CHAPTER 6
Activity-Based Management and Today’s Advanced Manufacturing Environment
Answers to Review Questions
6-1The philosophy of a just-in-time (JIT) inventory and production management system is that no materials are purchased and no products are manufactured until they are needed. The essence of the JIT philosophy is to reduce all inventories to their absolute minimum.
6-2The key features of a just-in-time inventory and production management system are as follows: a smooth production rate; a pull method of coordinating steps in the production process; purchase of materials and manufacture of subassemblies and products in small lot sizes; quick and inexpensive setups of production machinery; high-quality levels of raw material and finished products; effective preventive maintenance of equipment; an atmosphere of teamwork to improve the production system; and multiskilled workers and flexible facilities.
6-3"TQC" stands for total quality control. Since no parts are purchased or manufactured until they are needed for production in a JIT system, it is crucial that they be just right for their intended purpose.
6-4In a just-in-time (JIT) production system, raw materials and parts are purchased or produced just in time to be used at each stage of the production process. This approach to inventory and production management brings considerable cost savings from reduced inventory levels.
The key to the JIT system is the "pull" approach to controlling manufacturing. The diagram on the next page displays a simple multistage production process. The flow of manufacturing activity is depicted by the solid arrows running down the diagram from one stage of production to the next. However, the signal that triggers more production activity in each stage comes from the next stage of production. These signals, depicted by the dashed-line arrows, run up the diagram. We begin with sales at the bottom of the exhibit. When sales activity warrants more production of finished goods, the goods are "pulled" from production stage III by a signal that more goods are needed. Similarly, when production employees in stage III need more inputs, they send a signal back to stage II. This signal triggers production activity in stage II. Working our way back up to the beginning of the process, purchases of raw materials and parts are triggered by a signal that they are needed in stage I.
The “Pull” Method in a JIT System
This pull system of production management, which characterizes the JIT approach, results in a smooth flow of production and significantly reduced inventory levels.
6-5Five key features of JIT purchasing are as follows: only a few suppliers; long-term contracts with suppliers; materials and parts delivered in small lot sizes immediately before they are needed; only minimal inspection of delivered parts and materials; and grouped payments to each vendor.
6-6(a)CMS stands for cost management system.
(b)JIT stands for just-in-time.
(c)CNC stands for computer-numerically controlled.
(d)CAM stands for computer-aided manufacturing.
(e)CAD stands for computer-aided design.
(f)AMHS stands for automated material-handling system.
(g)FMS stands for flexible manufacturing system.
(h)CIM stands for computer-integrated manufacturing.
6-7The key differences in the plant layouts used by Aerotech's Phoenix and Bakersfield facilities are as follows:
(a)The Bakersfield plant uses a flexible manufacturing system.
(b)The Bakersfield plant uses an automated material-handling system.
(c)The Bakersfield plant uses a computer-aided design approach.
(d)The Bakersfield plant has substantially less space devoted to storage of raw materials, work in process, and finished goods.
6-8The installation of a flexible manufacturing system (FMS) usually results in a shift in the cost structure from variable costs to fixed costs.
6-9Off-line quality control consists of the activities during the product design and engineering phases that improve the manufacturability of the product, reduce production costs, and ensure high quality.
Cellular manufacturing is the organization of a production facility into FMS cells, which are groupings of machines and personnel designed to manufacture a particular set of products.
Activity-based management (ABM) is the use of activity-based costing information to improve operations and eliminate non-value-added costs.
6-10The two-dimensional activity-based costing model provides one way of picturing the relationship between ABC and ABM. The vertical dimension of the model depicts the cost assignment view of an ABC system. From the cost assignment viewpoint, the ABC system uses two-stage cost allocation to assign the costs of resources to the firm's cost objects. These cost objects could be products manufactured, services produced, or customers served.
