Management Accounting and Control Systems: Assessing Performance over the Value Chain

1
Management Accounting and Control
SystemsAssessing Performance over the Value
Chain

• Chapter 7

2
Management Accountingand Control System

• Generates and uses information to help decision
  makers assess whether an organization is
  achieving its objectives
• A cost management system is one of the central
  performance measurement systems at the core of a
  larger entity known as a management accounting
  and control system

3
Control In ManagementAccounting And Control

• A set of
• Procedures
• Tools
• Performance measures
• Systems
• Used by organizations to guide and motivate
  employees to achieve organizational objectives

4
In Control

• A system is in control if it is on the path to
  achieving its strategic objectives
• It is deemed out of control otherwise
• For the process of control to have meaning and
  credibility, the organization must have the
  knowledge and ability to correct situations that
  it identifies as out of control

5
Five Stages Of Control (1 of 2)

• Planning
• Developing an organizations objectives
• Choosing activities to accomplish the objectives
• Selecting measures to determine how well the
  objectives were met
• Execution
• Implementing the plan

6
Five Stages Of Control (2 of 2)

• Monitoring
• The process of measuring the systems current
  level of performance
• Evaluation
• When feedback about the systems current level of
  performance is compared to the planned level so
  that any discrepancies can be identified and
  corrective action prescribed
• Correcting
• Taking the appropriate actions to return the
  system to a state of in control

7
A Well-Designed MACS

• Designers of management accounting and control
  systems (MACS) have both behavioral and technical
  considerations to meet
• Behavioral aspects covered in a later chapter
• The technical considerations fall into two
  categories
• Relevance of the information generated
• Scope of the system

8
Characteristics of RelevantInformation (1 of 2)

• Accurate
• Inaccurate information is not useful for decision
  making because it is misleading
• Timely
• Accurate information that is available too late
  is of no use for decision making
• The MACS must be designed so that the results of
  performance measurement are fed back to the
  appropriate units in the most expedient way
  possible

9
Relevant Information (2 of 2)

• Consistent
• The language used and the technical methods of
  producing management accounting information do
  not conflict within various parts of an
  organization
• Flexible
• MACS designers must allow employees to use the
  systems available information in a flexible
  manner so they can customize its application for
  local decisions
• If flexibility is not possible, an employees
  motivation to make the best decision may be
  lessened for the decision at hand, especially if
  different units engage in different types of
  activities

10
Scope Of The System

• Must be comprehensive and include all activities
  across the entire value chain of the organization
• If the MACS measures and assesses performance in
  only the actual production process, it ignores
  the performance of
• Suppliers
• Design activities
• Postproduction activities associated with
  products
• Without a comprehensive set of information,
  managers can only make limited decisions

11
The Value Chain (1 of 2)

• A sequence of activities that should contribute
  more to the ultimate value of the product than to
  its cost
• All products flow through the value chain
• Begins with research, development, and
  engineering
• Moves through manufacturing
• Continues on to customers
• Customers may require service and will either
• consume the product
• dispose of it after it has served its intended
  purpose

12
The Value Chain (2 of 2)

• The value chain may be divided into cycles, which
  correspond to different cost control approaches

Research, Development Engineering Cycle
Manufacturing Cycle
Post-Sale Service and Disposal Cycle
Target Costing Value Engineering
Total-Life-Cycle Costing Environmental
Costing Benchmarking
Kaizen Costing
13
Total-Life-Cycle Costing (1 of 4)

• Total-life-cycle costing (TLCC) is the name of
  the process of managing all costs along the value
  chain
• TLCC is also known as managing costs from the
  cradle to the grave

14
Total-Life-Cycle Costing (2 of 4)

• A TLCC system provides information for managers
  to understand and manage costs through a
  products stages of

• Distribution
• Maintenance
• Service
• Disposal

• Design
• Development
• Manufacturing
• Marketing

15
Total-Life-Cycle Costing (3 of 4)

• Deciding how to allocate resources over the life
  cycle usually is an iterative process
• Initially a company may decide to spend more on
  design to reduce the costs of upstream costs,
  such as manufacturing, and service-related costs
• At a later time, the company may determine how to
  reduce those initial design costs of new products
• Opportunity costs play a heightened role in a
  total-life-cycle cost perspective
• It is possible to develop only a limited number
  of products over a particular time period

16
Total-Life-Cycle Costing (4 of 4)

• Numerous life-cycle concepts have emerged in
  various functional areas of business
• A TLCC perspective integrates the concepts so
  that they can be understood in their entirety
• From the manufacturers perspective,
  total-life-cycle product costing integrates these
  functional life-cycle concepts
• Research, development, and engineering
• Manufacturing
• Post-sale service and disposal

