Operations Management Flashcards
Customer expectations regarding quality have increased for two reasons:
- Automated manufacturing techniques
2. Adoption of international quality standards
Most commonly used measures of satisfaction are:
- Sales returns
- Warranty costs
- Customer complaints
Types of Quality: Quality of Design
Meeting or exceeding the needs and wants of customers.
Types of Quality: Quality of Conformance
Conforming to the design specifications
Execute product design and specified and appropriately.
Voluntary Costs of Quality: Prevention costs
The cost of prevention is the cost of any quality activity designed to help do the job right the first time.
Ex: Quality engineering, quality training, quality circles, statistical exposes control activities, supervision of prevention activities, quality data gathering, analysis, and reporting, quality improvement projects, technical support provided to suppliers, audits of the effectiveness of the quality system.
Voluntary Costs of Quality: Appraisal costs
The cost of quality control including testing and inspection. It involves any activity designed to appraise, test, or check for defective products.
Ex: testing and inspection of incoming materials, testing and inspection of in-process goods, final product testing and inspection, supplies used in testing and inspection, supervision of testing and inspection activities, depreciation of test equipment, maintenance of test equipment, plant utilities in the inspection area, field testing and appraisal at customer site.
Involuntary Costs of Quality: Internal Failure Costs
The costs incurred when substandard products are produced but discovered before shipment to the customer.
Ex: scrap, spoilage, rework, rework labor and overhead, reinspection of reworked products, retesting of reworked products, downtime caused by quality problems, disposal of defective products, analysis of the cause of defects in production, reentering data because of keying errors, debugging software errors.
Involuntary Costs of Quality: External Failure Costs
The cost incurred for products that do not meet requirements of the customer and have reached the customer.
Ex: cost of field servicing and handling complaints, warranty repairs and replacements, product recalls, liability arising from defective products, returns and allowances arising from quality problems, lost sales arising from reputation for poor quality.
Directional COQ Effects
- When the overall quality of conformance is low, more if the total cost of quality is typically related to cost of failure (which would be higher).
- Increases in the cost of prevention and the cost of appraisal are usually accompanied by decreases in the cost of failure and increases in the quality of conformance.
- The most effective method of reducing the overall cost of failure is to increase efforts to prevent failures.
- Increased spending on prevention portentously reduces both the cost of failure and increases the quality of conformance.
Six Sigma
Expresses how close (statistically) a product comes to its quality goal.
One Sigma = 68% of products are acceptable
Three Sigma = 99.7% “ “ “
Six-Sigma = 99.999997 perfect
Uses DMAIC (Define, Measure, Analyze, Improve, Control)
Pareto Charts
Ranks causes of Process variations by the degree of impact on quality.
Also know as 80/20 rule or low hanging fruit.
Balanced Scorecard
The balanced scorecard (BSC) is a performance management tool that helps an organization identify and evaluate critical success factors within the context of overall strategy.
•Integrates both financial and non financial measures to provide a comprehensive view of overall performance.
Balance Scorecard Categories: Financial
Focuses on specific measures of financial performance.
Balance Scorecard Categories: Customer
Specifies performance related to targeted customers and market segments.
Balance Scorecard Categories: Internal Business Processes
Depicts performance of internal operations that create value.
Ex: new product development, production, distribution, after sale customer service.
Balance Scorecard Categories: Learning, Innovation, and Growth
Specified performance characteristics of the companies personnel.
•ex: Skills, training, certification, moral.
Within each of the four Balance Scorecard classifications, the organization identifies its:
- Strategic goals
- Critical success factors
- Tactics
- Performance measures
Creating a Balanced Scorecard steps:
- Identify strategic objectives.
- Do SWOT analysis.
- Develop operational tactics.
- Develop performance measures for each tactic.
Features of a good balanced Scorecard:
*Articulates a company’s strategy by trying to map a sequence of cause-and-effect relationships through metrics.
•Assists in communicating the strategy to all members of the organization.
•Limits the number of measures used by identifying only the most critical ones
•Highlighting suboptimal trade-offs made by managers.
During creating a Balanced Scorecard - these 5 things should be avoided…
- Assuming the cause-and-effect linkages are precise.
- Seeking improvements across all measures all the time.
- Using only Objective measures on the Scorecard. (Use subjective measures also)
- Failing to consider both costs and benefits of initiatives.
- ignoring non financial metrics when evaluating employees.
