Finance and Measurements: Certification Exam Review

Transcription

1 TOCICO CONFERENCE 2009 Finance and Measurements: Certification Exam Review Prepared By: Charlene Spoede Budd 1

2 Disclaimer 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. 2

3 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 3

4 Exam 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 of Constraints Throughput Accounting and the above. A. Understanding rules and terms of GAAP financial statements B. Understanding Contribution or Direct Costing financial statements i. 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 4

5 Finance and Accounting Fundamentals (continued) C. Understand and contrast full absorption accounting i. Traditional and Activity Based Costing ii. Direct (or variable) costing vs. throughput accounting iii. Product profitability analysis as well as financial statement reporting a. Problem set deriving product profitability from common data set using: 1. Full absorption costing with various drivers 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 methodologies i. Impacts on unit costs ii. Product profitability, iii. Capital budgeting and investment planning decisions 5

6 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? 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) * See Slide 14 continued 6

7 TOC Thinking Process F & 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? 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 7

8 TOC Thinking Process F & 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. 8

9 III. Finance and logistical solutions (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. * See Slide 14 continued 9

10 Finance and Logistical Solutions (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) 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 10

11 Finance and Logistical Solutions (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 continued traditional and TOC environments. 11

12 Finance and Logistical Solutions (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 reporting information system (project buffers, feeding buffers). 12

13 IV. HOLISTIC Decision Making CASE (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 with the decision. * See Slide 14 13

14 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. 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. 14

15 Grading 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 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). 15

16 Throughput 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 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. 16

17 Abbreviated Mfg. Accounting Example Balance Sheet: Assets: 6 accounts shown Liabilities: 3 accounts shown Stockholders Equity: 2 accounts shown Income Statement: Sales, Cost of Goods Sold, and Expenses accounts shown 17

18 Assets Raw Materials Var. Mfg. Overhead Partial GAAP Balance Sheet Accounts Work in Process Beg. Bal. Beg. Bal. Beg. Bal. 1 Purch. 2 RM Used End. Bal Act. VOH 14 Over- Applied VOH Liabilities VOH Applied* 2 RM Used 4 D. Labor 7 VOH 8 Applied FOH Applied End. Bal. Fixed Mfg. Overhead Finished Goods 9 Units 9 Units 10 Cost of Completed Completed Units Sold End. Bal. Accts. Rec. Beg. Bal. Partial GAAP Income Statement Accounts Sales Closed to Ret. Earn Sell. Price Units Sold Cost of Goods 4 Indir. Labor 8 FOH Applied* 11 Sell. Price Collections Units Sold Debit Cash 6 Other 13 Underapplied Sold- 0 - Act. FOH FOH End. Bal. 10 Cost of Units Sold 14 Overapplied 13 Underapplied VOH FOH Accts. Payable Misc. Payables Payroll Payable Beg. Bal. Beg. Bal. Beg. Bal. Payments Payments Credit Cash 5 Act. VOH Payments 1 Purch. Credit Cash Credit Cash 3 Salaries 6 Other Act. FOH 4 Factory End. Bal. 12 Period Exp. Labor End. Bal. End. Bal. Shareholders Equity Common Stock Beg. Bal. Dividends Debited to Cash Retained Earnings Beg. Bal. Sales Expenses (Incl. C/G/S) Adjusted C/G/S Closed to Ret. Earn Expenses Salaries Closed to Ret. Earn. 12 Period Exp * Using Predetermined Overhead Rates Estimated Annual Overhead Estimated Activity Driver End. Bal TOCICO. All rights

19 Functional 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 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. 19

20 Functional Areas and TOC (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 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 20

21 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 reporting Evaluation of investment opportunities Short term (including make versus buy, adding products, etc.) Long term (including constraint location decisions) Appropriate performance evaluation metrics 21

22 Throughput Accounting IS NOT: 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) 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 22

23 In Summary... Throughput Accounting IS... All the metrics and measurements necessary to support Constraints Management operations, including project management, capital and other improvements, strategy and tactics, production, marketing, sales. 23

24 Some Accounting Fundamentals Managerial Accounting Typical approach: Divvy up the organization's total results (revenues and costs) to various areas Fully-absorbed costs (including the predetermined 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 24

25 Managerial Accounting Some organizations effectively use segment planning (budgeting) and reporting "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. 25

26 Segment Accounting Segment 1 Segment 2 Segment 3 Total $ 50,000 $150,000 $100,000 $300,000 Revenues Direct costs: Cost of goods sold 18,000 50,000 35,000 $103,000 Var. Costs 7,000 20,000 20,000 47,000 Fixed Costs Selling and admin. Var. Costs Fixed Costs Segment margin Common costs Operating income 3,000 4,500 8,000 15,500 1,500 3,000 2,500 7,000 $ 29,500 $ 77,500 $ 65,500 $172,500 $ 20,500 $ 72,500 $ 34,500 $127,500 30,000 $ 97,500 Activity-based accounting may be useful in tracing direct non-manufacturing costs to segments! 26

