tocico conference 2009

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TOCICO CONFERENCE 2009

1© 2009 TOCICO. All rights reserved.

Finance and Measurements:Certification Exam Review

Prepared By: Charlene Spoede Budd Prepared By: Charlene Spoede Budd


DisclaimerDisclaimer

This Certification Exam Review Workshop is to help applicants be aware of the content of the Certification Exam. It is not a training course, nor a sample exam.


The examples and discussion used in this workshop are to guide and assist your understanding of the general nature, scope, and level of detail of the Certification Exam. An exact answer to any/all questions should not be expected.


Objectives of this Workshop:Objectives of this Workshop:

1. To help candidates prepare for the F&M TOCICO examination.

2. To stress the necessity of functional areas having the same ultimate goal and consistent functional goals.

3. To look further at Throughput Accounting.

4. To convince you that:


a. You cannot “fight” or “ignore” accountants not fully trained in TOC

b. You need the accountants on board (you own accounting is insufficient)

c. Traditional internal accounting (unit costs, efficiencies, performance to budget) can sink a TOC implementation even after it has been established and showing good results


Exam Content SpecificationsExam Content Specifications

I. Finance and Accounting Fundamentals (2 hours*)Objective:

Demonstrate a practical knowledge of the fundamentals of both managerial and financial accounting and their underlying economic principles. Demonstrate the ability to compare and contrast the differences between The Theory


compare and contrast the differences between The Theory of Constraints Throughput Accounting and the above.

A. Understanding “rules” and terms of GAAP financial statements B. Understanding “Contribution or Direct Costing financial statementsi. Create financial statements from a common set of data elements under the rules for standard costing/gross margin vs. direct costing/contribution margin a. Proper placement of standard variances.

ii. Timing differences on balance sheet recognition and statement of cash flows recognition. continued


Finance and Accounting FundamentalsFinance and Accounting Fundamentals (continued)(continued)

C. Understand and contrast full absorption accountingi. Traditional and Activity Based Costing

ii. Direct (or variable) costing vs. throughput accounting iii. Product profitability analysis as well as financial statement reportinga. Problem set deriving product profitability from common data set using: 1. Full absorption costing with various drivers

2. Direct costing vs. TOC product profitability


2. Direct costing vs. TOC product profitability

3. Lean Accounting vs. TOC accounting

4. Compare and contrast logic for use of 3a1, 3a2 and 3a3 (above)

− Possible distortions resulting from use of each

D. Understanding standard cost allocation methodologiesi. Impacts on unit costs

ii. Product profitability,

iii. Capital budgeting and investment planning decisions


II. TOC Thinking Process-Finance & Measures (2 hours*)

Objective: Demonstrate the ability to analyze any environment’s finance, measures and decision making system using the four fundamental question of the thinking process.

A. Why change?


A. Why change? i. Understand and explain the UDE linkages to the core problem associated with external accounting requirements that overlap the internal decision making system and measures.

ii. Understand interdependencies of fundamental building blocks of return on Investment and the possible dysfunctions when they are used as KPI (key performance indicators)

continued* See Slide 14


TOC Thinking Process TOC Thinking Process –– F & MF & M

B. What to change?i. Understand and explain the core conflicts in finance and measures in any type of organizational system through the cloud format: ii. Demonstrate the ability to surface the erroneous assumptions that underlie the core conflicts in finance and measures in any type of organizational system. C. What to change to?


C. What to change to?i. Know how to link the ROI key components system subcomponents to a decision making system synchronized with a constraint focus. ii. Be able to create the necessary injections:

§ That overcome the erroneous assumptions that underlie the core conflicts in finance and measures in any type of organizational system

§ Build the logical connections from the proposed injections to their predicted effects

§ Add the additional injections necessary to round out solution to mitigate the risk and create the necessary buy-in.

continued


TOC Thinking Process TOC Thinking Process –– F & MF & M

D. How to cause the change?

i. Create:

− Injection maps,

− IO maps (focused on understanding the integration of new finance and measures in overall solutions)


− Prerequisite trees

− Transition trees to ensure a realistic, time sequenced implementation plan to implement your solution sets.

ii. Understand and communicate the obstacles and intermediate objectives that predictably arise across the organization/supply chain from changes in finance and measures to any level in the organization.


III. Finance and logistical solutionsIII. Finance and logistical solutions (2 hours*)(2 hours*)

Objective:

Demonstrate the ability to understand and design the new measures and decision making system to successfully support a Process of On Going Improvement using the logistical solutions of the Theory of Constraints.


Theory of Constraints.

continued* See Slide 14


Finance and Logistical SolutionsFinance and Logistical Solutions (continued)(continued)

A. Finance and Metric Requirements to support the decision making system for Supply Chain Logistics (Drum Buffer Rope and Replenishment Inventory Management). Requirements include being able to:

− Demonstrate the TOC methodology to design the buffer management reporting information system. (All types of buffers (stock, time and capacity): size, expedite, relevant data feedback loop, improvement)


loop, improvement)

− Understand the use of measures to align all levels of the organization with corporate long term goals.

− Contrast traditional accounting “measures” and “Rules” that reinforce “push” vs. “pull”, in product environments.

− Understand implementation of buffer management reporting for planning, process improvement and investment decisions.

− Understand the role of budgeting in a TOC environment.

− Know the role of measures and how they are used throughout the organization/supply chain in a Theory of Constraints Organization. continued



B. Critical Chain Project Management (CCPM)

− Demonstrate the TOC methodology to design the buffer management reporting information system (project buffers, feeding buffers).

− Understand the use of measures to align all levels of the organization with corporate long-term goals.


− Contrast traditional accounting “measures” and “Rules” that reinforce “push” vs. “pull”, in project environments.

− Demonstrate the ability to use Portfolio management to prioritize projects and investments in a Theory of Constraints Organization.

− Contrast traditional project risk measures for individual project planning and execution that reinforce re-planning Vs buffer management.

− Understand the role of Earned Value Analysis in both traditional and TOC environments.

continued



C. The integration of all enterprise logistical systems (DBR, S-DBR, Replenishment, CCPM) and the appropriate reporting and measures to create a portfolio management decision making model to tie their tactics and investments to the organization’s short run and long run strategy. Demonstrate the TOC methodology to design the buffer management


the TOC methodology to design the buffer management reporting information system (project buffers, feeding buffers).


IV. HOLISTIC Decision Making CASEIV. HOLISTIC Decision Making CASE (2 hours*)(2 hours*)

Objective:

Demonstrate the ability to synthesize, analyze, make decisions and implement the solution set as well as to identify and mitigate the risks associated


well as to identify and mitigate the risks associated with the decision.

* See Slide 14


Note . . .Note . . .

The eight hour examination may not strictly follow the two-hour sequences just described, but, on a random basis, will include the required elements.

*


include the required elements.

That is, each examination may not include all the material contained in the Exam Content Specification and may not have material compartmentalized (in 2-hour blocks) as illustrated on the previous slides.


Grading Criteria for F & M ExaminationGrading Criteria for F & M Examination

1. Completeness of response – have all the elements in the question been answered?

2. Correctness of response – is the answer


2. Correctness of response – is the answer within the range of acceptable responses?

3. Demonstrated knowledge, thought and reasoning ability of candidate – did the candidate address the question using knowledge of accounting, finance and metrics, along with Theory of Constraints understanding and did they demonstrate the logic behind their answer(s).


Throughput Accounting for Finance & MetricsThroughput Accounting for Finance & Metrics

Competency in finance and metrics requires a fairly detailed knowledge of traditional accounting. That is, you must have sufficient knowledge to discuss traditional


sufficient knowledge to discuss traditional accounting with accounting people not trained in Theory of Constraints.

The next two slides partially review the minimum manufacturing accounting knowledge you must have or acquire.


Abbreviated Mfg. Abbreviated Mfg. AccountingAccounting ExampleExample

• Balance Sheet:

− Assets: 6 accounts shown

− Liabilities: 3 accounts shown

− Stockholders’ Equity: 2 accounts shown


− Stockholders’ Equity: 2 accounts shown

• Income Statement:

− Sales, Cost of Goods Sold, and Expenses accounts shown

Cost of Units Sold

Raw Materials Work in Process

Finished Goods

Partial GAAP Balance Sheet Accounts Partial GAAP Income Statement AccountsAssets

Var. Mfg. Overhead Fixed Mfg. Overhead

Accts. Rec.

Beg. Bal. Beg. Bal. Beg. Bal.

Beg. Bal.

Sales

Cost of Goods Sold

- 0 - - 0 -- 0 - - 0 -

- 0 - - 0 -

- 0 - - 0 -

Purch.1 RM Used2RM Used2

D. Labor4

Indir. Labor4Act. VOH5

Other Act. FOH

6

VOH Applied*

7

VOH Applied

7

FOH Applied*8

FOH Applied

8

Units Completed

9 Units Completed

9 Cost of Units Sold

10

Sell. Price Units Sold

11

10

Sell. Price Units Sold

11

End. Bal.

End. Bal.

End. Bal.