Depicted in the horizontal dimension of the model that follows is the process view of an ABC system. The emphasis now is on the activities themselves, the processes by which work is accomplished in the organization. The left-hand side of the model depicts activity analysis, which is the detailed identification and description of the activities conducted in the enterprise. Activity analysis entails the identification not only of the activities, but also of their root causes, the events that trigger activities, and the linkages among activities. The right-hand side of the model depicts the evaluation of activities through performance measures. These processes of activity analysis and evaluation constitute activity-based management.
Two-Dimensional ABC Model
6-11Activity analysis is the detailed identification and description of the activities conducted in an enterprise. Activity analysis entails the identification not only of activities, but also of their root causes, of the events that trigger them, and of the linkages among them. Three criteria for determining whether an activity adds value are as follows:
(a)Is the activity necessary?
(b)Is the activity efficiently performed?
(c)Is the activity sometimes value-added and sometimes non-value-added?
6-12An activity's trigger is the preceding event that indicates that the activity should be performed. The activity's root cause is the event or activity that, if it had not occurred, would have prevented the activity in question from happening. For example, the event that triggers the activity of rework is the identification of a defective part during inspection. However, the inspection is not the root cause of the rework activity. The root cause of the defective part, and hence the need for rework, could lie in erroneous part specifications, in an unreliable vendor, or in faulty production.
6-13Four techniques for reducing or eliminating non-value-added costs that result from non-value-added activities are as follows:
(a)Activity reduction
(b)Activity elimination
(c)Activity selection
(d)Activity sharing
6-14Examples of activity sharing include the use of common parts in several related products, and the use of a common service facility (e.g., a photocopying center) by several departments.
6-15Customer profitability analysis refers to using the concepts of activity-based costing to determine how serving particular customers causes activities to be performed and costs to be incurred. Examples of activities that can be differentially demanded by customers include order frequency, order size, special packaging or handling, customized parts or engineering, and special machine setups. Such activities can make some customers more profitable than others.
6-16Activity-based costing is used to analyze customer-related costs and determine the cost drivers for these costs. This ABC data then forms the basis for the customer profitability analysis by assigning the appropriate amount of customer-related costs to each customer.
6-17A customer profitability profile, usually expressed in graphical form, shows the company’s cumulative operating income as a percentage of total operating income. The customers included in the profile generally are ranked either by operating income or by sales revenue.
6-18In some cases, companies do eliminate unprofitable customers. However, it is important for companies to not to be too quick in doing so. Companies often develop customer relationships over long time horizons by offering low prices and a high level of service up front. As the relationship develops, however, the customer may not require the same level of service and might be willing to pay a premium for the service. Customer profitability analysis helps management see the overall financial picture for each customer, and how management can use this information to help establish a strategic plan for the coming months, quarters, or years. Management may decide that it is worth keeping an unprofitable customer now to maintain the potential for future profitability.
6-19A trend analysis tracks customer-related costs over time to determine whether they are increasing, decreasing, remaining relatively stable or behaving in any particularly unusual manner. Trend analysis can help management decide which customer-related costs need their attention most urgently, and which customers need the most attention. Perhaps even better than comparing the customer-related costs to the company’s norms, would be to compare them to industry-wide norms, or the norms for the industry’s best performers. Such information can sometimes be generated from benchmarking studies, which focus on the best practices of organizations both within the industry and beyond.
6-20Continuous improvement may be defined as the constant effort to eliminate waste, reduce response time, simplify the design of both products and processes, and improve product quality and customer service.
The price down/cost down concept is the tendency of prices to fall over the life cycle of a newly introduced product. Moreover, if prices are to fall over time, manufacturers must continually reduce costs.
Target costing is the process of designing a product, and the processes used to produce it, in order to achieve a manufacturing cost that will enable the firm to make a profit when the product is sold at an estimated market-driven price. This estimated price is called the target price, the desired profit margin is called the target profit, and the cost at which the product must be manufactured is called the target cost.
