Week 10.ppt

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Week 10

Cost Management and

Strategic Decision Making

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Management Accounting Concepts

In most management accounting models, relevance and timeliness of information is stressed before verifiability or reliability.

Cost/benefit decisions must also be evaluated in accumulating information.

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Questions to consider when deciding how to account:

For what type of company would a particular technique be most appropriate (e.g., what type of product, what type of manufacturing process)?

For what type of decisions would a technique best suited (e.g., short-term versus long-term decisions)?

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Questions to consider when choosing a technique:

What assumptions are built into the technique?

How do these assumptions weaken the usefulness of the technique?

If so, could the technique be modified to produce more meaningful information?

Are there inter-relationships between described techniques?

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Questions to consider when choosing a technique:

Should a company use just ONE management accounting system — or should techniques be used in combinations, or for different types of decisions?

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Management accounting techniques often combine both financial and non-financial measures.

Non-financial measures are more difficult to “standardize.”

Quality; Functionality and features; Service.

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The answer to these questions depends on two factors:

What is the company’s business strategy? What is the level in the organization at

which the measurements are being made?

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Business strategy: Focuses on what a company tries to

deliver to its customers. Referred to as the company’s value

proposition. Encompasses things such as:

Cost Quality Functionality Features Service.

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Level of the organization: Business unit level:

Cost centre; Profit centre; Investment centre.

Product level: Batches; Unit level.

Degree of (de)centralization.

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Strategic Management

Strategic management can be defined as “the art and science of formulating, implementing, and evaluating cross-functional decisions that enable an organization to achieve its objectives.”

Strategic management focuses on integrating all departments within an organization.

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Before determining the objectives and measures, an organization must articulate its vision and mission statements.

A concise statement that defines the mid- to long-term (3 to 10 year) goals of the organization.

A concise, internally-focused statement of how the organization expects to compete and deliver value to customers

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CGA-BC will be the dominant accounting profession in B.C.

The Association is branded as a “must belong-to” organization in order to be a successful professional accountant in B.C.

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CGA-BC is an indispensable resource to its members and students, as well as to other stakeholders.

CGA-BC’s reputation among accounting students is that it is the best, the only choice for accounting education in B.C.

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To promote the excellence of its members and advance the accounting profession.

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The Vision and Mission set the general direction for the organization.

But these statements are far too vague to guide day-to-day actions and resource allocation decisions.

Companies start to make the statements operational when they define a strategy of how the vision and mission will be achieved.

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Before an entity can make decisions relating to strategy formulation, it must consider the nature of the organization.

The spectrum runs from service-oriented to manufacturing.

The key success factors are often diametrically opposed.

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Manufacturing organizations have the following characteristics:

Physical and/or durable products. Output can be inventoried. Low customer contact. Long response time. Regional, national and/or international

markets. Large facilities. Capital intensive. Quality easily measured.

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Service organizations have the following characteristics:

Intangible and/or perishable products. Output (usually) cannot be inventoried. High customer contact. Short response time. Usually local markets markets. Usually small facilities. Labour and/or knowledge intensive. Quality not easily measured.

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Strategic management can also be seen as a system of analysis, decisions, and actions an organization undertakes in order to create and sustain competitive advantages.

The purpose of strategic management is to exploit and create new and different opportunities for tomorrow.

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The strategic management process consists of three stages:

Strategy Formulation(create)

Strategy Implementation(do)

Strategy Evaluation(monitor)

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Strategy formulation includes: Developing a vision and mission. Identifying an organization’s external

opportunities and threats. Determining internal strengths and

weaknesses. Establishing long-term objectives. Generating alternative strategies. Choosing particular strategies to pursue.

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The strategic management process is based on the belief that organizations should continually monitor internal and external events and trends so that timely changes can be made as needed.

To survive, an organization must be capable of identifying and adapting to change.

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What are our chances of survival if we continue as we are?

What are the best opportunities for growth given our existing capabilities?

What are our competitive advantages and disadvantages?

Where can we invest to improve our capabilities most efficiently?

What changes can we realistically implement?

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A key factor is the behavioral impact of decisions taken.

That relates to both measurement and management.

The aphorism that “what gets measured, gets managed” is both a fact and a warning.

Be sure that an increase in the variable measured really is a “true” increase in performance.

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A MACS should generate and use information to help decision makers assess whether an organization is achieving its objectives.

MACS should be comprehensive and include all activities across the entire value chain of the organization.

MACS must be able to provide feedback as to whether the firm is achieving its strategy and if not, alert it to that fact.

Management Accounting and Control Systems (MACS)

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If the MACS measures and assesses performance in only the actual production process, it ignores factors such as:

Suppliers; Design activities; Postproduction activities associated

with products.


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A well-designed MACS must have relevant information and be:

Accurate; Timely Consistent; and Flexible.


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Accurate information is needed as inaccurate information is not useful for decision making.

Timely information is needed as: Accurate information that is available too

late is of no use for decision making. The results of performance

measurements must be fed back to the appropriate units in the most expedient way possible.


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The language used and the technical methods of producing management accounting information must be consistent and not conflict with various parts of an organization.


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MACS must allow employees to use the system’s available information in a flexible manner so they can customize its application for local decisions.

If flexibility is not possible, an employee’s motivation to make the best decision may be lessened for the decision at hand, especially if different units engage in different types of activities


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MACS must aid management with the five stages of control:

1. Planning: Developing an organization’s

objectives; Choosing activities to accomplish the

objectives; and Selecting measures to determine how

well the objectives were met.


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2. Execution: Implementing the plan(s).


3. Monitoring: Measuring the system’s current level

of performance.

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4. Evaluation: Feedback about the system’s current

level of performance is compared to the planned level so that any discrepancies can be identified and corrective action prescribed.


