Table of Contents

Theme 1 – introduction to the course.................................................................................3

Lecture 1 -....................................................................................................................................3
Lecture 2......................................................................................................................................3
Theme 2 – Registration of cost data...................................................................................6
Lecture 3 – Double Entry Bookkeeping.........................................................................................6
Lecture 4 – Variability Accounting (Vagn Madsen).......................................................................7
Theme 3 – Allocation of indirect costs................................................................................9
Lecture 5 – History of ABC............................................................................................................9
Traditional ABC...............................................................................................................................................9
The ABC paradox..........................................................................................................................................10
Lecture 6 Hierarchical ABC..........................................................................................................11
Lecture 7 Time Driven ABC.........................................................................................................13
Lecture 8 The CPH school Contribution Margin Model (Zakken Worre)......................................15
The Capacity Cost Network..........................................................................................................................17
Lecture 9 RECAP.........................................................................................................................18
Theme 4 – Economic logic for cost management..............................................................19
Lecture 10 – Intro to German Cost Accounting...........................................................................19
Gutenberg.....................................................................................................................................................20
Eugen Schmalenbach....................................................................................................................................21
Lecture 11 Flexible Standard Costing..........................................................................................23
Lecture 12 Extreme marginal costing..........................................................................................24
Theme 5 – Cost management for production....................................................................27
Lecture 13 Introduction to Japanese Cost Accounting................................................................27
Lecture 14 Target costing, cost tables and Kaizen costing...........................................................29
Target costing...............................................................................................................................................29
Kaizen costing...............................................................................................................................................30
Lecture 15 Theory of Constraints (TOC)......................................................................................31
Lecture 16 - exercises.................................................................................................................32
Lecture 17 – Quality Costing.......................................................................................................32
Theme 6 – Strategic cost management.............................................................................33
Lecture 18 Strategic management accounting............................................................................33
Applying Strategic Management Accounting...............................................................................................34
Strategic Management Accounting in practice............................................................................................35
Lecture 19: SMA – market perspective.......................................................................................35
Strategic positioning analysis and profit variance analysis..........................................................................35
Cost driver analysis (Structural and executional drivers).............................................................................35
Value Chain Analysis.....................................................................................................................................36
 Lecture 20 Total Cost of Ownership............................................................................................37
Types of decisions supported by TCO...........................................................................................................37
Levels of TCO analysis supporting SCM........................................................................................................38
Challenges and barriers + Critique...............................................................................................................39
Critique of Strategic Management Accounting............................................................................................39

Theme 7 – Cost management in inter-organisational context...........................................39

Lecture 22 Supply chains or shackles – where is the boundary...................................................39
Introduction to inter-organisational cost management..............................................................................39
Managerial challenges..................................................................................................................................40
Possible ways to handle the challenges.......................................................................................................40
Lecture 23 Open Book Accounting..............................................................................................41
Data validity - Kajüter and Kulmala..............................................................................................................42
Open Book Accounting as a strategic eye-opener – Mouritsen et al...........................................................43
Lecture 24 Spaces and Power.....................................................................................................43
Spaces – Mouritsen and Thrane...................................................................................................................43
Power............................................................................................................................................................44
Theme 1 – introduction to the course
Lecture 1 -
Cost management - Knowing the techniques, knowing the social content and the flows
Definition of cost - In order to create value, we need costs
Management - planning, organizing, making decisions
Cost management - making the decisions regarding using the resources in the optimal way
(to create value at minimal costs)
Cost management
 Managing the resources
 More looking into the future
 Can benefit from "past looking" - bookkeeping
Bookkeeping
 Can be used as a tool but without the communication and the social content
probably cannot be considered as cost management
 Can be used in cost management, if costs are divided in a way that makes sense and
can provide value to the management (raising costs, reasons behind the raised costs)
 It is part of cost management when we know where the numbers came from and
how to account for them (the social content) - how can the numbers from
bookkeeping be used in another context
 Financial bookkeeping is different from the bookkeeping used for the management
purposes
Farmers weighting lambs and generating non-financial performance measures
 The information on its own cannot stand alone, but has to be put into context
(growth rate, illnesses, parasites, …) - what can be done in order to reach the goal?
 Creating starting point for managerial decisions
Meetings (discussing plans and ideas)
 Depending on what and HOW are things being discussed
 How can things be translated into reality - showing models, expected consequences,
 In itself it is not cost management, but cost management should be part of the
agenda of these meetings
Cash flow
 Revenue is important aspect of cost management - comparing revenue with costs
 We run business in order to make profit and for that we need to take revenue into
account
Annual statements & SAP
 The technical aspect of cost management - cannot stand on its own, the context for
the data in needed
In cost management we might look at the same numbers from different points of view
depending on the desired outcome (how different techniques influence the different
solutions)
Lecture 2
COST
 Cost is a monetary representation of a resource (you cannot make a bike just with
money, you need to "trade" it for materials and labour)
 Money enables trades and calculations of costs
  A sacrifice or giving up resources for a particular purpose -> revenue - cost = profit
(accounting perspective)
 Cost is a cash transaction that is effectuated as a consequence of a specific decision -
does not take into account the revenue -> relevant costs
An accounting perspective
 Backward looking and needs to be adjusted
 Historic value - historical value do not need to represent current value
 Historical costs can be found in bookkeeping but the changes in the market need to
be taken into account and costs need to be adjusted
 May not be relevant for decision making
An economic perspective
 Future looking
 Hard to obtain - questionable validity and reliability
Occurrence of costs
 Consequence of a decision made concerning how to utilise resources
o Broken machine is not a cost - it is a sunk cost
o Search for possibilities - buying a new machine (investment required –>
depreciation); repair the broken one (maintenance-> capacity/fixed cost);
using laundry rooms (outsourcing -> variable cost); change technology
(strategic cost management)
 Depends on a human reaction to a certain problem
 Costs are manageable (there is different solutions)
Managing costs
 Four levers we can use to regulate cost - they are often interrelated
 Volume - decreasing the fixed costs per unit by producing a larger volume ->
economies of scale; discounts on larger number of units
 Efficiency - working smarter not harder, redesigning the process
 Purchase price of input factors
 Capacity utilisation - can be connected to both the volume and the efficiency ->
running machines on full capacity = producing the largest possible volume

MANAGEMENT
 Socio-technical discipline
 There are techniques that need to be applied in social context
 Different people create an intersubjective reality (common understanding of what
should we do in order to create profit)
Actors
 An actor intentionally seeks his goals and constructs a reality that works
Facts
 A fact is an understanding of a phenomenon that we rely on
 Evidence of a fact must be observable, testable, and readable
 Evidence can be found by both qualitative and quantitative methods (choice
depends on the characteristics of the fact)
 Historic costs, resources, …
 Based on a practical and theoretical knowledge
Possibilities
 Events that we can think of that might happen in the future
 Not factual possibilities - cannot happen
 Happen either before the actor initiates them or due to other forces
 Markets, human's potential, …
Values
 Motivators for actors to act
 Helping chose from the possibilities
 Basic values
 Instrumental values (incentive system, recognition, …)
 Strategy, culture, …
Communication
 The bridge between one actor to another
 Through communication existing facts, value and possibilities are challenged and
possibly changed
 Cost management techniques, cost manager's skills, …

Construct causality
 Possibilities are linked - one might include new possibilities and exclude others
 In order to create factual possibility, we might need to make several factually
possible steps (you cannot fly, but you can buy a plane and fly)
 Constructing reality - combining the four dimensions (fact, possibilities, values and
communications)
 Practical knowledge - empirical evidence - what practice says
  Theoretical knowledge - we can describe and discuss it with others in words
 Knowledge is not a dogma - can be and should be challenged
Truth
 Coherence - different sources communicate the same thing
 Correspondence - failed budget - was it an illusion?
 Pro-active truth
 Pragmatic truth

