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Chapter 19—Costing and the Value Chain
Financial and Managerial Accounting, 18e 19-1
19 COSTING AND THE VALUE CHAIN
Chapter Summary
The value chain is used to organize the discussion of several aspects of strategic
cost management. These include activity-based management, target costing, just-in-time
inventory procedures, and total quality management.
Activity-based management utilizes cost information from ABC systems to identify
and eliminate non-value-added activities. While Chapter 17 focused on activity-based
product costs, this chapter develops an extensive illustration to demonstrate the
management of activities associated with period costs. This is done to emphasize the
application of activity-based management across all phases of the value chain.
Target costing begins with planning and market analysis of customer needs, and
then proceeds to product development to generate a target price. Value engineering leads
to the most economically efficient combination of resources to create the product. Finally,
the target cost is attained through production and continuous improvement. A
straightforward example illustrates the execution of the four phases of the target costing
process.
The development of just-in-time inventory and production systems was one of the
earliest efforts of management to identify non-value-adding activities. The realization that
investment of resources in inventory added no value to the customer initiated the
development of the just-in-time philosophy. This philosophy emphasizes that all
production is driven by customer demand. The chapter centers on the importance of
supplier relationships, product quality, and flexible manufacturing in achieving the JIT
objective of controlling product costs.
The chapter concludes with a discussion of the components of quality costs and the
tradeoffs between prevention and appraisal costs on one hand and the costs of internal and
external failure on the other.
Learning Objectives
1. Define the value chain and describe its basic components.
2. Distinguish between non-value-added and value-added activities.
3. Explain how activity-based management is related to activity-based costing (ABC).
4. Describe the target costing process and list its components.
5. Identify the relationship between target costing and the value chain.
6. Explain the nature and goals of a just-in-time (JIT) manufacturing system.
7. Identify the components of the cost of quality.
8. Describe the characteristics of quality measures.
Chapter 19—Costing and the Value Chain
19-2 Instructor’s Resource Manual
Brief Topical Outline
A. The value chain
1. International financial reporting standards and the value chain
2. Value- and non-value-added activities—see Your Turn (page 845)
B. Activity-based management
1. Activity-based management across the value chain
a. Managing activities: an illustration (pages 846–848) – see
International Case in Point (page 849)
2. ABC: a subset of activity-based management
C. The target costing process
1. Components of the target costing process
2. Target costing: an illustration—see Your Turn (page 852)
3. Characteristics of the target costing process
D. Just-in-time inventory procedures
1. JIT, supplier relationships, and product quality
2. Measures of efficiency in a JIT system
a. Measuring quality
E. Total quality management and the value chain
1. Components of the cost of quality—see Case in Point (page 857)
2. Measuring the cost of quality
3. Productivity and quality—see Ethics, Fraud, & Corporate Governance
(page 858) and Pathways Connection (page 859)
F. Concluding remarks
Topical Coverage and Suggested Assignment
Class
Meetings on
Chapter
Topical
Outline
Coverage
Discussion
Questions*
Brief
Exercises*
Exercises*
Problems
*
Critical
Thinking
Cases*
1
A – B
1, 2, 3
1, 4
1, 2
2
2
C – D
6, 7, 8
2, 7, 8
8, 9
3
1
3
E – F
10, 11, 13
6, 9
13, 14
4
*Homework assignment (to be completed prior to class)
Chapter 19—Costing and the Value Chain
Financial and Managerial Accounting, 18e 19-3
Comments and Observations
Teaching Objectives for Chapter 19
Our goal in presenting this material is to help students to begin to think strategically about
the development and use of cost information. In so doing our objectives are to:
1. Introduce the value chain as a structure for strategic cost management.
2. Explain the distinction between value-added and non-value-added activities across
the value chain.
3. Show that activity-based costs are important to reducing and eliminating non-value-
added activities.
4. Explain how activity-based costs can be used to manage not only production, but also
activities across all components of the value chain.
5. Introduce target costing and its components.
6. Explain the JIT approach to identifying and reducing non-value-added activities.
7. Present measures of efficiency in a JIT manufacturing system.
8. Explain the trade-offs that exist among components of quality costs, and how those
trade-offs change with technical progress.
General Comments
Managing activities across the value chain represents a comprehensive integrated
approach to the traditional management functions of planning and control. Eliminating
non-value-added activities from the chain is central to this strategic approach to cost
management. Exercise 3 is designed to acquaint students with the value chain and the
identification of non-value-added activities in the chain.
We have emphasized that the ABC model developed in a previous chapter can be
usefully extended beyond product costing to a wide variety of period costs. Doing so
provides an opportunity to use ABC information to manage across the entire value chain.
This can be illustrated using Exercise 4. Although Problem 2 requires the calculation of
target costs, it provides a comprehensive opportunity for students to use cost information
to address activity-based management issues. We highly recommend reviewing this
problem in class. Case 1 is a more extensive alternative.
Target costing illustrates the use of cost information in planning and designing new
products as well as reengineering existing ones. Problem 3 captures the use of cost
estimates and budgets in the planning process. It also addresses the issue of process design
to minimize production costs.
Chapter 19—Costing and the Value Chain
19-4 Instructor’s Resource Manual
Quality costing, like ABM, emphasizes activity management across the value
chain. Prevention costs apply to the research and design phase, as well as in working with
suppliers and vendors. Appraisal costs and internal failures are most closely identified with
the suppliers and production component. Finally, external failure costs exert a significant
impact on customer service. Managing quality activities across the value chain highlights
the tradeoffs among these costs.