Underapplied FOH

13

Underapplied 13

Over-Applied VOH

14

- 0 - - 0 -- 0 - - 0 - Overapplied

VOH14

Collections Debit Cash

End. Bal.

Closed to Ret. Earn.

- 0 - - 0 -

Liabilities

Accts. Payable Misc. Payables Payroll Payable

Shareholders’ Equity

Retained EarningsCommon Stock

Beg. Bal. Beg. Bal. Beg. Bal.

Beg. Bal. Beg. Bal.

Sales

Expenses (Incl. C/G/S)

Expenses- 0 - - 0 -

Purch.1 Salaries3

Salaries3

Factory Labor

4

Act. VOH5

Other Act. FOH6

Underapplied FOH

13 VOH

Payments Credit Cash

End. Bal.


End. Bal.


End. Bal.

Adjusted C/G/S Closed to Ret. Earn.

- 0 - - 0 -

- 0 - - 0 -

Closed to Ret. Earn.

Period Exp.12

Period Exp.12

End. Bal.

Dividends Debited to Cash

* Using Predetermined Overhead Rates Estimated Annual Overhead

Estimated Activity Driver18

© 2008 TOCICO. All rights reserved.


Functional Areas and TOCFunctional Areas and TOC

• Accounting and Finance must:1. Understand TOC and the “entire system” approach (no area is “King”)

2. Understand how all functional areas integrate/interact

3. Help insure that the required functional synchronization


3. Help insure that the required functional synchronization happens everywhere

4. Develop appropriate internal metrics and measures that will support constraints management

5. Be comfortable adjusting internal statements to GAAP accounting for external reporting

• Other functional areas? Items 1, 2, and 3 above plus….


Functional Areas and TOCFunctional Areas and TOC (continued)(continued)

• Other functional areas Items 1, 2, and 3 (previous slide) plus….− Top executives are responsible for strategy and tactic and

must

− Appreciate and support the interaction and


− Appreciate and support the interaction and interdependence of employees, owners, and customers

− Determine the direction of the organization

− Engineering must develop new products and improvements rapidly (CC PM)

− Operations must “make synchronization happen” (DBR, buffer management, etc.)

− Marketing and Sales must develop appropriate “mafia offers” for customers


Throughput Accounting IS:Throughput Accounting IS:

• Planning/Budgeting designed to support Constraints Management

• Internal reporting metrics that support TOC

• Periodic reporting on a direct (variable) costing basis− Easily converted to absorption (GAAP) costing for external


− Easily converted to absorption (GAAP) costing for external reporting

• Evaluation of investment opportunities− Short term (including make versus buy, adding products,

etc.)

− Long term (including constraint location decisions)

• Appropriate performance evaluation metrics


• Similar to activity-based costing with only a timing difference

• Interested in tracking only raw material costs (as most – all?-- cost and management accounting textbooks say or imply)

Throughput Accounting IS NOT:Throughput Accounting IS NOT:


• Merely a product-mix method (you will see limited cost accounting textbook treatment with a P-Q example -- materials typically the only variable cost -- or some variation of P-Q, as well as the five steps illustrated)

• A fad of operations that really does not really impact traditional cost accounting


Throughput Accounting IS...Throughput Accounting IS...

All the metrics and measurements necessary to support Constraints Management operations, including

In Summary . . .In Summary . . .


Management operations, including project management, capital andother improvements, strategy and

tactics, production, marketing, sales.


Some Accounting FundamentalsSome Accounting Fundamentals

p Typical approach: Divvy up the organization's total results (revenues and costs) to various areas♦ Fully-absorbed costs (including the pre-

• Managerial Accounting


♦ Fully-absorbed costs (including the pre-determined fixed manufacturing cost per unit) are assigned to each unit produced

♦ Concentration usually is on reducing cost per unit (even if total fixed costs do not change)

♦ "Cost world" (cost is “King”) mentality reigns


Managerial AccountingManagerial Accounting

n Some organizations effectively use segment planning (budgeting) and reporting

p "Direct costs” (can be variable or fixed)


p "Direct costs” (can be variable or fixed) are traced to the responsible segment and common costs (usually headquarters-type costs) are kept in a lump sum and deducted from the organization's total segment margin.


Segment AccountingSegment Accounting

Segment 1 Segment 2 Segment 3 Total$ 50,000 $150,000 $100,000 $300,000

18,000 50,000 35,000 $103,000

RevenuesDirect costs:Cost of goods soldVar. Costs 7,000 20,000 20,000 47,000


3,000 4,500 8,000 15,500

$ 29,500 $ 77,500 $ 65,500 $172,500

Var. CostsFixed CostsSelling and admin.Var. CostsFixed Costs

Segment marginCommon costsOperating income

30,000$ 97,500

Activity-based accounting may be useful in tracing direct non-manufacturing costs to segments!

7,000 20,000 20,000 47,000

1,500 3,000 2,500 7,000

$ 20,500 $ 72,500 $ 34,500 $127,500


The Budgeting ProcessThe Budgeting Process

• Budgets should be based on actual production plans, not wishful thinking.

− Production plans should be based on producing the items that will be sold to customers (projected product mix)


(projected product mix)

− Budgets should be constructed by month (or less) and then summed to annual numbers

• Budgets must be flexible.

− assumptions will change


Throughput Segment AccountingThroughput Segment Accounting---- Add a New Segment?Add a New Segment?

(assume the constraint is not affected)

Revenues

Traceable costs:

Total

$360,000$300,000SegmentsCurrent

$60,000Segment

New


Yes!Yes!

Traceable costs:Var. Mfg. C/G/SVar. sell. and admin.Current direct fixed costsAdditional direct fixed costs

Segment margin

Common fixed costs

Operating income

$153,000

$130,00027,000

30,000

$123,000

5,000

105,00022,500

$127,500

45,000

25,0004,500

$ 25,5005,000


Direct Cost Reporting for Internal UseDirect Cost Reporting for Internal Use

§ Some companies (TOC and non-TOC) use direct or variable costing reporting internally for managers’ use

− Although prohibited by GAAP from using this


− Although prohibited by GAAP from using this type reporting externally, this is not a problem

− See example on next slide

Note: Variable Costing is sometimes called “Direct” Costing or “Contribution Margin” Costing. All these names are synonymous.


Direct (Variable) Costing ExampleDirect (Variable) Costing Example

Assume a company that has no beginning inventories of work-in-process or finished goods, produces 20,000 units and sells 15,000 units for $20 each. There is no


15,000 units for $20 each. There is no ending work-in-process inventory.

Costs (as traditionally prepared) are:

Cost ItemCost Item DetailsDetails TotalTotal Per UnitPer UnitDirect materials 40,000 units @ $2 $ 80,000 $ 4.00*

Direct labor 2,500 hours @ $8 20,000 1.00*

Var. mfg. OH 4,000 mach. hrs. @ $1040,000 2.00*

Fixed mfg. OH 4,000 mach. hrs. @ $1560,000 3.00*

Total product cost per unit . . . . . . . . . . . . . . . . . . . . . . . . . . $10.00

Var. sell. and admin. 22,500 1.50


Fixed sell. and admin. 30,000 2.00**

Total costs incurred $252,500

A Direct Cost (or Variable or Contribution Margin) Income Statement would look like the following:

** Based on 15,000 units sold* Based on 20,000 units produced

[See Slide 32 for Variable Costing results and slide 34 for Traditional results]



Revenues (15,000 units @ $20) $300,000Variable costs

Direct materials $60,000Direct labor (all variable) 15,000Variable mfg. overhead 30,000Variable sell. and admin. 22,500

Variable (Direct) Cost Income StatementVariable (Direct) Cost Income Statement


Variable sell. and admin. 22,500Total variable costs 127,500

Contribution margin $172,500Fixed costs

Manufacturing $60,000Labor? (if it is fixed, $20,000 would be here)Sell. and admin. 30,000Total fixed costs 90,000

Net operating income $ 82,500


n Direct or VC reporting, while used by relatively few companies, is one of the basic building blocks of Throughput Accounting. In the VC income statement, expenses include all fixed manufacturing overhead costs as expenses of the current period.

Bridge to Throughput AccountingBridge to Throughput Accounting


include all fixed manufacturing overhead costs as expenses of the current period.

n The traditional (absorption costing) income statement (next slide) shows $97,500 -$82,500 = $15,000 greater income than the variable costing (throughput) statement [because some fixed mfg. OH is assigned to units produced but not sold].


Traditional Traditional (Absorption Costing)(Absorption Costing) Income StatementIncome StatementFor the Period Ending the Last Day of the PeriodFor the Period Ending the Last Day of the Period

Revenues (15,000 units at average price of $20)$300,000Cost of goods soldBeg. Fin. Goods 0Cost of goods manufactured $200,000

(Using data from slide 30 and 31)


Cost of goods manufactured $200,000Less ending Finished Goods 50,000Cost of goods sold ($10 x 15,000 un) 150,000Gross profit (margin) $150,000Selling and admin. expensesVariable $ 22,500Fixed 30,000Total sell. and admin. expense 52,500Net operating income $ 97,500


• Must follow GAAP (use a fully-absorbed manufacturing cost for cost of sales and valuation of inventories)

• The accounting system generally is designed to accumulate and report GAAP data (only?)

