chap013 target costing constraint
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Copyright 2010 by The McGraw-Hill Companies, Inc. ll rights reser!e".McGraw-Hill#Irwin
Chapter Thirteen
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Explain how to use target costingto facilitatestrategic management
Apply the theory of constraints(TOC) tostrategic cost management
Describe how life-cycle costingfacilitatesstrategic management
Outline the objectives an techni!ues ofstrategic pricing
Learning Objectives
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The Product Life-Cycle
Four costing methods discussed in thischapter:
Target costing
Theory of constraints (TOC)"ife#cycle costing
$trategic pricing
All involve the entire product life cycle:
%anagers now nee to loo& at costs upstream(before manufacturing) an ownstream (aftermanufacturing)
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The Cost Life Cycle
Cost life cycle refers to the following sequenceof activities:
Research and Development (R&D)DesignManufacturing (or providing the service)Marketing/distributionCustomer service
It is the life-cycle of a prouct or service fro! theviewpoint of costs incurre
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"pstrea! #ctivities $ownstrea! #ctivities
%&$
%&$
$esign
$esign
'anufacturing
'anufacturing 'ar(eting
an $istribution
'ar(eting
an $istribution
Custo!er )ervice
Custo!er
)ervice
The Cost Life-Cycle
*continue+
Design decisionsaccount for much of total product life cclecosts
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The )ales Life-Cycle
TheSales life cycle is the sequence ofphases in the products or services life:
'ntrouction of the prouct or service to themar&et
rowth in sales
%aturity
Declineithrawal from the mar&et
* The sales life cycle is the life-cycle of aproduct or service from the viepoint ofsales volume achieved
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The )ales Life-Cycle
Introuction
,rowth 'aturity
$ecline
Ti!e
)
ales
!mportant costmanagementissues arise ineach stage ofthe life"ccle#
!mportant costmanagementissues arise ineach stage ofthe life"ccle#
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Target Costing
Target costing: a costing method in hichthe !rm determines the alloa"le #i$e$%&target'( cost for a product or service%given a competitive mar)et price and a
targeted pro!t
To options for reducing costs to achievethe target-cost level:
+y integrating new manufacturing technology usingavance cost management techni!ues, (such asA+C), an see&ing higher prouctivity
+y reesigning the prouct or service
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*mplementing TargetCosting
Determine the mar&et price
Determine the esire pro-t.
Calculate the target cost as mar&et priceless esire pro-t
/se 0value engineering1 to reuce cost
/se &ai2en costing an operational control to
further reuce costs
.3or example, expresse as a percent of sales ollars
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+alue,ngineering
+alue engineering #step (:
Analy2e trae#o4s between prouctfunctionality (features) an total prouct cost
5erform a consumer analysis uring the esignstage of the new or revise prouct to ientify
critical consumer preferences
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+alue ,ngineering#continued(
For !rms that can add and delete features
easily% functional analysis #e.amining the
performance and cost of each ma/or functionor feature of the product( can "e used
Benchmarkingis often use in this step toetermine which features give the -rm a
competitive avantage oal6 provie a esire level of
performance without exceeing the targetcost
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+alue ,ngineering#continued(
0esign analysis:
/seful when the !rm cannot add and delete
features easilyThe esign team prepares several possible
esigns of the prouct, each having similarfeatures with i4erent levels of performance
an i4erent costsAccountants wor& with the esign team to choose
one esign that best meets customer preferenceswhile not exceeing the target cost
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+alue ,ngineering#continued(
1ther cost-reduction methods:Cost tables: computer#base atabases (costs
an cost rivers)3irms that manufacture parts of i4erent si2e
from the same esign can estimate thei4erence in cost an material usage forincreasing or ecreasing si2e
Group technologyis a metho of ientifyingsimilarities in the parts of proucts a -rmmanufactures so the same parts can be use in
two or more proucts, thereby reucing costs
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2ai3en
2ai3en #step !ve(: using continuousimprovement 4 operational control to reducecosts in the manufacturing stageof theproduct life-cycle
Achieve through6$treamlining the supply chain
"ean manufacturing
'mproving manufacturing methos an prouctivity
programsEmploying new management techni!ues
/se extensively in the time perio between
prouct reesigns
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5ene!ts of TargetCosting
'ncreases customer satisfaction (esign isfocuse on customer value)7euces costs (more e4ective an e8cient
esign)9elps the -rm achieve esire pro-tability on
new an reesigne proucts7euces 0surprises1 of the type, 0e i not
expect it to cost that much:::1Can improve overall prouct !uality3acilitates coorination of esign,
manufacturing, mar&eting, an cost managersthroughout the prouct cost an sales life#cycles
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Target Costing