27 The 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) Budgets should be constructed by month (or less) and then summed to annual numbers Budgets must be flexible. assumptions will change 27

28 Throughput Segment Accounting -- Add a New Segment? (assume the constraint is not affected) Revenues Current Segments $300,000 New Segment $60,000 Total $360,000 Traceable costs: Var. Mfg. C/G/S 105,000 Var. sell. and admin. 22,500 Current direct fixed costs 45,000 Additional direct fixed costs Segment margin $127,500 25,000 4,500 5,000 $ 25,500 $130,000 27,000 5,000 $153,000 Common fixed costs Operating income Yes! 30,000 $123,000 28

29 Direct 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 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. 29

30 Direct (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 ending work-in-process inventory. Costs (as traditionally prepared) are: 30

31 Cost Item Details TOCICO 2008 Conference Total Per Unit Direct materials 40,000 $2 $ 80,000 $ 4.00* Direct labor 2,500 $8 20, * Var. mfg. OH 4,000 mach. $1040, * Fixed mfg. OH 4,000 mach. $1560, * Total product cost per unit $10.00 Var. sell. and admin. 22, Fixed sell. and admin. 30, ** Total costs incurred $252,500 * Based on 20,000 units produced ** Based on 15,000 units sold [See Slide 32 for Variable Costing results and slide 34 for Traditional results] A Direct Cost (or Variable or Contribution Margin) Income Statement would look like the following: 2007 TOCICO. All rights 31

32 ariable (Direct) Cost Income Statement Revenues (15,000 $20) $300,000 Variable costs Direct materials $60,000 Direct labor (all variable) 15,000 Variable mfg. overhead 30,000 Variable sell. and admin. 22,500 Total variable costs 127,500 Contribution margin $172,500 Fixed costs Manufacturing $60,000 Labor? (if it is fixed, $20,000 would be here) Sell. and admin. 30,000 Total fixed costs 90,000 Net operating income $ 82,500 32

33 Bridge to Throughput Accounting 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. 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]. 33

34 Traditional (Absorption Costing) Income Statement For the Period Ending the Last Day of the Period (Using data from slide 30 and 31) Revenues (15,000 units at average price of $20) $300,000 Cost of goods sold Beg. Fin. Goods 0 Cost of goods manufactured $200,000 Less ending Finished Goods 50,000 Cost of goods sold ($10 x 15,000 un) 150,000 Gross profit (margin) $150,000 Selling and admin. expenses Variable $ 22,500 Fixed 30,000 Total sell. and admin. expense 52,500 Net operating income $ 97,500 34

35 Financial Accounting 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?) 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 35

36 Financial Accounting Impact Note that although $252,500 total costs were incurred in the preceding example, only $150,000 + $52,500 = $202,500 of costs were expensed on the income 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. 36

37 Fixed Cost Allocations Because the fixed manufacturing overhead cost per unit is a function of production, a manager can lower the manufacturing cost per unit (and thus 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). 37

38 Fixed 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 ] 38

39 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. 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)! 39

40 Throughput Accounting and Capacity Accountants do not recognize the importance of the capacity of individual resources; they use average Average capacity (like capacity! average age) is insufficient! Excess Capacity? Surge Capacity? Average Capacity Protective Capacity Constraint Capacity Resources Diagram designed by James Holt used with permission Required Additional Capacity 40

41 Difference in Traditional and Direct Costing Statements? Inventories increasing? 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 decrease, 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. 41

42 Adjusting 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, Inventory ,000 Fixed costs charged to period ,000 (or whatever account was debited) 42

43 More on the Role of Allocations Traditional accounting Few overhead "buckets"; volume-based drivers (e.g., labor hours, machine hours, etc.) Usually no recognition of cost behavior (i.e., variable and fixed) No recognition of constraints (internal or external) 43

44 More on the Role of Allocations (continued) Activity-based accounting Many overhead "buckets (15 to >100); activitybased drivers (e.g., number of transactions, number of setups, number of moves, etc.) Much more complicated and more expensive than traditional allocations; more data must be gathered, etc. No recognition of constraints (assumes all costs are variable see next slide) 44

45 More on the Role of Allocations (continued) 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) 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. 45

46 Additional Financial Aspects of Throughput Accounting 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 made using the time "Flush" occurs for each investment (similar to "payback period" and NPV, but includes the period the cash was tied up here and could not be used for opportunities elsewhere), or the total dollar days for entire period of the investment. 46

47 Flush versus Present Value Value 13 6,250 TOCICO 2008 Conference 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 Value 1 $ (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) $ $ 2,500 $ (376,250) Payback point 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 Flush point 25 $ 6,250 $ 77,500 $ 141, $ 6,250 $ 83,750 $ 225, $ 6,250 $ 90,000 $ 315,000 $ 145,612 $ 144,754 $ 143,479 $ 141, TOCICO. All rights NPV $ 85,842 $ 85,030 $ 83,823 $ 81,844

