Finance and Measurements. TOCICO 2014 Conference

Transcription

1 Finance and Measurements Decision Making in Non-Internal- Constraint Organizations and Why It Is Difficult to Gain the True Support of Accounting and Finance Professionals in TOC Implementations Presented By: Charlene Spoede Budd Date: 09 th June,

2 Charlene Spoede Budd Professor Emeritus, Baylor University, Waco, Texas. Degrees: BBA and MBA, Baylor; PhD, The University of Texas at Austin (Texas, USA). Certifications: CPA, CMA, CFM, Jonah, PMP, TOC (all areas), CGMA. Authored or coauthored 6 books, 7 chapters, 1 guide, numerous articles, workshops, and presentations. Lecturer at Baylor, Monterrey Tech (Mexico), Hankamer in London (UK), Washington University (St. Louis, Missouri, USA). Charlene_Spoede@baylor.edu Invited speaker at the Theory of Constraints Practitioners Conference in Moscow, Russia, April

3 Tentative Presentation Agenda 1. What you must understand about accounting/finance professionals. 2. Types of management accounting currently most popular and why they are inferior to Throughput Accounting (TA). Relevant items for decision making is VERY misunderstood 3. TA for organizations without an internal constraint. 4. Why is it so difficult to install TA in TOC companies (and keep it running)? 3

4 Finance and Measurements 1. Why Change (the constant conflict)? Throughput Accounting (T, I, OE and T/CU) are necessary, but neither sufficient nor compelling for finance/accounting professionals. 2. What to Change? Broaden development of Finance and Measurements to cover non-constraint environments, longer term periods and interface with traditionally-trained F&A people 5. How to create POOGI? Train traditional F&M people in TOC or TOC people in accounting/finance; respect the value of traditionallytrained people and their skills 3. What to Change to? A combination of TOC metrics and Traditional Accounting/Finance achieve buy-in of F&M people 4. How to cause the change? Make sure companies implementing TOC have software that will track and report fixed and variable costs differently 4

5 Major Types of Accounting 1. Financial External financial statements; must follow specific rules (GAAP); cost allocations required. 2. Tax Rules established by national and regional governments; cost allocations required. 3. Managerial Internal decision use only; not public; cost allocations NOT required. May be combined Companies MUST follow There are no rules The next slide contains a very simple example illustrating the necessary (but not sufficient) financial accounting knowledge a person must have in order to pass the F&M certification examination. 5

6 Assets 5 2 Liabilities Partial GAAP Balance Sheet Accounts Raw Materials Work in Process Finished Goods Beg. Bal. Purch. End. Bal. Var. Mfg. Overhead Actual VOH Accts. Payable Beg. Bal. Shareholders Equity 4 12 Over- Applied VOH Payments (Credit Cash) 2 RM Used Purch. End. Bal. Common Stock Beg. Bal. VOH Applied* Beg. Bal. RM Used Direct Labor VOH Applied FOH Applied End. Bal. Fixed Mfg. Overhead Indir. Labor 7 FOH Applied* Actual Period Fixed OH Misc. Payables Payments (Credit Cash) Beg. Bal. 5 1 Actual VOH Retained Earnings Dividends (Credit to Cash) Actual Period FOH Beg. Bal. Beg. Bal. 8 Units 8 Units 10 Cost of Completed Completed Units Sold Underapplied FOH 13 Period Expenses End. Bal. End. Bal. Accounts Rec. Beg. Bal. 9 Sell. Price x Units Sold End. Bal. Payroll Payable Payments (Credit Cash) Sales Collections (Debit Cash) Beg. Bal. 3 3 Salaries Factory Labor End. Bal. Partial GAAP Income Statement Accounts (No interest expense; no taxes) Sales Closed to 9 Sell. Price x Ret. Earn. Units Sold Cost of Goods Sold Cost of Units Sold 12 Overapplied VOH 11 Underapplied FOH Adjusted C/G/S Expenses Closed to Ret. Earn Salaries Closed to Ret. Earn. 13 Period Exp Net Loss. Net Income. Expenses (Incl. C/G/S) * Using Predetermined Overhead Rates Estimated Annual Overhead Estimated Activity Driver End. Bal. Next Slide