Theme 2 – Registration of cost data

Lecture 3 – Double Entry Bookkeeping
Transaction
 Something that happens (buying, selling, ...) the financial impact has to be recorded
 An action in the organization
Daybook
 Gathering of the transactions
Journal
 Categorizing the transactions
Ledgers/general ledger
 DEB
Why double entry bookkeeping?
- Detail explanation of results via accounts (that could be solved by singe entry
bookkeeping) -> double entry needs to be balanced
 Many people are involved in all the steps -> validity (containing the right data)
Bookkeeping is just a representation of the economy of the organization
 There are specifics methods to bookkeeping that then create cognitive content
 We can trace invoices in the reality
 The best possible representation of the company available to manage it
 Nowadays most managerial support relies on single entry bookkeeping (including
non-financial measures)
 DEB is so that we do not make mistakes - entering it wrong twice is less likely than
entering once
DEB -> accountability
 Holding people accountable for their entries based on facts
  Liabilities <->Assets <-> Profit/loss
 Third party validation
 Accounting system, that is transparent, and people know how to use it
 Who? What? Amount? Where? When? Witness? How? - missing WHY?
Cost management system
Stage 1 systems – broken
Stage 2 – finl. reporting driven
Stage 3 – Customized, stand alone
Stage 4 – integrated
Lecture 4 – Variability Accounting (Vagn Madsen)
Variability Accounting
 Ambition to serve all accounting problems
 Never really worked out - not used in Danish accounting practice
The principles of variability accounting
 A registration system
 Idea was to create a form for all kind of accounting tasks
o profit analysis
o product calculation - much more complicated, can be done as a part of
planning
o Control - similar calculations as in product calculations, but looking in the
past - did we achieve what we wanted?
o ad hoc calculations
 Addition to DEB
 Database of unspoiled data
 The basic content of a record in the variability accounting
o Type of production factor
o Department
o Cost objective
o Quality of production factor (actual usage of production factor)
o Cost (the actual quantity multiplied by the standard price which is taken from
another table)
Basic concepts
 Direct costs are the main focus
 Invoice is not split into parts in the cost registration - unspoiled data
 Noting cost in the original form - no arbitrary allocation
 Variable and fixed costs are irrelevant - tries to avoid the fact that fixed/variable
costs are applicable only for 0-x number of units
 Similar to stage 3 system (L3) - central database
Variable Accounting trinity
 Department account code (type of production factor, department, cost objective) -
presented by account codes
 Account codes follow the natural cost flow
 More specific costs have to be registered as low as possible - a lot of numbers
 The salary of the CEO should be recorder in the company as a whole, compared to a
specific machine, that is used only in one department, that one should be noted
exactly only for that one, machine that is used for the more departments, then it is
registered higher in the hierarchy
  Invoices are not split up, but they are just noted in the hierarchy based on which
departments/productions/… are relevant
 Only direct costs can be split up
Variability factor
 A process that initiates causes and costs
 A guide for designing the account codes in order to build natural cost hierarchies

 Type of production factor represents the type of input to the production process;
this entry does not have a hierarchy.
 Department represents where inside the organization the production factor has
been used.
 Cost objective represents why the production factor has been utilized. Both
Department and Cost objective has cost hierarchies. Cost hierarchies are used
because we want to register the record as precise as possible, but without arbitrary
allocation.
 Quantity of production factor shows how many units of the production factor that
has been used.
 Cost is the standard cost per production factor unit.
Pagatorian Costs
- Expenditure derived cost concept
- Depreciation and interest are not part of the variability Accounting system
- Each cost has its own direct quantitative factors with which it varies proportionately

Divisibility
 Direct and indirect costs
 No definition as to what direct and
indirect cost (4 different dimensions) is
 How far down in the hierarchy it should
be accounted for the cost
 If c & d production both use a machine X,
it can be either noted in b, but then
information is lost, if we know how many hours can be used in c and d, then it can be
noted in individual departments (only if the measurement can be precise and does
not change in order not to spoil data)

Madsen’s costing system (registration of cost data – no allocation in the system) is called
“Variability accounting” from Goetz’ principles of non-arbitrary allocations.
 All costs are variable in respect to a department and object dimension.
 To have unbiased data one needs to record as much down their hierarchies as
possible (find the clearest link!)
Theme 3 – Allocation of indirect costs
Lecture 5 – History of ABC
Traditional ABC
Indirect Costs - what makes them so special, why it their allocation so important -> well, we
remember from BSc exercises that the overall profitability picture might change quite a bit
depending on how indirect costs are allocated, especially with several distinct
products/services.

Activity Based Costing is the subdivision of costs into certain cost objects based on their
activities. Therefore, costs will be allocated to products/ services in proportion to their
consumption of this activity.
It is a two-stage procedure (as mentioned by Hilton 2005 cited in the Gosselin paper) -
That’s the difference to traditional costing:
1. identification of significant activities and OH costs are assigned to activity cost pools
based on how these resources are consumed by the activities. There the logic is
about why (i.e. activity) are costs incurred, not where, e.g. the traditional
departments costing systems
2. the OH costs are allocated from each activity cost pool to each product line in
proportion of how much this makes use of it.

Where did ABC come from?

 Increased diversification of product mix (different use of support services)
 Traditional cost accounting systems tend to allocate costs in accordance with s.c.
volume drivers such as direct labour hours.
 In a case where a product uses much more e.g. warehousing time, this would not be
taken into consideration (would be allocated still based on direct labour hours and
not on warehousing time) -> risk of distorted product costs!
 The need in case of e.g. production of two rather different products in terms of
complexity

How does this approach may assist the management process?

 Why - questions: How do you implement such a system? First of all, the system
allows allocation of indirect costs based on an evaluation of the resources used in
order to carry out the activities. Thereby the link into the practices of people in the
organisation ought to be present. In order to support the management process it is
likely that the focus on activities that people take part makes it easier to speak with
people and make substantial changes of activities since this speaks to the practice
they are part of.
 Through the focus on capacity available (practical capacity) and capacity actually
used under the current activity level, the residual unused capacity is highlighted and
calls for managerial attention.
 Also mentioned in Gosselin, the fact that people observed the managerial
implications on top of the cost calculation advantages: ABC + ABM
The ABC paradox
Gosselin (1997): if ABC has demonstrated so much benefits, why nor more firms actually
employ it?
 Field studies and 25+ surveys: implementing ABC is much more complex than
expected, and confusion in the management accounting community about ABC
 Generally new techniques have been adopted by the accounting craft, however ABC
was much preached and praised but – from the surveys presented – not much
practiced!
 Abandonment after around 15 years, it was regarded as being too complex, many
implemented and then abandoned it
Problems with traditional ABC
 Full costing problem, e.g. full costing problem in decision making: if fixed costs are
included but do not result in cash flow changes (or result in insignificant changes) as
a result of product-level decisions then the benefits of dropping a product are
overestimated in the full unit cost presented to the decision-maker!
 Costs reflecting resource consumption do not determine cash flows.
 Breach of controllability because the ABB budgeting may sometimes allocate
responsibility to managers for activities which are not solely used in their
departments, i.e. reflect a different structure than the organization has.
 Mitchell (1994) was explaining the problem that for instance in ABB some
activities are used by more departments and hence the person in responsible
for one department has not the control over the usage

Indirect costs
 What makes them so special… or especially so hard to manage?
Not per unit costs -> they cannot be traced; they have to be allocated
Cannot be traced directly
 Cost accumulation is the collection of cost data in organized way by means of an
accounting system

Traditional costing - cost allocation based on volume drivers (direct labour hours, …)
ABC - cost allocation based on the activities
 
How does ABC assist the management process? -
 understand how much certain processes costs and make informed decisions, more
details, engage with the processes, better understanding

ABC Paradox (Gosselin)

 Difficult to implement
 Not suitable for all
 Many people are not using the way they should

Saying that activities cause costs – therefore the focus is on activities and not on “dollars”
 ABC can in some cases be a good investment as it can identify unprofitable activities
 ABC is most beneficial for companies with complex cost systems.
 The ABC analysis is up to the user and the management to analyse - which decisions
are best suited to the company's situation and strategy.
  The information from ABC can change a company's situation positively, as it forms
the basis for important decisions

Lecture 6 Hierarchical ABC

Degrees of variability!
 Output-unit- level costs: the cost of this activity increases with each additional unit
of output produced. Direct relationship with output units, while the higher-level
activities are essentially independent of output but related to higher-level cost
drivers
o Somehow part of them, Batch-level-costs: related to a group of units (e.g.
purchase costs)
o Product-sustaining costs: for activities undertaken to support individual
products or services (e.g. design costs, depending on the complexity)
o Facility-sustaining costs: cannot be traced to single products, but support the
organization as a whole (e.g. admin costs). Generally difficult to find
adequate cause-effect relationships for these costs and the cost allocation
base -> to be allocates somehow or just deducted from the operating
income.

The cost hierarchy distinguishes costs by whether the cost driver is

 a unit of output, or
 a group of units of outputs of a product or
 the product (line) itself.

Why is this important?

-> Because we don’t want to use unit level cost drivers for higher-level costs. this would give
managers the wrong impression about the variability (reversibility), i.e. that they can control
these

Our Kren and Tyson paper presents an example of different industries.