48 Flush Chart $400,000 $300,000 $200,000 $100,000 $0 ($100,000) ($200,000) Week Flush ($300,000) ($400,000) ($500,000) 48

49 TOCICO 2008 Conference Example: $60,000 investment incurred in week one; $150,000 cash inflow at end of week 27 Flush versus Present Value 10% 12% 15% 20% Total Flush Present Present Present Present Week Cash Flow Cum. Cash Value Value Value Value Value 1 $ (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) 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) Payback point 22 $ - $ (60,000) $ (1,320,000) 23 $ - $ (60,000) $ (1,380,000) 24 $ - $ (60,000) $ (1,440,000) Flush point 25 $ - $ (60,000) $ (1,500,000) 26 $ - $ (60,000) $ (1,560,000) does not occur 27 $ 150,000 $ 90,000 $ (1,470,000) $ 142,417 $ 140,949 $ 138,776 $ 135, TOCICO. All rights NPV $ 82,417 $ 80,949 $ 78,776 $ 75,232

50 Flush Chart Week Flush

51 Basics of Flush Calculations 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 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 51

52 Calculating Flush Where V n = V n-1 + Value i i V n = The Value for that day V n-1 = The Value for the previous day i Value i = The total Value ($ in the US) invested and/or returned, net, on that day 52

53 The Role of Performance Evaluation Measures "Tell me how you measure me, and I will tell you how I will behave." ("If you measure me in an irrational way, don't complain about irrational behavior.") Performance to budget usually VERY important in traditional accounting firms Focus is usually very short term (one quarter or one year) 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) Contribution to team work usually is not explicitly evaluated and is not explicitly rewarded continued 53

54 Performance Evaluation Measures (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 continued day rewards and penalties for performance evaluation purposes. 54

55 Performance Evaluation Measures (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 55

56 Throughput Accounting Summary What is throughput accounting? All the internal accounting and reporting that supports the TOC management philosophy Income statements on the direct or variable costing format Communication/publication of the actual or assumed internal constraint 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 56

57 Throughput Accounting Summary (continued) Efficiency reports on the constraint resource in terms of time required per job and percent of time up and operating (no idle time desired) Subordination of all other resources to the designated internal constraint Measurement of the efficiency of nonconstraint 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 57

58 Throughput Accounting Summary (continued) Buffer management support WO21 WO20 WO19 WO18 WO17 WO16 WO15 WO14 Ratio of buffer size to work still to be completed must be tracked and reported ( dynamic buffers are required when product mix constantly changes). 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. 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.) WO13 WO12 WO11 WO10 58

59 Throughput Accounting Summary (continued) Other measures that can be used at the local level that will support global strategy: Total throughput. Don't worry about "splitting" the total throughput into the amount contributed by each area (this is a relative measure). Total inventory. Investment requests should present the impact on the entire organization, not just the local area. 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).. 59

60 Throughput Accounting Summary (continued) 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 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. 60

61 A 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 61

62 Questions before looking at another case? [Futuro Case Follows] 62

63 Decision making using accounting information... Futuro International, Inc. A Case Study 63

64 Futuro International, Inc. - Case Details TOCICO Conference 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. 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 , 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

65 Futuro International, Inc. - Case Details TOCICO Conference 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 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 the decimal points as many places as you wish.) 65

66 Futuro International, Inc. - Case Details TOCICO Conference 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. 66

67 Futuro International, Inc. - Case Details TOCICO Conference 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 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. 67

68 Futuro International, Inc. - Case Details TOCICO Conference 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 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. 68

69 Futuro International, Inc. - Case Details TOCICO Conference 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 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. 69

70 Futuro International, Inc. - Case Details TOCICO Conference 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 analysis shown. (That is, assume that the activity pools and drivers shown are the best ones available.) 70

71 Futuro International, Inc. Selling Price = $150/Unit Selling Price = $120/Unit Selling Price = $90/Unit Demand: 90 Units/Week Demand: 50 Units/Week Demand: 80 Units/Week Product 1000 Product 2000 Product 3000 D 10 min D 5 min D 10 min C B Task 2 5 min 10 min 5 min 10 min C C RM #7 $5 per Unit A Task 1 5 min B Task 1 10 min A Task 2 5 min B Task 3 10 min B Task 4 5 min A Task 3 15 min RM #1 $20 per Unit RM #2 $20 per Unit RM #3 $20 per Unit RM #4 $20 per Unit RM #5 $20 per Unit RM #6 $20 per Unit 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 71

72 Product 3000 Selling Price = $90/Unit Demand: 80 Units/Week Product 3000 D 10 min C 10 min RM #7 $5 per Unit B Task 4 5 min A Task 3 15 min RM #5 $20 per Unit RM #6 $20 per Unit 2008 TOCICO. All rights 72