Value engineering (or value analysis) is a cost-reduction and process-improvement technique that utilizes information collected about a product's design and production processes and then examines attributes of the design and processes to identify candidates for improvement. The attributes examined include such characteristics as part diversity and process complexity.
Kaizen costing is the process of cost reduction during the manufacturing phase of an existing product. The Japanese word kaizen refers to continual and gradual improvement through small betterment activities, rather than large or radical improvement made through innovation or large investments in technology.
6-21Kaizen costing is most consistent with the old saying "slow and steady wins the race." Kaizen costing is the process of cost reduction during the manufacturing phase of an existing product. The Japanese word kaizen refers to continual and gradual improvement through small betterment activities, rather than large or radical improvement made through innovation or large investments in technology.
6-22Employee empowerment is the concept that workers are encouraged to take their own initiative to improve operations, reduce costs, and improve product quality and customer service.
Benchmarking is the continual search for the most effective method of accomplishing a task, by comparing existing methods and performance levels with those of other organizations, or with other subunits within the same organization. An example of benchmarking is an airline's determining how many of its competitors' flights are delayed and comparing the data with its own flight-delay record.
The most effective methods of accomplishing various tasks in a particular industry, often discovered through benchmarking, are referred to as best practices.
Reengineering is the complete redesign of a process, with an emphasis on finding creative new ways to accomplish an objective. Reengineering has sometimes been described as taking a blank piece of paper and starting from scratch to redesign a business process. Rather than searching continually for minute improvements, re-engineering involves a radical shift in thinking about how an objective should be met.
Organizational culture is the mind-set of employees, including their shared beliefs, values and goals.
A change champion is an individual who recognizes the need for change and, through his or her own efforts, seeks to bring it about. A successful change champion is usually at a high level in the organizational hierarchy, has strong entrepreneurial skills, demonstrates political savvy within the organization, and has the ability to persuade and motivate others.
6-23The theory of constraints (TOC) is a management approach that seeks to maximize long-term profit through proper management of organization bottlenecks or constrained resources. The key idea in TOC is to identify the constraints in a system that are preventing the organization from achieving a higher level of success. Then the goal is to relieve or relax those constraints. TOC recommends subordinating all other management goals to the objective of solving the constraint problem. For example, if limited capacity in a particular machining operation is increasing cycle time, reducing throughput, and reducing profits, then management would concentrate much of its efforts on expanding the capacity of that bottleneck operation. If efforts are continually made to relax constraints, continuous improvement in organizational performance is a likely result.
6-24The elimination of production bottleneck activities is an example of the theory of constraints. (See the preceding answer.)
6-25Five keys to the successful implementation of ABC, ABM, or other cost management approaches are the following:
(a)Strong functional organizational culture
(b)Top management support and commitment
(c)Change champion
(d)Change process
(e)Continuing education
6-26It is human nature to resist change. Moving from a traditional, volume-based product-costing system to an activity-based costing system is a radical change in the managerial-accounting system. People may be uneasy about such a change because they fear they will not understand the new system, will not be able to effectively use the information that the new system provides, or may be evaluated in a different way, one that may prove unfavorable toward them.
The same comments can be applied to the implementation of any of the management concepts discussed in the chapter (e.g., continuous improvement, ABM, Kaizen costing, re-engineering).
Solutions to exercises
Exercise 6-27 (15 minutes)
Traditional Factory* / JIT/FMS Factory*Raw materials...... / D / D
Electricity, machines...... / I / D
Electricity, lighting, and air-conditioning...... / I / I
Engineering salaries...... / I / D
Custodial wages...... / I / I
Depreciation, plant...... / I / I
Depreciation, equipment...... / I / D
Insurance...... / I / I
Machine repair, wages...... / I / D
Machine repair, parts...... / I / D
Direct labor...... / D / D
Supervisory salaries...... / I / I
Property taxes...... / I / I
Factory supplies...... / I / D
Inspection...... / I / D
*D denotes direct; I denotes indirect
Exercise 6-28 (25 minutes)
1. / Airline:(a) / "Deadheading," the practice of flying a nonworking flight-crew member to another city to work on a flight departing from that location. The crew member sometimes displaces a paying customer.