 Here the activities are classified based on their relation to the organisation’s output
(i.e. unit level cost driver)
  Unit level activities: their costs are directly related to output, have a direct
relationship with output units, while the higher level activities are essentially
independent of output but related to higher-level cost drivers
 Product sustaining costs relate more to the diversity of products or services offered
by a company, hence e.g. engineering costs would fall into that category

Example of hospital admissions: this does not depend on the patient days of the stay but
rather of the number of admissions. Of course, we could choose time (h) instead, but it
would not be as meaningful

The big question is “What if we do not produce as much as we budgeted – i.e., changes in
volume occur”?
 Unit level costs (they are not “wasted)”:
o can be acquired as needed (contingent on supplier’s, etc.)
o are variable with respect to output
o represent “flexible” resources, adjustable to meet changes in production
volume
 Higher level costs (they will be “wasted” – here “utilization” is key):
o must be acquired in advance
o fixed with respect to output
o contain fewer flexible resources
 are often “committed” resources instead
 Require long-term strategic changes to be changed
The hierarchy allows the categorisation of various activities in understandable categories –
which are more or less manageable (e.g, a department manager is not able to influence
facility level decisions such as top management salaries, etc. not assigning her the
responsibility for these reduces the breaches of responsibility) which can then be linked to
unique cost drivers and thus facilitate cost control!

The role of the cost driver

  Costs can be fixed according to one cost driver (e.g. output) and variable according
to others (e.g. batches or diversity of products offered)
 Thus, cost is not uniformly variable or fixed but its behaviour depends on the nature
of the cost driver chosen
 The distinction between recourses that have to be acquired in advance and those
that can instead be acquired as needed, allows better facility management
(especially identifying the cost of excess capacity)

The Cost driver rate

Through the focus on capacity available (practical capacity) and capacity actually used under
the current activity level the residual unused capacity is highlighted and calls for managerial
attention
Unused capacity can also be calculated as a residual by subtracting the actual allocated costs
from the total resource cost pool.
 Actually used capacity is the amount of resources used for the production at the
current activity level that the company works at.
 The practical capacity represents the total capacity level available for production,
this can also be formulated as potential number of activities. This means that time
used for maintenance, holidays, etc. are not included.
A cost driver rate is the cost for conducting one activity. The cost driver rate is calculated as:
Activity cost pool / practical capacity.
Activity cost pool Activity cost pool
The Death Spiral >
Actual capacity Practical capacity
It is important that we use practical capacity at the denominator or the cost driver rate. If
not, then the company might end in the so called death spiral. This happens when actual
capacity is used in the nominator -> This will cause too many costs allocated to each product
-> This will signal that some products are not profitable, and if prices at set based on costs ->
we might also set the prices at a level that is not competitive. -> Then we will probably sell
fever products, meaning that the activity level goes down, and in the next period we will use
an even lower denominator (if we continue using actual capacity) -> which again will lead to
higher cost allocation and higher prices.
Instead the practical capacity has to be used! This of cause will leave some capacity costs
unallocated. This sum of unallocated capacity costs is called Cost of unused capacity. By
making it explicit these costs call for managerial attention

Lecture 7 Time Driven ABC

Kaplan and Anderson, 2004: TDABC develops in response to the issues that we had
identified of traditional ABC, i.e. maintenance costs, etc. but mainly data collection with
surveys and monthly reports
A further problem that emerges from the interviews and surveys is that employees state
working at full capacity (issue of idle time, unused capacity not emerging) --> cost driver
rates at full capacity
Applying a single cost driver to ordering-related support costs illustrates the primary
weakness of a traditional ABC -> it would need additional cost pool for each of these
activities.
Basically, time as cost driver for all activities!
  We still partition indirect costs, here into a part for e.g. “implementing design
changes”, then calculate the unit per time.
 Not tracing resource costs to activities first and then to products/customers: direct
estimate of the resource demands required by each transaction, product or
customer
What are “key activities”?
 Cost per unit time of capacity (time, volume, etc.) is required
 Here we had several examples in the readings, e.g. the three separate activities
regarding the engineering changes
 More granular? -> time equations

For each group of resources, two parameters required:

1. How much does it costs to provide one unit of resource (cost of time unit of
capacity)
2. How much of these resource time (units) it takes to perform an activity
These unit time can be estimated even for complex, specialised transactions!

Cost driver rate = cost of one unit of that activity

Standard time to perform a key activity:

STEP 1 we know how much it costs to sew 1 minute
STEP 2 How much these resource time (units) it takes to perform an activity (slide)
- Direct estimate practival full capacity, e.g. 80-85% of theoretical capacity
- Updates and changes are simple, e.g by adding activities and estimate their unit-time
required.
What might create changes in cost drivers?
1. Changes in prices of resources supplied (e.g. increase in employee compensation)
2. Shift in the efficiency of the activity

Time equations
What if however our transactions of one type from before (e.g. the orders) might have
different nuances of complexity?
 Sort of splitting one activity into several variations of it, e.g. the shipment order
example:
 0,5 + Y/N air fright (6,5) + Y/N special package (2,5) + Y/N other dummy variables, in
this case it could account for up to 9,5 minutes!
 Kind of a process equation, able to reflect the granularity of processes (also in Stout
and Propri is mentioned the ordering process).
 The only way to model these differences in a traditional ABC system is to include
separate new activities, each of which would require a separate cost pool and
associated activity cost driver (and separate estimate of practical capacity of
resources supplied).
 Scalable!
 Mostly suited for service organisations that require a lot of man-hours

REFLECTION
 1. What is the validity of the time-driven ABC? Does it account for the real costs
absorbed?
 Not really, does not reflect the real nature of how costs behave
 We assume that all costs are to a certain extent variable
 Not all unused capacity has the same level of ..
 We cannot say that the account of variability is taken into account 100%
2. What are the consequences of the changed "unused capacity" focus?

3. Compared to traditional ABC, is the time driven ABC in fact easier to implement?
 It is easier to implement (we cannot say the opposite), definitely easier to adapt
 Data from ERP system makes it much easier
4. Is time-driven ABC fair - does it live up to the controllability principle?
 It might make things a bit more fair - the unused capacity can be highlighted

Lecture 8 The CPH school Contribution Margin Model (Zakken Worre)

Zakken Worre attempts to develop a theoretical framework that can be used to map the
organisation, the capacities involved in the organisation and their interrelationship.

He has the concept of variability that tends to grasp capacity constraints. And he uses
concept of reversibility in order to add a time dimension to cost management.

We remember that there are two alternative approaches for the valuation of inventory;
they are Variable (marginal) Costing and Absorption Costing.
 In marginal costing, marginal cost is determined by dividing fixed cost and variable
cost. Only variable costs are charged to operation, whereas the fixed cost are
excluded from it and are charged to profit and loss account for the period.
 Conversely, Absorption costing or otherwise known as full costing, is a costing
technique in which all costs, whether fixed or variable are absorbed by the total
units produced. It is mainly used for reporting purposes, i.e. for financial and tax
reporting -> Remember also Stock build up?
Definition: Marginal Costing is a costing technique wherein the marginal cost, i.e. variable
cost is charged to units of cost, while the fixed cost for the period is completely written off
against the contribution.
-> REFLECTING THE TRUE COST BEHAVIOUR!

The term marginal cost implies the additional cost involved in producing an extra unit of
output, which can be reckoned by total variable cost assigned to one unit. It can be
calculated as:
Marginal Cost = Direct Material + Direct Labour + Direct Expenses + Variable Overheads
The difference between product costs and period costs forms a basis for marginal costing
technique, wherein only variable cost is considered as the product cost while the fixed cost
is deemed as a period cost, which incurs during the period, irrespective of the level of
activity
Profitability: The ascertainment of departmental and product’s profitability is based on the
contribution margin.

Zakken Worre and Cost Accounting

His definition implies that cost accounting is a matter of putting numbers on actions made in
the organization. These numbers (quantitative descriptions) serve as the basis of managerial
judgement of cost behaviors and as such managerial decision making.
He claims that accounting numbers are not representing an objective truth, and therefore
the numbers must be handled carefully and the affirms that there is “no space for obsession
in cost accounting”!
Three main purposes:
1. Decision making
2. Data record that can be used for predictions
3. Report for external purposes

Distinction between variable and capacity costs as an unshaken principle!

Divisibility of costs based on sales activity as the main criterion of the distinction of variable
and capacity costs. What about marketing costs? -> they affect sales of another period!

Ask yourself the question: “Is it a function of the activity level performed?”
 Yes: variable costs (function of external activity performed)
 No: capacity costs
The basic capacities
 Accommodation capacity (sites and buildings)
 Material capacity (machinery, equipment, …)
 Staff capacity
The associated capacities
 Supplementary and substitutional capacity (everything that is missing and
needs to be bought)
 Rights (patents, trade marks, …)

Zakken Worre has three subcategories of capacity costs.

