Cost Management

and Productivity
 Cost Management
-is the process of planning and controlling the
budget of a business.
 Cost Management vs
Accounting
Cost management Accounting
to reduce the costs to provide the
expended by an information that is
organization while needed for good
strengthening the economic decision
strategic position of the making.
firm.
 Cost Terminology
Costs - sacrificed resource to achieve a specific objective.

Actual Cost - a cost that has occurred.

Budgeted Cost - a predicted cost.

Cost Object - anything off interest for which a cost

is desired.
Variable Cost - changes in total proportion to
change in the related level of activity or volume.

Fixed Cost - remain unchanged in total regardless of

changes in the related level of activity or volume.
Product Cost - refers to the costs used to create a product.

Direct Cost - can be conveniently and economically traced

(tracked) to a cost object.
Parts, Direct labor, Direct materials

Indirect Cost - cannot be conveniently or

economically traced (tracked) to a cost object.

Electricity, Rent, Property taxes

 Effective work management
involves different things:
Creating a plan

Working out

Observing costs

Taking corrective action

 Types of Product Costs
Direct Materials - contained in manufactured
products.
Direct Labor - the cost of the wages and fringe benefits
of the direct labor employees.

Indirect Manufacturing - factory cost that are not

traceable to the product. Also known as
Manufacturing Overhead Cost or Factory Overhead
Costs.
 Types of Inventories
Direct Materials - resources in stock and available for
use.

Work-in-Process (or progress) - products

started but not yet completed. Often
abbreviated as WIP.

Finished Goods - products completed and ready for

sale.
 Cost management plan sets up
to establish the following:
Required level of accuracy in activity cost estimates.
Define units of measurements of resources costs.
Organizational procedure links, such as control accounts in
the work breakdown structure.
Control thresholds indicate an agreed amount of variance that
can occur before action must be taken.
Rules of performance measurement including
the use of Earned value management.
Reporting formats and frequency.
Process descriptions for cost management.
 Estimating
Structuring

Budgeting
Planning
Cost Management
Project
Plan
Cost
Controlling
Techniques of Costing
Cost Volume Profit (CVP) Analysis
changes in production/sales volume are the sole cause for
cost and revenue changes.
technique that examines changes in profits in response to
changes in sales volume, costs and prices.
Which products or services to emphasize
The volume of sales needed to achieve a targeted
level of profit
The amount of revenue required to avoid losses
Whether to increase fixed costs
How much to budget for discretionary expenditures
Whether fixed costs expose the organization to an
unacceptable level of risk
P = Selling Price per unit
V= Variable Cost per unit
Q= Quantity of Product sold
F = Total Fixed Cost
 Suppose that Magik Bicycles wants to produce a new
mountain bike called Magik Bike III and has forecast the
ff. information:

Price per bike =800

Variable Cost per bike =300
Fixed Cost =5,500,000
Estimated Sales =12,000 bikes

Q1: What is the Operating Income of the Company?

Q2: How many bikes does the company must sold to obtain a
target Profit of 200,000?
Contribution Margin
- is the amount of money, in percentage or dollars, available
as a result of sales that can contribute to the fixed overhead
costs of the organization.
=
=

Contribution Margin per unit

- profit per unit cost.

=
Contribution Margin Ratio (%)
- Contribution Margin per unit divided by selling price

=

 Price per bike =800
Variable Cost per bike =300
Fixed Cost =5,500,000
Estimated Sales =11,400 bikes
Profit =200,000
Compute for the CM, CMu and CMR.
800 300
= 800 300 11,400 =
800
= 5 700 000 = 0.625 100
= 800 300 = 62.5 %
= 500 62.5%
=
Break - Even Point
- Firm has no profit or loss at a given sales level
 Price per bike =800
Variable Cost per bike =300
Fixed Cost 5,500,000
Compute for the break even point in quantity and in sales.
CVP Graph for Magik Bicycles Magik bike III
CVP and Income Taxes
Pre - tax profit Profit or Operating Income (OI)
After tax profit Net Income, OI with income tax (NI)
Suppose that Magik Bicycles plans for an after tax profit of
20,000 and its tax rate is 30%. What should be the
operating income of the company?
Operating Leverage
effect that fixed costs have on changes in operating
income as changes occur in units sold, expressed as changes in
contribution margin.
 Example:
Sales =9,120,000
Variable cost (11,400)(300) =3,420,000
Contribution Margin =5,700,000
Fixed Cost =5,500,000
OI =200,000

Q1: What is the Operating income of the company if it achieves

5% increase in its sales?
Q2: What is the New OI if the sales drop to 6%?
For Q1:

For Q2:
Effects of Sales - Mix on CVP
- The formula presented to this point have assumed a single
product is produced and sold. A more realistic scenario
involves multiple products sold, in different volumes, with
different costs.
Suppose that Magik Bicycles developed three different product,
a small bike for children and youths, a road bike, and mountain
bike. Fixed costs for the company are 14,700,000.