73 Product 2000 D 10 min Selling Price = $120/Unit Demand: 50 Units/Week Product 2000 D 5 min B Task 2 10 min C 5 min A Task 2 5 min B Task 3 10 min RM #3 $20 per Unit RM #4 $20 per Unit 2008 TOCICO. All rights 73

74 Product 1000 Selling Price = $150/Unit Demand: 90 Units/Week Product 1000 D 10 min D 5 min C 5 min B Task 2 10 min A Task 1 5 min B Task 1 10 min A Task 2 5 min RM #1 $20 per Unit RM #2 $20 per Unit RM #3 $20 per Unit 2008 TOCICO. All rights 74

75 Futuro International, Inc. [For Operating Expense Detail - See Appendix 2, slide 152] Selling Price = $150/Unit Selling Price = $120/Unit Selling Price = $90/Unit Demand: 90 Units/Week Demand: 50 Units/Week Demand: 80 Units/Week Product 1000 Product 2000 Product 3000 D 10 min D 5 min D 10 min C B Task 2 5 min 10 min 5 min 10 min C C RM #7 $5 per Unit A Task 1 5 min B Task 1 10 min A Task 2 5 min B Task 3 10 min B Task 4 5 min A Task 3 15 min RM #1 $20 per Unit RM #2 $20 per Unit RM #3 $20 per Unit RM #4 $20 per Unit RM #5 $20 per Unit RM #6 $20 per Unit 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 75

76 Futuro International, Inc. Traditional Assignment of Operating Expenses Labor: Wages ($4,800) are assigned according to total processing time spent on each Product Resource Minutes Required Per Unit Product Product Product Resource Totals A B C D Total Min./Unit Expected Un. Sales X 90 X 50 X 80 Tot. Time/Unit 4,050 1,750 3,200 9,000 Ratio (4,050/9,000, etc.) Ratio X Wages $2,160 $ 931 $1,709 $4,

77 Futuro International, Inc. Traditional Assignment of Operating Expenses TOCICO Conference Overhead: Remaining overhead (OE) assigned to Products based on expected total sales Product Product Product Total Expected sales ($150 X 90) $13,500 ($120 X 50) $6,000 ($90 X 80) $7,200 Tot. expected sales $26,700 Overhead $12,000 - $4,800 $7,200 = = Total Sales $26,700 $26,700 = $ per $1 77

78 Futuro International, Inc. Traditional Assignment of Operating Expenses Total Costs Assigned: $ X $13,500 $3,640 $ X $6,000 $1,618 TOCICO Conference Product Product Product Total $ X $7,200 $1,942 Total Overhead $ 7,200 Add Labor 2, ,709 4,800 Total assigned to each product * $5,800 $2,549 $3,651 $12,000 * does not include material costs 78 78

79 Futuro International, Inc. Activity-Based Accounting TOCICO Conference Alternative Activity Assignment of Operating Expense Using ABC (next 5 slides) STAGE 1 Resource Assignments to Activity Pools (Assignment ratios based on a combination of past experience and management expertise) 79

80 Activity-Based Costing Stage 1 Futuro International, Inc. Activity Pools Resource Planning Processing Support Total Purchasing $ 160 $ 145 $ 135 $ 440 Inventory Carrying Costs Accounting-Purchasing Computer Support Supervision Training Travel-Specific Travel-General Legal Expenses-Specific Legal Expenses-General Wages 771 2,400 1,629 4,800 Advertising/Promotion Sales Force Salaries ,400 Sales Force Expenses Rent and Depreciation General Administration ,000 Miscellaneous TOTAL $2,589 $5,442 $3,969 $12,

81 Futuro International, Inc. ABC Assignment of Operating Expenses TOCICO Conference 2 ACTIVITY ALLOCATIONS - STAGE Activity Pool Costs Assigned to Products Product Product Product Drivers and Quantities Total Planning No. of Projects Processing Time Spent* Support No. of Customers * See Slide

82 Futuro International, Inc. ABC Assignment of Operating Expenses TOCICO Conference Resource Minutes Required Per Unit (Revisited) Product Product Product Resource Total A B C D Tot. Min./Unit =

83 Futuro International, Inc. ABC Assignment of Operating Expenses TOCICO Conference Stage 2: Activity Pool Assignment Rates Planning Processing Support Tot. Pool Costs $2,589 $5,442 $3,969 Activity Driver Quantity Rate: Per Project ($2,589/9) $ Per Min. ($5,442/120) $ Per Cust. ($3,969/340) $

84 Futuro International, Inc. ABC Assignment of Operating Expenses - Pool Assignments: TOCICO Conference Prod Prod Prod Total Planning $ X 3 $ 863 $ X 4 $ 1,151 $ X 2 $ 575 Total Planning $2,589 Processing $45.35 X 45 2,041 $45.35 X 35 1,587 $45.35 X 40 1,814 Total Processing 5,442 Support $ X 140 1,634 $ X $ X 120 1,401 Total Support 3,969 Tot. OE Assigned* $4,538 $3,672 $3,790 $12,000 * does not include material costs 84