,.ample$%! is performing a target costing analsis of a hearingaid ($%!")' hich sells for *+, (cost - .+,) and has
,0 of the market# $oever' a competitor hasintroduced a ne model that incorporates a computer
chip that improves 1ualit# !ts cost is 2',,# 3consumer analsis indicates that cost"conscious
consumers ill remain loal to $%! as long as pricedoes not e4ceed .,,# $%! ants to maintain thecurrent rate of profit' 2,, per hearing aid#
.I !ust therefore reuce its cost to /011 */201 -/301+ to !eet its profit goal
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Target Costing ,.ample#continued(
0esign analysis options :
Alternative A: reuce 7;D, replace parts, anchange inspection proceure < savings = >.?@Alternative 5: replace parts an change inspection
proceure < savings = >.?@
Alternative C: increase 7;D to evelop a computerchip type hearing ai, replace parts, change inspectionproceure, renegotiate new supplier contract .?@
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Target Costing ,.ample#continued(
6anagement chooses alternative C"ecause:
The increase in 7;D will improve the -rmscompetitive position in the future
The move is strategically important6 the
new technology may be ominant in thefuture
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7uality Function 0eployment#7F0(
7F0: the integration of value engineering%mar)eting analysis% and target costing toassist in determining hich components of theproduct should "e targeted for redesign or
cost reduction
3our steps in B3D6
'entify an ran& customers purchasing criteria for theprouct
'entify the components of the prouct an the cost ofeach component
Determine how the proucts components contribute tocustomer satisfaction
Determine the importance (value) inex of each
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7F0 ,.ample: Step8
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7F0 ,.ample: Step9
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7F0 ,.ample: Step
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7F0 ,.ample: Step
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7F0 ,.ample:Conclusion
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6easuring and*mproving Speed
6any strategic initiatives underta)en "y!rms today focus on improving the speed ofoperations
6anufacturing cycle time #lead timeorthroughput time( is the amount of time"eteen the receipt of a customer order andthe shipment of that order
ote that start an -nish time of the cycle can bee-ne in several ways: Example6 the start timecoul be e-ne as the time raw materials areorere, an the -nish time the time that prouction
is complete
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6easuring and*mproving Speed
#continued(Manufacturing cycle eciency#6C,( is
de!ned as processing time divided "y totalcycle time
%CE separates total cycle time into6
5rocessing time
'nspection time
%aterials hanling timeaiting time, an so on
%ost -rms woul li&e to see %CE close to one
Constraintsare activities that slo a
products total cycle time
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The Theory ofConstraints #T1C(
T1C focuses on improving speed at theconstraints% to decrease overall cycle time
3ive steps in TOC6
'entify the constraint
Determine the most pro-table prouct mix giventhe constraint
%aximi2e the ow through the constraint
A capacity to the constraint
7eesign the manufacturing process for exibilityan fast cycle time
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T1C ,.ample
$%! manufactures both the second generation($%!") and the third generation ($%!") of hearing aids#%rices are competitive at .,, and 2',,' respectivel'
and are not e4pected to change# 5he monthl number oforders for $%!" is ',,, units and for $%!" is 2'6,,units# 7e customers are told the ma have to ait
three eeks or more for their orders' and management
is concerned about the need to improve speed in themanufacturing process#
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Step 8: T1C ,.ample
Step 8: *dentify the Constraint
* Develop a ow diagram, which shows these!uence an time of each process
* /se the ow iagram to ientify the constraintfor 95' (see example, next slie)
There is i8culty maintaining ae!uate sta8ng in
all process areas except process ? The constraint occurs in process , perform -nal
assembly an testF the other four processes haveslac& time
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Flo 0iagram: T1C ,.ample8lectronic
Components%rice - ,,
8lectronic
Components%rice - ,,
3ssemble8arpiece22, min#
3ssemble8arpiece22, min#
!nstall 9ther8lectronics
:, min#
!nstall 9ther8lectronics
:, min#
;inal 3ssembland 5est, min#
;inal 3ssembland 5est, min#
%ack and
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Step 9: T1C,.ample
Step 9: 0etermine the most pro!ta"leproduct mi. given the constraint
The most pro-table mix provies the
maximum total pro-ts for both proucts3irst, using throughput marginetermine the
most pro-table prouct given the constraint
Throughput margin = selling price less materialscost
'n the example, the relevant measure ofpro-tability is throughput margin per minute
in nal assembly and testing
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Step 9: T1C ,.ample#continued(
3s can be seen' $%!" has a higher throughput margin# !nthe absence of constraints' this product ould be moreprofitable' but ith the time constraint in process :' $%!"is the more profitable product#
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Step 9: T1C ,.ample#continued(