Youth Road Mountain

Forecasted volume(units) 10,000 18,000 12,000
Price per unit 200 700 800
Variable Cost per unit 75 250 300
Contribution Margin per unit125 450 500

What is the Weighted Average Contribution Margin per unit?

PRODUCTIVITY
 INTRODUCTION
Productivity is a scientific concept. It can be logically
defined, empirically observed and measured a quantitative
terms.
Productivity is useful as a relative measure of actual output
of production compared to the actual input of resources,
measured across time or against common entities.
Productivity describes optimum utilization of the resources
of an organization to produce output. It is often confused
with efficiency. Productivity is interpreted as a measure of
effectiveness. Productivity is doing the right thing efficiently.

EFFICIENCY
It is the ratio of the time needed to perform a task to some
predetermined standard time.
DEFINITION OF PRODUCTIVITY
1766- First time the word "Productivity" was mentioned in an
article by French Economist Quesnay.
1883- Littre defined productivity as the "faculty to produce"
that is the desire to produce.
1950- Organization for European Cooperation and
Development (OECD) offered a more formal definition of
Productivity as the quotient obtained by dividing output by
one of the factors of production.

Productivity defined as:

=

DEFINITION OF PRODUCTIVITY
EUROPEAN PRODUCTIVITY AGENCY (EPA) defined
productivity as:
"Productivity is an attitude of mind. It is the mentality of
progress of the constant improvements of that which exist. It is
the certainty of being able to do better today than yesterday
and continuously. It is the constant adaptation of the economic
and social life changing conditions. It is the continual efforts to
apply new techniques and methods. It is the faith in human
progress."
DEFINITION OF PRODUCTIVITY
"Productivity is never an accident. It is always the result of a
commitment to excellence, intelligent, planning, and focused effort."
-Paul J. Meyer

"A productivity measurement is the best yardstick fir company

management of different units within an enterprise and for
comparing managements of different enterprises." - Peter Drucker

BENEFITS OF PRODUCTIVITY
Higher the productivity, more income.
Higher the productivity, the lower the operational cost.
Higher the productivity maximizes the usages of
organizational resources.
Higher the productivity is a sign of organizational
growth, creates goodwill.
Higher the productivity, smoother the operation.
 PRODUCTIVITY MEASURES

1. LABOR PRODUCTIVITY

The resources inputs are aggregated in terms of labor hours.

Labor productivity is the amount of goods and services that a
worker produces in a given amount of time. It is the ratio of the
real value of output to the input of labor.

=

FACTORS INFLUENCING LABOUR PRODUCTIVITY:

The type and effectiveness of machines and equipment's

available.
The number of machines and equipment's available.
The upgradation and adoptions of new technologies.
The management practices.
The human capital available.
 PRODUCTIVITY MEASURES
2. CAPITAL PRODUCTIVITY
The resources inputs are the book value of capital
investments. Only fixed value is considered.

3. MATERIALS PRODUCTIVITY
The resources inputs are a combined value of materials
consumed.

=

 PRODUCTIVITY MEASURES

4. ENERGY PRODUCTIVITY
The resources input considered is the amount of
energy consumed.

=

 Direct Cost Productivity

The resources inputs are the aggregation of direct cost

associated with all items of resources used. It is on
monetary value basis.

=

Direct Labor Cost Productivity

The resources inputs are combined in terms of direct

labour cost. The productivity changes in wage rate as
well as changes in labour mix is considered.

=

 PRODUCTIVITY MEASURES
5. TOTAL FACTOR PRODUCTIVITY
It is the ratio of net output to the labor and capital input.

=
+

6. MULTI-FACTOR PRODUCTIVITY
Total productivity measure that incorporates all the inputs
required to male a product or provide a service. The inputs
could be grouped in various categories as long as they
determine the total inputs required to produced an output.

=

Where: K= Capital L= Labour E= Energy M= Materials S= Services
 PRODUCTIVITY MEASURES

FACTORS INFLUENCING FACTOR PRODUCTIVITY:

The nature and type of product.
The nature and type of manufacturing process.
The nature and type of Labor available.
The capital investments.
The management practices.
The external influencing factors.
The quality of products.
 NUMERICAL ON
PRODUCTIVITY MEASURES
Example:
1. In a tooth brush manufacturing industry standard time per piece
is 1.5 minutes. The output is 250 pieces per shift of 8 hours.
Calculate the productivity.
2. Following data is collected from a bearing manufacturing
company:
Output per shift of 8 hours is 1000 pcs.
Sales prices of each item is P10 per piece.
Labor hours charges are P250 per hour.
A material required is 50 kg. At the rate P100 per kg.
Capital inputs are of P500.
Energy inputs are of P150.
Calculate productivity indices.
 NUMERICAL ON
PRODUCTIVITY MEASURES
3. A crank shaft manufacturing company is operating
with full of efficiency. Calculate various productivity
indexes.

