Advanced manufacturing technologiesIn response to more intense and globalized completion, manufacturers areincorporating more flexible technologies into their production processes. Oneof most outstanding is advanced manufacturing technologies (AMT), a set oftools intended to automate and integrate the different stages of design,manufacturing, planning and control of the products. AMT results from theapplication of information and manufacturing technologies with the aim ofincreasing the response ability of plant and improve the results of theproduction process.Product Costing in Advanced Manufacturing TechnologiesIn a typical job shop operation, manufacturing costs are broken down intothree categories: direct materials, direct labor, and factory overhead. InAMTs, this classification scheme is somewhat less useful (Foster andHorngren, 1988a, 1988b).Direct materials This category of costs is usually the largest, irrespective ofthe manufacturing technology. In AMTs, direct materials used in a job aretracked by the central computer from the time the materials are releasedfrom the stock room until final assembly. This is made possible by bar codes,optical characters, or magnetic strips attached to the materials. In effect,bar coding (and its alternatives) allows firms to integrate their materialsresources planning (MRP) systems with their accounting systems. Given theproduction schedule, the MRP system schedules the delivery of parts andcomponents inventory needed for production from the stock rooms andwarehouses to the production floor or to the automated materials handlingsystem (AMHS). The primary effect of integrating the MRP system with theaccounting system is to reduce and often eliminate the paperwork associatedwith tracking direct materials in a conventional job shop environment. Errorsin tracking direct material costs are also minimized.Direct labor Direct labor in AMTs is minimal by comparison to conventionaltechnologies. In a conventional job shop operation, for example, an operatoris typically needed at each machine for loading, unloading, set-ups, machinecontrol, and so on. In AMTs, these functions are handled by programmable
controllers and the central computer in conjunction with the AMHS.Operators are nevertheless required to load and unload the AMHS.Troubleshooting operators make sure that production machinery is runningsmoothly and service the machines when necessary. Technicians andcomputer operators also perform maintenance duties. Tool setters get thetools ready for the job and set-up operators are used to set-up special dies,fixtures, and jigs. In most cases, it is next to impossible to trace a specificoperator to a particular job or product. A load operator may load 10 units ofproduct A, then 5 of B and 7 of C, all within a limited range of time. For allintents and purposes, most labor in AMTs is fixed factory overhead ratherthan variable direct labor. The amount of direct labor may be sufficientlyminimal so that very little costing bias is introduced by treating all labor asfixed factory overhead.Factory overhead and service support costsAfter direct materials, the next largest category of costs in AMTs is factoryoverhead or service support costs. The important question from amanagement accounting perspective is how to allocate these overhead coststo the product so that the resultant product costs truly reflect long-runresource usage.Unlike a typical job shop, processors and computers keep accurate data onmachine usage in AMTs. Specifically, the central computer collectsprocessing times for each job on all numerically controlled machines. Thismeans it is possible to use each machine or assembly of homogeneousmachines or manufacturing cell as a cost center (machine center) to bothaccumulate costs in cost pools and to allocate these costs to products.Consider the factory overhead item “equipment depreciation expense.” Onepotential method of allocating this cost to products is to cumulate theacquisition cost of machinery in each machine center. The cost of commonequipment like the central computer and the AMHS could be allocated toeach machine center based upon the proportion of each machine center’sequipment costs to the total equipment costs of all machine centers. Therationale here is that more costly machine centers are also more likely toplace greater demands on the common equipment resources. The cost ofeach machine center, inclusive of allocated common equipment costs, could
then be divided by the expected productive capacity of the machine center(in hours) over its economic lifetime. This calculation yields a depreciationrate for each machine center based upon hourly usage of that center.Products could then be costed based on this hourly rate and the actual usageof the machine center by the product.Operating expenses could be allocated to each product on the basis ofmachine center equipment costs, or machine center physical area, or bymachine power usage, depending on the specific expense. Maintenanceexpenses, for example, tend to vary with the complexity, automation, andspeed of the machine center, so that maintenance is probably best allocatedon the basis of machine center equipment costs. Building depreciation,custodial services, water, etc. should probably be allocated on the basis ofmachine center area. Power and electricity charges are best allocated tomachine centers on the basis of the rated capacity of the machine or, ifavailable, actual power usage of the machine center.Activity-Based