Financial Accounting�Financial Accounting�


• Reports contain past results

• Closing process may take up to five days each month, up to three months for an audit and issuance of annual report

• Permits managers to use the accounting principle of matching to increase profits by producing inventory


Financial Accounting ImpactFinancial Accounting Impact

Note that although $252,500 total costs were incurred in the preceding example, only

$150,000 + $52,500 = $202,500of costs were expensed on the income statement.


statement.This is because manufacturing costs of $10 per unit ($4 DM + $1 DL + $2 VOH + $3 FOH) times 5,000 units, or $50,000, were put in ending inventory and thus deferred (not recognized) until some future period (when these units are sold) even though the $15,000 of fixed overhead that is deferred will be incurred again in the next period.


Fixed Cost AllocationsFixed Cost Allocations

Because the fixed manufacturing overhead cost per unitper unit is a function of productionproduction, a manager can lower the manufacturing cost per unit (and thus the total manufacturing cost being


the total manufacturing cost being expensed on the income statement) by spreading the $60,000 fixed manufacturing overhead over more than 20,000 units (i.e., producing more units).


Fixed Cost Allocation CorollaryFixed Cost Allocation Corollary

If an organization reduces inventory without an offsetting increase in sales, net income will be negatively impacted.


(See inventory reduction example in Appendix 1.)

[See Appendix 1, slides 148-150]


Moral of FC Allocation Methods?Moral of FC Allocation Methods?

A “fully absorbed” unit cost was developed at a time when its implicit assumptions were true. Now it is useful only for external GAAP reporting and should not be used to make internal decisions.


decisions.

− It is a function of the driver quantity (usually production related such as DL hours, machine hours, units of production, etc.) based on some concept of capacity.

− Fixed costs are treated in a total unit cost as if they are variable – and they are NOT (at least not in the short run)!


Throughput Accounting and CapacityThroughput Accounting and Capacity

Accountants do not recognize the importance of the capacity of individual resources; they use average

capacity!Average capacity (like average age) is insufficient!

Average CapacitySurge Capacity?

Excess Capacity?Protective Capacity


Diagram designed by James Holt – used with permission

Capacity

1 3 5 6 7Resources

2 4Constraint Capacity

Required Additional Capacity


Difference in Traditional and Direct Costing Statements?Difference in Traditional and Direct Costing Statements?

• Inventories increasingincreasing? Traditional income always will be greater than direct or variable costing income. In the example: 5,000 units (increase in inventory.) x $3 fixed manufacturing overhead cost per unit = $15,000 greater than the variable costing statement.


• If inventories decreasedecrease, the opposite effect occurs: variable costing operating income is higher than traditional operating income. (Impact on inventory control programs?)

• Selling and admin. expenses are the same (in total), but in different locations on the two statements.


Adjusting Direct Costing to GAAPAdjusting Direct Costing to GAAP

Because the only numerical difference between a direct costing income statement and a traditional (full costing) income statement is the treatment of fixed costs in inventory, one adjusting entry at the end of a period will transform direct costing data to GAAP data. For our example,


data. For our example,

Inventory . . . . . . . . . . . . . . . . . . . . . 15,000

Fixed costs charged to period . . . . . . .15,000(or whatever account was debited)


More on the Role of AllocationsMore on the Role of Allocations

Traditional accountingn Few overhead "buckets"; volume-based

drivers (e.g., labor hours, machine hours, etc.)n Usually no recognition of cost behavior (i.e.,

variable and fixed)


variable and fixed)n No recognition of constraints (internal or

external)


More on the Role of AllocationsMore on the Role of Allocations (continued)(continued)

Activity-based accounting

n Many overhead "buckets“ (15 to >100); activity-based drivers (e.g., number of transactions, number of setups, number of moves, etc.)


n Much more complicated and more expensive than traditional allocations; more data must be gathered, etc.

n No recognition of constraints (assumes all costs are variable– see next slide)


Activity-based accounting (continued)

• Supports production's contention that "specialty" items cost more than "standard" items

• Usually no recognition of differential cost behavior (i.e., variable and fixed)

More on the Role of AllocationsMore on the Role of Allocations (continued)(continued)(continued)(continued)(continued)(continued)(continued)(continued)


• Usually no recognition of differential cost behavior (i.e., variable and fixed)

p ABC equates its long-term perspective to the belief that in the long run all costs can be changed and equates this fact with its stance that therefore all costs are “variable.”


• Investment (capital budgeting) decisions are made on the basis of changes in throughput, inventory, and operating expense.

• In the event there are competing investments with different cash flows, decisions can be

Additional Financial Aspects ofAdditional Financial Aspects ofThroughput AccountingThroughput Accounting


with different cash flows, decisions can be made using the time "FlushFlush" occurs for each investment (similar to "payback period" and “NPV”, but includes the period the cash was but includes the period the cash was tied up here and could not be used for tied up here and could not be used for opportunities elsewhereopportunities elsewhere), or the total dollar days for entire period of the investment.

FlushFlushversus versus Present Present ValueValue

Example: $60,000 investment incurred over 3 weeks; $150,000 cash inflow over 24 weeks

10% 12% 15% 20%Total Flush Present Present Present Present

Week Cash Flow Cum. Cash Value Value Value Value Value1 (20,000)$ (20,000)$ (20,000)$ 2 (20,000)$ (40,000)$ (60,000)$ 3 (20,000)$ (60,000)$ (120,000)$ (59,770)$ (59,724)$ (59,656)$ (59,541)$ 4 6,250$ (53,750)$ (173,750)$ 5 6,250$ (47,500)$ (221,250)$ 6 6,250$ (41,250)$ (262,500)$ 7 6,250$ (35,000)$ (297,500)$ 8 6,250$ (28,750)$ (326,250)$ 9 6,250$ (22,500)$ (348,750)$ 10 6,250$ (16,250)$ (365,000)$ 11 6,250$ (10,000)$ (375,000)$ 12 6,250$ (3,750)$ (378,750)$ Payback point


ValueValue 12 6,250$ (3,750)$ (378,750)$ 13 6,250$ 2,500$ (376,250)$ 14 6,250$ 8,750$ (367,500)$ 15 6,250$ 15,000$ (352,500)$ 16 6,250$ 21,250$ (331,250)$ 17 6,250$ 27,500$ (303,750)$ 18 6,250$ 33,750$ (270,000)$ 19 6,250$ 40,000$ (230,000)$ 20 6,250$ 46,250$ (183,750)$ 21 6,250$ 52,500$ (131,250)$ 22 6,250$ 58,750$ (72,500)$ 23 6,250$ 65,000$ (7,500)$ 24 6,250$ 71,250$ 63,750$ 25 6,250$ 77,500$ 141,250$ 26 6,250$ 83,750$ 225,000$ 27 6,250$ 90,000$ 315,000$ 145,612$ 144,754$ 143,479$ 141,385$

NPV 85,842$ 85,030$ 83,823$ 81,844$

“Flush” point

Payback point

47



$100,000

$200,000

$300,000

$400,000

FlushFlush ChartChart


($500,000)

($400,000)

($300,000)

($200,000)

($100,000)

$01 3 5 7 9 11 13 15 17 19 21 23 25 27

Week

Flush

Example: $60,000 investment incurred in week one; $150,000 cash inflow at end of week 27

10% 12% 15% 20%Total Flush Present Present Present Present

Week Cash Flow Cum. Cash Value Value Value Value Value1 (60,000)$ (60,000)$ (60,000)$ (60,000)$ (60,000)$ (60,000)$ (60,000)$ 2 -$ (60,000)$ (120,000)$ 3 -$ (60,000)$ (180,000)$ 4 -$ (60,000)$ (240,000)$ 5 -$ (60,000)$ (300,000)$ 6 -$ (60,000)$ (360,000)$ 7 -$ (60,000)$ (420,000)$ 8 -$ (60,000)$ (480,000)$ 9 -$ (60,000)$ (540,000)$ 10 -$ (60,000)$ (600,000)$ 11 -$ (60,000)$ (660,000)$ 12 -$ (60,000)$ (720,000)$

FlushFlushversus versus Present Present ValueValue


12 -$ (60,000)$ (720,000)$ 13 -$ (60,000)$ (780,000)$ 14 -$ (60,000)$ (840,000)$ 15 -$ (60,000)$ (900,000)$ 16 -$ (60,000)$ (960,000)$ 17 -$ (60,000)$ (1,020,000)$ 18 -$ (60,000)$ (1,080,000)$ 19 -$ (60,000)$ (1,140,000)$ 20 -$ (60,000)$ (1,200,000)$ 21 -$ (60,000)$ (1,260,000)$ 22 -$ (60,000)$ (1,320,000)$ 23 -$ (60,000)$ (1,380,000)$ 24 -$ (60,000)$ (1,440,000)$ 25 -$ (60,000)$ (1,500,000)$ 26 -$ (60,000)$ (1,560,000)$ 27 150,000$ 90,000$ (1,470,000)$ 142,417$ 140,949$ 138,776$ 135,232$

NPV 82,417$ 80,949$ 78,776$ 75,232$

Payback point

“Flush” point does not occur

49



-400000

100000

600000

1 3 5 7 9 11 13 15 17 19 21 23 25 27

FlushFlush ChartChart


-1900000

-1400000

-900000

Week

Flush


Basics of Basics of FlushFlush CalculationsCalculations

• On Day 1, you invest $1. You have lost the opportunity to use that dollar for that day.

