Chapter 4: Specialist cost & management accounting techniques Flashcards
Why is activity based costing developed
Absorption costing was good for orgs with 1 product/ simple products
Now OH are a larger proportion of total costs
It used to be more labour intensive than machine so direct costs were higher than indirect
Now use more machines so production OH have increased
Diversity & complexity of products has increased
What is the difference between traditional costing methods and ABC?
1) OH allocation - ABC= separate cost pools so assigned directly to products rather than using cost driver rates & reapportioning
2) OH absorption = traditional is a volume based (machine/ labour hrs) measure to charge OH to products. ABC uses cost drivers (no. of orders/ dispatches)
3) Cost-drivers- used in ABC to show what causes cost increases - OH not varying with output can be traced directly which can’t be done in traditional
How to calculate ABC
1) Identify major activities- Group into cost pools
2) Identify cost drivers for each activity - what causes the cost of the activity to occur
What is a cost pool
Collection of OH costs associated with specific activities identified
Advantages of ABC
1) More accurate cost per unit- improved pricing. sales, strategy, PM & decisions
2) Better insight into what drives OH costs
3) Recognises not all OH costs are related to production& sales volumes
4) OHs are a sig proportion of total costs - need to understand drivers
5) Derive realistic costs
6) Can be applied to all OH costs - mostly used in manufacturing
7) Can used in service costing
Disadvantages of ABC
1) Limited benefit if OH are mostly volume related/ small proportion of total cost
2) Impossible to allocate all OH costs to specific activities
3) Choice of activities & cost drivers may be inaccurate
4) More complex to explain to stakeholders
5) Benefits of ABC may not justify costs - more time-consuming
Why is ABC introduced into the public sector?
1) Public responsibility- tight control of running costs when resources from central Gov are limited
2) Public accountability- taxpayer money spent wisely ?
3) Resource allocation within orgs- concerns whether the services had equitable distribution or scarce distribution
4) Helping managers manage- Better awareness of what activities actually cost to provide before deciding what to cut
Why is the public sector resisting ABC
Need to measure resources/ cost of service- usually time spent (time sheets) which is a challenge
What are the 2 types of throughput accounting?
Total Quality Management (TQM)
Just in Time (JIT)
What is total quality management (TQM)
management technique which seeks to ensure goods are produced, service supplied of highest quality
Mainly in Japanese organisations
What are fundamental features of TQM?
1) prevent errors before they occur
2) Importance of total quality in the design of systems & products
3) Real participation of all employees
4) Commitment of senior management to the cause
5) Recognition of vital role of customers & suppliers
6) Recognition of the need for continual improvement
What is just in time
pull-based system of production
Pulling through the system in response to customer demand
Goods only produced when needed- eliminates large inventories or materials & finished goods
What are key characteristics of JIT?
1) High quality
2) Speed - meet customer needs
3) Reliability
4) Flexibility
5) Low costs
What are key features of companies operating in a JIT & TQM environment?
1) High automation
2) High levels of OH and low direct labour costs
3) Customised products in small batches
4) High quality & continuous improvements
What is throughput accounting
Make best use of scarce resources
What are the 3 main assumptions of throughput accounting?
1) Only totally variable cost ST is buying raw materials from external suppliers
2) Direct labour costs aren’t variable ST - normally salaried/ guaranteed weekly wage
3) Same as contribution
Throughput calculation
Throughput= sales revenue- direct material cost
What is the aim of throughput accounting?
Max measure of profitability while reducing operating expenses and inventory
Determine what factors prevent the throughput from being aka bottleneck
ST = best use of bottleneck –> idle time in nonbottleneck resources-> small inventory hold up so doesn’t delay production
LT= bottleneck eliminated - more efficient machine
What is the theory of constraint and steps?
By Goldratt & Cox
Step 1: Identify bottleneck
Step 2: Decide how to exploit the bottleneck
Step 3: subordinate everything else to the decision in step 2
Step 4: Elevate the system’s bottleneck
Step 5: If bottleneck has been broken go back to step 1
What are the 3 Throughput accounting ratios (TPAR)?
1) Throughput (return) per factory hour= throughput per unit/ product’s time on the bottleneck resource
2) Cost per factory hour= Total factory cost/ Total bottleneck resource time available
3) TPAR= Return per factory hour/ cost per factory hour
Total factory cost= fixed production cost (excluding labour, marketing) aka operating expense
What does TPAR>1 mean?
throughput> operating costs
Products should make profit
Priority given to products generating best ratios
What does TPAR < 1 mean?
throughput is insufficient to cover operating costs
Loss
Decision making in throughput accounting environment
when ranking products it’s sufficient to look at their respective return per hour
But ranking across products/ divisions it’s suitable to look at TPAR figures to reflect differences in costs between factories
What are the criticisms of the TPAR?
