Advanced Management Accounting Flashcards
What is target costing?
Target costing is a strategic cost management technique used by companies to manage costs during the product development phase. It focuses on determining the maximum allowable cost for a product based on the target selling price and desired profit margin. By integrating cost considerations into the product design process, target costing aims to achieve cost efficiency and maintain profitability.
Key characteristics of target costing?
Customer focus: Target costing starts with identifying customer needs and preferences to determine the target selling price. The perceived value of the customer plays a crucial role in setting the cost targets.
Cross-functional collaboration: Target costing requires collaboration between various departments, including product design, engineering, purchasing, production, and marketing. Cross-functional teams work together to achieve cost reductions and find innovative solutions.
Cost reduction throughout the lifecycle: Target costing emphasizes cost reduction efforts throughout the product’s life cycle, from the initial design phase to production and beyond.
Stages and process of target costing?
Target pricing: Target pricing is determined by considering market factors, desired profit margins, and the perceived value of the product. The target cost is calculated by subtracting the desired profit margin from the target selling price. This cost becomes the maximum allowable cost for the product.
Estimate the actual cost of the product: Cross-functional teams work together to design and develop the product. The emphasis is on cost efficiency, value engineering, and finding ways to achieve the target cost without compromising product quality or customer expectations.
Cost analysis: Cost analysis is performed to identify cost drivers and areas where cost reductions can be achieved. Value engineering techniques are used to identify alternative materials, processes, or design changes that can lower costs without sacrificing quality or functionality.
Decision rule in target costing?
The decision rule in target costing is simple: the cost of the product should not exceed the target cost. If the estimated cost exceeds the target cost, cross-functional teams must find ways to reduce costs, improve efficiency, or explore alternative solutions until the target cost is achieved.
Advantages of target costing?
Cost efficiency: Target costing encourages cost-consciousness from the early stages of product development, leading to cost reductions and improved cost efficiency.
Customer-centric approach: By considering customer needs and preferences, target costing helps design products that deliver better value and quality, increasing customer satisfaction.
Competitive advantage: Target costing enables companies to offer products at competitive prices while maintaining profitability, giving them a competitive edge in the market.
Negatives of target costing?
Time-consuming: Implementing target costing requires significant time and resources, particularly during the initial stages of market research, design, and cost analysis.
Challenging to implement: Achieving the desired cost reductions while maintaining product quality and functionality can be challenging, requiring effective cross-functional collaboration and innovation.
Attribute Costing
A marketing-centric approach that views products as bundles of benefits or attributes.
Aims to determine the costs of these individual attributes, which are seen as the ultimate cost drivers.
Can be used to set target prices and costs, and to identify cost-saving opportunities.
Target / Attribute Costing
A process for setting target prices and costs for products.
Starts with determining the target price, followed by calculating the target cost after deducting the target profit per unit.
The actual cost of production is estimated, and if it exceeds the target cost, measures are taken to reduce it.
A ‘Value Index’ for each individual function/attribute is calculated, and cost reduction methods are applied if the index is >1.
Value Engineering
A systematic approach to evaluate a product’s design and identify cost-saving alternatives without sacrificing functionality.
Involves functional analysis and design analysis, aiming to reduce the number of parts, use standard parts, or increase modularity.
Can be used to reduce the cost of products without sacrificing their value to customers.
Inter-organisational Cost Management (IOCM)
A process for coordinating resources across independent organisations to create value and ensure the achievement of target cost without sacrificing functionality.
Used in strategic alliances, joint ventures, supply chains, and networks.
Requires management accountants to provide information under complex trust/distrust situations in asymmetrically dependent relationships.
What is customer profitability?
Customer profitability is the net dollar contribution of individual customers to an organisation.
What is Customer Profitability Analysis (CPA)?
CPA is the analysis of the revenue streams and service costs associated with specific customers or customer groups.
What is Customer Lifetime Value (CLV)?
CLV is the sum of accumulated cash flows of a customer over their entire lifetime with the company, discounted using the weighted average cost of capital (WACC).
