Accounting: The Language of Business - Vol. 1 (Part 117)

"These are the souls of the broken factories / The subject slaves of the broken crown / The dead accounting of old guilty promises / These are the souls of the broken town." - Gordon Sumner 

 Process Cost Systems (Part D)

by

Charles Lamson

Using the Cost of Production Report for Decision Making

The cost of production report is one source of information that may be used for managers to control and improve operations. A cost of production report will formally list costs in greater detail than in Exhibit 7 (from part 116). This greater detail helps management isolate problems and opportunities. To illustrate, assume that the Blending Department of Holland Beverage Company prepared cost of production reports for April and May. In addition, assume that the Blending Department had no beginning or ending work in process inventory either month. Thus, in this simple case, there is no need to determine equivalent units of production for allocating costs between completed and partially completed units. The cost of production reports for April and May in the Blending Department are as follows:

Note that the preceding reports provide more cost detail than simply reporting direct materials and conversion costs. The May results indicate that total unit costs have increased from $0.50 to $0.53 cents, or 6% from the previous month. What caused this increase? To determine the possible causes for this increase, the cost of production report may be restated in per-unit terms, as shown below. 

=

Both energy and tank cleaning per unit costs have increased dramatically in May. Further investigation should focus on these costs. For example, an increasing trend in energy may indicate that the machines are losing fuel efficiency, thereby requiring the company to purchase an increasing amount of fuel. This unfavorable trend could motivate management to repair the machines. The tank cleaning costs could be investigated in a similar fashion.

In addition to unit production cost trends, managers of process manufacturers are also concerned about yield trends. Yield is the ratio of the materials output quantity to the input quantity. A yield less than one occurs when the output quantity is less than the input quantity due to materials losses during the process. For example, if 1,000 pounds of sugar enter the packing operation, and only 980 pounds of sugar were packed, the yield would be 98%. Two Percent or 20 pounds of sugar were lost or spilled during the packing process. 

Just-in-Time Processing

The objective of many companies is to produce products with high-quality, low-cost, and instant availability. One approach to achieving this objective is to implement just-in-time processing. Just-in-time processing (JIT) is a philosophy that focuses on reducing time and cost and eliminating poor quality. A JIT system achieves production efficiencies and flexibility by reorganizing the traditional production process.

In a traditional production process (illustrated in Exhibit 9), a product moves from process to process as each function or step is completed. Each worker is assigned a specific job, which is performed repeatedly as unfinished products are received from the preceding department. For example, a furniture manufacturer might use seven production departments to perform the operating functions necessary to manufacture furniture, as shown in the diagram in Exhibit 9.

For the furniture maker in the illustration, manufacturing would begin in the Cutting Department, where the wood would be cut to design specifications. Next, the Drilling Department would perform the drilling function, after which the Sanding Department would sand the wood, the Staining Department would stain the furniture, and the Varnishing Department would apply varnish and other protective coatings. Then, the Upholstery Department would add fabric and other materials. Finally, the Assembly Department would assemble the furniture to complete the process.

In the traditional production process, production supervisors attempt to enter enough materials into the process to keep all the manufacturing departments operating. Some departments, however, may process materials more rapidly than others. In addition, if one department stops production because of machine breakdowns, for example, the preceding departments usually continue production in order to avoid idle time. This may result in a buildup of work in process inventories in some departments.

In a just-in-time system, processing functions are combined into work centers, sometimes called manufacturing cells. For example, the seven departments illustrated above for the furniture manufacturer might be reorganized into three work centers. As shown in the diagram in Exhibit 10, Work Center One would perform the cutting, drilling, and sanding functions, Work Center Two would perform the staining and varnishing functions, and Work Center Three would perform the upholstery and assembly functions.

In the traditional production line, a worker typically performs only one function. However, in a work center in which several functions take place, the workers are often cross trained to perform more than one function. Research has indicated that workers who perform several manufacturing functions identify better with the end product. This creates pride in the product and improves quality and productivity.

Implementing JIT may also result in reorganizing service activities. Specifically, the service activities may be assigned to individual work centers, rather than to centralized service departments. For example, each work center may be assigned the responsibility for the repair and maintenance of its machinery and equipment. Accepting this responsibility creates an environment in which workers gain a better understanding of the production process and the machinery. In turn, workers tend to take better care of the machinery, which decreases repairs and maintenance costs, reduces machine downtime, and improves product quality.

In a JIT system, wasted motion from moving the product and materials is reduced. The product is often placed on a movable carrier that is centrally located in the work center. After the workers in a work center have completed their activities with the product, the entire carrier and any additional materials are moved just in time to satisfy the demand or need of the next work center. In this sense, the product is said to be "pulled through." Each work center is connected to other work centers through information contained on Kanbans, which is the Japanese term for cards.

The experience of Caterpillar Inc., illustrates the impact of JIT. Before implementing JIT, an average transmission would travel 10 miles through the factory and require 1,000 pieces of paper for materials, labor, and movement transactions. After implementing JIT, caterpillar improved manufacturing so that an average transmission traveled only 200 feet and required only 10 pieces of paper (Warren, Reeve, & Fess, 2005).

In summary, the primary benefit of JIT systems is the increased efficiency of operations, which is achieved by eliminating waste and simplifying the production process. At the same time, JIT systems emphasize continuous improvement in the manufacturing process and the improvement of product quality. 

*WARREN, REEVE, & FESS, 2005, ACCOUNTING, 21ST ED., PP. 796-799*

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