USE OF COST MANAGEMENT SYSTEM FOR EFFICIENCY

1. Activity Based Management

Activity based management (ABM) is used to determine the profitability of every
aspect of a business, so that those areas can be upgraded or eliminated. The intent is to
achieve a more fine-tuned organization with a higher level of profitability. The information
used in an ABM analysis is derived from activity based costing, where
general overhead costs are assigned to cost objects based on their use of activity drivers. A
cost object is anything about which a business wants to collect cost information, such as
processes, customers, products, product lines, and geographic sales regions. Several
examples of how ABM can be used are:
 To determine the total profitability of a customer, based on its purchases, sales
returns, and use of the time of the customer service department.
 To determine the total profitability of a new product, based on its sales, warranty
claims, and repair time required for returned goods.
 To determine the total profitability of the R&D department, based on the funds
invested and outcome of new products developed.

2. Cost of Quality
The cost of quality is the accumulated cost of not creating a quality product. These costs
can include reworking a product, testing it, field service to make corrections after a product
has been installed, and replacing a faulty product. This aggregate cost is reported to
management to give them a basis for ensuring that processes always produce to customer
expectations.
A customer perceives a product as having a high level of quality if it conforms to his
expectations. Thus, high quality is really just making sure that a product does what a
customer expects it to do. Based on this definition, quality is not having the highest possible
standards for creating the ultimate product. Thus, if you insist on creating a m ahogany
interior for a car’s glove box when the customer only wants it to be big enough to store
maps, then you have just gone to considerable expense to create something that a customer
does not define as being of high quality.

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 This view of quality means that a company can eliminate any costs that customers
have no quality perceptions about. The cost reduction can impact a great many areas. For
example, it may be perfectly acceptable to use lower-quality or thinner materials, or to allow
blemishes in areas where customers cannot see them, or to allow production at a lower
tolerance level than is currently the case (which eliminates some rework costs).

3. Just in Time
Just-in-time (JIT) inventory management, also know as lean manufacturing and sometimes
referred to as the Toyota production system (TPS), is an inventory strategy that manufacturers
use to increase efficiency. The process involves ordering and receiving inventory for production
and customer sales only as it is needed to produce goods, and not before.
 The Purpose of JIT :
a) Ordering inventory on an as-needed basis means that the company does not hold
any safety stock, and it operates with continuously low inventory levels. This
strategy helps companies lower their inventory carrying costs, increase efficiency
and decrease waste. JIT requires manufacturers to be very accurate in forecasts for
the demand of their products.
b) Just-in-time inventory management is a positive cost-cutting inventory management
strategy, although it can also lead to stockouts. The goal of JIT is to improve a
company's return on investment by reducing non-essential costs.
c) Some competing inventory management systems exist, including short-cycle
manufacturing (SCM), continuous-flow manufacturing (CFM) and demand-flow
manufacturing (DFM).
d) The JIT inventory system represents a shift away from the older "just-in-case"
strategy, in which producers carried much larger inventories of stock and raw goods,
in case they needed to produce more units because of higher demand.

 History of the Technique :

The management technique originated in Japan and is often attributed to Toyota.
However, many believe that Japan's shipyards were the first to develop and successfully
implement this approach. Its origins are seen as three-fold: Japan's post-war lack of cash,

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 lack of space for big factories and inventory and Japan's lack of natural resources. Thus
the Japanese "leaned out" their processes, and JIT was born.
News about the process and success of JIT/TPS reached western shores in 1977 with
implementations in the US and other developed countries beginning in 1980.

 Benefits of The System :

JIT offers advantages such as allowing manufacturers to keep production runs short,
and move on to new products quickly and easily if needed. Companies using JIT no
longer need to maintain a huge expanse of warehouse space to store inventory. A firm
also no longer needs to spend large amounts of money on raw materials for production,
because it only orders exactly what it needs, which frees up cash flow for other uses.

 The Strategy in Use at Toyota :

Toyota started using JIT inventory controls in the 1970s and took more than 15 years
to perfect its process. Toyota sends off orders to purchase production parts only when it
receives new orders from customers.
Toyota and JIT manufacturing will succeed as long as the company maintains a
steady production rate, with high-quality workmanship and no machine breakdowns at
the plant that could stall production. Additionally, it needs reliable suppliers that can
always deliver parts quickly, and the ability to efficiently assemble machines that put
together its vehicles.