17
Research, Development, And Engineering (RDE)
Cycle

• The RDE Cycle has three stages
• Market research
• Emerging customer needs are assessed and ideas
  are generated for new products
• Product design
• Scientists and engineers develop the technical
  aspects of products
• Product development
• The company creates features critical to customer
  satisfaction and designs prototypes, production
  processes, and any special tooling required

18
Cost Control in the RDE Cycle

• By some estimates, 80 to 85 of a products
  total life costs are committed by decisions made
  in the RDE cycle
• Committed costs are those that a company knows it
  will have to incur at a future date
• Decisions made in this cycle are critical
• An additional dollar spent on activities that
  occur during this cycle can save at least 8 to
  10 on manufacturing and post-manufacturing
  activities
• Design changes
• Service costs

19
Manufacturing Cycle

• After the RDE cycle, the company begins the
  manufacturing cycle
• Costs are incurred in the production of the
  product
• This is where product costing traditionally plays
  its biggest role
• Usually at this stage there is not as much room
  for engineering flexibility to influence product
  costs and product design because they have been
  set in the previous cycle

20
Cost Control in theManufacturing Cycle

• Operations management methods help to reduce
  manufacturing life-cycle product costs
• Facilities layout
• Just-in-time manufacturing
• Companies have begun to use management accounting
  methods such as activity-based cost management to
  identify and reduce non-value-added activities in
  an effort to reduce costs in the manufacturing
  cycle

21
Post-sale Service Disposal Cycle

• This cycle overlaps the manufacturing cycle
• The service cycle begins once the first unit of a
  product is in the hands of the customer
• Disposal occurs at the end of a products life
  and lasts until the customer retires the final
  unit of a product
• The costs for service and disposal are committed
  in the RDE stage

22
The Service Cycle

• The service cycle typically consists of three
  stages
• Rapid growth
• From the first time the product is shipped to the
  growth stage of its sales
• Transition
• From the peak of sales to the peak in the service
  cycle
• Maturity
• From the peak in the service cycle to the time of
  the last shipment made to a customer

23
The Disposal Cycle

• Disposal occurs at the end of a products life
  and lasts until the customer retires the final
  unit of a product
• Disposal costs often include those associated
  with eliminating any harmful effects associated
  with the end of a products useful life
• Products whose disposal could involve harmful
  effects to the environment, such as nuclear waste
  or toxic chemicals, often incur very high costs

24
Life-Cycle Costs

• The following table illustrates four types of
  products and the percentage of life-cycle costs
  incurred in each cycle

Combat Jets Commercial Aircraft Nuclear Missiles Computer Software
RDE Manufacturing Service Disposal Average Years in Life Cycle 21 45 34 30 20 40 40 25 20 60 20 2 to 25 75 25 5
For computer software, RDE and manufacturing
are often tied directly together
25
Target Costing

• A method of profit planning and cost management
  that focuses on products with discrete
  manufacturing processes
• Its goal is to design costs out of products in
  the RDE stage of a products total life cycle
• Rather than trying to reduce costs during the
  manufacturing stage
• It is a relevant example of
• How a well-designed MACS can be used for
  strategic purposes
• How critical it is for organizations to have a
  system in place that considers performance
  measurement across the entire value chain

26
The Traditional Method

• Begins with market research into customer
  requirements followed by product specification
• Companies engage in product design and
  engineering and obtain prices from suppliers
• Product cost is not a significant factor in
  product design at this stage
• After the engineers and designers have determined
  product design, they estimate cost
• Product designers do not attempt to achieve a
  particular cost target
• If the estimated cost is considered to be too
  high, then it may be necessary to modify the
  product design

27
The Target Costing Method (1 of 5)

• Both the sequence of steps and the way of
  thinking about determining product costs differ
  significantly from traditional costing
• Although the initial steps appear similar to
  traditional costing, there are some notable
  differences
• First, marketing research under target costing is
  not a single event as it often is with the
  traditional approach
• While customer input is obtained early in the
  marketing research process, it is also collected
  continually throughout the target costing process

28
The Target Costing Method (2 of 5)

• Second, much more time is spent at the product
  specification and design stage
• To minimize design changes during the
  manufacturing process when it is far more
  expensive to implement
• Third, the total-life-cycle concept is used by
  making it a key goal to minimize the cost of
  ownership of a product over its useful life
• Not only are costs such as the initial purchase
  price considered, but also the costs of
  operating, maintaining, and disposing of the
  product