Costing in Advanced Manufacturing TechnologiesActivity based costing (ABC) maintains as its primary tenet that productcosts are generated by non-volumetric cost drivers such as productcomplexity, set-ups, quality control inspections, and materials handling, toname only a few, as well as the volume of production (Cooper and Kaplan,1992). This insight is particularly pertinent to AMTs, where most costs,except for direct materials, are of an overhead or service support nature andare usually not driven by the volume of production. Take set-up costs, forexample. It is generally immaterial whether the set-up is for a run of 10,000units or 10 units, as the set-up costs are likely to be the same. Allocatingset-up costs by volume rather than the number of set-ups (the cost driver)would lead to overcosting high volume products and under-costing lowvolume products. If, in turn, prices are cost determined, as in markuppricing, this would result in high volume products being overpriced and lowvolume products being underpriced.The nature of cost in AMTs is such that the relevant cost drivers must becarefully defined. Consider set-up costs again. In AMTs there are two typesof set-ups: initial set-ups and subsequent set-ups. New products have to beprogrammed, their production scheduling simulated and tested by trial runs
in order that they mesh effortlessly within an automated system. Theseinitial set-ups are quite costly, involving the time and effort of computeranalysts and process engineers. Essentially, these costs are driven bydemand for the product over its life cycle. Therefore, initial set-up costsshould be capitalized in an ABC analysis and allocated to the product basedon the total number of units to be manufactured over the product’s lifecycle. In other words, initial setup costs are driven by the volume ofproduction. Subsequent set-up costs, on the other hand, are driven by thenumber of set-ups rather than the volume of production, as noted above.JIT, TQM, and Management AccountingAMTs, especially FMS plants, often adopt Just in Time (JIT) inventorysystems. In a JIT system, delivery of inventory components and parts takesplace immediately prior to production. Ideally, there is almost no standinginventory of direct materials or work in process. Therefore, a sine qua nonfor JIT is a stable demand for the product family and a commitment to TotalQuality Management (TQM), namely, the production of high quality productsvia high quality manufacturing processes (Ittner and Larcker, 1998, 2001).Firms adopting JIT typically reduce the number of their suppliersdramatically. Long-term contracts stipulating price and acceptable qualitylevels are negotiated with the remaining suppliers. In most cases, suppliersare required to do in-house quality inspections prior to delivery. Inventory isnormally delivered in shop-ready containers to facilitate materials handling.There is some evidence that plants adopting AMTs, JIT, and TQM within thesame limited time period are not as successful as plants that adopt JIT andTQM without further investment in AMTs (Sim, 2001). This phenomenon isprobably due to the inability of management and workers to cope withexcessive change within the same time period.JIT simplifies the management accounting system in some ways andincreases its complexity in others (Foster and Horngren, 1998a). On the onehand, JIT increases the direct traceabil-ity of costs by reducing jointoverhead costs such as warehousing and materials handling. The reductionor elimination of these costs also reduces the number of cost pools used toaccumulate costs. As a consequence, JIT changes the basis for allocatingindirect costs to production departments. Instead of using warehouse space
as an allocation basis for purchases and material handling costs, the dollarvalue of materials or the number of deliveries are used. JIT also simplifiesthe internal accounting system by reducing the frequency and detail ofpurchase deliveries. Since JIT induces constant flow manufacturing andminimizes spoilage and reworked units, firms adopting JIT often change frommore complex job costing systems to simpler process costing or even toback flush costing systems. On the other hand, the performancemeasurement requirements of a JIT environment add complexity to themanagement accounting system because the focus changes from traditionalfinancial performance measures, such as cost variances and profit data, thatare weak indicators of plant operational performance, to the incorporation ofnon-financial performance measures that are more directly related to theunderlying activities of the plant manufacturing process (Fullerton andMcWatters, 2002; Callen, Morel, and Fader, forthcoming). In particular,purchase price variances are deem-phasized, as are labor variances,because of the team effort required to successfully implement and maintaina JIT philosophy.Measuring Performance in Advanced Manufacturing TechnologiesComputer integration in AMTs has given manufacturing firms the capabilityof developing physical and financial performance measures at a fairlydisaggregated level (Maskell, 2000). Such performance measures include (1)partial productivity measures (e.g., output per employee) and indices oftotal factor productivity; (2) partial quality measures (e.g., product quality)and indices of total quality; (3) partial flexibility measures (e.g., processflexibility) and indices of total flexibility in FMS; and (4) disaggregatedinventory turnover ratios for all types of inventories and for each productline in JIT plants. Other performance measures commonly used in AMTplants include manufacturing cycle time, idle time, scrap and rework costs,material cost variances, percent of on-time delivery, percent of orders filled,and so on. There have also been attempts to integrate a number of theseperformance measures (e.g., quality, flexibility, and productivity) into oneintegrated performance measure. In particular, management accounting hasemphasized the balanced score-card as a desirable comprehensiveintegrated performance measure that provides strategic guidance forachieving long-term firm objectives in a timely fashion. The balanced