What are these three subcategories, and what is the purpose of this categorisation?
 Specific capacity costs: capacity costs that are only related to one specific cost object
(if we decide to exclude the product or product group we can in many cases exclude
this capacity costs)
 United – direct capacity costs: Capacity costs that are related to several cost objects,
but can be validly allocated via measurement of consumption.
 United – indirect capacity costs: Capacity costs that are related to several cost
objects but cannot be allocated validly (classic indirect costs!).

The purpose of the categorization is related to the concept of reversibility, that is, can the
cost be eliminated if sales of a certain product is stopped. Through several steps of
contribution margins, we can see the contribution of products to the overall profit.
Note that capacity costs have completely different management control characteristics and
should therefore never be allocated to product-levels.
 They can be allocated to the product segments e.g, for the inspirational analysis, i.e.
to determine which segment is more profitable (never allocate capacity cost to
products)

Variability
 - The relationship between the number of sales activity units and the number of
resource units
- When there is a one-to-one relationship, then it is a variable cost
- Is measured by the degree of variability
Reversibility
- The possibility to obtain and get rid of a resource
- Reversibility is not necessarily symmetric
- Reversibility refers to the time it takes from deciding to get rid of a resource until it
will have impact on the company costs. For instance, unit costs / variable costs will
have impact on costs the time you stop the activity. The cost labour will not have
impact before the period for being laid off has expired, for instance 2 weeks.

The cost accounting System

It has not an own purpose, but stores data which can then be used outside of it to answer to
specific questions. Pure system, distinction between:
 Data recording (pure data)
 Data manipulation (outside of the system)
Costs must be stored in a way that clarifies degree of variability and reversibility off the cost
items.
Cost records must include
- Amount of costs and number of cost units
- Number of capacity draft units
- Number of performance units

Madsen’s costing system (registration of cost data – no allocation in the system) is called
“Variability accounting” from Goetz’ principles of non-arbitrary allocations.
 All costs are variable in respect to a department and object dimension.
 To have unbiased data one needs to record as much down their hierarchies as
possible (find the clearest link!)

The Capacity Cost Network

The capacity network constitutes the foundation of the tracking mechanism of the capacity
costs Steps:
1. Define what each capacity unit is there for, i.e. for what performance
2. Determine costs of presence and functioning
3. Define the total performance ability for each capacity (the measurable key capacity)
Vertical specialization, some capacities are performing, and some are servicing the
performing capacities.

Control begins during the registration

All costs registered must be recorded by costs and classified:
- By type of cost units
- By process or task
- By performance objective
- And a reference to a person because it is people who create and decide costs
Registration depth for capacity costs
The company can choose one or more of four registration levels concerning Capacity Costs
 1. Cost in monetary units (whole cost data without arbitrary allocations)
2. Resource spending in units (number units represented by the cost)
3. Capacity draft units (the number of units that covers the cost, equivalent to the
capacity concept of ABC)
4. Performance units (a measurable expression of the output from the process)

Lecture 9 RECAP
Variability Accounting and Capacity Cost Accounting
Strengths:
- Solid database designed to provide the foundation for all types of managerial
challenges.
- Both frameworks seem to have a “human touch”, i.e., the frameworks begin with a
solid understanding of the business context they are supposed to model.
Weaknesses:
- Complicated concepts that can be difficult to put into a practical context
- No precise and step-wise implementation guide
- Not accessible for an international audience
- According to Israelsen and Rohde very limited links to IT
Opportunities:
- Possible to implement (and scale) by means of IT
- If VA or CCA are part of an ERP-package, then it is likely that people will use it.
Threats:
- Can a dynamic business environment be a threat?
o Yes – but using a relational database platform helps you make easy and
consistent updates
- Must the level of dynamicity be taken into account when the depth of registration is
decided?
 o No – because using a relational database platform helps you make easy and
consistent updates

Theme 4 – Economic logic for cost management

Lecture 10 – Intro to German Cost Accounting
Business is about making money.
Hence, we need models that can build a bridge between abstract economic theory and
practical possible accounts of the process of making money.

Understand cost behaviour

Cost management requires an understanding of cost behaviour. Cost behaviour is situated
in the local company. Understanding cost behaviour is essential in order to predict costs,
and to point at possibilities in specific situations. A possibility can also be doing something
else. Hence the concept of opportunity cost is important to have in mind, despite we cannot
find this cost in our accounting system.
Historically, the three main points are:
 German cost theory was based on economic theory, i.e. on consumption functions
of economic resources (accruals principle).
 Results are in-depth explanation of the behaviour of costs and – especially – the
linkage to the impact of management’s actions on total cost, explaining that the
same output can result in various cost levels (total cost).
 Hence it permits realistic projections of cost to be verified in the real world
 The theories developed did not only strive for theoretically correct solutions but also
to kept in mind practical feasibility (similar to the Danish approach)

Different from what we studied from the US, already in the early 19th century the
distinction between financial and factory accounting with the industrialisation.
Accurate costing, with the causation principle for the allocation of overhead – while the
viability of labour costs was already questioned (as allocation base).
We abandon the linearity assumptions here... not only linear cost development! As opposed
to the more linear cost behaviours that was assumed by the earlier models seen.

The cost theory in Germany was based on the Law of diminishing returns (Theory of
diminishing returns or increasing marginal costs) -> indicates the different cost structures.
The basic production function is not sufficient, a realistic analysis of cost behaviours is
possible only by tracing consumption of production (input) factors. Gutenberg develops a
multi-stage consumption function from which appropriate singular cost functions may be
derived.
(Variance analysis levels) Costs vary based on managements’ forecast of the expected
demand of products produced by adaption of:
 Operating time - overtime when the other inputs are constant (over proportional
costs)
 Operating intensity
 Quantity of input factors
Gutenberg
Main takeaway from Gutenberg: Different combinations of cost functions - There is not one
and only cost function, but rather different combinations & constraints of input factors,
which in turn result in choices (costs do not automatically vary with production volume –
costs are consequences of managerial decisions). Further refined by Heinen and as a basis
for flexible standard costing

Temporal disposition of resources

Question: How to increase production when normal
capacity is reached?
Operating time – to augment the intensity when quality
and quantity of input factors are fixed, then
a) intensity of usage (faster/ slower machine runs) ->
when production speed increases we often
experience that the unit costs increase. This can be
due to higher energy consumption, more
mistakes/errors, etc
b) or overtime (higher payment)
-> over proportional costs as soon as normal capacity is
exhausted.
1. More energy/mistakes
2. Overtime = more money and more mistakes.

Intensity disposition of resources

• Question: What if we want instead to install more normal capacity?
 Quantitative adaption when the aggregates (machines and employees) is adjusted by
either activating or deactivating existing equipment or shifts -> +/- variable costs
AND +/- (output) interval fixed cost
 Short or long term decisions – unit costs change on the base of utilisation of new
aggregates. Step development: new capacity is installed able to produce 10 more
products, hence if one marginal product is produced, lots of idle capacity is left
 Hence, the more we produce, the more the cost of idleness decreases!
Quality disposition of resources
 Question: What if there is a constraint of high-quality resources available? (higher
lower quality resulting in higher costs!, also efficiency decreases and costs increase
therewith)
 Lower quality resources result in higher costs
 Hence, progressive cost curve because after the initial utilisation of the most efficient
resources, resources of lower quality must be utilised
 Example might be skilled labour force, or other +/- efficient input factors
Gutenberg's theory obviously corresponds to reality more closely than earlier hypotheses,
because it explains the fact, that a given output does not necessarily result in a single cost
function but can be accomplished by several different input combinations. This permits
management to explore its choices. Within a given set of constraints, management will
always strive to find the minimal cost combination. However, it may not always be possible
to make an accurate prediction of cost levels, because of practical measurement problems.
How can Gutenberg's different perceptions of cost behaviour assist managers?
- It makes management able to explore options (the different regulators)
- The minimal cost combination - might be hard to create precise cost forecasts
- Input increases, capacity increases, new machinery

The basic production function is not sufficient, a realistic analysis of cost behaviours is
possible only by tracing consumption of production (input) factors:
• the same output can result in various cost levels.
• the linkage to the impact of management’s actions on total cost
• there is not one and only cost function, but rather different combinations &
constraints of input factors, which in turn result in choices
Eugen Schmalenbach
- Cost identification
- Cost registration
- Cost allocations

