Below are the first 10 and last 10 pages of uncorrected machine-read text (when available) of this chapter, followed by the top 30 algorithmically extracted key phrases from the chapter as a whole.
Intended to provide our own search engines and external engines with highly rich, chapter-representative searchable text on the opening pages of each chapter.
Because it is UNCORRECTED material, please consider the following text as a useful but insufficient proxy for the authoritative book pages.
Do not use for reproduction, copying, pasting, or reading; exclusively for search engines.
OCR for page 126
APPENDIX B
Management Accounting in the
Future Manufacturing Environment
1
The new manufacturing environment will require a major re-
thinking of corporations' management accounting systems. Com-
puter-integrated manufacturing (CIM) equipment requires exten-
sive digital data for command and control of operations. These
same data can be user! to measure resource utilization and the
quantity and quality of output on a continuous basis. For example,
the time each product spends waiting to be processed and actually
being processed on each machine is readily available. Also, phys-
ical counts on actual output, rework, and scrap can be tracked
continuously. Therefore, it becomes possible to compute actual
costs on a real-time basis by individual product classes.
In contrast, traditional cost measurement systems compute
costs and output over fairly Tong periods, typically a month. Be-
cause of the time required to collect this information, the monthly
cost report is not available until the middle of the subsequent
month. Also, the data are aggregated, so monthly variances are
difficult to trace to individual products or batches.
The new manufacturing technology provides an opportunity
to move from cost measurement on a delayed, aggregate basis to
performance measurement on a continuous, hourly, or daily basis,
by resource category, cost center, and product class. Such new
measurements will permit better understanding of product costs
and permit more rapid detection of problems and opportunities
for learning and improvement of manufacturing processes.
126
OCR for page 127
127
The CIM environment will also make cost accounting systems
based on direct labor obsolete. Many companies still distribute
costs from the factory and from cost centers to products based
on direct labor burden rates. Such a system may have been rea-
sonable decades ago, when these systems were designed, because
direct labor was the most expensive component of total manufac-
turing cost. In highly automated environments, however, direct
labor is a very small percentage of total costs, 5 percent or even
much less. The direct labor that is used is more concerned with
set-up and supervision than with actual processing of output. As
overhead and indirect costs have escalated and direct labor costs
have diminished, the burden rate on direct labor has reached 500
percent or, in highly automated environments, 1,000 to 2,000 per-
cent. Clearly, this is a confusing way to trace factory costs to
products.
More imagination is needed for tracing costs to products,
which inevitably will require new and multiple overhead allocation
bases. For example, costs associated with materials (purchasing,
traffic, receiving, distribution, and storage) can be traced to ma-
terials purchases based on material dollars or on quantity, size, or
weight of materials, as seems reasonable. Costs associated with
acquisition, maintenance, repair, and operation of machines can
be traced to products on a machine-hour basis. Costs of produc-
tion control and expediting departments can be traced to products
based on the number of set-ups. The costs of engineering, quality
assurance, and customer support and service should be traced to
the products which require or which benefit from the use of these
departments. Since materials, equipment, and overhead will be
the most important manufacturing costs, it becomes imperative
to develop cost accounting systems that will trace these costs to
products rather than rely on arbitrary allocations based on direct
labor, a diminishing component of manufacturing costs.
The present monthly cost accounting reporting cycle, with its
allocation of overhead based on direct labor content, exists mainly
to distribute manufacturing costs between goods sold and inven-
tory so that monthly profit and loss statements can be computed.
This financial reporting objective has been the main driver for cost
accounting systems. It has created the situation in which cost data
OCR for page 128
128
are too late to be very useful in cost control and too aggregated to
be helpful in identifying actual costs for product mix and pricing
· ~
c .eclslons.
This financial accounting objective of measuring product costs
and profits for periods as short as a month or a quarter, or per-
haps even a year, will be undermined by the new manufacturing
technology. Most manufacturing costs will become fixed costs
product design, equipment and facilities, salaries and wages-
which will not vary with the volume of production. Indeed, many
of these costs must be incurred before any items are produced;
they are sunk costs. The primary variable costs of production will
be materials, some energy to operate equipment, and maintenance
and repair of machines. This type of cost structure implies very
high gross margins; that is, variable costs must be a small fraction
of selling prices if the firm is to recover its investment in product
and process development, equipment, software development, and
prototypes and testing.