 Potential Risks :
JIT inventories can bring about disruptions in the supply chain. It only takes one
supplier of raw materials who has a breakdown and cannot deliver the goods on time,
to shut down a manufacturer's entire production process. A customer order for goods
that surpasses the company's forecasted expectations may cause parts shortages that
delay the delivery of finished products to all customers.

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  An Example of Disruption :
In 1997 a fire that took place at a brake parts plant owned by the company Aisin
destroyed its capacity to produce a P-valve part for Toyota vehicles. Aisin was the
sole supplier of this part for Toyota, and the company had to shut down production
for several weeks. Because of Toyota's JIT inventory levels, it ran out of P-valve
parts after just one day.
A fire at the company that was the sole supplier of the part to Toyota and the fact
that the plant was shut down for weeks could have devastated Toyota's supply line.
Fortunately, one of Aisin's suppliers was able to retool and start manufacturing the
necessary P-valves after just two days.
Nevertheless, the fire cost Toyota nearly $15 billion in lost revenue and 70,000
cars. The problem trickled through to other other suppliers for Toyota as well. Some
suppliers were forced to shut down because the auto manufacturer didn't need their
parts to complete any cars on the assembly line.

4. Lean Production and Accounting

 Lean Production :
Lean manufacturing or lean production, often simply "lean", is a systematic method for
waste minimization within a manufacturing system without sacrificing productivity. Lean also
takes into account waste created through overburden and waste created through unevenness in
work loads. Working from the perspective of the client who consumes a product or service,
"value" is any action or process that a customer would be willing to pay for.
Lean manufacturing makes obvious what adds value, by reducing everything else (which is
not adding value). This management philosophy is derived mostly from the Toyota Production
System (TPS) and identified as "lean" only in the 1990s. TPS is renowned for its focus on
reduction of the original Toyota seven wastes to improve overall customer value, but there are
varying perspectives on how this is best achieved. The steady growth of Toyota, from a small
company to the world's largest automaker, has focused attention on how it has achieved this
success.

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 Lean Accounting :
a) Definition of Lean Accounting
Lean manufacturing is a business management tool that focuses on reducing
waste from production processes. Lean accounting is an offshoot of lean
manufacturing that seeks to eliminate waste from a company’s capital resources by
applying lean manufacturing principles to the company’s financial functions.
b) History
According to Bob Emiliani’s book, “Better Thinking, Better Results,” lean
manufacturing is typically attributed to the Toyota Production System of Japan in
the 1920s. Emiliani also notes that U.S. and European companies began adapting
lean manufacturing principles to financial operations in the 1980s.
c) Facts
Lean accounting transforms the traditional cost accounting function of allocating
business costs to produced goods or services by creating measurable results for
tracking the efficiency of overall operations. Lean accounting does this by
reviewing all aspects of a company’s operations, trying to limit the inefficient
production processes that do not add value to the company.
d) Features
Two principles exist in the lean accounting business function: measure and
motivate. The measure principle allows accountants to review specific business
functions and determine how well they achieve the stated goals of the company.
Business functions such as resource procurement, hiring practices and the
equipment used to produce goods or services are just a few functions lean
accounting attempts to measure. Lean accounting also seeks to expose what
company managers and employees are doing right in the company and improve this
behavior through motivating employees to duplicate these actions.

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CASE : COLORSCOPE INC.

INTRODUCTION :

Andrew Cha, who is a specialist in graphics designing, started his own company after years
of hard work and through experience gained by working with different companies; he established
the firm with the name of Colorscope in 1976. Colorscope has different portfolio of customer
ranging from impulse customers to long-term loyal customers, the amount of loyal customers
comprise 80% of the total customers of the company.
The operational process at Colorscope started from receiving orders of customers; these
orders were mostly related to magazines and some other sort art and graphics work. All the
specifications and design requirements were recorded on phone calls and then the person who
was entitled to record the task did the preparation; this involved the creation of templates by
physically cutting and pasting text, graphics and photographs, and special effects were also
included at an additional cost. Then in the next step of the production process, template pictures
were digitalized and scanned. Further the task was sent to the assembly division where operator
changed the color and shade of scanned images as per the specifications of the customer. Then
the task was finally sent for quality control to the Quality Control (QC) Department and if the
task was not as per the specifications of the customer; it was sent back to that specific process for
reworking which meant that all the following processes had to be repeated for that specific task.
Once passed from the QC Department; the task was completed.