Supplemental Exercises
Internet Exercise
In this chapter, you are introduced to the concept of Six Sigma. Research this
process along with the industry certifications. Compare and contrast the objectives and
requirements of the Yellow Belt, Green Belt, and Black Belt. What are the advantages and
benefits associated with holding a Six Sigma certification?
Chapter 19—Costing and the Value Chain
Financial and Managerial Accounting, 18e 19-5
CHAPTER 19 NAME #
10-MINUTE QUIZ A SECTION
Indicate the best answer for each question.
1. Examples of value-added activities include all of the following except:
a Product design.
b Material movement.
c Assembly activities.
d Establish an effective distribution network.
2. Of the following components of total quality cost, which is most damaging to a company
attempting to achieve a reputation as a world-class manufacturer?
a Prevention costs.
b Appraisal costs.
c Internal failure costs.
d External failure costs
3. Of the following processes, which is chiefly concerned with products and services that have
not yet been developed?
a Just-in-time manufacturing.
b Activity-based management.
c Target costing.
d Total quality management.
4. For a furniture manufacturer, which of the following activities could not be eliminated without
changing the customer’s perception of the product’s desirability?
a Inspection of incoming shipments of wood and fabrics.
b Movement of work-in-process from one work station to another.
c Set-up of machinery to produce different pieces of furniture.
d Reducing the product’s distribution network.
5. The cost borne by the customer of disposing of nickel-cadmium batteries is a component of
the batteries’:
a Life-cycle cost.
b Overhead cost.
c Cost of quality.
d Direct production cost.
Chapter 19—Costing and the Value Chain
19-6 Instructor’s Resource Manual
CHAPTER 19 NAME #
10-MINUTE QUIZ B SECTION
Listed below are eight technical accounting terms introduced or emphasized in this chapter:
Activity-based management
Life-cycle costing
Value-added activity
Non-value-added activity
Target costing
Total quality management
Just-in-time manufacturing system
Cycle time
Each of the following statements may (or may not) describe one of these technical terms. In the
space provided below each statement, indicate the accounting term described, or answer “None” if
the statement does not correctly describe any of the terms.
a The process of using activity-based costs to help reduce or eliminate non-value-added
activities.
______________________________
b Can be eliminated without affecting the desirability of the product from the perspective
of the customer.
______________________________
c The length of time for a product to pass completely through a specific manufacturing
process.
______________________________
d If eliminated, the desirability of the product to consumers is decreased.
______________________________
e Consideration of all potential resources that will be consumed by a product from
development through disposal.
______________________________
f A method in which a product’s selling price is determined by adding a fixed profit margin
to its production cost.
______________________________
g An approach that explicitly monitors quality costs and rewards quality enhancing
behavior.
______________________________
Chapter 19—Costing and the Value Chain
Financial and Managerial Accounting, 18e 19-7
CHAPTER 19 NAME #
10-MINUTE QUIZ C SECTION
Listed below are eight components of the total cost of quality. In the space provided identify each
as a cost of prevention, appraisal, internal failure, or external failure.
1. Product design
2. Product returns due to defects
3. Inspection of raw materials shipments
4. Employee training
5. Rework of defective units prior to shipment
6. Estimated lost sales due to poor quality
7. Warranty expense
8. Inspection of finished goods
9. Scrap
Chapter 19—Costing and the Value Chain
19-8 Instructor’s Resource Manual
CHAPTER 19 NAME #
10-MINUTE QUIZ D SECTION
Resourceful Corporation is considering the implementation of a JIT inventory system. The
company recently analyzed its cycle time to determine the average number of days spent in each
activity of its production process. A summary of the analysis is shown below:
Production Activity Number of Days
Receiving materials 1
Inspecting materials 4
Storing materials 9
Moving materials into production 6
Setting-up production equipment 7
Cutting materials 6
Assembling materials 7
Painting finished products 4
Packaging finished products 1
a Resourceful’s value-adding production activities include:
b Resourceful’s total cycle time is __________ days.
c Resourceful’s manufacturing efficiency ratio is __________%.
d Which activities might be reduced or eliminated should Efficient implement a JIT system?
Chapter 19—Costing and the Value Chain
Financial and Managerial Accounting, 18e 19-9
SOLUTIONS TO CHAPTER 19 10-MINUTE QUIZZES
QUIZ A
1 B
QUIZ B
a Activity based management
QUIZ C
Prevention
QUIZ D
Chapter 19—Costing and the Value Chain
19-10 Instructor’s Resource Manual
Assignment Guide to Chapter 19
Brief
Exercises
Exercises
Problems
Cases
Net
Item number
1 – 10
1 – 15
1
2
3
4
5
6
7
8
1
2
4
3
Time estimate (in minutes)
< 15
< 15
30
60
30
40
30
40
50
30
50
40
25
30
Difficulty rating
E
E
M
S
M
M
M
M
S
M
M
S
M
M
Learning Objectives:
1
2, 10
1. Define the value chain and
describe its basic
components.
2. Distinguish between non-
value-added and value-added
activities.
4, 6
1, 3, 8, 10,
13
3. Explain how activity-based
management is related to
activity-based costing (ABC).
6
1, 3, 4, 9,
15