85 Futuro International, Inc. TOCICO Conference 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 the best mix. (You should be prepared to turn in a piece of paper with one number representing projected net income per week.) 85

86 Futuro International, Inc. Case (continued) Write down your solution here before proceeding to the following slides: 86

87 "Don't turn anything down" " APPROACH (We can do everything!) TOCICO Conference Prod Prod Prod Total Revenues (90 X $150) $13,500 (50 X $120) $6,000 (80 X $90) $7,200 Total Revenue $ 26,700 Material Costs (90 X $60) 5,400 (50 X $40) 2,000 (80 X $45) 3,600 Tot. RM Costs 11,000 Throughput $ 8,100 $4,000 $3,600 $ 15,700 Operating Exp. 12,000 Oper. Inc. before taxes $ 3,

88 Futuro International, Inc. "Don't turn anything down" " 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... 88

89 Futuro International, Inc. TRADITIONAL PROFITABILITY ANALYSIS TOCICO Conference Prod Prod Prod Total Revenues (90 X $150)$13,500 (50 X $120) $6,000 (80 X $90) $7,200 Total Revenues $26,

90 TRADITIONAL PROFITABILITY ANALYSIS TOCICO Conference Prod Prod Prod Total Costs Material Costs (90 X $60) $ 5,400 (50 X $40) $2,000 (80 X $45) $3,600 Total Total RM Costs $11,000 Wages 2, ,709 4,800 Overhead 3,640 1,618 1,942 7,200 Total Costs $11,200 $4,549 $7,251 Gross Profit $ 2,300 $ 1,451 ($ 51) Gross Mar./Unit [$2,300 90] $25.56 [$1,451 50] $29.02 [($51) 80] #2 #1 ($ 0.64) #

91 Futuro International, Inc. Traditional Profitability Analysis TOCICO Conference Conventional wisdom suggests that the company should drop Product 3000! 91

92 Maximum Profit Available Traditional (hypothetical) Approach TOCICO Conference Units CM per Sold Unit Total CM Product $80 $ 4,000 Product $90 8,100 Product $45 0 Total CM $12,100 Operating expense 12,000 Oper. income before taxes $

93 Traditional Profitability Analysis TOCICO Conference 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. 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. 93

94 Traditional Profitability Analysis Product Information resource (minutes) Units Demanded Time required on each for each unit produced A B C D Total Product * Product Product * 10 minutes for RM #2 and 10 minutes for RM #

95 Traditional Profitability Analysis Total Time Required on Resources (in minutes) A B C D Product , Product , Product , Total 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% 95 95

96 Traditional Profitability Analysis Reality Approach Units CM Total "B" Resource Sold per Unit CM Time Used Product $80 $ 4,000 1,000 min Product $90 6,300 1,400 Product $ Total CM (T) $10,300 2,400 min Operating exp. 12,000 Oper. loss before taxes ($ 1,700) Will activity-based accounting information help? 96 96

97 Activity Profitability Analysis Total Assigned Costs Per Unit: Prod Prod Prod Total Planning $ 863 $ 1,151 $ 575 $ 2,589 Processing 2,041 1,587 1,814 5,442 Support 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,

98 Activity Profitability Analysis Profitability - Activity-Based Approach Prod Prod Prod Total Revenues (90 X $150)$13,500 (50 X $120) $6,000 (80 X $90) $7,200 Total Revenues $26,700 Total Costs 9,938 5,672 7,390 23,000 Product Margin $ 3,562 $ 328 ($ 190) Margin per Unit [$3,562 90] $39.58 [$328 50] $ 6.56 [($186) 80] ($ 2.33) #1 #2 #

99 Activity Profitability Analysis Maximum Profit Available - Activity-Based Approach Units CM Total "B" Resource Sold per Unit CM Time Used Product $90 $ 8,100 1,800 min Product $80 2, Product $ Total CM $10,500 2,400 min Operating exp. 12,000 Oper. loss before taxes ($ 1,500) This still does not look good. Let s try one more approach

100 Futuro International, Inc. Constraint Profitability Analysis Prod Prod Prod Avg. selling price/unit $150 $120 $90 Variable costs/unit Throughput (CM)/unit $ 90 $ 80 $45 Constraint min. required-b resource Throughput B Time $4.50/min. $4.00/min. $9.00/min. #2 #3 #

101 Constraint Profitability Analysis Maximum Profit Available - Constraint Approach Units CM "B" Resource Sold per Unit Total CM Time Used Product $45 $ 3, min Product $90 8,100 1,800 Product $ Total CM $ 12,500 2,400 min Oper. exp. 12,000 Operating Income before taxes $ 500 Required information to make the best decision(s)? (see next page)

102 Information Required to Solve The Futuro Case? Contribution margins of each product Selling prices of each product Bill of materials for each product Routings for each product Resources required for production Usage of each resource per unit produced Resource availabilities Each resource Specific period of time 102