1) Focus on ST, with fixed supply of resources and expenses –> not realistic ST
2) Difficult to apply in the LT when costs are variable & vary with sales/ cost drivers –> ABC may be more appropriate
How to improve TPAR
1) Increase the sales price for each unit sold
2) Reduce material costs per unit (change material/ supplier)
3) Reduce total operating expenses to reduce cost per factory hour
4) Improve productivity of bottleneck- decreases time required to make each unit
Calculation steps for throughput multi-product decision making
Step 1: Identify bottleneck
Step 2: Calculate throughput per unit for each product
Step 3: Calculate throughput per unit of the bottleneck resource for each product
Step 4: Rank products in order of throughput per unit of bottleneck resource
If all made in the same production line - ranking done on return/ hour if not use TPAR
Step 5: Allocate resources using the ranking & answer the question
What is target costing
Setting a target cost by subtracting a desired profit from a competitive market price
E.g Sony, Toyota, Swatch
Opposite of conventional cost plus pricing
Steps to derive a target cost
Step 1: Target price set, based on customers perceived value of product- market based price
Step 2: Required target operating profit per unit is calculated. Based on return on sales or investment
Step 3: Target cost= target price- target profit
Step 4: Calculate cost gap
Step 5: Value analysis, value engineering, functional analysis- can reduce costs while satisfying customer needs
Negotiating with customers may go ahead before deciding whether to go ahead with project
What is the target cost gap
Estimated product cost - target cost
Diff between what an org thinks it can currently make a product for and what it needs to make it for for a required profit
Examples for closing the target cost gap
Eliminating materials/ cheaper materials
Labour saving w/o quality compromise
increased productivity
CAN’T BE DONE BY INCREASING SELLING PRICE- it’s determined by the market
Use value analysis to work out what features are essential to the customer
What are the benefits of target costing
1) Focuses on what consumers are prepared to pay
2) Incorporates only features customers want
3) Cost control is considered earlier in the process
4) motivation to reduce costs and be more efficient
5) improve competitiveness
What is value analysis
Relates to existing products
Adds value to product as perceived by customer & identify unnecessary costs within goods
Examines purpose/ function of product
What is value engineering
relates to not yet produced products
Adds value to product as perceived by customer & identify unnecessary costs within goods
Examines purpose/ function of product
What is cost value
cost incurred by the firm incurring the product
What is exchange value
amount of money consumers want to pay
What is use value
relates to its function
The product performs the way it’s intended to do
What is esteem value
relates to the regard associated with ownership e.g paying a premium or price-skimming prices
What is functional analysis
uses the functions of a product as the cost objective
Initial designs/ review of existing products
services/ company strategy/ OHs
Identify alternative ways of achieving functions consumers value
What are the problems with target costing in the service industry
SHIP
Simultaneity
Heterogeneity
Intangibility
Perishability
What is simultaneity (inseparability)
inseparability of production & consumption
Customers are often present during the production of a service- no transfer of ownership
No service exists until it’s actually experienced/ consumed by the person who brought it
What is heterogeneity
Quality & consistency varies
not all services are performed the same each time
What is intangibility
difficult to define the service & attribute costs
services include high levels of indirect costs
consistent methods of cost attributes are needed- not always easy
direct charges not always possible
What is perishability
unused service capacity from 1 time period can’t be stored to the next
Can’t handle supply- demand through production/ scheduling
What is lifecycle cost
Tracks & accumulate costs and revenues attributable to each product over its entire lifecycle
product costs aren’t evenly spread across its life- approx 90% of its life cycle costs determined in early cycle ( prototyping/ designs etc) - need most control over early days
What is the lifecycle cost calculation
Total cost of the product over its entire lifecycle/ total number of units of that product
What does a sunk cost fall under
R&D
Irrecoverable but built into cost regimes
What are the 5 product life cycle phases
1) Product development
2) Market development & launch
3) Growth
4) Maturity
5) Decline / revitalisation
What costs are associated with the 5 lifecycle phases
1) Product development: set up costs, R&D, product design, building facilities
2) Market development & launch: marketing & promo costs, production costs per unit = high –> low volumes
3) Growth: marketing & promo, sales increase so unit costs decrease- more to spread fixed costs around
4) Maturity: initially profits will increase as set up & fixed costs are recovered, Marketing & distribution may increase to respond to increased competition, variable production costs fall (economies of scale), price competition/ differentiation erodes profitability as firms compete with limited remaining customers
5) Decline: marketing costs cut, production economies lost, replacement product developed (R&D), additional development to refine model/ product
How to maximise a product’s return over its lifecycle
1) Design costs out of the product
2) Minimise the time to market
3) Minimise the break-even point
4) Maximise the length of the life cycle itself
How does the design cost maximise return over its lifecycle
90% of costs incurred in the design stage
Affects the future components needed to build it
Minimise costs overall and not work in isolation
How does minimising the time to market maximise return over its life cycle
Competitors monitor eachother closely
Get into market ASAP to maintain profitability
Gets to establish the market before other competitors
How does minimising the breakeven point maximise return over its life cycle
Low price at launch boosts sales more rapidly- lower contribution per unit
but high price may lower sales and increase contribution
Weigh up between establishing market share vs good quality product
How does maximising the length of the life cycle maximise return over its life cycle
Get to market ASAP- longer to generate profit
Find other uses for the product or staggered entry into different markets- reduces costs, increases revenue , prolong product life, skimming the market
Benefits of life cycle costing
1) Draws management attention to all costs (including marketing, design, R&D- normally treated a period costs
2) Focuses on measuring a product’s cost from concept to withdrawal (not period by period)
3) Understanding the relationship between decisions at the design stage & cost of other functions e.g marketing
4) LT return of product- more sustainable
5) Better decisions - more accurate info on costs & revenues of each product
Why are organisations starting to be more environmentally conscious?