(b) / Preparing excess food for a flight, which is not consumed, because the flight occupancy was misforecast.
(c) / Returning, repairing, or replacing lost or mishandled luggage.
(d) / Canceling a flight because of an aircraft maintenance problem that should have been prevented by routine maintenance.
Exercise 6-28 (continued)
2. / Bank:(a) / Correcting customer account errors due to keypunch errors in the bank.
(b) / Following up on checks or deposit slips lost by the bank.
(c) / Performing banking procedures manually when the computer is down.
(d) / Defaulted loans made to risky borrowers as a result of inadequate credit checks.
(e) / Losses due to employee embezzlement and petty theft.
3. / Hotel:
(a) / Breakage of dishes and glassware; loss of or damage to linens and towels.
(b) / Loss of room keys.
(c) / Overstaffing the front desk during nonpeak hours.
(d) / Preparing excess food.
Exercise 6-29 (30 minutes)
The sky's the limit on responding to this problem. A good model for the response is contained in Chapters 5 and 6 for Aerotech Corporation.(1) / The major steps in Aerotech's traditional production process are described at the beginning of Chapter 5.
(2) / Aerotech's Bakersfield plant layout, which uses advanced manufacturing technology, is shown in Exhibit 6-1.
(3) / An explanation of how Aerotech's Bakersfield facility eliminated or reduced non-value-added costs is given in Chapter 6. See the pages around Exhibit 6-1. For example, the Bakersfield facility eliminated the holding areas between production departments, thus eliminating the non-value-added cost of waiting time. Aerotech also installed an automated material-handling system in the Bakersfield facility that resulted in substantial reductions in the non-value-added costs of move time.
Exercise 6-30 (40 minutes, plus time at restaurant)
Several restaurant activities are listed in the following table, along with the required characteristics for each activity. Many other possibilities could be listed, depending on the level of detail.Activity Description / Value-Added
or Non-Value-
Added /
Activity Trigger /
Root Cause
Taking reservations / VA / Customer calls on phone / Customer desires reservation
Customers waiting for a table / NVA / Customer arrives, but no table is ready / An error was made in reservation; service is slow; customers are slow; customers arrive without reservations
Seating customers / VA / Table becomes available / Customer's reservation (or turn in line) comes up; table becomes ready
Taking orders / VA / Customers indicate readiness to order / Kitchen staff needs to know what to prepare
Serving meals to customers / VA / Meals are ready / Meals are ready; customers are hungry
Returning meal to kitchen for revised preparation / NVA / Customer complains about meal / An error was made in explaining the menu; there is an error in the printed menu description; meal was prepared wrong; customer is picky
exercise 6-30 (continued)
Customers eating meal / VA / Meals are served and are satisfactory / Customers are hungryClearing the table / VA / Customers are finished / Customers are finished
Delivering check to table / VA / Customers are finished ordering and eating / Customers need to know amount of bill
Collecting payment / VA / Customers have produced cash or credit card / Restaurant needs to collect payment for services rendered
Exercise 6-31 (30 minutes)
1. / Description of course registration process:(a) / Receive list of courses in mail, along with "bubble sheet" for filling in desired courses and sections.
(b) / During allotted week, select courses and fill in bubble sheet.
(c) / Return bubble sheet to bursar's office. Often must stand in line for more than an hour to turn in sheet. Required, since sheet and student ID must be checked by bursar's personnel.
(d) / One month later, receive preliminary schedule. If acceptable, no further action necessary. Just pay tuition. Automatically enrolled. Final schedule received shortly, before next semester starts. If didn't pay tuition, schedule is dropped.
EXERCISE 6-31 (CONTINUED)