.
● Each business function in the value chain continually examines its
own activities to improve quality and eliminate defects.
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Costs of Quality
● Quality-related costs generally fall into four different categories.
○ Prevention costs: Costs incurred to avoid poor quality goods or services.
○ Appraisal costs: Costs incurred to detect poor quality goods or services.
○ Internal failure costs: Costs incurred on defective units before delivery
to customers.
○ External failure costs: Costs incurred on defective units that are not
detected until after delivery is made to customers.
This one is the biggest cost (including potentially
significant reputation damage), but hardest to estimate.
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Costs of Quality
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Relationship Among Costs
● Conformance costs VS. Non-conformance costs
○ Conformance costs: Costs incurred to make sure the product or service
conforms to its intended design and is not defective.
■ Include prevention and appraisal costs.
○ Non-conformance costs: Costs incurred because the product or service
is defective.
■ Include internal failure and external failure costs.
● Trade-off
○ Investing more in prevention costs at the front end of the value chain
may generate even more savings in the back end.
○ Companies that embrace TQM design and build quality into their
products rather than having to inspect and repair later.
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Non-Manufacturing Costs of Quality
Service firms and merchandisers also incur costs of quality! Think
about a service firm—what are some examples of these costs?
● Prevention costs:
○ conduct staff training, develop standardized service checklists…
● Appraisal costs:
○ review work continuously, inspect before releasing…
● Internal failure costs:
○ A movie has gone through filming, but then the director finds there
is not enough good material, and the film needs some reshoot
[Batman v Superman: Dawn of Justice (2016) movie]
● External failure costs:
○ reputation damage [Arthur Andersen from its infamous audit failure]
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Costs of Quality Reports
● Costs of quality reports identifies, categorize, and quantifies the costs
incurred by the company related to quality.
○ Managers typically use these reports as part of their TQM approach.
○ Help managers identify ways for the company to improve quality while
at the same time controlling costs.
Assume Global Fitness, another manufacturer of fitness equipment, is
having difficulty competing with Life Fitness because it doesn’t have the
reputation for high quality that Life Fitness enjoys.
➢ Let’s look at Global Fitness’s costs of quality report.
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Using Costs of Quality Reports to Aid Decisions
Very little
Prevention
and
Appraisal
costs
Huge
amount of
internal
failure and
external
failure costs
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Using Costs of Quality Reports to Aid Decisions
After analyzing the costs of quality report, Global Fitness’s
CEO considers investment on a new quality program:
Global Fitness expects this quality program to reduce costs by:
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Using Costs of Quality Reports to Aid Decisions
Net benefit!
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Now turn to E4-27A
Classification
Classification
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E4-27A Requirement 2
(Cost) / Benefit Analysis (Cost)/Savings
Net Benefit (Cost)
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