• On Day 2, you have not yet gotten your dollar back. You’ve now lost the


• On Day 2, you have not yet gotten your dollar back. You’ve now lost the opportunity to use that dollar for the second day, in addition to the first day or you now have $1 x 2 Days = 2 Dollar Days


Calculating Calculating FlushFlush

Vn = Vn-1 +

Where

V = The Value for that day

∑i

iValue


Vn = The Value for that day

Vn-1 = The Value for the previous day

= The total Value ($ in the US)invested and/or returned, net, on that day

∑i

iValue


The Role ofThe Role ofPerformance Evaluation MeasuresPerformance Evaluation Measures

"Tell me how you measure me, and I will tell you how I will "Tell me how you measure me, and I will tell you how I will behave."behave."

n Performance to budget usually VERY important in traditional accounting firms

n Focus is usually very short term (one quarter or one

("If you measure me in an irrational way, don't complain about irrational ("If you measure me in an irrational way, don't complain about irrational behavior.")behavior.")


n Focus is usually very short term (one quarter or one year)

n EVA (Economic Value Added) is the latest way to balance long-term and short-term decisions (some percentage of bonus for profitable operations in the current period may be deferred until later periods)

n Contribution to team work usually is not explicitly evaluated and is not explicitly rewarded continued


Performance Evaluation Measures Performance Evaluation Measures (continued)(continued)

• Must encourage people to do the right thing for the organization – not for a piece of the organization or for their own personal benefit


− Did people do what they were supposed to do?

− Did people do things they were NOT supposed to do?

− If you MUST conduct a formal performance evaluation (most such systems are dysfunctional), think about "netting" dollar day rewards and penalties for performance evaluation purposes.

continued


Performance Evaluation MeasuresPerformance Evaluation Measures (continued)(continued)

• This means that management must KNOW what everyone is expected to do in order to have legitimate benchmarks− Operations must be in control

− Final throughput, present and future, should be everyone’s ultimate goal


− Throughput speeded up should be recognized and rewarded

• Measures can be relative rather than absolute

• Performance to budget should have little or no weight


Throughput Accounting SummaryThroughput Accounting Summary

• What is throughput accounting? All the internal accounting and reporting that supports the TOC management philosophyp Income statements on the direct or variable

costing format


costing format

p Communication/publication of the actual or assumed internal constraint

p Scheduling for the entire facility (organization) based on the requirements of an internal constraint (which is geared to produce customer orders or, if necessary, produce to a forecast)

continued


p Efficiency reports on the constraint resource in terms of time required per job and percent of time up and operating (no idle time desired)

p Subordination of all other resources to the designated internal constraint

Throughput Accounting SummaryThroughput Accounting Summary (continued)(continued)


designated internal constraint

p Measurement of the efficiency of non-constraint resources in terms of (1) time required per job (when they have work to do) and (2) adherence to the schedule to support the constraint (nothing early, nothing late --penalties both ways)

continued


p Ratio of buffer size to work still to be completed must be tracked and reported (“dynamic” buffers are required when product mix constantly changes).


WO10

WO20 WO12WO13WO21

WO15WO16WO17

WO18WO11

WO14WO19n Buffer management support


p Frequent reporting of "holes" in Regions 1, 2, and 3 of the (1) constraint buffer, (2) assembly buffer (if one exists) and (3) the shipping buffer with the intent of highlighting problem areas where the quality or setup reduction teams can concentrate.

p As "holes" are eliminated, the buffer size can be reduced (Since the manufacturing lead time of the facility is the sum of the buffers, as the buffers are reduced, lead time also is reduced.)



• Other measures that can be used at the local level that will support global strategy:

p Total throughput. Don't worry about "splitting" the total throughput into the amount contributed by each area (this is a relative measure).


p Total inventory.

p Investment requests should present the impact on the entire organization, not just the local area.

p Dollar days (computed similar to Flush example, slides 47-50) — can be inventory dollar days (days until inventory needed) or throughput dollar days (days until throughput is earned)..



− Throughput delayed, for whatever reason, should be "punished" (by calling attention to it).

− Quality problems may be "charged" to the area that discovers a problem so any difficulty will be corrected as soon as possible. If a quality problem


corrected as soon as possible. If a quality problem is not reported, but discovered at point of assembly or by the customer, the area that should have discovered and fixed the problem can be "charged" for the throughput lost times the number of days until the situation can be corrected.


A Few Closing CommentsA Few Closing Comments

• Accountants are very intelligent and highly trained in traditional accounting

• Accountants are not trained in TOC in universities (as of now!)


• Accountants can be a valuable member of your management team

− Make sure they receive ALL TOC training

− Help them develop the information system you need


Questions before looking at another case?


[Futuro Case Follows]


A Case StudyA Case Study

Decision making using accounting information . . .

Futuro International, Inc.Futuro International, Inc.


A Case StudyA Case Study


• Assume you are a manager, with no significant accounting training, employed in an organization that is involved in international operations. Your task is to help the organization achieve its overall objective of earning the highest net income it can both now and in the future.

Futuro International, Inc. Futuro International, Inc. -- Case DetailsCase DetailsTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 Conference


and in the future.

• Your organization has adopted a resource-based * strategic approach. You must develop plans that will enable your company, Futuro International, Inc., to make the best use of its current resource base and, later, make resource acquisition and other decisions.

* See A Resource-Based View of the Firm, B. Wernerfelt, Strategic Management Journal, 5, 1984, pp 171-180, From Critical Resources to Corporate Strategy, B. Wernerfelt, Journal of General Management, 14, 1989, pp 4-12, and The Resource-Based Theory of Competitive Advantage: Implications for Strategy Formulation, R. M. Grant, California Management Review, Spring, 1991, pp 114-135.


Futuro International, Inc. Futuro International, Inc. -- Case DetailsCase Details

• That is, make your initial decision(s) based on the resources you have available immediately. Longer-term decisions will involve relaxing the static-resource assumption.

• In order to absorb, digest, and come to



• In order to absorb, digest, and come to conclusions in a short period of time, all the details of the company studied in this case have been greatly simplified. You will process this simplified information in a world of certainty in order to remove the many compounding, confusing factors (excuses?) we can point to as reasons why our decisions did not turn out as expected. (If the small numbers bother you, move (If the small numbers bother you, move the decimal points as many places as you wish.)the decimal points as many places as you wish.)


• One of the biggest assumptions is that processing times are known with certainty. If Resource A represents marketing effort, for example, we know exactly how much time is required to obtain an order for each of the products.



• Futuro International, Inc. is a company that currently does business in many countries and is open to additional international expansion. It has three major products that are sold to customers. Production of each of these products require different times on company resources, and require different variable costs.


• Resources may be viewed as individual personnel, departments, or divisions. If these resources are in different countries, we will assume away any import/export and taxation problems. Once again, to keep the calculations manageable, we will assume that Futuro has only one resource of each



assume that Futuro has only one resource of each type (A, B, C, and D).

• The diagram following these instructions explains the processing (rectangular boxes) that is required to produce one unit, and the variable costs (circles) for each of the products.


• The selling price for Product 1000 is $150 per unit, and the market demands 90 units per week. That is, if Futuro decides to provide 90 units, they will be purchased. If Futuro wants to provide 100 units for Product 1000, 10 will not be sold.

• Product 2000 units have a selling price of $120 per



• Product 2000 units have a selling price of $120 per unit and a market demand of 50 units per week.

• The selling price for Product 3000 is $90 per unit and the market demands 80 units per week.

• It is Futuro’s decision which units it wants to produce. However, market demand for each product is limited.


• Operating expenses, excluding the variable costs shown on the diagram, total $12,000 per week.

• Following the flow diagram, we have provided some details of the $12,000 in weekly expenses. If you prefer a simple traditional analysis, you will want to



prefer a simple traditional analysis, you will want to use the data provided under “Traditional Assignment of Operating Expenses,” or some variation of this data. If you prefer a more detailed analysis that utilizes the activities performed by the resources, you will want to use the data provided under “Alternative Activity (ABC) Assignment of Operating Expenses.”


• You should use whatever data set (one of the two provided or some other data set) you feel most comfortable using to make the decisions you must make. So that we face a comparable situation, please do not assume any detailed breakdown of costs that departs from the activity



breakdown of costs that departs from the activity analysis shown. (That is, assume that the activity pools and drivers shown are the best ones available.)