In his cost concept for managerial accounting, Eugen Schmalenbach includes ‘Additional
Costs’. These ‘Additional Costs’ mainly include salary for the owner and interest payment for
the equity invested. Why are these ‘Additional Costs’ important to include?
The concept additional costs has to be seen in the light of that Schmalenbach developed his
concepts for small personally owned companies. Accounts for such companies did not
include salary for the owner and other transaction between the company and the private
economy of the owner. In order to highlight these transactions and thereby create a more
precise picture of the resource spending inside the company, Schmalenbach found that
these additional costs had to be part of the accounts. From an economic perspective,
additional costs can be perceived as opportunity costs since the owner could have chosen to
work for a salary in in other company. The same is the case for equity, it could be invested in
another investment project.
His main opinion about accounting in a company is to support decision making – accrual
accounting methods to find the rules to calculate the negative a positive element of
economic benefits in a certain period.
Inadequacy of cash flows and financial accounting with linear depreciation of assets
influencing the profits of the periods, e.g. extraordinary expenses are no costs, but
opportunity costs are!
Discrepancies between expenditures and costs are caused by:
 Temporal differences: e.g. linear vs. usage-based depreciation, delayed recording of
repair costs – all important for price determination on a actual consumption base
 Material differences:
1. Expenses which will never become costs-> not purpose-oriented expenses
“(cost)neutral expenses” – similar to Worre’s capacity levels, secondary levels
(e.g. speculation activities or other that do not relate to production)
2. Costs which are different from expenses due to different accounting
valuation bases – opportunity costs (?)
Valuation (i.e. is there a resource consumption?): Schmalenbach insists on the need to
analyse and adjust expenses before these will represent actual input consumption, that is
cost. Only if costs are measured in terms of resource consumption will it be possible to
observe their true behaviour.
 "Additional costs" - the opportunity cost - salary of the owner, equity invested in the
firm
 Accrual accounting
 Financial accounting is not sufficient for managerial decision making
o E.g., Linear depreciation is not important for managerial decisions, however it
is important for the external reporting
 Specifics concepts and techniques - similar to ABC - cost pooling, allocation based on
activity (causation principle)
 Only the basics costs are allocated (based on Schmalenbach)
 Direct costs go directly to the products
 Indirect costs go to the cost centres
 Cost capacity presence - similar to cost of idleness
 Schmalenbach - not impressed by ABC because it is not relevant for short term
neither for long term (too arbitrary to guide future estimates of cash flows)
- Discrepancies between expenditures and costs due to temporal and material
differences
- Two main principles:
1) Accrual accounting: to find the rules to calculate the negative and positive
elements of economic benefits in a certain period.
2) Valuation: the need to analyse and adjust expenses before these will
represent actual input consumption, that is cost
- Managerial support at the centre of cost accounting
- “Additional costs”, can be perceived from an economic perspective as opportunity
costs

Important characteristics of German costing tradition:

• Characterized by economic logic, inspired by the Law of diminishing returns
• Separation of financial accounts and cost/man. accounts due to different purposes.
• The cost centre is central for allocating costs
• Focus on registrations
• Causation principle or established distribution ratios
Under-proportional, proportional, and over-proportional cost behaviours based on 1) plant
and equipment size; 2) speed of output and 3) lot sizes.

Lecture 11 Flexible Standard Costing

Kilger and Plaut showed us how we can organise the company in order to make accounting
and cost management possible. This is done by defining small cost centres with one activity
to which we can assign costs. Costs are then consolidated as production of a product
progresses. This highlights the importance of keeping variable and fixed costs separate. If
we do not do that, fixed costs are transformed into variable costs, and we make wrong
economic decisions concerning activity level as production progresses.
A very specific time and configuration of the “model
Cost center: to ensure robust cause-effect relationships

Planning and controlling method

 Not full costing (fully recovering costs) but rather MC with some ABC -> Decision
making in the focus (short term = MC)
o Resource-centric view of cost pools: robust cause-effect-relationship
between resources consumed and appropriate cost driver (pull instead of
push principle – push = ABC)
o That’s why there have to be so many cost centres, in order to have this as
robust as possible
o Highly repetitive and routinised operations in these centres are a
requirement
 Allocation of direct labour and material and some overhead

Flexible Standard Costing isolates cost consumption of the cost centres and consolidates
cost consumption in accordance with the workflow in the organisation. During the
consolidation process direct costs and indirect costs are kept separated. In addition, primary
costs and secondary cost within the both direct and indirect costs are kept separated. This
will keep the company cost structure transparent throughout the consolidation process
 EX POST control: variance analysis!

The three principles for cost allocation

Costs always include a quantitative component (consumption of resources) and a value
component. The first are units of something and the second are the “monetary” costs
(prices-cash outflows) and opportunity costs.
These principles are formulated from a short-term perspective
 Cause and effect: No increase in activity --> no increase in costs, e.g., material,
energy, price-rate labour, depreciation on production units (somehow direct var.)
 Demand: the costs could have been incurred before the consumption decision is
taken, e.g., use of a machine or time-based wage contract labour force (remember
reversibility of indirect, fix costs)
 Average principle contains the two previous as cases; demand includes the cause-
effect instead.

Resource centric view: Cost is a function of the resources consumed to produce output
Important is the way in which costs are examined and determined if they are fixed or
variable:
 Direct costs -> follow the principle of cause-effect (here labour is considered direct)
 Primary = classic costs
 Secondary = transferred-in costs
The distinction between direct and indirect costs and keeping these cost categories isolated
when costs are consolidated trough several production cost centres allow managers to
make right economic decisions concerning production volume, because fixed costs will not
be transformed into variable costs from cost centre to cost centre.
Why is that? – because the costs maintain their traits throughout the consolidation process
The distinction between primary cost and secondary costs allows to see the costs that are
effects of decisions made inside the specific cost centre and thereby hold the cost centre
manager accountable for these costs only.
Cost centres have tended to be designed so that each centre revolves around a single
”activity” where each department has only one cost driver (e.g. the number of tests
performed):
Hence, activity-specific cost centres accomplish the same as ABC does.

- If there is no bottleneck, everything with positive CM should be produced

- If there is one bottleneck, - divide the (absolute) CM of a product by the number of
units necessary for the product on the bottleneck capacity – capacity is dedicated to
the products with the highest relative CM
- If there is more than one bottleneck -> linear programming based on (absolute)
contribution margins and the units of bottleneck capacities both available and
needed for every product

Lecture 12 Extreme marginal costing

Riebel defines costs as the cash consequence of a certain decision. The decision involves a
certain time horizon. His definition of costs is hence similar to the concept of relevant cost
for decision making. The framework fits well for decisions that can be isolated and fixed in
time and space. But when related aspects of the decisions cannot be made at the same
time, as is the case for many long-term decisions, then important elements must be left out
because their cash impact cannot be considered to be part of the decision.

With Riebel we have an extreme example or the time dimension in costing! Relative
because it is time dependent and an example of extreme marginal costing

• Decision-oriented concept of contribution margin accounting (extreme marginal costing)

• “Rebel’s Generic Direct Costing” as in the Weber article

• Einzelkosten – “generic direct costs” are intended as a generic concept referring to any
possible decision object.

Sort of a relative contribution approach based on a reconstruction of reality with objective

data.
Central objective: provide flexible and reliable decision support for the whole range of
potential managerial decision problems.

In times dominated by absorption costing, Riebel found his way through several industries
since being a chemist in 1949, a time dominated by absorption costing (full costing as
opposed to marginal costing). He kept his scientific approach.

 The central problem which inspired Riebel’s concepts was an accounting problem
faced in particular in the chemical industry: the cost allocation to joint products!
 The problem of a series of arbitrary choices to the splitting point and the
identification of the by-products’ costs.
 Riebel: lack of independence of measurement and reliability and validity of cost
allocation to support decisions in the old systems
 His conclusion: any allocation of joint production costs to separate units of output is
arbitrary! Consequently, the appropriate accounting system to joint production must
be a contribution costing technique!

His four conceptional requirements:

1) Accounting should serve management, external reporting is secondary (a by-
product)
2) Information based on undistorted representation of reality (subjective calculations
have to be explicit)
3) Principle of decision relevant consequences: match positive and negative
consequences of action or non-action with relevant data
4) Ability to apply the relevance principle to all problems of importance (different costs
for different purposes)

Grundrechnung = purpose neutral database, based on Schmalenbach’s early ideas

(Remember the three levels from Schmalenbach: Cost identification and registration, then
allocations...)

