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

Chapter 7

Management Accounting and 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
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Control In Management Accounting And Control

A set of:
Procedures Tools Performance measures Systems

Used by organizations to guide and motivate employees to achieve organizational objectives

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In Control
A system is in control if it is on the path to achieving its strategic objectives 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

Five Stages Of Control

Planning Execution Monitoring Evaluation Correction

Stages of Control: Planning

Developing an organizations objectives Choosing activities to accomplish the objectives Selecting measures to determine how well the objectives were met

Stages of Control: Execution and Monitoring

Execution
Implementing the plan

Monitoring The process of measuring the systems current level of performance

Stages Of Control: Evaluation and Correcting

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

A Well-Designed MACS
Designers of management accounting and control systems (MACS) have both behavioral and technical considerations to meet The technical considerations fall into two categories
Relevance of the information generated Scope of the system

Characteristics of Well-defined MACS

Accurate Timely Consistent Flexible

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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
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The Value Chain

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
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The Value Chain

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 Kaizen Costing

Total-LifeCycle Costing Environmental Costing Benchmarking

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Total-Life-Cycle Costing (
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

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Total-Life-Cycle Costing
A TLCC system provides information for managers to understand and manage costs through a products stages

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Total-Life-Cycle Costing
Deciding how to allocate resources over the life cycle usually is an iterative process Opportunity costs play a heightened role in a total-life-cycle cost perspective

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Total-Life-Cycle Costing
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 functional life-cycle concepts:
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Research, Development, And Engineering (RD&E) Cycle

The RD&E Cycle has three stages: Market research Product design Product development

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Cost Control in the RD&E Cycle

By some estimates, 80% to 85% of a products total life costs are committed by decisions made in the RD&E cycle 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

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Manufacturing Cycle
After the RD&E cycle, the company begins the manufacturing cycle 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

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Cost Control in the Manufacturing Cycle

Operations management methods help to reduce manufacturing life-cycle product costs Companies have begun to use management accounting methods such as activity-based cost management to identify and reduce non-valueadded activities in an effort to reduce costs in the manufacturing cycle

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Post-sale Service & Disposal 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 RD&E stage
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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

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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
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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

RD&E Manufacturing Service & Disposal Average Years in Life Cycle

21% 45% 34%

20% 40% 40%

20% 60% 20%

75%* * 25%

30

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2 to 25

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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 RD&E stage of a products total life cycle 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

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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 After the engineers and designers have determined product design, cost is estimate
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Target Costing Method (

Although the initial steps appear similar to traditional costing, there are some notable differences:
Marketing research is customer-driven Costs are managed using concurrent design and engineering 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

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The Target Costing Method

Price-lead costing used to determine a target selling price and target product volume based 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 The target cost is the difference between the target selling price and the target profit margin

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The Target Costing Method

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 Several iterations usually are needed before it is possible to determine the final target cost

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The Target Costing Method

Two other differences characterize the process: Cross-functional product teams make up of individuals representing the entire value chain guide the process throughout Suppliers play a critical role in making target costing work

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Cost Analysis - example

Cost analysis requires 5 sub-activities:
1. Develop a list of product components and functions 2. Do a functional cost breakdown 3. Determine a relative ranking of customer requirements 4. Relate features to functions 5. Develop relative functional rankings
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Conduct Value Engineering - example

Value engineering organized effort directed at the various components for the purpose of achieving these functions at the lowest overall cost without reductions in required performance, reliability, maintainability, quality, safety, recyclability, and usability

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Conduct Value Engineering - example

Two sub-activities:
Identify components for cost reduction by computing a value index (ratio of the value to the customer and the percentage of total cost devoted to each component) Generate cost reduction ideas

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Concerns About Target Costing

Some studies of target costing in Japan indicate that there are potential problems in implementing the system Companies may manage many of these factors

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Examples of Problems with Target Costing

Lack of understanding of the target costing concept Poor implementation of the teamwork concept Employee burnout Overly-long development time

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Kaizen Costing
Also focused on cost-reduction 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
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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 tied to the profitplanning system 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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Example From Auto Plant

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
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Example From Auto Plant

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 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

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Concerns About Kaizen Costing

The system places enormous pressure on employees to reduce every conceivable cost 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

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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 These issues are being incorporated into cost management systems and overall MACS design

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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
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Types of Environmental Costs

Environmental costs fall into two categories: Explicit costs Implicit costs

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Benchmarking
A way for organizations to gather information regarding the best practices of others Often highly cost effective Selecting appropriate benchmarking partners is a critical aspect of the process The process typically consists of five stages

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Stage 1
Internal study and preliminary competitive analyses The organization decides which key areas to benchmark for study 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
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Stage 2 (1 of 2)
Developing long-term commitment to the benchmarking project and coalescing the benchmarking team the level of commitment to benchmarking must be long 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
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Stage 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

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Stage 3 (
Identifying benchmarking partnerswilling participants who know the process Some critical factors are as follows: Size of the partners Number of partners Relative position within and across industries Degree of trust among partners

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Stage 4
Information gathering and sharing methods Two related dimensions emerge from the literature: Type of information that benchmarking organizations collect Methods of information collection

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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

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