Environmental Management Accounting (EMA)
1) Legal & regulatory requirements to environmental management
2) Meet customers’ needs & concerns relating to environment
3) maintain a good public image
4) Manage risk & impact of environmental disasters
5) Cost savings with improved use of resources
6) sustainable development - meet current needs without compromising ability of future gen
What is Environmental Management Accounting (EMA)?
accounting info needs of managers in relation to corp activities affecting environment& environment related impacts on the corporation
What does EMA include?
1) Identify & estimate costs of environment- related activities
2) Identify & Monitor use & cost of resources
3) Environmental considerations as part of capital investment decisions
4) Assessing likelihood & impact of environmental risks
5) Include environment indicators as part of monitoring
6) Benchmark activities against environment best practice
According to Bennett & James- how does a company’s concern for the environment impact its performance?
1) ST savings via waste minimisation & energy efficiency
2) Less environmental performance= higher cost- investors demand higher risk premium
3) Energy & environmental taxes e.g landfill tax
4) Pressure groups- reputation
5) Legislation- sunsets some products. Sunrises others
6) Cost of processing input which becomes waste= 5-10% of some revenue
7) Phasing out CFCs= markets for alternative products
According to Bennet & James- how can environmental & business benefits be achieved?
1) Integrate environment into capital expenditure decisions
2) Manage & understand environmental costs- normally hidden in OH, environmental & energy aren’t allocated to relevant budgets
3) Waste minimisation schemes
4) Environmental life cycle cost- impact of mining materials through to operating equipment and disposal
5) measure environmental performance- statutory disclose & customer demand
6) Involve MA in strategic approaches - identify practical initiatives
What actions could the green team of MAs put forward in strategic approaches?
1) ‘Environment Champion’ - within planning/ accounting to ensure environmental considerations are taken into account
2) Assessing if new data sources are needed - more & better data
3) Comparisons between sites/ offices to highlight poor performance & peer pressure for action
4) Checklists for internal auditors
How can environmental management impact financial performance
1) Improves revenue - can sell premium & reach customer needs/ wants. More sales & better reputation. Poor management= losses
2) Cost reductions- efficient processes
3) Increase in costs - legal & regulatory requirements & improve image- could be offset by gov grants. Save LT money
4) Cost of failure- clean- up & fines from an environmental disaster
What are internal costs of environmental costs?
1) Improved systems & checks to avoid fines
2) waste disposal costs
3) product take back costs (e.g customers to return items for recycling e.g batteries)
4) Regulatory cots e.g taxes
5) Upfront costs e.g obtaining permits
6) Back-end costs e.g decommissioning
What are external costs of environmental costs?
Imposed on society but not from the company that generates the cost in the first place
e.g carbon emissions, energy & water, forest degradation, health care, social welfare
Some ways to get around this are planting trees if the company deforests
What are 3 other classifications of environmental costs ?
1) Hansen & Mendoza
2) The US Environmental Protection Agency
3) The United Nations Division for sustainable development
What are the 4 aspects of Hansen & Mendoza?
1) Environmental prevention costs - prevent production of waste e.g insulation, training, CO2 filters
2) Environmental Detection costs - ensure they comply with regulation & standards e.g contamination tests
3) Environmental internal failure costs - costs from activities that have produced contaminates that haven’t been discharged into the environment e.g recycling scrap
4) Environmental external failure costs - costs on activities performed after discharging waste into environment e.g oil spills
What is the US environmental protection agency 4 types of costs?