B Task 2

Selling Price = $120/UnitDemand: 50 Units/Week

C


D10 min

C CRM #7$5 perUnit



D5 min

D10 min

Product 1000 Product 3000Product 2000

A Task 15 min

B Task 110 min

B Task 210 min

RM #4$20 perUnit

RM #3$20 perUnit

B Task 310 min

C 5 min

RM #2$20 perUnit

RM #1$20 perUnit

C 5 min

C10 min

B Task 45 min

RM #6$20 perUnit

Unit

RM #5$20 perUnit

A Task 315 min

A, B, C, D: 1 each (no OT, no cross-training) Available time: 2,400 min/wk

Operating Expenses (not including VC) = $12,000/wk

A Task 25 min

71


CRM #7$5 perUnit


D10 min

Product 3000

Product 3000

C10 min

B Task 45 min

RM #6$20 perUnit

Unit

RM #5$20 perUnit

A Task 315 min


B Task 2


C

D10 min

D5 min

Product 2000

Product 2000

B Task 210 min

RM #4$20 perUnit

RM #3$20 perUnit

B Task 310 min

C 5 min

A Task 25 min


Product 1000

B Task 2


D10 min

C

D5 min

Product 1000

A Task 15 min

B Task 110 min

B Task 210 min

RM #3$20 perUnit

RM #2$20 perUnit

RM #1$20 perUnit

C 5 min

A Task 25 min


B Task 2


C


D10 min

C CRM #7$5 perUnit



D5 min

D10 min


[For Operating Expense Detail - See Appendix 2, slide 152]


A Task 15 min

B Task 110 min

B Task 210 min

RM #4$20 perUnit

RM #3$20 perUnit

B Task 310 min

C 5 min

RM #2$20 perUnit

RM #1$20 perUnit

C 5 min

C10 min

B Task 45 min

RM #6$20 perUnit

Unit

RM #5$20 perUnit

A Task 315 min


A Task 25 min



Labor: Wages ($4,800) are assigned according to total processing time spent on each Product

Resource Minutes Required Per Unit

Product Product ProductResource 1000 2000 3000

Totals


Traditional Assignment of Operating ExpensesTraditional Assignment of Operating Expenses


76

TotalsA 10 5 15B 20 20 5C 5 5 10D 10 5 10

Total Min./Unit 45 35 40Expected Un. Sales X 90 X 50 X 80Tot. Time/Unit 4,050 1,750 3,200 9,000

Ratio (4,050/9,000, etc.) .45 .194 .356

Ratio X Wages $2,160$ 931 $1,709$4,800



Overhead: Remaining “overhead” (OE) assigned to Products based on expected total sales

Product Product Product1000 2000 3000 Total

Expected sales($150 X 90) $13,500

Traditional Assignment of Operating ExpensesTraditional Assignment of Operating ExpensesTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 Conference


Overhead $12,000 - $4,800 $7,200Total Sales $26,700 $26,700 = $0.2697 per $1

= =

($150 X 90) $13,500($120 X 50) $6,000($90 X 80) $7,200

Tot. expected sales $26,700



Product Product Product1000 2000 3000 Total

$0.2697 X $13,500 $3,640

$0.2697 X $6,000 $1,618

Traditional Assignment of Operating ExpensesTraditional Assignment of Operating Expenses

Total Costs Assigned:TOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 Conference


Add Labor 2,160 931 1,709 4,800Total assigned toeach product * $5,800 $2,549 $3,651 $12,000

78

$0.2697 X $7,200 $1,942

Total Overhead $ 7,200

* does not include material costs


Alternative Activity Assignment of Alternative Activity Assignment of Operating Expense Using ABC Operating Expense Using ABC (next 5 slides)(next 5 slides)

STAGE 1


ActivityActivity--Based AccountingBased AccountingTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 Conference


STAGE 1

Resource Assignments to Activity Pools

(Assignment ratios based on a combination of past experience and management expertise)

TOCICO 2009 ConferenceTOCICO 2009 ConferenceTOCICO 2009 ConferenceTOCICO 2009 ConferenceActivity Pools

Resource Planning Processing Support TotalPurchasing $ 160 $ 145 $ 135 $ 440Inventory Carrying Costs 0 49 71 120Accounting-Purchasing 12 28 20 60 Computer Support 32 30 18 80 Supervision 100 500 300 900 Training 27 44 49 120 Travel-Specific 11 212 307 530 Travel-General 214 193 193 600

ActivityActivity--Based Costing Based Costing ��Stage 1Stage 1 Futuro International, Inc.Futuro International, Inc.


80

Travel-General 214 193 193 600Legal Expenses-Specific 41 74 65 180 Legal Expenses-General 95 85 60 240 Wages 771 2,400 1,629 4,800Advertising/Promotion 106 70 44 220Sales Force Salaries 560 560 280 1,400 Sales Force Expenses 140 150 70 360 Rent and Depreciation 48 86 76 210General Administration 200 450 350 1,000 Miscellaneous 72 366 302 740TOTAL $2,589 $5,442 $3,969 $12,000


ACTIVITY ALLOCATIONS - STAGE 2

Activity Pool Costs Assigned to Products

Product Product Product

ABC Assignment of Operating ExpensesABC Assignment of Operating ExpensesFuturo International, Inc.Futuro International, Inc.



Product Product ProductDrivers and Quantities 1000 2000 3000 TotalPlanning – No. of Projects 3 4 2 9Processing – Time Spent* 45 35 40 120Support – No. of Customers 140 80 120 340

* See Slide 74.


Resource Minutes Required Per Unit (Revisited)

Product Product ProductResource 1000 2000 3000 Total

A 10 5 15

ABC Assignment of Operating ExpensesABC Assignment of Operating ExpensesFuturo International, Inc.Futuro International, Inc.



82

A 10 5 15B 20 20 5C 5 5 10D 10 5 10

Tot. Min./Unit 45 35 40 120+ + =


ABC Assignment of ABC Assignment of OperatingOperating ExpensesExpenses


Stage 2: Activity Pool Assignment Rates

Planning Processing Support

Tot. Pool Costs $2,589 $5,442 $3,969Activity Driver Quantity 9 120 340



Activity Driver Quantity 9 120 340

Rate:Per Project ($2,589/9) $ 287.6667Per Min. ($5,442/120) $ 45.35Per Cust. ($3,969/340) $11.6735


ABC Assignment of Operating ExpensesABC Assignment of Operating Expenses -- Pool Assignments:Pool Assignments:

Prod. 1000 Prod. 2000 Prod. 3000 TotalPlanning$287.6667 X 3 $ 863$287.6667 X 4 $ 1,151$287.6667 X 2 $ 575Total Planning $2,589Processing




Processing$45.35 X 45 2,041$45.35 X 35 1,587$45.35 X 40 1,814Total Processing 5,442Support$11.6735 X 140 1,634$11.6735 X 80 934$11.6735 X 120 1,401Total Support 3,969Tot. OE Assigned* $4,538 $3,672 $3,790 $12,000

* does not include material costs


Your assignment:Your assignment:

Calculate the maximum income Futuro can earn in one week. If the system does not have sufficient capacity to produce all units demanded, you must decide which product is most profitable and which is least profitable so that you can select




profitable and which is least profitable so that you can select the best mix.

(You should be prepared to turn in a piece of paper with one number representing projected net income per week.)


Futuro International, Inc. Case Futuro International, Inc. Case (continued)(continued)

Write down your solution here before proceeding to the following slides:


______________________


Prod. 1000 Prod. 2000 Prod. 3000 Total

Revenues(90 X $150) $13,500(50 X $120) $6,000(80 X $90) $7,200Total Revenue $ 26,700

""Don't turn anything downDon't turn anything down" APPROACH" APPROACH(We can do everything!)



87

Total Revenue $ 26,700Material Costs(90 X $60) 5,400(50 X $40) 2,000(80 X $45) 3,600Tot. RM Costs 11,000Throughput $ 8,100 $4,000 $3,600 $ 15,700Operating Exp. 12,000Oper. Inc. before taxes $ 3,700


""Don't turn anything downDon't turn anything down" Approach. . ." Approach. . .

• Of course, this course of action is not possible.

• We cannot produce everything the market



demands!

• Let’s see what traditional analysis would recommend. . .



Revenues

(90 X $150)$13,500

TRADITIONAL PROFITABILITY ANALYSISTRADITIONAL PROFITABILITY ANALYSISFuturo International, Inc.Futuro International, Inc.



89

(90 X $150)$13,500

(50 X $120) $6,000

(80 X $90) $7,200

Total Revenues $26,700


Prod. 1000 Prod. 2000 Prod. 3000 TotalTotal Costs

Material Costs(90 X $60) $ 5,400(50 X $40) $2,000(80 X $45) $3,600

TRADITIONAL PROFITABILITY ANALYSISTRADITIONAL PROFITABILITY ANALYSIS



90

(80 X $45) $3,600Total RM Costs $11,000Wages 2,160 931 1,709 4,800Overhead 3,640 1,618 1,942 7,200Total Costs $11,200 $4,549 $7,251Gross Profit $ 2,300 $ 1,451 ($ 51)Gross Mar./Unit

[$2,300 � 90] $25.56[$1,451 � 50] $29.02[($51) � 80] ($ 0.64)

#2 #1 #3


Conventional wisdom suggests that the Conventional wisdom suggests that the company should drop Product 3000company should drop Product 3000!!