103 From the Cost World to the Throughput World... Throughput World What does it mean to say T is #1? We must concentrate on the few things that have a high impact on the bottom line! (Leverage points!) (.1 % responsible for 99.9% of We must view the improvement) organization as a chain. 1 Dependent variables;.1:99.9 Rule All parts of the organization are heavily dependent on all other functions...if one part doesn t function, T doesn t happen! Anchor? THROUGHPUT

104 1 We must find the weakest link(s) 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

105 If we want continuous improvement we need to establish a PROCESS to focus our actions on the constraint(s)! Know the effect on NI If the market is the constraint, due date delivery performance must be 100%; 99% isn t good enough! What about the rest of the resources? WARNING Don t let INERTIA become the constraint!! First Step? IDENTIFY the system s constraint Step Two: Decide how to EXPLOIT the constraint. Step Three: SUBORDINATE everything else to the above decision. Step Four: ELEVATE the constraint Step Five: If, in the previous steps, a constraint has been broken, GO BACK to Step One. 2 Prioritize if more than one. Get the most out of what you already have. Traditional efficiency measurements increase WIP. The constraint isn t an act of GOD. Performance can be improved. All rules and policies setup in Steps 2 and 3 now must be reviewed. 105

106 End of Case Solutions [ Futuro Case Extensions Follow] 106

107 Futuro International, Inc. - Case Extensions Analyzing Investment Options TOCICO Conference Your process engineers have proposed several opportunities to invest in equipment or fixtures to improve the 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. 107

108 Futuro International, Inc. - Case Extensions Investment A: TOCICO Conference For a $3,000 investment, the time required by resource A, task 3, to 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)

109 Futuro International, Inc. Selling Price = $150/Unit Selling Price = $120/Unit Selling Price = $90/Unit Demand: 90 Units/Week Demand: 50 Units/Week Demand: 80 Units/Week Product 1000 Product 2000 Product 3000 D 10 min D 5 min D 10 min C B Task 2 5 min 10 min 5 min 10 min C C RM #7 $5 per Unit A Task 1 5 min B Task 1 10 min A Task 2 5 min B Task 3 10 min B Task 4 5 min A Task 3 15 min RM #1 $20 per Unit RM #2 $20 per Unit RM #3 $20 per Unit RM #4 $20 per Unit RM #5 $20 per Unit RM #6 $20 per Unit 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 TOCICO. All rights

110 Futuro International, Inc.- Investment A Investment A Solution Cost: $3,000; Benefit? TOCICO Conference 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. Increasing A s capacity just means that A will have more idle time. However, traditional cost/benefit analysis might follow the following approach:

111 Futuro International, Inc.- Investment A Traditional Cost/Benefit Analysis TOCICO Conference Minutes saved per unit: 5 Number of units processed per weekx 80 Total minutes saved per week 400 Cost per minute ($4,800/9,600) x $0.50 Total amount saved per week $200 Payback period: $3,000/$ weeks. Therefore, investment A would meet most firms investment criteria. 111

112 Futuro International, Inc.- Investment A Traditional Cost/Benefit Analysis TOCICO Conference Problem: The $200 saved each week is a phantom number. Resource A must still be present and operating; there will be more idle time. No money is saved. This is not a good investment at this time. 112

113 Futuro International, Inc.- Investment B1 Investment B1: TOCICO Conference For a $6,000 investment, the time required by resource B, task 4, to process a component (RM #5) can be reduced from 5 minutes to 3 minutes per unit. Should Futuro be interested?

114 Futuro International, Inc. Selling Price = $150/Unit Selling Price = $120/Unit Selling Price = $90/Unit Demand: 90 Units/Week Demand: 50 Units/Week Demand: 80 Units/Week Product 1000 Product 2000 Product 3000 D 10 min D 5 min D 10 min C B Task 2 5 min 10 min 5 min 10 min C C RM #7 $5 per Unit A Task 1 5 min B Task 1 10 min A Task 2 5 min B Task 3 10 min B Task 4 5 min A Task 3 15 min RM #1 $20 per Unit RM #2 $20 per Unit RM #3 $20 per Unit RM #4 $20 per Unit RM #5 $20 per Unit RM #6 $20 per Unit 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 TOCICO. All rights

115 Futuro International, Inc.- Investment B1 Investment B1 Solution TOCICO Conference Cost: $6,000; Benefit? 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 numbers. Minutes saved per unit: 2 Number of units processed per week x 80 Total minutes saved per week

116 Futuro International, Inc.- Investment B1 Investment B1 Solution With the additional B minutes, Futuro can produce more of Product Line How many more? (160 minutes)/(20 min/unit) = 8 more units CM (Throughput) per unit x $ 80 Additional income per week $640 (New net income ($500 + $640) = $1,140) Payback period: $6,000/$640 = weeks. Yes, make this investment

117 Futuro International, Inc.- Investment B1 Traditional Cost/Benefit Analysis 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 Total 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. 117