1) Conventional costs - raw materials & energy are relevant
2) Potentially hidden costs - costs that lose their identity in general OH
3) Contingent costs- incurred at a future date e.g clean up
4) Image & relationship costs - intangible e.g preparing environmental reports
What is the UN division for sustainable development
costs incurred to protect environment e.g prevent pollution, wasted materials, capital & labour (inefficiencies)
What is regulatory environmental costs?
Notification
Reporting, monitoring, testing
training, protective equipment
insurance, taxes
waste management, pollution control
What are upfront environmental costs
Site studies & prep
R&D, installation, labour, supplies, capital equipment
What are back-end environmental costs?
Closure/ decommissioning
Disposing inventory
Site survey
What is voluntary (beyond compliance) environmental costs
Community outreach/ training/ reports
Planning/ feasibility/ recycling
R&D/ insurance
Habitat & wetland protection, landscaping
What are the 4 EMA techniques recognised by the UN
1) Input/ output analysis
2) Flow cost accounting
3) Activity based costing
4) Lifecycle costing
What is input/ output analysis
Records flows of materials
What is flow cost accounting
uses material flows & organisational structure
Looks at costs & value of quantities involved
Materials flows divided into 3 categories : material, system, delivery & disposal
Reducing quantity of materials to have a positive effect on LT total costs
What is activity based costing
allocates internal costs to cost centres/ drivers based on what drives the cost
Between environmental-related costs (can go to a joint cost centre) & environment driven costs (hidden or general OH)
What is lifecycle costing?
requires full environmental consequences/ costs from production to be taken across its whole life cycle
Advantages of environmental costing
1) Better/ fairer product costs
2) Improved pricing - products with higher environ cost= higher price
3) better environ cost control
4) facilitates quantification of cost savings from environmentally friendly measures
5) integrate environ costs into strategic management
6) reduces potential for cross- subsidisation of environ damaging products
What are the disadvantages of EMA?
1) time consuming
2) expensive to implement
3) difficult to determine accurate & appropriate costs
4) external costs not experienced by the company may be ignored (carbon footprint)
5) some internal environ costs are intangible (employee health)
6) company that incorporates external costs= competitive disadvantage if they don’t do this
What is sustainable development
development that meets the needs of today without compromising needs of the future
What are the inputs and outputs of sustainable development?
Input (resources) only consumed at rate they can be reproduced or offset
Output (waste & products) mustn’t pollute the environment at a rate greater than can be cleared or offset
Key issues in accounting for sustainability factors
1) no globally accepted framework for sustainability reporting- no consistent guidance
2) insufficient skills or resources in orgs to identify & report on sustainability issues
3) reluctant to focus on factors that detriment maximising shareholders wealth
What is triple bottom line reporting
Extends traditional reporting frameworks to include environmental, social & economic performance
Full cost of any plans/ developments for measurement & decision making
Uses triple ps
What are the triple Ps
Planet
People
Profit
What does the planet in triple P stand for
Environmental performance
Manage resource consumption, energy usage & limiting environmental damage
Less resource depletion e.g not over fishing
Normally measure:
Electricity/ fossil fuel consumption
water usage
GHG & pollutants
% of resources recycled vs landfill
What does the people in triple P stand for
Social performance
Respect workers rights
Promote community it operates in
Normally measure:
Job created/ unemployment rates
average pay level
H&S e.g accident rates
Equality e.g diversity
What does the profit in triple P stand for
Economic performance
Balance profit with planet & people
Normal measures:
Profitability of individual businesses/ divisions
Taxes paid
What is the role of management accountants?
develop sustainable strategies that are forward looking about value creation & risk mitigation
What is culture
sum total of all beliefs, attitudes, norms & customs within an org
How can finance professionals promote an ethics based culture
Discourage unethical/ illegal practices
Money laundering
terrorist financing
fraud/ theft/ bribery
bullying
st decision making
How can you promote sustainable practices in an organisation
1) Products & services - from renewable sources only & are they replenished & look after animal welfare? Expected life of product & can it be recycled? Excessive packaging?
2) Customers- recycling programme & incentives to do so? Help them reduce carbon footprint?
3) Supply chain- environmental suppliers & close by & fair prices paid? Encourage them to reduce carbon footprint and help reduce landfill waste?
4) The workplace- measurable targets for energy water usage, energy efficiency, safe
5) Employees- working conditions, rights, job security, community projects, equality
6) Other functions- take into consideration environmental impact of decisions and measure impact of social initiatives