The Grundrechnung basically related to the Riebel’s 4th requirement, that management
should be able to use (retrieve) relevant data for specific decisions (different costs for
different purposes). Separation of original data on one hand, and all forms of data
application on the other

 Database intended to store as many attributes concerning the costs as possible. The
idea is that we cannot know in advance what type of questions we would like to
raise in the future, therefore we need to store as much data as possible in its raw
form
 Separation of original data on one hand, and all forms of data application on the
other Theoretically only “hard’ data are to be stored at the most disaggregated level
like” elements in a construction set” (Riebel).
 Physical quantities and values should be segregated to allow adjustments
 Useful for Periodic and standard evaluations (dashboards) and singular, ad-hoc
evaluations
  Store as many attributes to each single data item as possible, this is a problem in real
life (see raw data) -> DOWNSIDE: the high degree of registration in practice (e.g. Raw
material and all the required attributes for serving the decisions).

Replacement Value:
Replacement value becomes relevant due to Riebel’s definition of cost. He defines costs as:
cash impact from a specific decision made.
 Part of this decision can be to buy new raw material in replacement for the raw
material used. This means that if you use for instance raw materials the cost will be
the price you have to pay in order to replace the material at stock. If that is the case,
this cost data is needed in order calculate the cost related to the decision.
 Not the production decision but the replacement decision would generate the costs,
the production decision could be “for free”!

Decisions and actions as the source of cost/benefits:

 Often made sequentially
 Based on potentials (capacity) which are already realised, committed or irreversible
 Decisions and actions have a multidimensional character and are joint in a multiple
manner (temporal dimension of decisions)

Main principle: any allocation of joint production costs to separate units of output is
arbitrary! Consequently, the appropriate accounting system to joint production must be a
contribution costing technique (different form Stand. Felx Costing where part of the
overhead is allocated, Riebel thinks this is not for an additional unit of product, but for
having costs centres ready to operate instead)

Two additional requirements:

1. cash-based costs = hard data, to provide independent cost measurement

2. Flexible structure to support any management decision making (we could even
implement ABC with activity-based decision objects)

TIME ELEMENT: Only if we record and depict the chronological decision points, the
beginning, and the end of binding, can we recognise the “becoming sunk” of planned cost
and expenses, the beginning and ending of irrelevance for future decisions as well as the
stretch of time where responsibility control is limited to the keeping and use of the potential
(capacity)
-> Time is a crucial element to determine which costs to consider and which not!

Revenues are defined accordingly (positive and negative decision consequences) • Cash =
objective value

 The decision-oriented approach requires an unequivocal criterion to judge the

traceability of costs and other accounting figures to the object under consideration.
 Identifiable costs (Einzelkosten): incremental expenditures (payments and liabilities)
or outlays resulting from a decision about the object under consideration.
Contributions to profit (and common costs) arise only if the matched revenues
 (receipts) and costs (expenditures) have their origin in the same identical initial
decision (Identity principle)
 If costs cannot be identified with a specific object, they are common costs!
 Whether costs are specific or common depends on the object (relative distinction)

The practical limitations of Riebel’s approach are that all future decisions (the
sequence) must be perfectly known.
 As many decisions as possible in a sequential manner -> complicated to use in
practice / impossible without arbitrariness.
 The decision maker needs to know the entire decision sequence ex ante (this
would however only really possible ex post)
 Cash consequences must be perfectly known
 Requires a series of simplifications of the environment – uncertainty is not
considered!
Generic concept of direct costs: Now cost that in other systems would be overhead (R&D,
admin, etc.) become direct costs in relation to a specific decision
-> Increasing complexity because all decisions need to be defined ex ante!
-> This would make the identification of reliable and valid contribution margins

Theme 5 – Cost management for production

Lecture 13 Introduction to Japanese Cost Accounting
- Originated for production purposes – now also implemented in service organisations
- Quality focus – not only on reducing costs but also producing products of high
quality
- More long-term oriented decision making -> additional costs of producing one extra
unit are usually not taken into account
- Cost taken into account much earlier in the development process than in Western
CM
- Japanese CM – continuous cost reduction vs Western – periodical cost reduction
- Meeting customers’ demands at the lowest costs possible, aid of reducing the costs
of current products and reducing waste
- Growing importance of VC (up to 90% of costs)
- Determining product costs is one of the most important features
- Holistic approach in Japan – cost reduction over the product’s entire lifetime,
maximizing long-term profits – can include the whole value chain
- Broad concept with TQM, automation etc. – removing the barriers of communication
among employees -> increased motivation and innovative energy
Total cost management system = target costing + kaizen costing
- Not only about cost reduction but also profit planning
- Actively controlling costs before and/or during product development
- Western – costs taken into account much later, once a lot of fixed costs were
generated
- Kaizen – instrument for realizing short-term profit goals
- Target costing – long-term profits
- Both focusing on feed-forward control opposite to Western feedback control
- More pragmatic – the economic impact of different possibilities and of the cost
reduction

Role of Management Accounting

- Not producing precise information for strategic decisions but to make employees act
in accordance with the company’s strategy (think strategically)
- Extensive use of nonfinancial measures and strict market orientation
Kousuu and Gentan-i
- Labour and other cost = charge rate * Kousuu - man hour (similar to time driven
costing)
- Gentan-i = all Kousuu that are needed in order to create one product (all machine
Kousuu, workforce Kousuu, material Kousuu) -> non-direct material consumption
(indirect costs)
- Gentan-i: "Gen" (material), "tan" (unit): Gentan-i therefore profiles the pattern of
non- direct material resource consumption by individual product lines
- A complete set of Kousuu represents a detailed inventory of all the conversion and
support activity undertaken in the firm
- Accountants are producing financial information on the monetary level of costs but
also non-financial information (Kousuu) – pattern of consumption
- This type of information can be usefully presented in various ways. For example,
with an input object focus, it can be designed to represent the time distribution of
the various work elements comprising a production line, a shift, or a factory for any
specified period of time. Alternatively, by focusing on an output object, Kousuu may
also be expressed in terms of the various time components of the work required to
produce one unit of final product. In this latter form it is known as Gentan-i
- Gentan-i therefore profiles the pattern of non-direct material resource consumption
by individual product lines
 Kousuu provides the basis for generating a regular flow of highly detailed
information on operational performance. This information not only provides
timely feedback to management but provides the foundation for three
specific areas of cost management.

Lecture 14 Target costing, cost tables and Kaizen costing

Target costing
- Cost planning or cost projection – not cost control
- Reduction of costs in the planning and design phases – standard costing is mainly for
production
- Mainly for assembly-oriented industries, not process-oriented ones
 - More value engineering tool than an accounting tool
- CM role – understanding proposal setup and making calculations showing how the
changes will impact the cost level
- Market its orientation
- Realization of customers’ expectation with respect to price and quality
- Two processes:
 Planning of a specific product that satisfies the customer’ needs and to
establish a target cost from the target profit and the target sales price
 The process of realizing the target cost by VE and comparison with target
costs and achieved costs
- Reducing costs and setting level through substantial changes in product design,
production setup and use of technology
- Target price: expected selling price
- Target profit: what do we want to earn?
- Allowable costs: maximum costs in order to meet target profit
- Drifting costs: cost level under the current conditions – starting point
- Target costs: cost level we can begin with but must be further handled via Kaizen
Costing
- Determining target costs – top-down (from profit planning), bottom-up (from
engineering), combination
- Target costs are obtained for the entire product and later are divided into smaller
units (two basic methods for splitting the costs)
 Functional areas methods – allocating target costs to product functions
according to customers’ expectations – recommended when the new product
development process is complex and extensive; problems – assumes a direct
relationship between perceived value and costs and components often
contribute to several functions
 The component method – allocating target costs to various groups of the
components. Suitable for products with relatively small degree of innovation
and material-/technology- oriented developments. Problems – the
customers’ wishes are not taken into account – decisions are done based on
the engineers

Presenting data during target costing procedures

- Cost tables -pre-calculated cost consequences of a limited set of scenarios
- CAD-CAM during design – bill-of-material combined with standard unit costs can
show total unit cost consequences of the design
- Dynamic cost accounting – management accountant makes queries for ERP based
on the requests
Employee involvement
- Accountants must be doing reliability check – involved people meet the proposed
cost reductions
- Commitment to the numbers
Kaizen costing
- “Cost change good”
- Two areas of focus:
1) Meet cost targets for specific products
 • Launched products are above allowable costs (target costs)
• Profit margin threatened by price reductions
2) Improve production process
• Beneficial for all the involved products (also not developed yet)
- Cost reduction in the manufacturing phase
- Reducing the costs !!below the standard costs!!
- Similar to budgetary system – oriented to favourable variances through continuous
improvement in operations
- Cost control checks if standard costs are met and investigates why not
- Kaizen focuses on cost reduction – stimulates changes
- Requires commitment from all members in the organisation
- Continuous accumulation of small betterments rather than innovative improvements
(those should be done in development and design)