29
The Target Costing Method (3 of 5)

• After these initial steps, the target costing
  process becomes even more distinctive
• Determining a target selling price and target
  product volume depends on the companys perceived
  value of the product to the customer
• The target profit margin results from a long-run
  profit analysis, often based on return on sales
• Return on sales is the most widely used measure
  because it can be linked most closely to
  profitability for each product
• The target cost is the difference between the
  target selling price and the target profit margin

30
The Target Costing Method (4 of 5)

• Once the target cost has been set, the company
  must determine target costs for each component
• The value engineering process includes
  examination of each component of a product to
  determine whether it is possible to reduce costs
  while maintaining functionality and performance
• In some cases, product design may change,
  materials used in production may need replacing,
  or manufacturing processes may require redesign
• Several iterations usually are needed before it
  is possible to determine the final target cost

31
The Target Costing Method (5 of 5)

• Two other differences characterize the process
• First, cross-functional teams made up of
  individuals representing the entire value chain
  guide the process throughout
• From both inside and outside the organization
• A second difference is that suppliers play a
  critical role in making target costing work
• If there is a need to reduce the cost of specific
  components, firms will ask their suppliers to
  find ways to reduce costs

32
Supply Chain Management

• Develops cooperative, mutually beneficial,
  long-term relationships between buyers and
  suppliers
• As trust develops between buyer and supplier,
  decisions about how to resolve cost reduction
  problems can be made with shared information
  about each others operations
• The buyer may expend resources to train the
  suppliers employees in some aspect of the
  business
• A supplier may assign one of its employees to
  work with the buyer to understand a new product

33
Concerns About Target Costing

• Some studies of target costing in Japan indicate
  that there are potential problems in implementing
  the system
• Especially if focusing on meeting the target cost
  diverts attention away from the other elements of
  overall company goals
• Companies may find it possible to manage many of
  these factors
• Organizations interested in using the target
  costing process should be aware of them before
  attempting to adopt it

34
Examples of Problems (1 of 2)

• Conflicts can arise between various parties
  involved in the target costing process
• Excessive pressure on subcontractors and
  suppliers to conform to a schedule and reduce
  costs can lead to alienation and/or failure of
  the subcontractor
• Design engineers may become upset when other
  parts of the organization are not cost conscious
• They argue that they exert much effort to squeeze
  pennies out of the cost of a product while other
  parts of the organization (administration,
  marketing, distribution) are wasting dollars

35
Examples of Problems (2 of 2)

• Employees in many Japanese companies working
  under target costing goals experience burnout due
  to the pressure to meet the target cost
• Burnout is particularly evident in design
  engineers
• Development time may increase because of repeated
  value engineering cycles to reduce costs
• May lead to the product coming late to market
• For some types of products, being six months late
  may be far more costly than having small cost
  overruns

36
Kaizen Costing (1 of 2)

• Similar to target costing in its cost-reduction
  mission
• However, it focuses on reducing costs during the
  manufacturing stage of the total life cycle of a
  product
• Kaizen is the Japanese term for making
  improvements to a process through small,
  incremental amounts rather than through large
  innovations

37
Kaizen Costing (2 of 2)

• Kaizen costings goal is to ensure that actual
  production costs are less than the prior year
  cost
• Kaizens goals are reasonable
• The product is already in the manufacturing
  process, thus it is difficult and costly to make
  large changes to reduce costs
• It is tied to the profit-planning system
• If the cost of disruptions to production are
  greater than the savings due to kaizen costing,
  then it will not be applied

38
Example From Auto Plant (1 of 2)

• An annual budgeted profit target is allocated to
  each plant
• Each automobile has a predetermined cost base,
  which is equal to the actual cost of that
  automobile in the previous year
• All cost reductions use this cost base as their
  starting point
• The targeted cost reduction is the amount the
  cost base must be reduced to reach the profit
  target

39
Example From Auto Plant (2 of 2)

• The target reduction rate is the ratio of the
  target reduction amount to the cost base
• This rate is applied over time to all variable
  costs
• Results in specific target reduction amounts for
  materials, parts, direct and indirect labor, and
  other variable costs
• Then management makes comparisons of actual
  reduction amounts across all variable costs to
  the pre-established targeted reduction amounts
• If differences exist, variances for the plant are
  determined

40
Concerns About Kaizen Costing

• The system places enormous pressure on employees
  to reduce every conceivable cost
• Some Japanese automobile companies use a grace
  period just before a new model is introduced
• This cost-sustainment period provides employees
  with the opportunity to learn any new procedures
  before the company imposes kaizen targets on them
• Kaizen costing leads to incremental rather than
  radical process improvements
• This can cause myopia as management tends to
  focus on the details rather than the overall
  system