How does CPA work?
CPA involves analysing the revenue streams and service costs associated with individual customers or customer groups.
It provides an understanding of the ‘true’ costs of each customer, identifies profitable and non-profitable customers, and informs strategic decision-making related to pricing, discounting, and marketing.
CPA can be supported by Activity-Based Costing (ABC), which allows for more accurate assignment of overhead costs.
What are the benefits of CPA?
CPA allows companies to identify the true cost of each customer, make more informed decisions, better prioritise customer service, optimise marketing spend, and improve customer retention.
It also enables the efficient allocation of resources, the evaluation of marketing strategies, and the identification and management of customer-related risks and opportunities.
What are the barriers to implementing CPA?
Potential barriers to implementing CPA include convincing management of the benefits, having the necessary data capture systems, overcoming resistance to change among employees, and changing sales incentive systems to reward profitability rather than volume.
CPA may also overlook the combinations of products or services purchased by customers.
What are cost pools?
Cost pools are categories of costs associated with serving customers, such as logistics, order processing, technical service, customer consultants, equipment, sales, marketing, and business development.
What are cost drivers?
Cost drivers are factors that cause costs to increase or decrease, such as the costs charged by logistics partners, the number of orders placed by customers, service hours spent by mechanics at customers, consultant hours spent at customers, cost of equipment placed at customers, and sales volume.
How can customers be segmented?
Customers can be segmented based on various dimensions, such as profitability and loyalty.
Common approaches include the one-dimensional model (Platinum, Gold, Iron, Lead tiers) and the two-dimensional matrix (e.g., net price vs. cost to serve, contribution to sales vs. volume).
What is CLV?
CLV is a measure of the net present value of the future income stream derived from a customer over their entire relationship with the company.
It incorporates factors such as the price paid by the customer, the cost of serving the customer, the probability of repeat purchases, the company’s discount rate, and the cost of acquiring the customer.
Decision Trees
Decision trees are a powerful tool for analysing complex decision-making scenarios.
They are constructed by representing decisions as nodes and possible outcomes as branches.
The expected value of each decision option can be calculated by multiplying the probability of each outcome by the value of that outcome.
Decision trees can be used to assess risks, identify critical factors, and communicate complex information to stakeholders.
Sensitivity Analysis
Sensitivity analysis is a technique used to assess the impact of changes in key variables on a decision.
It involves varying the values of key variables and recalculating the expected value of each decision option.
Sensitivity analysis can help identify critical factors and potential risks that could significantly impact the outcomes of a decision.
What is a decision tree?
A decision tree is a powerful tool for analysing complex decision-making scenarios. It is constructed by representing decisions as nodes and possible outcomes as branches. The expected value of each decision option can be calculated by multiplying the probability of each outcome by the value of that outcome.
What is sensitivity analysis?
Sensitivity analysis is a technique used to assess the impact of changes in key variables on a decision. It involves varying the values of key variables and recalculating the expected value of each decision option. Sensitivity analysis can help identify critical factors and potential risks that could significantly impact the outcomes of a decision.
How can decision trees and sensitivity analysis be used to make better decisions?
Decision trees and sensitivity analysis can be used to make better decisions by helping to quantify potential outcomes, assess risks, and consider different scenarios. These techniques enhance the robustness and reliability of decision-making processes, leading to more effective strategic planning and resource allocation.
What is the impact of market structure on pricing?
The market structure impacts the price an organisation can charge. In a perfectly competitive market, with no barriers to entry/exit, perfect information, no transaction costs, and homogeneous products, prices are highly competitive. In an imperfect market, characterised by monopolies, oligopolies, or monopolistic competition, companies can exert more influence over prices.
What are some common pricing strategies?
Some common pricing strategies include cost-based pricing, market-based pricing, penetration pricing, and market skimming.
Cost-based pricing emphasises covering the company’s costs. Prices are typically set based on a formula that adds a targeted return to the total cost of production.