118 Futuro International, Inc.- Investment B2 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. Should Futuro do it? 118

119 Futuro International, Inc. Selling Price = $150/Unit Selling Price = $120/Unit Selling Price = $90/Unit Demand: 90 Units/Week Demand: 50 Units/Week Demand: 80 Units/Week Product 1000 Product 2000 Product 3000 D 10 min D 5 min D 10 min C 5 min B Task 2 10 min C 5 min C 10 min RM #7 $5 per Unit A Task 1 5 min B Task 1 10 min A Task 2 5 min B Task 3 10 min B Task 4 5 min A Task 3 15 min RM #1 $20 per Unit RM #2 $20 per Unit RM #3 $20 per Unit RM #4 $20 per Unit RM #5 $20 per Unit RM #6 $20 per Unit 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 TOCICO. All rights

120 Futuro International, Inc.- Investment B2 Investment B2 Solution TOCICO Conference Cost: $7,000; Benefit? Once again, we are interested in this investment because it involves the constraint. Let s examine the details: Minutes saved per unit: 2 Number 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? 120

121 Futuro International, Inc.- Investment B2 Investment B2 Solution TOCICO Conference (200 minutes)/(18 min/unit) 11 more units CM (T) per unit x $ 80 Additional income per week $880 (New net income ($500 + $880) = $1,380) Payback period: $7,000/$880 8 weeks. Yes, make this investment! 121

122 Futuro International, Inc.- Investment B2 Traditional Cost/Benefit Analysis 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 Total amount saved per week $ TOCICO Conference Payback period using traditional analysis: $7,000/$ 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. 122

123 Futuro International, Inc.- Investment C Futuro International, Inc.- Investment C TOCICO Conference 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 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.) 123

124 Futuro International, Inc. Selling Price = $150/Unit Selling Price = $120/Unit Selling Price = $90/Unit Demand: 90 Units/Week Demand: 50 Units/Week Demand: 80 Units/Week Product 1000 Product 2000 Product 3000 D 10 min D 5 min D 10 min C B Task min 10 min 5 min 10 min C C RM #7 $5 per Unit A Task 1 B Task 1 A Task 2 B Task 3 B Task 4 A Task min 10 min min 10 min 5 min min RM #1 $20 per Unit RM #2 $20 per Unit RM #3 $20 per Unit RM #4 $20 per Unit RM #5 $20 per Unit RM #6 $20 per Unit 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 TOCICO. All rights

125 Futuro International, Inc.- Investment C Investment C Solution TOCICO Conference Cost: $15,000 ($10,000 + $5,000 bonus) plus $800 per week; Benefit? This investment does not involve the constraint, but resource A people will leave (retire) and a 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: $15,000/$ weeks. This would be an acceptable investment. However, if Futuro has limited funds, it would not be the first choice. 125

126 Priorities for Futuro International, Inc. Investment Priorities: TOCICO Conference Investment Effect on Net Income: B2 B1 C A $880 increase 640 increase 400 increase 0 increase (right now) 126

127 Futuro International, Inc. Prioritizing Quality Improvement Projects TOCICO Conference 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 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). 127

128 Futuro International, Inc. Selling Price = $150/Unit Selling Price = $120/Unit Selling Price = $90/Unit Demand: 90 Units/Week Demand: 50 Units/Week Demand: 80 Units/Week Product 1000 Product 2000 Product 3000 D 4% 7% 8% 10 min D 5 min D 10 min C B Task 2 5 min 10 min 5 min 10 min C C RM #7 $5 per Unit A Task 1 5 min B Task 1 10 min A Task 2 5 min B Task 3 10 min B Task 4 5 min A Task 3 15 min RM #1 $20 per Unit RM #2 $20 per Unit RM #3 $20 per Unit RM #4 $20 per Unit RM #5 $20 per Unit RM #6 $20 per Unit 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 TOCICO. All rights

129 Futuro International, Inc.-Quality Improvements Solution Prioritizing Quality Improvement Projects-Solution TOCICO Conference Product No. of units processed Error rate 4% 7% 8% No. of units scrapped

130 Futuro International, Inc. Quality Improvements Dilemma TOCICO Conference Product Error percentage 4% 7% 8% However, since we know that we produce only 10 units of Product 2000, we most likely would rank it as our third priority, go first to Product 3000 and then improve Product Product Line Priorities #2 #3 #1 130

131 Futuro International, Inc. Quality Improvements Dilemma TOCICO Conference The next most common way to choose where to improve first, is to look at the quantity of units lost: Product No. of units lost Priorities #2 #3 #1 Or, traditionally trained accountants might want 131

132 Futuro International, Inc. Traditional Approach to the Quality Improvements Dilemma TOCICO Conference Product RM (per unit) $ $ $ Time lost 45 min. 35 min. 40 min. Value of lost time x $0.50 x $0.50 x $0.50 Cost-lost time Tot. cost/unit $ $ $ No. of units x 3.6 x.7 x 6.4 Total cost $ $ $ Priorities #2 #3 #1 132