41
Environmental Costing

• Environmental remediation, compliance, and
  management have become critical aspects of many
  businesses
• All parts of the value chain, and their costs,
  are affected by environmental issues
• Environmental costing involves
• Selecting suppliers whose philosophy and practice
  in dealing with the environment matches the
  buyers
• Disposing of waste products during the production
  process
• Addressing post-sale service and disposal issues
• These issues are being incorporated into cost
  management systems and overall MACS design

42
Controlling Environmental Costs

• Only when managers and employees become aware of
  how the activities in which they engage create
  environmental costs will they be able to control
  and reduce them
• The activities that cause environmental costs
  have to be identified
• The costs associated with the activities have to
  be determined
• These costs must be assigned to the most
  appropriate products, distribution channels, and
  customers

43
Types of Environmental Costs

• Environmental costs fall into two categories
• Explicit costs
• The direct costs of modifying technology and
  processes, costs of cleanup and disposal, costs
  of permits to operate a facility, fines levied by
  government agencies, and litigation fees
• Implicit costs
• More closely tied to the infrastructure required
  to monitor environmental issues
• These costs are usually administration and legal
  counsel, employee education and awareness, and
  the loss of goodwill if environmental disasters
  occur

44
Benchmarking

• A way for organizations to gather information
  regarding the best practices of others
• Often highly cost effective, by
• Avoiding the mistakes that other companies have
  made
• Not reinventing a process or method that others
  have already developed and tested
• Selecting appropriate benchmarking partners is a
  critical aspect of the process
• The process typically consists of five stages

45
Stage 1

• Internal study and preliminary competitive
  analyses
• The organization decides which key areas to
  benchmark for study
• Then the company determines how it currently
  performs on these dimensions by initiating
• Preliminary internal competitive analysis
• Preliminary external competitive analyses
• Both types of analyses will determine the scope
  and significance of the study for each area
• These analyses are not limited to companies in a
  single industry

46
Stage 2 (1 of 2)

• Developing long-term commitment to the
  benchmarking project and coalescing the
  benchmarking team
• Because significant organizational change can
  take several years, the level of commitment to
  benchmarking has to be long term rather than
  short term
• Long-term commitment requires
• Obtaining the support of senior management to
  give the benchmarking team the authority to
  spearhead the changes
• Developing a clear set of objectives to guide the
  benchmarking effort
• Empowering employees to make change

47
Stage 2 (2 of 2)

• The benchmarking team should include individuals
  from all functional areas in the organization
• An experienced coordinator is usually necessary
  to organize the team and develop training in
  benchmarking methods
• Lack of training often will lead to the failure
  of the implementation

48
Stage 3 (1 of 3)

• Identifying benchmarking partnerswilling
  participants who know the process
• Some critical factors are as follows
• Size of the partners
• Will depend on the specific activity or method
  being benchmarked
• For example, if an organization wants to
  understand how a huge organization with several
  divisions coordinates its suppliers, then it
  would probably seek an organization of similar
  size
• Size is not always an important factor

49
Stage 3 (2 of 3)

• Number of partners
• Useful for an organization to consider a wide
  array of benchmarking partners
• Must be aware that as the number of partners
  increases, so do issues of coordination,
  timeliness, and concern over proprietary
  information disclosure
• Researchers argue that todays changing business
  environment is likely to encourage firms to have
  a larger number of participants
• Increased competition and technological progress
  in information processing increases benchmarking
  benefits relative to costs

50
Stage 3 (3 of 3)

• Relative position of the partners within and
  across industries
• Newcomers and those whose performance has
  declined are more likely to seek a wider variety
  of benchmarking partners than those who are
  established industry leaders
• Those who are industry leaders may benchmark
  because of their commitment to continuous
  improvement
• Degree of trust among partners
• Developing trust among partners is critical to
  obtaining truthful and timely information
• Most organizations operate on a quid pro quo
  basis, with the understanding that both
  organizations will obtain information they can use

51
Stage 4

• Information gathering and sharing methods
• Two related dimensions emerge from the
  literature
• Type of information that benchmarking
  organizations collect
• There are three broad classes of information on
  which firms interested in benchmarking can focus
  product, functional (process), and strategic
  benchmarking
• Methods of information collection
• There are two major methods of information
  collection for benchmarking, unilateral and
  cooperative

52
Stage 5

• Taking action to meet or exceed the benchmark
• The organization takes action and begins to
  change
• After implementing the change, the organization
  makes comparisons to the specific performance
  measures selected
• The decision may be to perform better than the
  benchmark to be more competitive
• The implementation stage is perhaps the most
  difficult stage of the benchmarking process, as
  the buy-in of members is critical for success

53
If you have any comments or suggestions
concerning this PowerPoint presentation, please
contactTerry M. Lease(terry.lease_at_sonoma.edu)S
onoma State University