Market-based pricing focuses on the perceived value to the customer. This strategy centres pricing decisions on the perception of the product’s worth, rather than solely on the cost of production.
Penetration pricing involves charging a low price initially to gain market share before raising prices.
Market skimming starts with a high price to capitalise on inelastic demand, before lowering the price to attract more price-sensitive customers.
What is the Theory of Constraints (TOC)?
The Theory of Constraints (TOC) is a methodology introduced by Eliyahu M. Goldratt to improve organisational performance. It is based on the principle that a chain is only as strong as its weakest link, and therefore, the slowest department limits production rates, also known as a bottleneck. The ultimate goal is to increase throughput (rate at which the system earns money) while reducing inventory and operational expenses.
What are the Five Focusing Steps of TOC?
The Five Focusing Steps of TOC are:
Identify the system’s constraints.
Decide how to exploit the constraints.
Subordinate everything else to the decisions made at step 2.
Elevate the system’s bottlenecks.
If a new constraint arises, revert to step 1. Don’t let inertia become a new bottleneck.
What are the advantages of TOC?
Preventing non-critical machines from being run to capacity, thus avoiding excess inventory and related costs.
Assisting in making optimal decisions.
Being simpler to understand than linear programming.
Enhancing understanding of how constrained resources contribute to profitability.
What is Throughput Accounting?
Throughput Accounting is a method of accounting that focuses on throughput (sales revenue minus direct materials cost) and other operational expenses (all operating costs excluding direct materials). The goal is to maximise the throughput return per bottleneck hour, while keeping conversion costs to a minimum.
What are some criticisms of Throughput Accounting?
Its potential oversimplification of operating expenses as fixed.
The risk of overemphasising a single bottleneck, potentially losing opportunities to increase net throughput.
What is quality?
Quality is an attribute of a product or service that signifies its excellence, and it’s often determined by its ability to meet customer needs and expectations.
What are the strategic dimensions of quality?
Quality is a key competitive variable, offering a strategic advantage to businesses. Quality improvement programs can lead to customer satisfaction, increased business volume, and prevention of market share decline. Quality affects profits from both the revenue and cost dimensions. Furthermore, the PIMS database shows that perceived superior quality leads to higher ROI.
What is Total Quality Management (TQM)?
Total Quality Management (TQM) is a continuous improvement strategy in quality, productivity, and effectiveness, with management taking responsibility for processes and outputs. It involves corporate quality planning, leadership commitment, a TQM culture, structures, staff development, and a focus on quality costs. It contrasts with traditional management, which often looks for quick fixes and short-term goals. TQM emphasises long-term, continuous improvement and is motivated by customer satisfaction.
What are the two aspects of quality?
The two aspects of quality are quality of design and conformance quality. Quality of design measures how well a product or service meets customer needs and wants, and conformance quality refers to how consistently a product or service performs according to design and product specifications.
What are the costs of quality?
The costs of quality are the costs incurred to ensure that products, materials, or services meet specifications, as well as the costs incurred due to products or services not conforming to requirements or customer/user needs. The costs of quality can be divided into three categories: costs of prevention, costs of appraisal, and costs of failure.
What is strategic cost management?
Strategic cost management involves understanding the ‘true’ makeup of costs and reflecting that in decision-making information. It moves from cost containment to cost management, using tools like life cycle costing, target costing, value engineering, Kaizen, and Theory of Constraints (TOC). It also includes reporting quality costs and strategically using Activity-Based Costing/Management (ABC/M) to add value and improve decision-making in the value chain, supply chain, and in determining product and customer profitability.
What is the role of management accountants in quality management?
Management accountants play a key role in quality management by providing information and analysis to help managers identify and reduce costs, improve efficiency, and meet customer requirements. Management accountants can also help to implement quality improvement programs and measure the results of those programs.
What are the characteristics of traditional production?
The characteristics of traditional production include low product differentiation, slow customer response, low automation, large batch sizes, functional layout, centralisation, tall hierarchy, and semi-skilled specialised workers.
What are the characteristics of lean production?