scorecard integrates four categories of performance measures: financial(e.g., return on assets), customer oriented (e.g., customer satisfaction),internal business process (e.g., product quality), and learning growth (e.g.,hours of employee training). The paucity of evidence currently availableregarding the efficacy of balanced scorecard implementation does not permitgeneralization. Nevertheless, intuition suggests that more complextechnological environments are more likely to benefit from an integratedperformance medium that informs management and workers about thefirm’s goals. The only empirical result to date regarding the relationshipbetween technology and adoption of the balanced scorecard is that firmsthat have a higher proportion of new products have a tendency to emphasizemeasures in the scorecard that relate to new products.Since a large portion of costs in AMTs involves fixed resources, an evaluationof unused capacities is essential for cost management. One approach tomeasuring unused capacity and unused capacity cost for each fixed resourceis to determine its utilization possibility. Engineering specifications can beused to estimate maximum possible utilization (in terms of output ormachine hours or other appropriate cost drivers), which is then reduced forexpected repair and/or maintenance downtime. If available, the utilizationlevel of competitors may be used as a gauge. This maximum capacity levelis then used to compute unused capacity for each resource in the firm.Dividing the fixed resource cost by this maximum capacity yields a costapplication rate suitable for reasonably accurate product cost determination.Multiplying this application rate by unused capacity measured in terms of thecost driver yields, in turn, an estimate of the unused capacity cost. Theunused capacity costs for each resource is a powerful aid for appropriatecost management through continuous improvement, outsourcing unusedcapacities, and so on. In addition, this approach to product costdetermination can also help in assessing the best competitive market pricefor the product.Investment and the Profitability of Advanced Manufacturing TechnologiesAccounting information is a potentially important input into the decision toinvest in AMTs. The problem is that many of the benefits and costs of AMTs,such as the benefits and costs of productivity, quality, and flexibility, are
difficult to quantify. A related problem is that manufacturing systems tend tobe too dynamic and too complex to describe adequately in mathematicalterms. Therefore, although a discounted (after tax) cash flow (DCF) model isappropriate for AMTs as well as conventional technologies, it is far moredifficult to estimate the cash flows of the former. Research in this area hasconcentrated on integrating simulation models of the manufacturing firmwith DCF models to evaluate investment in AMTs versus conventionaltechnologies. Unfortunately, these models are highly sensitive to thediscount rate and it is not at all clear what discount rate is appropriate,especially since the risk structure of AMTs is very different from conventionaltechnologies. The decision to invest in flexible manufacturing is a case inpoint. If the FMS and the conventional plant have similar cost structures, theFMS likely dominates the conventional technology (Callen and Sarath,1995). FMS plants, however, require extremely large initial capital outlaysby comparison to conventional technologies. Moreover, FMS plants are moresusceptible to swings in the business cycle (which may affect the demand forthe entire product family) yet less susceptible to unpredictable changes indemand for any given product within a product family. The upshot is that inmany cases investments in AMTs are never fully rationalized and thedecisions to invest in AMTs are often made on the basis of “feel” rather thanthe underlying economics. In point of fact, accounting has had far less of animpact on the decision to adopt AMTs than is prudent. Indeed, recentarchival research studies find mixed results regarding the profitability ofadopting AMTs. Many of these studies are problematic, however, becausetheir analysis is based on firm level data, whereas AMTs are often adopted atspecific plants only. The few plant level studies to date do provide fairlyconvincing evidence that AMTs are more profitable than conventional plants(Flynn, Sakakibara, and Schroeder, 1995; Callen, Fader, and Krinsky, 2000).Although the excess profitability of AMT plants over conventional may simplyreflect risk-return tradeoffs – AMT plants may be more risky, for example,because of minimal buffer stocks – in fact, the empirical evidence suggeststhat plants that adopt AMTs are more profitable than conventional plants,even after controlling for the additional risks (Callen, Morel, and Fader,2003).