$%! ill produce all ',,, units (total demand) for $%!"since it is the more profitable' and the remaining capacitill be used to produce $%!"# $%!" ill use 2'+,, (',,,units 4 ,#+ hour per unit) hours of the ':,,"hour capacit#
5he =,, hours remaining allo for production of =,, unitsof $%!"#
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Step : T1C ,.ample)tep 4: 'a5i!i6e the flow through the constraint
< "oo& for ways to spee the ow bysimplifying the process, improving prouct
esign, reucing setup, an reucingother elays
< Objective is to balance the ow ofprouction through the system (processesprior to an incluing the constraint) by
carefully timing an scheuling those
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Step : T1C ,.ample#continued(
)tep 4: 'a5i!i6e the flow through the constraint*continue+
3nother method to use is Takt time(total time available to
meet e4pected customer demand)
84ample> if a manufacturing plant operates 6 hrs#/da?after alloing for break time' :,, minutes ofmanufacturing time are available/da# !f average customer
demand is 6,, units' the 5akt time is , seconds per unit'that is , seconds per unit# 5akt time is used to balancethe flo of product through the processes#
711 !inutes8911 units 41 secons per
unit takt time
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Steps 4 ;: T1C,.ample
)tep 7: # capacity to the constraint
3dding ne machines or additional labor is a long"termmeasure that can improve flo through the constraint
)tep 0: %eesign the !anufacturing process forfle5ibility an fast cycle-ti!e
5his step involves the most complete strategic response tothe constraint because simpl removing one or more minorfeatures of a product might speed up the production
process significantl
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T1C vs$ A5C
TOC #;C
'ain
Objective
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The Five Steps in Strategic0ecision 6a)ing: *mportance of
Speed in the Fashion *ndustry: The5ur"erry
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Life-CycleCosting
Life-cycle costing provides a more complete
perspective of product costs and protability thanpricing based on manufacturing costs only
%anagers nee to be concerne with costs outsie themanufacturing process because upstream an ownstreamcosts can account for a signi-cant portion of total life#cyclecosts
The most crucial way to manage these costs is at theesign stage of the prouct an the manufacturing process
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Life-Cycle Costing #continued(
0ecision-ma)ing at the design stage is
critical "ecause decisions at this point
commit a !rm to a given production%mar)eting% and service plan% and loc) inmost of the products total life cyclecosts$
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Life-Cycle Costing,.ample
#ccoring to the traitional prouct-line state!entsbelow< #$I-3 appears to be the !ore profitable prouct
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Life-Cycle Costing ,.ample#continued(
owever< when upstrea! an ownstrea! *i=e=< life-cycle+costs are consiere< #$I-> is actually !ore profitable
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StrategicPricing
Strategic pricing decisions requireinformation from:
a) The cost life#cycle
b) The sales life#cycle
The cost information for pricing iscommonly "ased on one of four
methods:3ull manufacturing cost plus mar&up"ife#cycle cost plus mar&up3ull cost an esire gross margin percent
3ull cost plus esire return
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Strategic Pricing #continued(
Strategic pricing depends on the position of theproduct or service in the sales life-cycle
%hase 2
!ntro#
%ricing is set relativel high to recover development costsand take advantage of ne"product demand
%hase
Broth
%ricing is likel to sta relativel high as the firm attemptsto build profitabilit
%hase
Maturit
5he firm becomes more of a price taker than a pricesetter and attempts to reduce upstream and donstream
costs
%hase :
Decline
5he firm becomes more of a price taker than a pricesetter and attempts to reduce upstream and donstreamcosts
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*arget costingetermines the allowable (i:e:,0target1) cost for a prouct or service, givena competitive mar&et price an a target pro-t
The target costing approach involves -vesteps6
Determine the mar&et priceDetermine the esire pro-t
Calculate the target cost(mar&et price lessesire pro-t)/se value engineeringto reuce cost/se kai+en costingan operational controlto
further reuce costs
Chapter )u!!ary
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Chapter )u!!ary *continue+
*Thetheory of constraints (TOC) focuses onimproving spee at the constraints, which causesa ecrease in overall cycle time
* 3ive steps in TOC6
< 'entify the constraint< Determine the most pro-table prouct mix
given the constraint< %aximi2e the ow through the constraint< A capacity to 0relax1 the constraint< 7eesign the manufacturing process for
exibility an faster cycle#time
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Chapter )u!!ary *continue+
Life-cycle costingprovides a more completeperspective of product costs and product orservice profitabilit because it considers the
entire cost life ccle of the product or service
Management accountants prepare informationfrom both the perspective of the cost life"ccle
and the sales life"ccle to help managementmake strategic pricing decisions
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