Traditional Profitability AnalysisTraditional Profitability Analysis





Product 2000 50 $80 $ 4,000

Product 1000 90 $90 8,100

Maximum Profit AvailableMaximum Profit AvailableTraditional (hypothetical) ApproachTraditional (hypothetical) Approach

Units CM perSold Unit

Total CM



92

Product 3000 0 $45 0

Total CM $12,100

Operating expense 12,000

Oper. income before taxes $ 100


But wait a moment... This performance is not possible. Project management people tell us we can not deliver all of Product 1000 and Product 2000 units demanded. We do not have enough capacity.

Traditional Profitability AnalysisTraditional Profitability AnalysisTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 Conference


not have enough capacity.

So, we will deliver what we can while we look for a higher gross margin product, consider restructuring one more time, or look for a buyer for this business.


Product Information

Units Time required on each resource

Demanded for each unit produced (minutes)



94

(minutes)

A B C D Total

Product 1000 90 10 20* 5 10 45

Product 2000 50 5 20 5 5 35

Product 3000 80 15 5 10 10 40* 10 minutes for RM #2 and 10 minutes for RM #3


Total Time Required on Resources (in minutes)

A B C DProduct 1000 900 1,800 450 900Product 2000 250 1,000 250 250Product 3000 1,200 400 800 800



95

Product 3000 1,200 400 800 800Total Needed 2,350 3,200 1,500 1,950

Total Available 2,400 2,400 2,400 2,400

Resource Load 98% 133% 63% 81%


Units CM Total "B" Resource

Sold per Unit CM Time Used

Product 2000 50 $80 $ 4,000 1,000 min

Product 1000 70 $90 6,300 1,400

Traditional Profitability Analysis Traditional Profitability Analysis ��Reality ApproachReality Approach


96

Product 1000 70 $90 6,300 1,400

Product 3000 0 $45 0 0

Total CM (T) $10,300 2,400 min

Operating exp. 12,000

Oper. loss before taxes ($ 1,700)Will activity-based accounting information help?


Total Assigned Costs Per Unit:


Planning $ 863 $ 1,151 $ 575 $ 2,589

Processing 2,041 1,587 1,814 5,442

Support 1,634 934 1,401 3,969

Activity Profitability AnalysisActivity Profitability Analysis


97

Support 1,634 934 1,401 3,969

Tot. alloc. costs $4,538$3,672$3,790$12,000

Material Costs

($60 X 90) 5,400

($40 X 50) 2,000

($45 X 80) 3,600 11,000

Total Costs $9,938$5,672$7,390


Profitability - Activity-Based Approach

Prod. 1000 Prod. 2000 Prod. 3000 TotalRevenues

(90 X $150)$13,500(50 X $120) $6,000(80 X $90) $7,200

Total Revenues $26,700



98

Total Revenues $26,700Total Costs 9,938 5,672 7,390 23,000Product Margin $ 3,562 $ 328 ($ 190)Margin per Unit

[$3,562 ÷÷÷÷ 90] $39.58[$328 ÷÷÷÷ 50] $ 6.56[($186) ÷÷÷÷ 80] ($ 2.33)

#1 #2 #3


Maximum Profit Available - Activity-Based Approach

Units CM Total "B" Resource

Sold per Unit CM Time Used

Product 1000 90 $90 $ 8,100 1,800 min



99

Product 1000 90 $90 $ 8,100 1,800 minProduct 2000 30 $80 2,400 600Product 3000 0 $45 0 0Total CM $10,500 2,400 minOperating exp. 12,000Oper. loss before taxes ($ 1,500)

This still does not look good. Let�s try one more approach.


Constraint Profitability AnalysisConstraint Profitability Analysis

Prod. 1000 Prod. 2000 Prod. 3000

Avg. selling price/unit $150 $120 $90

Variable costs/unit 60 40 45

Throughput (CM)/unit $ 90 $ 80 $45



100

Constraint min.required-B resource 20 20 5

#2 #3 #1

Throughput ÷÷÷÷ B Time $4.50/min. $4.00/min. $9.00/min.


Maximum Profit Available - Constraint Approach

Units CM "B" Resource

Sold per Unit Total CM Time Used

Product 3000 80 $45 $ 3,600 400 min

Product 1000 90 $90 8,100 1,800

Constraint Profitability AnalysisConstraint Profitability Analysis


101

Product 1000 90 $90 8,100 1,800

Product 2000 10 $80 800 200

Total CM $ 12,500 2,400 min

Oper. exp. 12,000

Operating Income before taxes $ 500RequiredRequired information to make the best decision(s)?information to make the best decision(s)?

(see next page)(see next page)


Information Required to Solve Information Required to Solve The Futuro Case?The Futuro Case?

n Contribution margins of each product

p Selling prices of each product

p Bill of materials for each product

n Routings for each product


n Routings for each product

p Resources required for production

p Usage of each resource per unit produced

n Resource availabilities

p Each resource

p Specific period of time


All parts of the

Dependent variables; .1:99.9 Rule

We must concentrate on the few things

What does it mean to say T is #1?

Throughput WorldFrom the Cost World to the Throughput World . . .


1

We must view the organization as a chain.

All parts of the organization are heavily dependent on all other

functions...If one part doesn’t

function, T doesn’t happen!

Anchor? THROUGHPUT

(.1 % responsible (.1 % responsible for 99.9% offor 99.9% ofimprovement)improvement)

on the few things that have a high

impact on the bottom line! (Leverage

points!)

103


We must find the weakest link(s)

1

Every firm must have at least one


The weakest link (or that which causes the weakest link) is called a CONSTRAINT -- anything that limits the system from achieving higher performance in terms of its goal.

2


Traditional efficiency Step Three:

SUBORDINATESUBORDINATEWhat about the rest of the resources?

If we want continuous improvement we need to establish a PROCESS to focus our actions on the constraint(s)!

Know the effect on NI

First Step?IDENTIFYIDENTIFY the

system’s constraint

2

Get the most out of what you already have.

Step Two:Decide how toEXPLOITEXPLOIT the constraint.

If the market is the constraint, due date delivery performance must be 100%; 99% isn’t good

enough!

Prioritize if more than one.


Traditional efficiency measurements increase WIP.

SUBORDINATESUBORDINATEeverything else to the above decision.

All “rules” and “policies” setup in Steps 2 and 3 now must be reviewed.

Step Five:If, in the previous steps, a constraint has been broken, GO BACK GO BACK to Step

One.

resources?

WARNINGDon’t let INERTIA INERTIA

become the constraint!!

Performance can be improved.

The constraint isn’t an act of GOD.Step Four:

ELEVATEELEVATE the constraint


End of Case SolutionsEnd of Case Solutions


[ Futuro Case Extensions Follow]


Analyzing Investment Options

Your process engineers have proposed several opportunities to invest in equipment or fixtures to improve the efficiency of the Futuro operation. Work

Futuro International, Inc. Futuro International, Inc. -- Case ExtensionsCase ExtensionsTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 Conference


efficiency of the Futuro operation. Work in small groups to analyze these opportunities. Indicate whether or not each of these investments should be approved. If you decide to approve more than one investment, establish a priority ranking for the alternatives.


Investment A:

For a $3,000 investment, the time required by resource A, task 3, to process a component (RM #6) can be

Futuro International, Inc. Futuro International, Inc. -- Case ExtensionsCase ExtensionsTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 Conference


process a component (RM #6) can be reduced from 15 minutes to 10 minutes per unit.

(Since total wages=$4,800 and 4 resources x 2,400 minutes = 9,600 total minutes,labor cost per minute = $4,800/9,600 = $0.50)

108

B Task 2


C


D10 min

C CRM #7$5 perUnit



D5 min

D10 min


Operating Expenses (not including VC) = $12,000/wk 109

A Task 15 min

B Task 110 min

B Task 210 min

RM #4$20 perUnit

RM #3$20 perUnit

B Task 310 min

C 5 min

RM #2$20 perUnit

RM #1$20 perUnit

C 5 min

C10 min

B Task 45 min

RM #6$20 perUnit

Unit

RM #5$20 perUnit

A Task 315 min


A Task 25 min

109



Investment A Investment A SolutionSolution

Cost: $3,000; Benefit?

Intuitively (after having gone through the initial solutions to the Futuro Industries case), the first response to this proposal is “No, resource A is not our problem.

Futuro International, Inc.Futuro International, Inc.-- Investment AInvestment A



is “No, resource A is not our problem. Increasing A’s capacity just means that A will have more idle time.

However, traditional cost/benefit analysis might follow the following approach:

110


Minutes “saved” per unit: 5Number of units processed per weekx 80Total minutes “saved” per week 400“Cost” per minute ($4,800/9,600) x $0.50

Futuro International, Inc.Futuro International, Inc.-- Investment AInvestment A

Traditional Cost/Benefit AnalysisTraditional Cost/Benefit AnalysisTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 Conference


“Cost” per minute ($4,800/9,600) x $0.50Total amount “saved” per week ≈≈≈≈ $200

Payback period: $3,000/$200 ≈≈≈≈ 15 weeks. Therefore, investment A would meet most firms’ investment criteria.