Benchmarking Defined
A process in which organizations compare their own processes and performance with the processes and performances of business leaders within or across competing industries.
- Should be an ongoing process.
- Supports continuous learning and improvement.
Best Practices Defined
- The most efficient and effective means of accomplishing a task.
- To identify best practices, an organization observes the practices of leading companies.
- The organization compares best practices to its own processes and producers to identify potential for improvement.
Competitive Analysis includes:
- Conventional profitability / return analysis
- Value based management
- Target pricing markups
- Price elasticity
Focus of ROI
ROI is consistent with external financial analysis used to evaluate broad performance.
Weaknesses of ROI
•Suffers from accrual distortions
•Accrual accounting is often
arbitrary (Designed to fulfill
external reporting goals)
•Accounting conventions are concerned with compliance, not with economic performance.
• Suffers from the diluted hurdle Rate problem.
Residual Income (RI)
RI is designed to eliminate diluted hurdle rate problem.
RI is a general form of economic profit
RI recognizes the cost of capital and expressed answer in dollars (rather than a rate)
Value based Manamgement
Two most popular metrics:
EVA (Economic Value Added)* important*
•Is a specific form of RI that is often used for
incentive compensation and investor
relations.
CFROI (Cash Flow Return on Investment)
•Is a cash-based metric used for incentive
compensation, valuation, and capital
budgeting.
Strategic Risk
Addresses long-term, broad-based exposure related to the overall strategy of the organization.
*to achieve the organization’s mission.
Operational Risk AKA Business Risk
Short term in nature and includes process risk, shared services risk, foreign/off-shore risk, and credit/default risk.
*includes daily implementation issues to achieve the strategy of the company.
Market Risk Aka systematic risk
Associate with economic events of national disasters.
Beyond the companies control
Other Risk Management Approaches
- Structuring operating leverage to the company’s advantage.
- ex: lease assets
- Providing contingency planning for disaster Recovery and business continuity.
- ex: building in redundancy, insurance
- Using hedging and diversification to offset exposure.
- Using insurance for risk mitigation/elimination.
- Evaluating the level of uncertainty when estimating future costs and revenues.
Hedging Defined
Used to offset future uncertainty with options and futures contracts related to commodities, foreign currency, and other investment exposure to minimize price risk.
Diversification Defined
Reduces general unsystematic and portfolio risk but does not completely offset risk as hedging does.
(Uses investments with similar volatilities but in opposite directions)
Insurance is used to …
- Decrease exposure to specific, known hazards.
- Deals with pure risk (where there is only a risk of losing - best case would be to break even) as opposed to speculative risk where gain is also possible.
Evaluating Uncertainty
Involves estimating future costs and revenues and maintaining cost control as a risk management strategy.
Theory of Constraints
Determining where bottlenecks (constraints) exist and optimizing output by relaxing that constraint.
•Constraints result from a variety of different resources (e.g. Labor hours, machine hours, or square feet)
Optimization rule for product mix decisions:
•Maximize the contribution margin per unit of the constrained resource
Ex: contribution margin per direct labor hour or machine hour – by doing this the company will maximize profitability.
Lean Manufacturing
Blends the features of custom and mass production processes to make a small number of a high variety of products. Aka. Mass customization
Goals include: increasing quality, reducing waste, and minimizing resource consumption in the process.
TQM tools will be found in lean manufacturing.
Approach to Lean Manufacturing
- Identify the steps in the value stream
- Eliminate steps that do not increase customer value
- Streamline the process
- Continuously evaluate to reach for perfection (no waste)
Lean Manufacturing environment (pull-type):
- Flexible equipment
- Low setup times
- Highly-skilled laborers
The Demand Flow Approach
Is embedded in lean applications to manage the process based on continuous flow planning and customer demand.
Six Sigma
A continuous improvement approach to systematically reduce defects.
The name reflects a level of quality that is virtually perfect.
Six Sigma’s Five Steps
- Define the process (business goals)
- Measure the process (in terms of defects)
- Analyze the process (using TQM tools to determine the root cause of defects)
- Improve the process (based on results from analysis)
- Control the process (by using TQM tools to monitor and sustain quality)
Difference between manufacturing costs and operating expenses
Mfg costs: “factors of production”
Accounted for as assets in the form of inventory. These will eventually be expended through COGS.
Increases in assets increase income
Operating exp:
Increasing expenses decrease income
Three Factors of Production
- Direct Material: Significant raw materials and components that make up the finished product.