Total cost management system (target + kaizen costing) allows these targets! Total = in all
the life cycles of a product as well as the involvement of all people involved

Lecture 15 Theory of Constraints (TOC)

- Optimisation of production within a set capacity level
- Identifying the bottleneck – making sure it is running at full capacity and a buffer
stock is there
- Requirement – you can sell extra units
- Not only in production – bottleneck = dependency from key activities – critical path)
Steps:
1) Identify the system’s constraints
• Calculate the load on each workplace
• Workplaces with no excess capacity are potentially bottlenecks
• Look for piling up inventory
2) Decide how to exploit the system’s constraints
• Identify the best product mic by throughput per bottleneck minute
• Throughput = revenue – purchased materials and bought out services (totally
VC)
• Make sure that the constraint facility runs at the maximum capacity + hold
buffer stock in case the other facilities stop working
3) Sub-ordinate everything else to the above decision
• Drum – rhythm
• Rope – the longer the rope, the more buffer time (inventory) is in the system
4) Elevate the system’s constraints
5) If a constraint has been broken, back to step one

Worre’s Capacity Network

- The basic capacities
- The associated capacities
- Cost of presence
- Functioning costs
Goldratt
- many operational expenses are effectively fixed, excess capacity is “free”, bottleneck
capacity is “very” expensive
- Allocating only material expenses, not direct labour costs (Riebel)
- Financial accounting standards require inclusion of all production costs. This will lead
to reported higher profit when inventory is rising
- Allocating indirect costs is pointless. Using ABC is even more pointless. – attack on
short-term decisions

TOC and ABC

- Using ABC cost data for TOC is problematic because we start including indirect costs,
that are not discretionary
- Using hierarchical ABC on a unit-level we might approach TOC thinking

LEAN production
- Some excess inventory is necessary and desirable in order to produce customized
products in JIT productions
Lecture 16 - exercises
Lecture 17 – Quality Costing
- High proportion of overall costs
- Quality control – reactive
- Quality assurance – proactive
- Quality costs – expenditures incurred by the producer, user and by the community,
associated with product or service quality
- Quality-related costs – expenditures incurred in defect prevention and appraisal
activities plus the losses due to internal and external failure – ensuring and assuring
quality
- Measuring brings management’s attention and help identify the spaces for
improvements – first step towards control and improvement
- Better to prevent than to cure
- Connected to opportunity costs - the market shares the company is going to lose if
they produce low quality products and the customers start buying from the
competition
- Continuous improvement process in order to reduce the quality costs

Quality cost categories – shouldn’t it be quality-related costs???

- Prevention costs: the cost of any action taken to investigate, prevent or reduce the
risk of non-conformity or defect
- Appraisal costs: the cost of evaluating the achievement of quality requirements
including e.g., cost of verification and control performed at any stage of the quality
loop
- Internal failure costs: the costs arising within an organisation due to non-
conformities or defects at any stage of the quality loop such as costs of scrap,
rework, retest, re-inspection, and re-design
- External failure costs: the costs arising after the delivery to a customer/user due to
non-conformities or defects which may include the costs of claims against warranty,
replacement and consequential losses and evaluation of penalties incurred
 - Morten: 5th dimension – repair costs/recycle
- Categorisation happens after the costs are collected
- External ones are experienced by the customers and therefore bare a risk of losing
customers

The role of the accountant

- Support the quality process (provide info for cost consequences of quality
improvements)
- Contribute with accounting virtues (correspondence -> quality cost must correspond
to a real-world quality reference; coherence -> relationship between quality
phenomenon and quality cost must provide meaning for the users)

The economist approach

- Problematic because it is out of sync with the TQM idea – continuous improvement
of quality – utopia
- Constantly stretching the curves -> they become irrelevant

Theme 6 – Strategic cost management

Lecture 18 Strategic management accounting
Quality costing in current environmental crisis – reduce scrap, reduce waste, not saving just
costs but also materials. Motivation to repair vs buy
Strategy
- Bromwich: the provision and analysis of financial information on the firm’s product
markets and competitors’ cost and cost structures and the monitoring of the
enterprise’s strategies and those of its competitors in these markets over a number
of periods
- Basically, looking outside of the company and further than one year as accounting
periods
- Definition is limited to financial information – more recent definitions involve non-
financial performance measures - in many cases, the non-financial measures set the
agenda

Strategic management accounting focus

Requirements
- Understanding of what adds value to the customer
 - How to utilise cost structure and turn it into a competitive advantage
- Have an eye on possibilities that can be used and turned into an improvement for
company performance – pro-active approach
- Endurance, sense of pragmatic truth, willingness to adjust to reality as it unfolds

Bromwich’s economic eye

Barriers to entry
- Economies of scale
- Product differentiation
- Absolute cost advantage – sunk costs
- Capital requirements
Applying Strategic Management Accounting
Strategic Management Accounting Components
1) Strategic positioning
- Understanding the market
- Creating financial models supporting decision-making (budgets, investment
decisions)
- Understand with what the product contributes to the customer’s experienced
value (????)
- Understand competitors (cost structure, financial power, …)
2) Getting a customer and market focus
- Customer profitability analysis
- Competitor analysis
- Brand value accounting (how customers see us? Investment in brand value?)
3) Strategic decision support
- Revised profit and loss accounts (long-term thinking, how to depreciate
investments in smarter working)
- Revised contribution analysis (less focus on contribution margins)
4) Strategic cost management
- ABM
- Quality costing
- Life-cycle costing
- Target costing and kaizen
5) Strategic performance management/measurement
 - Balance scorecard
- Intellectual capital investment
- EVA (economic value added)
- Shareholder value
Strategic Management Accounting in practice
- Kim Langfield-Smith: SMA concepts can be found, but since companies have a
tendency to behave autonomously the validity of the surveys are low
- Since Bromwich’s paper – SMA has entered the MA scene
Indirect effect
- Strategy talk is influenced by understanding the role of management accounting
- SMA might not be using specific techniques but using traditional techniques in more
strategic way
Lecture 19: SMA – market perspective
Exam 2017 – value chain analysis
Strategic positioning analysis and profit variance analysis
Role of Cost Management

Variance analysis - needs to be performed at deeper levels to find the underlying problems

Cost driver analysis (Structural and executional drivers)

“Cost driver” kind of measure to distribute costs from resources to activities
Short-term decision making
- Traditional cost accounting primarily uses production volume as the main cost driver
- That is ok unless the production technologies and market structure come under
pressure and become objects of strategic consideration -> then other concepts and
frameworks are needed for managing costs
Economic structure drivers (Structural cost drivers – Shank)
- Scale – fine tuning capacities
- Scope – degree of vertical integration
- Experience
- Technology – low cost versus product differentiation
- Complexity
Executional drivers
cost can be driven by other aspects than volume (traditionally, volume is the cost driver)
- Work force involvement
 - Total Quality Management
- Capacity utilization
- Product configuration
- Exploiting linkages with suppliers and/or customers
Summing up:
- For strategic analysis, volume is usually not the most useful way to explain cost
behaviour
- What is more useful in a strategic sense is to explain cost position in terms of the
structural choices and executional skills which shape the firm’s competitive position.
For example, Porter analyses the classic confrontation between GE and West. in
steam turbines in terms of the structural and executional cost drivers for each firm
- Not all the strategic drivers are equally important all the time, but some (more than
one) of them aver very probably very important in every case. For example, Porter
develops a strategic assessment of X’s position based primarily on scale and capacity
utilization issues
- For each cost driver there is a particular cost analysis framework which is critical to
understanding the positioning of a firm. Being a well-trained cost analyst requires
knowledge of the various frameworks
Value Chain Analysis
- Outsourcing or insourcing
- How to control suppliers
- Cost of quality
- Technologies and capabilities
- Since virtually no two companies compete in the same set of value activities, value
chain analysis is a critical first step in understanding how a firm is positioned in its
industry. Building sustainable competitive advantage requires a knowledge of the full
linked set of value activities of which the firm and its competitors are a part.
- Once the value chain is fully articulated, critical strategic decisions regarding
make/buy and forward/backward integration become clearer. Investment decisions
can be viewed from the perspective of their impact on the overall chain and the
firm's position within it. For strategic decision making, cost analysis today cannot
afford to ignore this critical dimension.
Lecture 20 Total Cost of Ownership
- Costing the way from supplier to usage in own production
TCO
- “is a purchasing tool and philosophy at understanding the relevant costs of buying a
particular good or service from a particular supplier”
- Cost is more than an invoice price
- Often presented as measuring cost vs. managing them
Theoretical roots
- Williamson – Transaction Cost Economics – more abstract phenomena in his analysis
- Lisa Ellram – TCO is more specific

Types of decisions supported by TCO

- Supplier selection
- Communication
- Ongoing Supplier Management
- Drive Improvement
- Create Understanding
 - In some texts Ellram suggests that TCO can be done by comparing supplier on a
number of qualitative dimensions with non-financial indicators
- Different indicators are weighted and ranked (benchmarking)

Levels of TCO analysis supporting SCM

Challenges and barriers + Critique
Challenges
Complexity
- No easy access to the data
- Lack of validity
Organizational culture
- Create cost awareness instead of price focus
- Involvement of more than the purchasers
Proper use and relevance
- One size does not fit all – use TCO with caution

Critique
- More a costing approach than a cost management framework
1) Main focus is to provide cost estimates for purchasing
2) Less focus on changing the cost levels and cost structures
- Perhaps mainly interesting for companies with low purchasing power compared to
the supplier
- Or companies that purchase standard components, but terms of delivery differ
between suppliers and may be negotiable

Critique of Strategic Management Accounting

Strategy – not simply long-term planning but must also consider the plans of competitors –
the main objective is to place and keep the firm in a position of a competitive advantage.