Problem:

The $200 “saved” each week is a phantom number. Resource A must still be present and operating; there will be more idle time.

Futuro International, Inc.Futuro International, Inc.-- Investment Investment AATraditional Cost/Benefit AnalysisTraditional Cost/Benefit Analysis



and operating; there will be more idle time. No money is saved. This is not a good investment at this time.


Investment B1:

For a $6,000 investment, the time required by resource B, task 4, to process a component (RM #5) can be

Futuro International, Inc.Futuro International, Inc.-- Investment B1Investment B1TOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 Conference


113

process a component (RM #5) can be reduced from 5 minutes to 3 minutes per unit.

Should Futuro be interested?

113


B Task 2


C


D10 min

C CRM #7$5 perUnit


D5 min

D10 min


114114Operating Expenses (not including VC) = $12,000/wk

A Task 15 min

B Task 110 min

B Task 210 min

RM #4$20 perUnit

RM #3$20 perUnit

B Task 310 min

C 5 min

RM #2$20 perUnit

RM #1$20 perUnit

C 5 min

C10 min

B Task 45 min

RM #6$20 perUnit

Unit

RM #5$20 perUnit

A Task 315 min


A Task 25 min

114114



Futuro International, Inc.Futuro International, Inc.-- Investment B1Investment B1

Investment B1 Investment B1 SolutionSolution


Intuitively (after having gone through the initial solutions to the Futuro Industries case), the first response to this proposal is “Yes,” resource B is our problem. Increasing B’s capacity means that Futuro can produce more output. Let’s look at the



Minutes saved per unit: 2

Number of units processed per week x 80Total minutes saved per week 160

Futuro can produce more output. Let’s look at the numbers.


Futuro International, Inc.Futuro International, Inc.-- Investment Investment B1B1

With the additional B minutes, Futuro can produce more of Product Line 2000. How many more?

(160 minutes)/(20 min/unit) = 8 more units

Investment B1 Investment B1 SolutionSolution


116

unitsCM (Throughput) per unit x $ 80Additional income per week $640(New net income ($500 + $640) = $1,140)

Payback period: $6,000/$640 = 9.375 weeks.

Yes, make this investment116



However, if we had evaluated the time saved in the traditional cost-world manner, we might have determined the following:

Total minutes saved 160“Cost” per minute x $ 0.50

Traditional Cost/Benefit AnalysisTraditional Cost/Benefit Analysis


“Cost” per minute x $ 0.50Total amount saved per week $80

Payback period using “traditional” analysis: $6,000/$80 ≈≈≈≈ 75 weeks. Using traditional analysis, we might incorrectly decide that this is a bad investment. This especially is true if the person making the decision does not understand the constraint concept or does not know where the constraint is located.


For a $7,000 investment, the time required by resource B, task 2 (RM #3), can be reduced from 10 minutes to 8 minutes per unit.



unit.

Should Futuro do it?

B Task 2


C


D10 min

C CRM #7$5 perUnit



D5 min

D10 min



A Task 15 min

B Task 110 min

B Task 210 min

RM #4$20 perUnit

RM #3$20 perUnit

B Task 310 min

C 5 min

RM #2$20 perUnit

RM #1$20 perUnit

C 5 min

C10 min

B Task 45 min

RM #6$20 perUnit

Unit

RM #5$20 perUnit

A Task 315 min


A Task 25 min

119



Minutes saved per unit: 2

Investment B2Investment B2 SolutionSolution



Once again, we are interested in this investment because it involves the constraint. Let’s examine the details:



Minutes saved per unit: 2Number of units processed per week(90 Product 1000s; 10 Product 2000s) x 100

Total minutes saved per week 200

With the additional B minutes, Futuro can produce more Product 2000 units. How many more?



(200 minutes)/(18 min/unit) ≈≈≈≈ 11 more unitsCM (T) per unit x $ 80Additional income per week$880

Investment B2Investment B2 SolutionSolutionTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 Conference


$880

(New net income ($500 + $880) = $1,380)

Payback period: $7,000/$880 ≈≈≈≈ 8 weeks. Yes, make this investment!



However, had we evaluated the time saved in the traditional cost-world manner, we might have determined the following:

Total minutes saved 200“Cost” per minute x $ 0.50

Traditional Cost/Benefit AnalysisTraditional Cost/Benefit AnalysisTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 Conference


“Cost” per minute x $ 0.50Total amount saved per week $100.00

Payback period using “traditional” analysis: $7,000/$100 ≈≈≈≈ 70 weeks. Using traditional analysis, we might incorrectly decide that this is a bad investment. This might happen if the person making the decision does not understand the constraint concept or does not know where the constraint is located.


For a $10,000 investment, plus an increase of $800 in wages, resource C would be able to perform all the operations currently performed by resource A. In addition, the processing time required by resource C to

Futuro International, Inc.Futuro International, Inc.-- Investment CInvestment C

Futuro International, Inc.Futuro International, Inc.-- Investment CInvestment CTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 Conference


processing time required by resource C to do its jobs, including those previously done by resource A, would be cut in half. If Futuro chooses to undertake this investment, resource A can be eliminated. Phasing out resource A would require a $5,000 charge to operations. (Assume that resource A wages are 1/4 of total weekly wages of $4,800.)

B Task 2


C


D10 min

C CRM #7$5 perUnit



D5 min

D10 min


2.5 2.5 2.5


A Task 15 min

B Task 110 min

124

B Task 210 min

RM #4$20 perUnit

RM #3$20 perUnit

B Task 310 min

C 5 min

RM #2$20 perUnit

RM #1$20 perUnit

C 5 min

C10 min

B Task 45 min

RM #6$20 perUnit

Unit

RM #5$20 perUnit

A Task 315 min


A Task 25 min

2.5 2.5 2.5

2.5 7.52.5

124124



Cost: $15,000 ($10,000 + $5,000 bonus) plus $800 per week; Benefit?

Futuro International, Inc.Futuro International, Inc.-- Investment CInvestment C

Investment CInvestment C SolutionSolution

This investment does not involve the constraint, but resource A people will leave (retire) and a replacement will not be hired. Therefore, a true



replacement will not be hired. Therefore, a true cost savings results: $4,800/4 = $1,200 per week minus the $800 additional salaries for resource C = $400 per week savings. Payback period: $15,000/$400 ≈≈≈≈ 38 weeks. This would be an acceptable investment. However, if Futuro has limited funds, it would not be the first choice.


Investment Priorities:

Investment Effect on Net Income:

Priorities for Futuro International, Inc.Priorities for Futuro International, Inc.TOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 Conference


B2 $880 increaseB1 640 increaseC 400 increaseA 0 increase (right now)


Your quality supervisor has determined that virtually all errors that occur in the operation are caused by problems at resource D. The scrap rate is 4% of Product 1000, 7% for Product 2000, and 8% for Product 3000. The quality improvement team


Prioritizing Quality Improvement ProjectsPrioritizing Quality Improvement ProjectsTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 Conference


for Product 3000. The quality improvement team can only focus their attention on one product at a time.

Which product line should receive top priority? That is, errors in which product causes the greatest loss? (Assume that there is an equal potential for error reduction for each of the three products, and the time and cost involved is the same for each product).

B Task 2


C


D10 min

C CRM #7$5 perUnit



D5 min

D10 min


4% 7% 8%


A Task 15 min

B Task 110 min

128

B Task 210 min

RM #4$20 perUnit

RM #3$20 perUnit

B Task 310 min

C 5 min

RM #2$20 perUnit

RM #1$20 perUnit

C 5 min

C10 min

B Task 45 min

RM #6$20 perUnit

Unit

RM #5$20 perUnit

A Task 315 min


A Task 25 min

128128



Prioritizing Quality Improvement ProjectsPrioritizing Quality Improvement Projects--SolutionSolution

Product 1000 20003000No. of units

processed 90 10

Futuro International, Inc.Futuro International, Inc.--Quality Improvements SolutionQuality Improvements Solution



processed 90 1080Error rate 4% 7%

8%No. of units scrapped 3.6 .7

6.4

Traditional analyses of value lost due to scrap:


Product 1000 2000 3000

Error percentage 4% 7% 8%

However, since we know that we produce only 10 units of

Futuro International, Inc.Futuro International, Inc.Quality Improvements DilemmaQuality Improvements Dilemma



Product 2000, we most likely would rank it as our third priority, go first to Product 3000 and then improve Product 1000.

Product Line 1000 2000 3000Priorities #2 #3 #1


The next most common way to choose where to improve first, is to look at the quantity of units lost:

Product




Product 1000 2000 3000

No. of units lost 3.6 .7 6.4

Priorities #2 #3#1

Or, traditionally trained accountants might want to look at the “value” lost because of the scrap:


Product 1000 2000 3000RM (per unit) $ 60.00 $ 40.00 $ 45.00Time lost 45 min. 35 min. 40 min.Value of lost time x $0.50 x $0.50 x $0.50

Futuro International, Inc. Futuro International, Inc. ��Traditional Approach to Traditional Approach to the Quality Improvements Dilemmathe Quality Improvements Dilemma



lost time x $0.50 x $0.50 x $0.50Cost-lost time 22.50 17.50 20.00Tot. cost/unit $ 82.50 $ 57.50 $ 65.00No. of units x 3.6 x .7 x 6.4Total cost $297.00 $ 40.25 $416.00

Priorities #2 #3 #1


We get the same priorities with any of the previous methods: Improve Product 3000 first, then Product 1000, and, if we get around to it, Product 2000.