- Direct Labor: Wages for work that directly converts raw materials into finished products.
- Manufacturing Overhead: Cost of labor and supplies that support the production process but are not easily traceable to the finished product.
Prime Costs
Direct materials costs plus direct labor costs
Conversion Costs
Direct Labor costs plus factory overhead costs
Product costs are also known as
Inventoriable costs or manufacturing costs
They generally attach to physical product units and are expensed in the period in which the goods are sold.
Can be associated with the production of specific revenues.
If units are in inventory, the costs are assets. If the costs represent units that have been sold, then they are expensed through COGS
Period Costs
Operating costs
Period costs cannot be matched with specific revenues (i.e. Accountants salary) and are expenses in the period incurred.
Actual Costing
Simplest and most accurate method and waits until all the costs are known and then records them in the accounts.
AQ (actual quantity) x AP (actual price)
Normal Costing
A moderately simple and moderately accurate method where DM and DL are traced to WIP when the costs become known.
-Would be done on periodic basis.
AQ (actual quantity) x POR (predetermined overhead rate)
DM and DL = recorded at AQ x AP
Overhead = allocated by predetermined overhead Rate that is estimated at beginning of year (AQ x POR)
Results are then reconciled to actual at the end of year.
Standard Costing
A Costing method that uses predetermined, estimated rates and quantities to record both direct costs and overhead.
SQA (standard quantity slowed) x SP (standard price)
*both estimated at the beg of year.
Indirect Labor is a ____ cost
CONVERSION COST
•Indirect Labor goes into manufacturing overhead
Two types of spoilage:
- Normal Spoilage: Uncontrollable and unavoidable as part of the current manufacturing process.
•Included in COGS as a routine cost of business.
•Unless traceable to a job, the cost of normal
Spoilage is spread equally across all jobs.
•For Process costing, it is spread over the
good units produced. - Abnormal Spoilage: Controllable and avoidable (e.g. When due to carelessness or inefficiency) - generally unexpected.
•Includes natural disasters and other events
•Considered a period Cost and is not
included as a part of COGS.
•For Process Costing it is removed from the
Costing system and treated as a period cost
Treatment for a Scrap
- Scrap is material left over after production.
- Any monies received from the dale of Scrap can be used to reduce factory OH, and thereby reduce COGS.
- Alternatively, if the value of scrap is significant and saleable, it can be treated as “other sales” in the revenue category.
Cost Behavior Defined
Allows us to predict how costs change in response to changes in production or sales.
High-Low Method
Provides a rough estimate of the fixed and variable cost components that comprise total costs.
- The idea is to calculate the change in costs from two production volume extremes.
- Fixed costs are determined by removing the variable cost component from the total cost.
CVP (Cost-Volume-Profit) Model Assumptions
•Price, variable cost per unit, and fixed costs behave as constants (i.e. as Defined)
•Total costs can be divided into a fixed component and a component that is variable with respect to the level of output.
•Cost behavior is assumed to be linear.
•Volume is the ONLY DRIVER of Costs and revenues.
•The number of units produced equals the number of units sold (i.e. No change in inventory)
•The model applies to operating income (i.e. The CVP model is a before-tax model).
*convert Net Income in question to pretax
Margin of Safety
The margin of safety indicated the difference between the current sales level and the breakeven point.
- Indicates how much revenue can decrease before operating income becomes negative.
- Can be expressed in units or dollars.
The only difference between variable and absorption Costing is…
The treatment of fixed manufacturing costs.
•Absorption Costing is required for external reporting purposes and prescripts that fixed manufacturing costs be treated as a product cost.
Job Order Costing
Used for production of large, relatively expensive, heterogeneous (customer ordered) items.
OH is applied based on standard OH Rate.
Costs are accumulated by job. This usually means grouping costs by customer.
Process Costing
Used to accumulate costs for mass-produced, continuous, homogeneous items that are often small and inexpensive.
Costs are accumulated by Process. This usually means grouping costs by department or operation.
Process Costing
Is used to accumulate costs of mass-produced, continuous, homogeneous items that are often small and inexpensive.
Cost Allocation Process - Complications
- Partially completed items in beginning and ending inventories.
- The 3 factors of production may be at different levels of completion.
- Some costs do not occur uniformly across the process (particularly true for raw materials)
- The choice of inventory evaluation methods affects the flow of costs.