7 Management Accounting in the U. S. Powerful Cost per Unit concept Variable costs per unit (RM and other variable costs), plus allocated portion of fixed costs (fixed costs allocated based on chosen driver). Allocation example: Estimated fixed overhead costs of $5,000,000; Driver is estimated labor hours of 65,000; Production overhead rate for fixed production overhead costs: $,,, = $ per labor hour 7

8 Cost per Unit (continued) From where did the $5,000,000 come? Overhead costs to be allocated From where did the 65,000 labor hours come? Object 1 Object 2 Object 3 Assumptions: Company will sell 100,000 units of Product 1 and 25,000 units of Product 2 (50,000 and 15,000 labor hours for Products 1 and 2, respectively); (Product 1 requires 0.5 labor hours; Product 2 requires 0.6 hours.) 8

9 Standard Cost Accounting Used in preparing budgets prior to start of a new year Permits faster closing of books (during year and at end of year) Sets targets for production to achieve Designed for a mass-production environment Changes in unit standards are infrequent (for consistency) 9

10 Standard Cost Accounting (continued) Standard Cost per Unit Example: Product 1 Product 2 Raw Materials $ $ Labor hours (at $10/hr.) (0.5 hr., Un.1; 0.6 hr., Un.2) Manufacturing Overhead ($ /hr.*) Total Cost per Unit $ $ * From slide 7 calculation: $,,,. = $ per hr. 10

11 Standard Cost Accounting (continued) IF the allocation rate had been based on estimated total materials costs of $1,500,000, the overhead rate would be: $5,000,000 $1,500,000 = $ per dollar of material cost and standard costs per unit would be: Product 1 Product 2 Raw Materials $ $ Labor hours (0.5 hr.; 0.6 hr.) Manufacturing Overhead ($3.3333) Total Cost per Unit $ $ Change from previous cost 13% 44% 11

12 Standard Cost Accounting Systems Problems that may result: 1. Engineering standards may not be achieved prior to end of product s life 2. Promotes excessive production to lower unit costs 3. Usually results in high work-in-process inventory 4. Production forced to focus on efficiencies (and, typically, utilizations) 5. Due date performance suffers 6. Causes major conflicts between sales and production 12

13 Activity-Based Cost Accounting What about Activity-Based Cost (ABC) Accounting? Purchasing Cost Corporate Cost Info. Sys. Cost Other OH Costs Resource costs First stage allocation Activity Pool A Activity Pool B Activity Pool C D E F Second stage allocation User 1 of Activity User 2 of Activity 13

14 ABC Accounting (continued) Activity-Based Costing (ABC) assumptions: 1. Activities consume resources; products consume activities. 2. All costs are variable (very long-term concept). 3. Selection of pool driver (allocation base) is logical and straightforward. 4. Mixing variable and fixed costs in one pool is acceptable. 5. Data collection costs are negligible. jfciii1 Assumptions 2, 3, and 4 are not supported by experience. 14

15 Slide 14 jfciii1 Is assumption 5 supported by experience? I thought ABC was quite expensive to implement. jcox, 4/30/2014

16 Lean Accounting Lean Accounting is now heavily promoted Establishes value streams of mostly dedicated resources to avoid many allocations Developed to support Lean Manufacturing (loosely based on the Toyota Production System) Objectives: o Improve flow and due date performance o Reduce headcount and eliminate costs everywhere 15

17 Lean Accounting (continued) Problems: 1. Sometimes cost cuts are too deep; Average cost per unit regularly reported; reduction expected; Excess resource capacity reported (value streams encouraged to increase excess capacity, then remove it). 2. Does not encourage organization team concepts (each value stream evaluated on its own). 3. Some allocations still occur! 4. No system focus. 16

18 Damage Caused by Allocations Traditional cost accounting (including standard costs), ABC, and to some extent, Lean are based on allocating costs to products. The moment you begin arbitrarily allocating costs to products, you begin to focus on the wrong thing(s) for decision-making purposes. All allocations are arbitrary! 17