133 Futuro International, Inc. Quality Improvements Dilemma TOCICO Conference 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 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: 133

134 Futuro International, Inc.: Quality Improvements Dilemma Solution Out of Pocket Costs: Product RM (per unit) $60.00 $40.00 $45.00 TOCICO Conference 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 Tot. cost per unit * See footnote $ on next slide $ $

135 Quality Improvements Solution Marginal Cost TOCICO Conference * marginal cost: The value of the lost time is the 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.) 135

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

137 Futuro International, Inc. Exploring Market Opportunities TOCICO Conference Futuro has decided to explore market opportunities in China. Futuro has found a potential customer in China who is willing to purchase up to 20 units per week of each of our products. The only catch is that this customer will only pay 80% of what the products sell for domestically. 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). 137

138 Futuro International, Inc. Exploring Market Opportunities TOCICO Conference 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. Therefore, Futuro should consider the impact of selling any units to the China customer on Futuro s bottom line. 138

139 Futuro International, Inc.-Market Opportunities Solution Product China 1000 China 2000 China 3000 Sell. price/unit $120 $ 96 $ 72 RM costs Throughput (CM) $ 60 $ 56 $ 27 B time req.d 20 min. 20 min. 5 min. Throughput/ ( B time) $ 3.00/min. $ 2.80/min. $ 5.40/min. Product Product Product Domestic T/ ( B time) $4.50/min. $4.00/min. $9.00/min TOCICO. All rights

140 Futuro International, Inc.-Market Opportunities Solution New Priorities: #1 Product 3000 #2 China 3000 #3 Product 1000 #4 Product 2000 #5 China 1000 #6 China 2000 TOCICO Conference 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 BUT 140

141 Futuro International, Inc.-Market Opportunities Solution Make Sure the Constraint Status is Unchanged! TOCICO Conference 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 Demanded for each unit produced (minutes) Resource A B C D Total Product Product Product China

142 Futuro International, Inc.-Market Opportunities Solution Resource A is a Problem! Total Time Required on Resources (in minutes) A B C D Product , Product Product , China Total Needed 2,425 2,400 1,475 1,925 Total Available2,400 2,400 2,400 2,400 TOCICO Conference Therefore, Futuro must cut the China 3000 order down to 18 units a week to avoid an interactive constraint. 142

143 Futuro International, Inc.-Market Opportunities Solution Revised Profitability with China 3000 Sales TOCICO Conference Time CM Units Sold CM/Unit Tot. Used Product $45 $ 3, min China $ Product $90 8,100 1,800 This is a 17-1/2% improvement over the initial situation Product where 2000 Futuro could earn a 5 maximum of $80 $500 per week "B" 143

144 Futuro International, Inc.- Market Opportunity Solution TOCICO Conference 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 144

145 Futuro International, Inc.- Market Opportunity Solution TOCICO Conference 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 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. 145

146 TOCICO Conference End of Futuro Case Extensions; End of Workshop Presentation Discussion? Questions? 146

147 TOCICO CONFERENCE 2009 Finance & Measurements Appendix 1 Adopted from Spoede Budd, Charlene, Improvement Initiatives and Accounting Function Restructuring,, Accounting Policy & Practice Series, BNA, Inc. (forthcoming, 2007), with permission of Tax Management, Inc., a subsidiary of BNA, Inc. All rights Prepared By: Charlene Spoede Budd 147

148 TOCICO 2008 Conference

149 149

150 TOCICO 2008 Conference

151 TOCICO CONFERENCE 2009 Finance & Measurements Appendix 2 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 Prepared By: Charlene Spoede Budd, Baylor University 151

152 TOTAL OPERATING EXPENSES Resource Driver Total Cost Purchasing Orders $ 440 Inven. Carry. Costs $ of items carried 120 Acct.-Purchasing Transactions 60 Computer Time & supplies used 80 Supervision Time spent 900 Training Number of people 120 Travel-Sp. Product benefiting 530 Travel-General Product sales 600 Legal Exp.-Sp. Time billed 180 Legal Exp.-Gen. Product sales 240 Wages Time per activity 4,800 Advertising Product benefiting 220 Sales Salaries Salespeople/product 1,400 Sales Exp. Product benefiting 360 Rent Square feet occupied 20 Bldg.(Depre.) Square feet occupied 80 Equip. (Depre.) Square feet occupied 60 F & F (Depre.) Square feet occupied 50 Gen. Admin. Time spent; product benefiting 1,000 Miscellaneous Product sales 740 TOTAL 152 $12,000

153 About Charlene Spoede Budd TOCICO Conference Charlene is Professor Emeritus, Baylor University, and holds certifications in all TOC-ICO areas and also is a CPA, CMA, CFM, and PMP. (Charlene_Spoede@baylor.edu) She has co-authored several text books in accounting and co-authored A Practical Guide to Earned Value Project Management (2005 and 2010) and Internal 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. 153