3 Steps in Process Costing
- Determine equivalent units (EU)
•EU refers to the number of whole units that could have been produced during the period in terms of cost incurred. (Ex: cost of 6 units that are 50% complete is equivalent to the cost associated with 3 units that are 100% complete. - Compute cost per EU
- Determine (a) cost of goods transferred out of WIP and (b) ending WIP inventory.
Cost Flow Assumptions
The cost flow assumption determines which equivalent units figure to use
Weighted Average: assumes that prior period costs and current period costs are averaged together.
FIFO: assumes that prior period costs and current period costs are treated separately.
*difference in treatment = beginning inventory.
Joint and By-Products Defined
Joint products and by-products are the result of a single manufacturing process that yields multiple products.
*two or more products of single sales value are said to be joint products when they:
•Are producers from the same set of raw materials.
•Are not separately identifiable until a split-off point.
By-Products differ from joint products in that they have relatively insignificant sales value when compared to the main products.
•Costing- because of their relatively insignificant sales value, by-products usually are not allocated a share of the joint costs of production.
•Net proceeds from the sale of by-products are used to reduce the cost of the main products. No revenue is recognized from the sale of the by-products. (Can be recognized as misc. income)
Split-off point
The point at which products manufactured through a common process are differentiated and processes separately.
Joint costs
Costs incurred prior to split-off; must be allocated to the joint products.
•External reporting agencies typically don’t care how they are allocated.
Separable Costs
Additional processing costs incurred beyond the split-off point.
•Attributable to individual products; they are not allocated to the joint products.
Relative Physical Volume Method
Costs are allocated based on the quantity of products purchased.
•The total volume of all products is established (pounds, feet, gallons, etc.), each product’s pro rats share is determined, and the joint costs are allocated based on that proportion.
Relative Sales Value Method
Costs are allocated based on the relative sales values of the products either at split-off or after additional processing.
•When significant markets exist for the products at the split-off point, the relative sales value of each product is used to allocate costs.
When there is NO MARKET AT SPLIT-OFF POINT: the ratio of the net realizable value of each product to the total net realizable value is used to allocate costs. (Ie. final market value less any additional separable processing costs of each product.)
Scrap
A remnant of the production process that has some, but very little, recovery value. Scrap is seldom processed beyond the split-off point.
- Net proceeds from sale of scrap are used to reduce overhead costs (credit to factory OH control).
- If scrap is identified with a particular DM, it may be odder against that cost.
Standard Costing / Variance Analysis
Variances are analyses of differences between standard costs and actual costs:
•Non-material variances- write off COGS
•Material variances - allocate to ending WIP, FG, and COGS.
Names of Variancss
Variances due to the difference between actual and standard price: price or rate variances
Variances due to the difference between actual and standard quantity: quantity or efficiency variances.
Sales Mix Variance
The sales mix Variance quantifies the effect on CM resulting from selling difference proportions of products with differing profit margins.
Sales Quantity Variance
The sales quantity Variance is due to selling a different number of units than expected at the weighted-average unit CM for the sales mix.
Sales Volume Variance
The sales volume Variance is the net of the sales mix and quantity Variances.
Spending Variance
Variance due to price changes in indirect material and labor, and poor budget estimates.
•It is a controllable variance.
Efficiency Variance
Variance due to variations in the efficiency of the base used to allocate overhead (i.e. Direct Labor hours, direct Labor dollars, etc.)
•It is OFTEN a controllable variance.
Volume Variance
Variance due to differences in the actual level attained (at standard) and the estimated/budgeted total fixed costs.
•Considered an uncontrollable variance.
Budgeting (Fixed Spending) Variance
Variance due to price differences in the total fixed OH costs and the budget.
The difference between the estimated total fixed OH and the actual total fixed OH.
Four-Way Variance Method
Comprised of the two variable OH variances (efficiency and variable spending) and the two fixed OH variances (Budget and volume Variances)
Least common of 3 methods (2 and 3 way)
Three-Way Variance Method
Combines the variable OH spending variance and the fixed OH budget (spending) variance into a single variance.
•Often referred to as the “total spending variance”
Two-Way Variance Method
Combines the total OH spending variance and the fixed OH budget (spending) variance into a single variance.
•Often referred to as the “controllable or flexible budget variance”
Relevant costs and benefits Defined
Future costs and benefits that differ among alternatives.
Avoidable costs Defined
Those that can be eliminated by choosing one alternative over the other; they are always considered relevant.