With this pattern of cash expenditures and cash inflows, in-
come measurement over short periods becomes a meaningless ex-
ercise since it is wholly dependent on arbitrary assumptions about
the amortization of prior-period expenditures to current produc-
tion and sales. The more meaningful measurement of income oc-
curs over the full span of the product's life cycle. By how much
will the net cash revenues (saTes less variable costs and period ex-
penses) exceed the investment required to get the product into
production? At what rate are current and expected future sales
generating cash to recover the cash invested in product and pro-
cess development? At the end of the product's life, management
will be able to know whether and by how much the product gen-
erated cash in excess of that invested in it, but to apportion this
income or loss to arbitrarily short periods within this life cycle
will not be an interesting or relevant exercise.
However, saying that income cannot be measured over short
periods does not imply that meaningful short-term performance
indicators cannot be devised. Certainly the rate of cash recovery
will be an important financial measure, but a variety of nonfi-
nancial measures will be equally important. These should include
key indicators of manufacturing, marketing, and research and de
OCR for page 129
129
velopment success For example, measures of quality, including
internal and external failure rates, yields, and rework, can be
computed. Measures of production efficiency, such as machine
availability, throughput and lead times, average inventory levels,
and set-up times, can be calculated. Percentage of delivery times
met, whether product development milestones are being achieved,
customer satisfaction measures, employee absenteeism, turnover,
skill levels, and morale will be much more interesting short-term
performance measures than a financial profit figure requiring ar-
bitrary allocations of expenditures on past, current, and future
product and process developments. Thus, the new manufacturing
environment not only will require entirely new cost measurement
and management systems, but also will cause managers to aban-
don attempts to measure profitability over periods as short as a
month, quarter, or even a year. Nonfinancial measures may pro-
vide a better indicator of a firm's ability to earn long-term profits
than any short-term profit figure managers may attempt to com-
pute.
Finally, firms will find it necessary to expand their procedures
for justifying investment in new process technology. Current pro-
cedures tend to emphasize easily quantified savings in labor, ma-
terials, or energy. Further, these savings tend to be recognized for
arbitrarily truncated periods, sometimes only one or two years. In
addition, new equipment is justified on the assumption that the
firm will continue to do the same volume of business even if the
new investment is not undertaken. None of these assumptions will
be valid or helpful when contemplating investment in new process
technology, for several reasons.
First, while CIM equipment offers significant direct labor sav-
ings, it also offers considerable improvements in quality, inventory
and floor space reduction, great reductions in throughput and lead
times, and flexibility to accommodate product redesigns and new
generations of products. To consider only easily measurable labor
savings significantly understates the benefits of CIM technology.
Second, the benefits from CIM technology will persist over
long periods. It is unlikely that the hardware and software invest-
ments in CIM technology can be repaid in a couple of years, but
the flexibility of this technology ensures that its useful economic
OCR for page 130
130
life will be much longer than that of conventional dedicated equip-
ment. Therefore, analytic capital authorization procedures must
use realistic estimates of the considerable useful economic life of
this equipment.
Third, firms that do not invest in the new technologies will
soon find that they are no longer the low-cost, high-quality pro-
ducers and wait experience declining net cash flows. Therefore, the
correct way to evaluate new process technology is not to extrap-
olate from past and current cash flows, but to find a pattern that
predicts the decline in cash flows owing to anticipated adoption of
new technology by competitors.
~ summary, the new manufacturing technology will require
major modifications in the way Finns measure and manage costs, in
their measures of performance both financial and nonfinancial-
during short periods, and in the way they justify investments in
new technology. Failure to make these modifications will inhibit
the ability of firms to be effective and efficient global competitors
in the manufacturing environment of the twenty-first century.
Representative terms from entire chapter:
cost accounting