19 Adjustments Required for All U. S. Costing Systems Internal reporting methodologies (standard costs, ABC, etc.) must be converted to actual costs for external reporting (Public Company reports, tax returns, etc.). Under- or over-applied manufacturing overhead amounts must be closed at year end and cost of sales adjusted. Costs must be shown by functional area: cost of sales; general, selling, and administrative, including finance costs; other income/expense; income taxes 18

20 Throughput Accounting Originally developed from the 5 focusing steps Considers the entire system Primary focus is on revenue generation, then inventory reduction, then cost reductions Does NOT allocate fixed production or other fixed costs Resource capacity availability is important Protective Capacity Surge Capacity Considers only relevant items in making decisions 19

21 What are relevant items? 1. Future items revenues, costs, investments, etc. 2. Items that are different for each alternative. Therefore, previous investments ( sunk costs) ALWAYS are irrelevant! 20

22 Familiar Throughput Metrics Throughput (T) Revenue minus total variable costs Inventory/Investment (I) Costs incurred to be in a position to produce Operating Expense (OE) Costs that must be incurred each period Throughput per unit of the constraint Useful only when there is an internal constraint Return on Investment (ROI) Income divided by investment 21

23 Basic P-Q Example Operating Expenses: $6,000 per Week Product P Sell. Price $90 Demand: 100/week D 15 min. Product Q Sell. Price $100 Demand: 50/week D 5 min. Each Resource (A, B, C, D) is available 2,400 minutes each week Purch. Part $5 C 10 min. A 15 min. C 5 min. B 15 min. B 15 min. A 10 min. Raw Mat. $20 Raw Mat. $20 Raw Mat. $20 22

24 Decisions with NO Internal Constraint Typical system information required: 1. Period of time during which assumptions will remain valid. 2. Capacity freely available during the time frame of the decision. 3. Change in Throughput (revenue minus variable costs). 4. Knock on change in Throughput of other products currently being produced and sold. 5. Change in operating costs resulting from the decision. 6. Change in investment resulting from the decision. 7. Change in customer service or long-term prospects resulting from the decision. 23

25 Make versus Buy Decision A company has the following production costs per unit for one of its products that it expects to sell 40,000 units of during the upcoming year: Materials $1.00 Labor (piecework).25 Fixed production costs.75 Total production costs $2.00 The Purchasing Department has found a source that sells this part for $1.75 per unit. Should the company outsource production of this unit if there is no alternative use for the production facilities? 24

26 Decision Analysis Throughput Accounting: Assuming no ill effects from not paying the piece worker... DO NOT outsource! Purchase price = $1.75 Good Decision! Cost to make = 1.25 Advantage to make = $0.50 per unit 40,000 units x $0.50 = $20,000 advantage to make Traditional costing: Yes, outsource and save $0.25 a unit x 40,000 units = $10,000 better off. Bad Decision! WHY? 25

27 Discontinue Department? A department store operates a lunch counter that has consistently shown an annual operating loss of $5,000. Projected financial income for the current year: Sales $80,000 Cost of sales 60,000 Gross profit $20,000 Operating costs Direct (wages, food, etc.) $16,000 Allocated (heat, light, space) 9,000 25,000 Net Loss $ (5,000) A local vending company wants to lease the space for $1,500 per year and operate the lunch counter. Should the company accept the lease proposal? 26

28 Decision Analysis (discontinue department?) Throughput Accounting: NO! (Do not sign lease) Sales $80,000 Cost of sales $60,000 Operating costs 16,000 76,000 Throughput $ 4,000 Less lease opportunity cost 1,500 Advantage to continue operating counter $ 2,500 Good Decision! 27

29 Decision Analysis (discontinue department?) Traditional accounting: YES! Sign the lease! Current loss $(5,000) Lease income 1,500 Increase in profit $ 6,500 Bad Decision! Why? 28

30 Obsolete Inventory Decision A company has 10,000 obsolete cameras that are carried in inventory at a cost of $10 each. In its effort to reduce inventory, the company finds that the cameras can be sold as they are for $2 each. However, they also can be reworked at a cost of $40,000, after which, the company is confident, they can be sold for $7 each. Capacity is available to perform the rework. What should the company do? 29

31 Decision Analysis (obsolete inventory) Throughput Accounting: Rework the cameras! Sale of reworked cameras $70,000 Cost of rework 40,000 Throughput $30,000 Opportunity cost 20,000 Advantage of reworking $10,000 Good Decision! 30