5. Correction: Taking the appropriate actions to

return the system to a state of in control.

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MACS: The Value Chain

A sequence of activities that 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.

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Customers may require service and will either:

consume the product; or dispose of it after it has served its

intended purpose. The value chain may be divided into

cycles, which correspond to different cost control approaches.

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Research, Development & Engineering

Cycle

Manufacturing Cycle

Post-Sale Service and

Disposal Cycle

Target Costing & Value Engineering

Kaizen Costing

Total-Life-Cycle Costing

Environmental Costing

Benchmarking

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MACS: Target costing

Target costing is 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 RD&E stage of a product’s total life cycle rather than trying to reduce costs during the manufacturing stage.

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Thus, target costing tries to minimize design changes during the manufacturing process when it is far more expensive to implement changes.

To achieve this goal, the total-life-cycle concept is used.

Minimize the cost of ownership of a product over its useful life, where costs include the initial purchase price and the costs of operating, maintaining, and disposing of the product.

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Target costing is an iterative process.

It begins with market research into customer requirements followed by product specification.

While customer input is obtained early in the marketing research process, it is also collected continually

Companies then engage in product design and engineering, and obtain prices from suppliers — but product cost is not the focus.

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Only after the engineers and designers have determined product design is cost estimated.

If the estimated cost is deemed “too high,” then it may be necessary to modify the product design.

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Thus, 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.

Product design may change, materials used in production may need replacing, or manufacturing processes may require redesign.

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Target costing makes use of cross-functional teams representing the entire value chain to guide the process.

Suppliers play a critical role in making target costing work.

If there is a need to reduce the cost of specific components, suppliers will be asked to find ways to reduce costs.

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After determining the target cost, the firm would then determine a:

target selling price and target product volume.

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However, target costing is not without problems.

The focus on meeting the target cost diverts attention away from the other company goals.

Employees (especially design engineers) working under target costing goals often experience burnout due to the pressure to meet the targeted cost.

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Excessive pressure on subcontractors and suppliers to conform to a schedule and reduce costs can lead to alienation and/or failure of the subcontractor.

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Design engineers may become upset when other parts of the organization are not cost conscious.

The engineers become frustrated when they exert much effort to squeeze pennies out of the cost of a product while other parts of the organization (administration, marketing, distribution) are thought to be wasting dollars.

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Development time may increase because of repeated value engineering cycles to reduce costs.

Because of all the repeated cycles, the product may be late to market.

For some products, being six months late may be far more “costly” than having small cost overruns.

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MACS: Kaizen costing

Kaizen costing is 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.

The goal of kaizen costing is for current period actual production costs to be less than the prior period’s costs.

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Kaizen costing is similar to target costing in its cost-reduction mission.

Kaizen costing can be used on products already in the manufacturing process, where it is difficult, costly and time-consuming to make large changes to the production process.

However, if the cost of disruptions to production are greater than the savings due to kaizen costing, then it will not be applied.

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SRL Inc. budgets a target profit of $8,000,000 (a 10% return on assets).

Last year’s actual production costs of $25,000,000 are used as the starting point (the cost base).

The targeted cost reduction is the amount the cost base must be reduced if SRL Inc. is to reach the profit target.

Note this also depends on targeted sales revenues.

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Assume targeted sales revenues are $32,000,000.

Given that we have targeted a profit of $8,000,000, then targeted costs have to be $24,000,000 — a reduction of $1,000,000 from last year.

Now we can determine the targeted reduction rate — which is the ratio of the target reduction amount to the cost base — $1,000,000/$25,000,000 = 4%

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This rate is applied over time to all variable costs, resulting in specific target reduction amounts for materials, parts, direct and indirect labor, and other variable costs.

Management will then compare actual reduction amounts across all variable costs to the pre-established targeted reduction amounts to determine variances.

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One drawback to Kaizen costing is that the system places enormous pressure on employees to reduce every conceivable cost.

Also, Kaizen costing leads to incremental rather than radical process improvements.

This can cause management to focus on the details rather than improving the overall system.

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MACS: Benchmarking

Selecting appropriate benchmarking partners is a critical aspect of the process.

Benchmarking typically consists of five stages.

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MACS: Benchmarking Stage 1

Decide which key areas to benchmark for study. These areas can be:

production related; or process related (and include support

processes). Measure current performance on the

key areas by initiating preliminary: internal competitive analyses; and external competitive analyses.

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Develop a long-term commitment to the benchmarking project since:

Significant organizational change can take several years;

Benchmarking requires the support of senior management — specifically, the authority to make changes; and

Benchmarking must include individuals from all functional areas in the organization.

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Identify benchmarking partners — willing participants who know the process.

Recognize critical factors, such as: The number of partners; The size of the partners; The degree of trust among partners; and The relative position of the partners

within and across industries.

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The number of partners: It makes sense for an organization to

consider a wide array of benchmarking partners.

On the other hand, as the number of partners increases, so do issues of coordination, timeliness, and concern over proprietary information disclosure.

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The number of partners: Today’s 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.

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The size of 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.

Notwithstanding, size is not always an important factor.

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The 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.

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The relative position of the partners: 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.

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Information gathering and sharing issues relate to the type of information that benchmarking organizations collect and the methods of information collection.

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The type of information that benchmarking organizations collect depends on the area being “benchmarked.”

There are three broad classes of information on which firms can focus:

product, functional (process), and strategic benchmarking.

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The methods of information collection also must be considered.

There are two methods of information collection for benchmarking:

unilateral and cooperative.

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Take action to meet or exceed the benchmark.

The organization takes action and begins to change.

After implementing change, the organization makes comparisons to the specific performance measures selected.

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Take action to meet or exceed the benchmark.

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.

Date post:	22-Jan-2015
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