PROBLEM STATEMENT :
Colorscope is facing difficulties in retaining its customers partly because of the quality of
their work and due to the prices charged to customers along with the absence of some sort of
internal controls.

ANALYSIS :
Work Flow at Colorscope Inc. :
The work flow started at Colorscope from receiving orders on phone calls and then
recording the specifications that might cause some data to be misinterpreted or erroneously
recorded which caused reworking on the task, so that it was fully completed and returned to the

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QC Department. Since the receiving and recording of the task was the first stage of work; hence
if there was any mistake at this stage then the entire process had to be repeated in order to rework
the task. In the next stage of the process, templates of picture were created by physically cutting
and pasting the graphs, images and text.
The scanning process was done using three laser scanners and the task was sent to the
assembly department once the scanning process was completed. The assembly was done using
the old fashioned and obsolete technology, which resulted in inferior quality of output and
increased cost. New technology should be brought in to remain competitive in the printing
industry and monitoring of work should be carried out to suggest the improvements needed.

Pricing Strategy :
Costs of work done at each process of the given task has to be analyzed and costing
system such as activity based cost should be used while allocating the overhead cost such as rent
cost to each process. Activity/capacity responsible for incurring the cost (cost driver) should be
used to allocate the cost between each process. Since rent expenses directly relates to floor space
hence; it would be reasonable to allocate rent on the basis of floor area occupied by each
department.
Cost per task needs to be calculated as per Appendix-A based on activity based costing,
and loss-making tasks should be evaluated further. In this evaluation, cost incurred as a result of
in-house error and cost associated with idle time and space should not be considered as these are
abnormal losses. New technology should be brought in to minimize the depreciation cost due to
the use of old equipments.
This is noted as part of the job costing process that almost all the loss-making tasks have
been reworked either due to changes in customer specifications or in-house errors; this should be
evaluated that what is the policy of additional charges on rework requested by customer and the
customer should be told in advance that later changes in work will require additional cost to be
paid. Frequency of reworking tasks should be minimized. As per the Appendix-B, 8% of the jobs
were reworked during June 1996 regarding the task preparation process and 15% in respect to
rest of the three processes.

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Accounting and Control System:
Activity based costing can be used as an accounting system for arriving at the base price of
each task done by justifying the work against cost consumed by each process. So that each
process is evaluated against its performance and cost consumed.
Control system should be in place for proper and smooth operations at all the stages of
production processes. The work flow at the Colorscope is well standardized but it is not
documented. It should be documented and communicated at all levels of production processes
hence; there is no point in deviating from the standard procedures. Customer specifications
should also be sent to each production process so that it is matched with the work completed at
each step that will again help in minimizing the chances of rework.
Since all the staff is cross-trained and can perform the activities of the entire process
involved without the need of any additional training hence; at every stage the task should go
through a quality control process before it is forwarded to the next level, this will help in
minimizing the chances of rework suggested by the quality control division at the final stage.
As part of the internal control system, supervisory controls should be introduced at all
stages of processes in order to assess the performance of each individual and processes involved
in the completion of a task, and based on that supervision corrective actions should be
implemented.

SETTLEMENT:
Improve the technology at this time is very fast, very strong for the sustainability level of
Colorscope, Inc. in the face of competition. So Colorscope must improve and streamline
operations and determine the price of its strategy by implementing activity based management
(ABM). The following are the things that can be done by the Colorscope company to streamline
its operations, namely:
a) Evaluate and improve product processes with rework work by optimizing the ability and
accuracy of employees in the assembly process. Because with reworking causes ineffective
time, especially at the time of the deadline.
b) Improve performance in making customer orders, with the fact that the need to encourage
the company to make orders by conducting operations and reducing rework that badly
requires training from its workers.

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c) Companies must be more than selective in accepting orders from customers that are
sufficient for several key customers to save production costs. Because the company provides
a variety of services, it must provide more diverse resources.

CONCLUSION:
Companies need to evaluate and improve pricing policies. Because the price policy used is
insignificant for markets that provide various services with claims of the same quality and at a
lower price. Colorscope must set the main price then a price strategy. For price redesign
strategies can be done with operational costs. When Colorscope wants to focus on profits,
Colorscope must be able to achieve targeted profits by finding revenue and costs to achieve the
determined profit. If Colorscope focuses on the volume sold, Colorscope must pay attention to
the number or volume of its customers. For operational costs, we run Colorscope using job-order
costing, because Colorscope can determine prices according to the customer-desired messages,
such as different price orders. And also can control costs for costs.