Question Answered

Before learning Six Sigma and Lean techniques I followed standard accounting:

(All tables and numbers are courtesy of Ron Crabtree, CPIM, CIRM Villanova Lean Accounting Lecture)

                                                                        Total Burdens 1,550,000

Direct Labor ‘Planned’ Hours                                                     98,000

(50 people working 49, 40-fr weeks)       

Burden absorption rate to apply:                                       $          15.82

Direct labor rate:                                                                  $          15.00

Fringes, vac./hol. And taxes at 27%                                  $          4.05

Total variable labor hourly:                                                $          19.05

Labor with Burden                                                               $          34.87

A new method of accounting is Activity Based Costing – Comparison to “Absorption”

Absorption                                                                 Activity Cost Approach

- Job Overhead absorbed                                       - Job A and B ABC:

in hourly rate                                                            - OE cost                                $100  

- Job A uses 10 hours @ $16= 160                        - Purchasing                          $150

in overheads                                                              - Work order                         $125

- Job B uses 100 hours = $1,600 in overheads   - Accounting                          $125

                                                                                    - Eng. Supt.                           $200

                                                                                    - Activity Cost           Total   $700

If you used the Absorption method you over charge the customer an extraordinary amount for Job B and end up taking a loss on Job A.

Now to answer the original question I posted:

We use Throughput Accounting based on the Theory of Constraints.  Because you are practicing Lean and Six Sigma Techniques you know your total system, the constraints, and are thus better able to focus on Value Add time.  You know how to calculate system output value.

                                                                                                For 100 items

                     Job A hrs. req’s        Job B hrs req’s Job A req’s    Job B req’s

Resource X                7                                  5                      700                 500

Resource Y                3                                  6                      300                 600

Resource Z                8                                  7                      800                 700

Sales Value                $100                           $125          $10,000          $12,500

Knowing your system you know that Resource Y is a capacity constraint resource and only has 400hrs available.  If you chose B then you can only produce 67 x $125 = $8,375.  BUT if you chose A then you can produce 100 x $100= $10,000 plus you have another 100hrs available from resource Y and can produce 17 units of B at $125 =  $2,125

Total profits if you chose A = $12,125

Total profits if you chose B = $8,375

When I first posted this question Rob, as I expected, was right on target with his questioning… he knew to look further.

 “Michael,

I am not sure we have enough information. Job A and B each require the same amount of total hours of resources which you say are all costing the same amount. Let's say in your example the three resources are x= designer, y= installer, z=service technician. Job A requires more design time, and more service time, but very little installer time, Job B requires a more balanced number of hours, and it also pays more.

I would want to know whether there are any limits on the amount of each resource (emphasis added) and whether one of these resources was more iffy in terms of delivery or availability,

(text removed)

Rob

www.corporateveilpro.com

Is Your Corporation Protecting You?”

I cannot state the reason for this post more effectively than Sales Trainer and Coach www.SteveChambers.com stated:

 “Six Sigma is a cool tool (emphasis added) and a neat philosophy with which to approach business. Thinking in a lean and efficient manner is a key business strength.”