Theme 7 – Cost management in inter-organisational context

Lecture 22 Supply chains or shackles – where is the boundary
Introduction to inter-organisational cost management
- Value chain (out/insourcing, control of suppliers, cost of quality, technologies, and
capabilities)
- Outsourcing seems to be a relevant strategy for many companies
- Outsourcing may contain more aspects than just considerations on price against
certain levels of quality
- Outsourcing requires considerations concerning how decisions made by other will
impact own performance potential
- No precise definition of inert-organisational relation
- Attempt: cooperation between two or more organisations that extents exchange of
products and/or services and money beyond arm’s-length relationships.
1) Dyadic relations: primary focus – two organisations
2) Network relations: more organisations
3) Examples: joint ventures, strategic alliances, joint development projects,
extended buyer-supplier relationships
Main drivers for increased focus on inter-organisational relationships
- Globalisation increase the need to be present everywhere (few companies are able
to do that, consequently partners are necessary in order to face the spatial
challenge)
- Rapid technological development (survival requires access to latest standards)
 - Increased technical complexity (components have to be compatible, meaning that
exchange of information during product development in necessary)

Motives for entering interorganisational relationships

- Access to relevant resources
1) Focusing on core competences means that one’s company contributes on a
very small part of the value chain
2) Consequently, one actively has to look for partners in order to jointly
compose to the final product
- Flexibility
1) Acting in an environment or flux creates a need for flexibility
2) Concerning volume when amount of items change
3) And content, when the demand of customers changes, then it might be
necessary to find another supplier
Managerial challenges
- Losing the possibility of direct interventions
- Having to actively chose relations
- Losing some kind of information and you have to manage based on aggregated
information

Possible ways to handle the challenges

Build infrastructural control systems
- Example: supermarket chain wants to control up-stream supply chain -> require
suppliers to use certain ERP if they want to supply the chain -> requirement possible
due to supermarket’s position – the direct link to customer
- Joint ERP system destroys the boundaries between parties – transparency
- The system is institutionalised and thereby relations become more static
- It can strike back from the suppliers – they will not share confidential information
and the basis for decision making become fragile
Familiarity and trust
- Cooper and Slagmulder
 1) Target costing is the heart of IOCM
2) The degree of IOCM depends on the closeness of the relations
- Trust as means for absorbing uncertainty
1) Trust is central concept within most literature on inter-organisational
relations
2) Trust is perceived as a means for absorbing uncertainty
• Trust and control are found to serve as substitutes or complementary
3) Trust takes time
• Trust is built through successive positive experiences with the other
party
• Trust creates a bond between the parties that makes it hard to break
the relationship
Boundaries
- In the case company contract is central
- The contract is used as a communication device in which the term for trade is settled
- Power is what drives the negotiations the contract becomes the boundary
- Through power the flexibility is intact

Key takeaways
- From the perspective of a single company the purpose of participating in inter-
organisational relations is access to relevant resources and flexibility
- Interorganisational relations challenges management:
1) Loss of possibility for intervention
2) Loss of information
3) More venerable (ctihodný)
- Management accounting models in the shape of computer software can increase
exchange of information and embrace the relationship
- Focus on trust can reduce the perception of vulnerability
- Power can help you keep focus on the purpose of the relationship

Lecture 23 Open Book Accounting

Open Book Accounting
- The disclosure of product/activity/process cost information in a customer-supplier
relationship
- A means to identify areas of improvement withing the supply chain and collectively
estimate the feasibility of these potential changes
- Means in the sense of:
1) Price negotiations
2) Communication of objectives
 3) Product development
4) Keeping suppliers alert
5) Setting an economic logic agenda
Theoretical foundation
- Early contributions – Early Cost Economics (Williamson) – used to explain how to
organise; Contingency theory – trust vs. control
- Later contributions – Theories rooted in an interpretative or critical paradigm; Focus
on the process of OBA and focus on the impact of OBA practice have on the
cooperation between parties
Data validity - Kajüter and Kulmala
- If companies do not have the same goals, there might be tendency not to tell the
whole truth
- Skewed information applied in the management process without critical
consideration can cause faulty decisions
1. Suppliers experience no extra benefit from openness and main contractors do
not offer win-win solutions.
2. Suppliers think that accounting information should be kept in-house.
3. Network members cannot produce accurate cost information and see no sense
in sharing poor cost data.
4. Suppliers are afraid of being exploited if they reveal their cost structure.
5. Suppliers do not have capable resources or resource support from main
contractors for the development of accounting systems.
6. Network members cannot agree on how open-book practice should be
implemented
- Inter-organisational management accounting depends on the power relations among
the involved parties
- Information only flows if one of the parties is able to force through the flow
- This means that data validity is likely to be reduced since the parties will only
transfer the information that they want to transfer
- From a stringent contingency theoretical perspective, interorganisational
management accounting becomes nonsense since you cannot rely on the outcome
of the management models
Open Book Accounting as a strategic eye-opener – Mouritsen et al.
Lecture 24 Spaces and Power
Spaces – Mouritsen and Thrane
- ANT – accounting is the “force” – an actor – in establishing and developing
interorganisational relationships
Management accounting as an active actor
- Case study of a real network and seek answers for some of the identified weaknesses
- Employment of ANT helps to find possible answers

- M&T change focus from the single company as the stable entity to the network as
the stable entity
- M&T identifies two management technologies
1) Self-regulating mechanism – allows interaction and exchange to occur
unobtrusively “self-regulating mechanisms stabilise the flow of interaction in
the network by making the circulation of money predictable, which allows
the ongoing, task-oriented interaction to take place in terms of exchange of
information, clients, projects and knowledge without having to consider
money flows”
2) Orchestration mechanisms – define the boundaries and rules for interactions
“directly guide the transformations of the network, its participants and
complementarity relations. It transforms the segmentation of links in the
network through discrete actions where the question of money and
investment is addressed head on. This may produce conflict. When conflict
exists the concern for trust is at its highest, not in terms of a benevolent
acceptance of others and mining their interest, but as a general absence of
trustworthiness. This absence of trustworthiness is used to claim that
decision-making does not abide with the ‘operating principles’ of the network
phenomenon.
 - Partners come and go but the network enterprise continues, as it is not primarily
dependent on a specific set of partners. It is more dependent on the procedures that
allow any partner to interact with other partners or are expeller either calmly
through the effects of self-regulating mechanism or through direct conflict e.g., in
relation to orchestrating mechanisms
- The network enterprise is to a large extent the management control technologies
- The individual firms do not constitute the network – it is constituted by the rules
inscribed in management control technologies, which is why the network in an
enterprise
Power
- Trust is slow – it requires successive positive experience to be effective
- High trust ties the parties together, which makes it difficult to break the relations
- Trust is an issue only when it is not present (Mouritsen and Thrane)
- Power can be also used for absorbing uncertainty
- Power does not have the same weakness as trust (power can be used immediately,
to the extent that you are able to define what you want and to sanction what you do
not want; power does not involve a personal investment and therefore a break of
the relation is not a personal defeat)
- All illustrations: trust is a picket from which you step by step make the leash longer,
power is a fence
- Theoretical framework is governmentality
- Ability to set the agenda
- Being able to decide what is right and what is wrong makes it possible to manage at
the distance via different management technologies
- People have free will – they do not always do the right things
- Power is conducted in a constant battle between the parties concerning who is right
- Involved parties construct common understanding and direction for future actions
- Governmentality is done by management technologies (budgets, BSC)