The characteristics of lean production include a high degree of product differentiation, fast response to customer demand, high automation, small batch sizes, flow-based layout, decentralisation, flat hierarchy, and multi-skilled collaborative workers.
What is standard cost?
Standard cost is the planned unit cost of the product, component, or service produced in a period. It is used for pricing contracts, valuing inventory, evaluating performance, alerting managers to potential issues, and promoting motivation.
What is variance analysis?
Variance analysis identifies and understands the difference between planned and actual performance. It allows detailed reporting of variances, enabling responsible managers to investigate reasons and take remedial action or change the standard.
What are planning and operating variances?
Planning variances arise from changes in external factors unknown to standard-setters at planning time. Operational variances arise from factors within the control of operational managers. Planning variances adjust the original standard to reflect current reality, while operational variances indicate the extent to which current reality has been achieved. These variances can be calculated for changes in material prices or usage, labour rate or efficiency changes, and sales price or volumes.
MACSs and Strategy
Defender
Holds a strong position in a narrow product-market domain
Traditional centralised functional organisation
Detailed controls
Prospector
Creates market turbulence with new products
Organic management arrangements
Promotes innovation and entrepreneurial effort
Analyser
Adopts a dual core organisation with tight controls for stable sphere and looser controls for dynamic sphere
Reactor
Has an obsolete strategy, dominated by politics and careerism
MACSs are treated as a bookkeeping system
Porter (1980 / 1985) Five Forces
Rivalry among existing competitors
Threat of new entrant
Threat of substitute products or services
Bargaining power of buyers
Bargaining power of suppliers
The Levers of Control Framework
Diagnostic Controls
Monitor organisational outcomes and rectify deviations from pre-set standards
Communicate key performance variables
Monitor strategy implementation
Conserve management attention
Interactive Controls
Managers use these systems to assess strategic adequacy over time and engage in subordinates’ decision activities
Focus on strategic uncertainties
Enable fine tuning and alteration of strategies
Choosing interactive systems
Selection depends on strategic uncertainty related to technology, regulation, market protection, value chain complexity, and ease of tactical response
Control systems and incentives
Diagnostic system rewards are typically formula-based
Interactive system incentives reward innovative efforts and contributions based on subjective assessments
Belief Controls
Guide employee behaviour, inspiring commitment to the organisation’s core values, vision, and purpose
Boundary Controls
Help set performance goals and codes of conduct
Guide employee behaviour within limits
Promote creativity and reduce opportunism
Internal Controls
Protect assets, ensure reliable accounting records, and financial information through structural, systems, and staff safeguards
Dynamic Tensions and Balance
The levers of control create dynamic tension between innovation and predictable goal achievement, requiring balance between planned strategies and emergent strategies
Examples of balancing the levers of control
Diagnostic processes can facilitate interactive debate to produce new strategies
Diagnostic and boundary processes can provide employees with guidelines and targets
Balance between diagnostic and belief systems can be achieved when strategic plans are communicated as part of a belief system, and then converted into measurable success factors.
Managers may combine boundary and belief systems to articulate limits around strategic opportunities
Unbalanced emphasis on any one lever may lead to unintended consequences:
Excessive focus on interactive processes may cause constant change, destabilising the organisation or hindering operational tasks.
Overuse of diagnostic systems can stifle dialogue, innovation, creativity, and conceal the need for change.
Rigid boundary systems may prevent employees from seeking higher-reward alternatives
Overemphasis on current belief systems can lead to pathological conformity, impeding necessary change when the environment demands a shift in the existing paradigm
Creativity and Innovation
Creativity
Refers to the ability to conceive unique ideas and inventions
Innovation
Implementation of these novel ideas
Both require different organisational and individual capabilities
Control in creativity and innovation involves selecting and training employees, strengthening communication, and celebrating success to instil shared values
Prescriptions for Organisation Design for Creativity
Larger organisations need to adopt characteristics of smaller organisations to foster creativity
These include an entrepreneurial atmosphere, market interaction, flat structures, and developmental offshoots