Unavoidable costs: remain the same regardless of which alternative is chosen. As such, they are IRRELEVANT to decision making.
Irrelevant cost: Sunk Cost
A cost that has already been incurred and cannot be changed.
Accounting costs Defined
Costs that can be found in the fundamental books of record (e.g. The general ledger.)
Opportunity cost
The benefit forgone that results from choosing one alternative course of action rather than another.
Avoidable costs are opportunity costs and unavoidable costs are not opportunity costs.
Marginal cost
The cost of producing one more unit.
*does not establish relevance.
Incremental cost
The difference between two decision alternatives. (The added processing cost)
*does not establish relevance.
Incremental revenue
Difference between revenues from each option.
Special order relevant costs
- The only relevant costs are the costs directly attributable to the special order
- If the company is operating at capacity, the opportunity costs associated with production that must be cancelled in order to complete the special order.
Transfer Pricing Defined
The price charged by the selling division to the buying division.
Goal Congruence
Occurs when the department and division managers make decisions that are consistent with those of the organization as a whole.
Additional outlay cost
Incremental production costs incurred by selling unit.
Dual Pricing
Is an attempt to eliminate the internal conflicts associated with transfer prices by giving both buying and selling divisions the price that “works best” for them.
Activity-Based Costing
A method of assigning overhead (indirect) costs to products.
•Uses Process-based drivers and multiple cost pools to significantly improve the accuracy of product cost allocation.
Activities
Procedures that cause work
Cost drivers
Measures that are closely correlated with the way in which an activity accumulates costs.
•based by which costs are assigned to products.
Cost center
An area where costs are accumulated and then distributed to products. (E.g. AP, product design, and marketing)
Cost pools
A group of costs that are associated with a specific cost center.
Value-adding costs
Costs that contribute to the products ultimate value.
Ex. Design work, packaging.
Non-value adding costs
Costs that do not contribute to the products value
Ex. Storage of raw materials.
Want to reduce these as much as possible.
Cost Hierarchy (activity-based Costing)
- Facility-level Activities
- Product sustaining-level activities
- Batch-level activities
- Unit-level activities.
Effects of adopting ABC
More precise measures of cost
More cost pools
More allocation bases
Process Management
Takes place to achieve an understanding of the work that takes place in an organization.
Processes Defined
A series of activities conducted to accomplish a Defined objective.
Process management key objectives
- Increase manager understanding
2. Promote the elimination of waste
Business Process Re-Engineering
A process analysis approach that results in radical change (extreme transformation)
Outsourcing
Contracting a business process to an external provider.
Shared Services
One part of an organization provided an essential business process that previously had been provided by multiple parts of that same organization.
Offshoring
Where a process is moved to a foreign country.
The budgeting process begins with a ___
Sales forecast
•Expresses planned sales in. dollars and in units.
•Estimates Flow forward to the cash budget and the production budget.
Mast Budget
Is a comprehensive plan for the overall activity of a company.
The master budget is developed for a specified level of activity.
It is a static budget.
Flexible Budget
Is adjusted when actual sales deviate from the planned sales.
This helps analyze actual results by comparing them with expected results at the actual level of activity.
Most frequently used for manufacturing and sales activities.
Probability Analysis
Used to determine the likelihood of a specific event occurring when several outcomes are possible.
- A probability for each outcome is assessed.
- The probability of a particular outcome is always between 0 and 1 (never and always)
- Sum must always equal 1.
Expected Value Calculation
The expected value is the long-run average outcome.
Joint Prpbability
The probability of an event occurring given that another event has already occurred.
Variance analysis
Measures the dispersion of values around the expected value.
- The smaller the variance, the more tightly clustered the observations.
- Smaller variances are usually associated with less risk.
Correlation Analysis
Measures the strength of the relationship between two or more variables.
- the correlation coefficient (R) measures the strength of the relationship.
- (R) may have values from -1 to 1
- Negative = indirect relationship
Coefficient of Determination
(R^2) indicates the degree to which the behavior of the independent variable predicts the behavior of the dependent variable.
•the closer R^2 is to 1, the better the independent variable predicts the dependent variable.
Regression Analysis
Predicts the value of one factor (the dependent variable) based on the value of one or more other factors (the independent variables).
•Linear regression Analysis is frequently used in cost accounting to evaluate the strength of the relationship between costs and cost drivers.
3 traditional cost systems for manufacturing overhead
- Actual
- Normal
- Standard