PARTICULARS UNIT QUANTITY

SALES No.s 100,000
LABOR Hrs. 20,000
RAW MATERIALS Rs. 20,000
CAPITAL Hrs. 6,000
 PRODUCTION TO
PRODUCTIVITY
The production refers to the total value, quality of goods or
services produced during a period.
Productivity is such a relative terms as it shows not only the
value or quantity of output or production but also its relation to
the input or resources used in turning out a given amount of
output.
Productivity and production management's ultimate goal is
the efficient consumption and allocation of resource inputs to
maximize the quality and quantity of goods produced or
services rendered.
Productivity Models

Harris Model
This model shows the inadequacy of partial productivity
measures.
Total productivity is expressed :

O
TOTAL PRODUCTIVITY =
L C R Q
Where:
O= Total Output
L= Labour Input
C= Capital Input
D= Raw Materials
Q= Other Miscellaneous Inputs
 Sumanth Model
The general expression of the productivity can be stated as
follows:

Total Productivity=

Total Productivity= (1 + 2 + 3 + 4
+ )/(H+M+FC+WC+E+X)

where O, is output, H human input, M material input, FC fixed

capital input, WC working capital input, E energy input, and X
other expenses input.
 Taylor-Davis Model

In this model:
the price deflation is considered
raw material is not considered as input on the basis

The model is given as below:

++
Total Factor Productivity=
+ +[ + +]
where:
S= Net sales adjusted (i.e. deflated to base year)
C= Inventory change (raw materials, finished goods and
WIP)
MP= Manufacturing plant (Unsalable products, such as
jigs, fixtures, etc. )
E= Exclusions (materials and services purchased from
outside +depreciation of assets )
W= Wages and salary
B= Benefits
KW= Working capital
KF= Fixed capital
FB= Investors contribution (expressed in percentage)
DF= Price deflator
 APC Model
The term profitability is the overriding goal for the
success and growth of any business; it can be defined as
the ratio between revenue and cost.

This model,
Based on the premise that a firm generates profits from
two sources:

Productivity
Price recovery improvements
Productivity
- a measure of real growth changes in physical
input and output quantities.

Price Recovery
- the extent to which input cost or increase is
passed onto the customer (i.e. the extent to which
inflation is recovered through sales price increases)
APC model:
can be regarded as simple measurements that
manufacturers can use easily and frequently
based on the premise that profitability is a function of
productivity and price recovery

Productivity- relates to quantities of the output and

quantities of inputs.

Price recovery- relates to price of output and cost of

the inputs

Profitability=


=


= x

= Productivity x Price Recovery

The second approach used to model the productivity is

Profitability= Productivity + Price recovery

(PPP) model developed by Miller (1984)

it generates information by measuring changes in profits
beyond what they would be if a given profitability
standard or goal is realised
FACTOR INFLUENCING
PRODUCTIVITY
 HUMAN
Human factors include both their capability as well as their
willingness

a. Capability: Productivity of an organisation depends upon

the competence and calibre of employees of the organization.

b. Willingness to Work: Motivation and morale of people are

very important factors that determine. These are affected by
wage incentive schemes, labour participation in management,
communication systems, informal group relations promotions
policy, union management.
Technological Factors
Capacity of plant
Product nature
Availability and nature of raw materials
Automation and modernisations techniques
Maintenance techniques
Production planning and control
Plant layout and location
Quality control techniques
Nature and type of machinery
Research and development
 MANAGERIAL FACTORS
In the organizations, productivity is low despite ltest
technology and trained manpower.

Competent and dedicated managers can obtain extraordinary

results from ordinary people

Management is the catalyst to create both. Advance

technology requires knowledgeable workers who in turn
work productively under professionally qualified
managers.
 NATURAL FACTORS

Physical
Geographical
Climate conditions
 SOCIOLOGICAL
Social customs
Traditions
Institutions

The joint family system affected incentive to work hard in India

Close ties with land and native place hampered stability and
discipline among industrial labour.
 POLITICAL FACTORS
Law and order
Stability of government
Harmony between states
Taxation policies of the government influence
willingness to work
Capital formation, modernization and expansion of
plants
Industrial policy
Tariff policies
Elimination of sick and inefficient units
 Economic Factors
Size of the market
Banking & Credit facilities
Transport & communication system