However, what we should be examining is




However, what we should be examining is the total loss (out of pocket) to the company because of the quality problem.

A better approach to selecting quality priorities in this environment would be the following:


Out of Pocket Costs:Product 1000 20003000RM (per unit) $60.00$40.00 $45.00

Futuro International, Inc.: Quality Improvements Futuro International, Inc.: Quality Improvements Dilemma SolutionDilemma Solution



“B” time lost 20 min. 20 min. 5 min.Val. of lost time(mar. cost)* x $4.00 x $4.00 x $4.00

Cost-lost time 80.0080.00 20.00Tot. cost per unit $140.00 $120.00$ 65.00

* See footnote on next slide


* marginal cost:The value of the lost time is the contribution margin per minute that the

Quality Improvements Solution Quality Improvements Solution ��Marginal CostMarginal CostTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 Conference


contribution margin per minute that the company would lose on its lowest priority product. (This assumes that the more profitable scrapped units will be replaced.)


This quality solution is counter-intuitive. We should improve errors first at the lowest error rate: Product 1000. However, if we fix this problem first, we will save $504 per week versus saving only $416 if we

Quality Improvements Solution ExplanationQuality Improvements Solution ExplanationTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 Conference


save $504 per week versus saving only $416 if we fix the problem at Product 3000.



Futuro has decided to explore marketopportunities in China. Futuro has found apotential customer in China who is willing topurchase up to 20 units per week of each of ourproducts. The only catch is that this customer

Exploring Market OpportunitiesExploring Market OpportunitiesTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 Conference


products. The only catch is that this customerwill only pay 80% of what the products sell fordomestically.

It is Futuro’s choice to decide if they want to sell anything to this new customer, and if so, how much. What should Futuro do? (For simplicity, assume that all costs, such as transportation, would not change and that collectibility is not an issue).



Even though Futuro is operating at full capacity and still cannot satisfy all domestic demand, every opportunity should be considered carefully before it is dismissed.

Exploring Market OpportunitiesExploring Market OpportunitiesTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 Conference


considered carefully before it is dismissed.

Therefore, Futuro should consider the impact of selling any units to the China customer on Futuro’s bottom line.

Futuro International, Inc.Futuro International, Inc.--Market Opportunities SolutionMarket Opportunities Solution

Product China 1000 China 2000 China 3000Sell. price/unit $120 $ 96 $ 72RM costs 60 40 45Throughput (CM) $ 60 $ 56 $ 27“B” time req.d 20 min. 20 min. 5 min.Throughput/Throughput/(“B” time) $ 3.00/min. $ 2.80/min. $ 5.40/min.

Product Product Product1000 2000 3000

Domestic T/(“B” time) $4.50/min. $4.00/min. $9.00/min

139




New Priorities:#1 Product 3000#2 China 3000#3 Product 1000#4 Product 2000



#4 Product 2000#5 China 1000#6 China 2000

With this priority structure, Futuro would produce all of Product 3000 (90 units), all of China 3000 (20 units), all of Product 1000, five units of Product 2000, and no units of China 1000 and China 2000. BUT…


Futuro International, Inc.Futuro International, Inc.--Market Opportunities Market Opportunities SolutionSolution

Because the “3000” line consumes so much Resource A time, this new mix should be checked against Resource A availability.

Product Information:

UnitsTime required on each resource

Make Sure the Constraint Status is Unchanged!Make Sure the Constraint Status is Unchanged!TOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 Conference


UnitsTime required on each resourceDemanded for each unit produced (minutes)Resource A B C D TotalProduct 1000 90 10 20 5 10 45Product 2000 5 5 20 5 5 35Product 3000 80 15 5 10 10 40China 3000 20 15 5 10 10 40



Total Time Required on Resources (in minutes)

A B C DProduct 1000 900 1,800 450 900Product 2000 25 100 25 25Product 3000 1,200 400 800 800

Resource A is a Problem!Resource A is a Problem!TOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 Conference


Product 3000 1,200 400 800 800China 3000 300 100 200 200Total Needed 2,425 2,400 1,475 1,925Total Available2,400 2,400 2,400 2,400

Therefore, Futuro must cut the China 3000 order down to 18 units a week to avoid an interactive constraint.


Units "B" Time

Sold CM/Unit Tot. CM UsedProduct 3000 80 $45 $


Revised Profitability with China 3000 SalesRevised Profitability with China 3000 SalesTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 Conference


3000 80 $45 $ 3,600 400 minChina 3000 18 $27486 90Product 1000 90 $90 8,100 1,800Product 2000 5 $80400 100

This is a 17-1/2% improvement over the initial situation where Futuro could earn a maximum of $500 per week.


Futuro International, Inc.Futuro International, Inc.-- Market Opportunity SolutionMarket Opportunity Solution

IF Futuro were in the position of having excess capacity, it should do everything in its power to “sell” that excess capacity. Futuro might attempt to segment its markets in some way.



This means, in the short run, perhaps offering special prices on some variation of one of its current Product Lines. A better solution is to try to find some product line that it can produce with its current resource base that it is not currently producing. This alternative is especially attractive if the “new” product line requires resources C and D rather than B or A.


There are many ways to segment a market: price is one of the worst ways and should be used cautiously. The price approach can be deadly if regular customers hear of it. Japan, however, has segmented its markets by price (and by geography) for a long time, and, as

Futuro International, Inc.Futuro International, Inc.-- Market Opportunity SolutionMarket Opportunity SolutionTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 ConferenceTOCICO 2008 Conference


(and by geography) for a long time, and, as far as we know, has never been convicted of “dumping.”

Pricing, in general, should be based on the capacity of the selling firm and value to the customer. “Cost,” as far as the customer is concerned, is irrelevant in the pricing decision.


End of Futuro Case Extensions;

End of Workshop Presentation



End of Workshop Presentation

Discussion?

Questions?


TOCICO CONFERENCE 2009TOCICO CONFERENCE 2009

Finance & MeasurementsFinance & Measurements


Finance & MeasurementsFinance & MeasurementsAppendix 1Appendix 1

Prepared By: Charlene Spoede Budd Prepared By: Charlene Spoede Budd

Adopted from Spoede Budd, Charlene, Adopted from Spoede Budd, Charlene, Improvement Initiatives and Accounting Function Improvement Initiatives and Accounting Function RestructuringRestructuring, Accounting Policy & Practice Series, BNA, Inc. (forthcoming, 2007), with permission , Accounting Policy & Practice Series, BNA, Inc. (forthcoming, 2007), with permission of Tax Management, Inc., a subsidiary of BNA, Inc.of Tax Management, Inc., a subsidiary of BNA, Inc. All rights reserved.All rights reserved.




148


TOCICO CONFERENCE 2009


Finance & MeasurementsAppendix 2

Prepared By: Charlene Spoede Budd, Baylor Prepared By: Charlene Spoede Budd, Baylor UniversityUniversity

Adopted from Spoede Budd, Charlene, Improvement Initiatives and Accounting Function Restructuring, Accounting Policy & Practice Series, BNA, Inc., 2007, with permission of Tax Management, Inc., a subsidiary of BNA, Inc. All rights reserved.

TOTAL OPERATING EXPENSESTotal

Resource Driver CostPurchasing Orders $ 440Inven. Carry. Costs $ of items carried 120Acct.-Purchasing Transactions 60Computer Time & supplies used 80Supervision Time spent 900Training Number of people 120Travel-Sp. Product benefiting 530Travel-General Product sales 600Legal Exp.-Sp. Time billed 180


Legal Exp.-Sp. Time billed 180Legal Exp.-Gen. Product sales 240Wages Time per activity 4,800Advertising Product benefiting 220Sales Salaries Salespeople/product 1,400Sales Exp. Product benefiting 360Rent Square feet occupied 20Bldg.(Depre.) Square feet occupied 80Equip. (Depre.) Square feet occupied 60F & F (Depre.) Square feet occupied 50Gen. Admin. Time spent; product benefiting 1,000Miscellaneous Product sales 740

TOTAL $12,000152



About Charlene Spoede BuddAbout Charlene Spoede BuddAbout Charlene Spoede BuddAbout Charlene Spoede BuddAbout Charlene Spoede BuddAbout Charlene Spoede BuddAbout Charlene Spoede BuddAbout Charlene Spoede Budd

Charlene is Professor Emeritus, Baylor University, and holds certifications in all TOC-ICO areas and also is a CPA,

CMA, CFM, and PMP.([email protected])

She has co-authored several text books in accounting and co-authored A



in accounting and co-authored A Practical Guide to Earned Value Project Management (2005 and 2010) andInternal Reporting and improvement Initiatives (2007) with husband Chuck Budd.

She also has published many articles in accounting and project management journals and several chapters in the TOC Handbook.

tocico conference 2009

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