32 Decision Analysis (obsolete inventory, continued) Traditional accounting: NO! Sell as is for $2 per unit. Our company already is losing $8 per unit; Rework will cost an additional $4 per unit, we will lose even more! Bad Decision! Why? 31

33 The BEST (Safe) Approach When a major decision must be made: 1. If changes in product mix or quantities are involved, make sure resource capacities are available to accommodate the change; 2. Compute the income after the change and compare it to the status quo before the change. Note: Learn to be comfortable with uncertainty; do not punish good decisions that turn out badly. 32

34 Cost Accounting Problems 1. Most accounting/finance people do not recognize the importance of individual resource capacities. 2. Use of financial accounting methods (particularly fixed cost allocations) for management decisions. 3. People are not mindful of appropriate (relevant) decision inputs. 33

35 Decision Caveats ALWAYS: Know what is being assumed. Make a record of the assumptions. Be alert to inaccurate assumptions. Check to see how decisions should be revised when assumptions are invalidated. 34

36 Typical Throughput Accounting Metrics Due date performance Flow time Control point loadings (entry, exit, merge, etc.) Buffer performance (variation control) Total throughput (local and global) Delay to throughput (throughput dollar days) Work rule violations 35

37 Primary Traditional Accounting Focus PUSH product costs through the system PROMOTE -- Sales people will sell to Customers Use Low-Cost Suppliers and High Resource Utilization to Reduce COSTS! Note: This slide and the next adapted from Demand Driven Performance by Debra Smith and Chad Smith. 36

38 Throughput Accounting Focus POSITION supporting role of Finance PULL management demand for assistance Finance role: Responsive team member; flexible, resilient internal reporting structure; cash buffer management; metrics that matter; GAAP compliance for required external reporting. 37

39 Throughput Accounting Is... All the metrics and measurements necessary to support FLOW operations, including project management, capital and other improvements, strategy and tactics, production, marketing, sales

40 Throughput Accounting Income Statement Model Segment 1 Segment 2 Segment 3 Total Revenues Segment Costs: Cost of sales Variable Costs Unique Fixed Costs Selling and admin. Var. Costs Unique Fixed Costs Total Costs Segment margin Common fixed costs Operating income $ 50,000 $150,000 $100,000 $300,000 $ 18,000 50,000 35,000 $103,000 10,000 10,000 3,000 4,500 8,000 15,500 1,500 3,000 2,500 7,000 $ 22,500 $ 57,500 $ 55,500 $135,500 $ 27,500 $ 92,500 $ 44,500 $164,500 67,000 $ 97,500 No fixed costs are allocated among segments! 39

41 Why Flawed Assumptions Exist 1. Government regulations for external financial statements; 2. Education focuses on financial accounting Undergraduate, Graduate, including MBAs; 3. Manual transaction systems prior to 1960 promoted standard cost systems; 4. Financial systems imbedded in ERP, MRP-II and other enterprise software systems; 5. Linear perspective of the world (Newton s additive view). 40

42 Why Finance People May Resist Throughput Accounting No time to set up another accounting system Too new and confusing to users Sales people will cut prices; company will lose money Financial records will not be consistent Lack of trust in other areas 41

43 Why Change Is So Difficult Accounting/finance people have much POWER and INFLUENCE: Their work load has increased dramatically Required external reports, Big data collection/analysis, jfciii2 CB1 CFOs sometimes also must take on the COO and/or HR roles Past record of success ; Know their allocations are arbitrary, but sincerely believe they are necessary! 42

44 Slide 42 jfciii2 CB1 Not sure why ' is here? jcox, 4/30/2014 "'" was a typo. Charli Budd, 5/7/2014

45 Overcoming Resistance to Throughput Accounting (TA) Software now is available at reasonable prices spreadsheets can fill the information gap for a short time period Easy to reconcile TA to GAAP All people affected by the change to TA must be assisted in the transition; a Purpose a Picture, a Plan, a Part to play 1. Give up the old methods 2. Develop new methods 3. Enter the new reality 43

46 Thank you for allowing me to present Questions? 44