COST MANAGEMENT

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 .
“ Good things come to those who go out
and get them. Nobody achieved greatness
waiting for to find them”.

- HERD

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The Chinese have an idiom. Loosely translated, it

says that it’s better to be a dog in a peaceful time than

a man in a chaotic time.

There’s also a related curse, also often attributed to

the Chinese:

“May you live in interesting times.”

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Cost

A monetary measure of

(1) consuming a resource or its output to achieve a

specific managerial objective, or

(2) making a resource or its output available and not

using it.
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Costing

The process of calculating how much a product or

service will cost.
COST MANAGEMENT

“ Management of cost related activities achieved by

collecting, analyzing, evaluating,
and reporting cost information used
for budgeting, estimating, forecasting,
and monitoring costs. ”

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 Expenditures, Costs & Expenses

Expenditure – company purchases raw materials for

$100

Cost – company reports $100 of raw materials on

balance sheet

Expense – company records $100 expense on

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income statement when it sells the product that
 Cost Terms
The term “cost” appears in many contexts and carries a
number of meanings.

Different categories of cost terms are merely different ways to

look at costs or to slice and dice cost information.

They are not necessarily complementary to or mutually

exclusive of other cost categories.

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 Variable and Fixed Costs
Variable costs: costs that increase or decrease (in
total) relative to increases or decreases in the level
of business activity.

Fixed costs: costs that do not change (in total)

relative to changes in business activity.

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 Sunk Costs

Sometimes called “past costs.” These costs are

NOT relevant to the decision making process.

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 Opportunity Costs

These are the values of potential benefits foregone

when a decision is made.

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 Direct and Indirect Costs
Direct costs: Costs that are directly traceable to some
object such as a product, activity or department.

Indirect costs: Costs that are NOT directly traceable to a

product, activity or department.

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 Controllable and Non-controllable
Costs
Yet another way to slice and dice costs. This time it has to do
with the degree of influence a manager has over the cost.

If a management decision can impact the cost in the short

term, it is considered controllable.

Conversely, if a manager cannot influence (control) the cost in

the short term, then it is non-controllable. A manager’s
performance should NOT include an assessment of non-
controllable costs.

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 Cost Accounting Standards issued by
Institute of Cost Accountants of India
CAS-1 Classification of Cost For preparation of Cost Statements

CAS 2 Capacity Determination To bring uniformity and consistency in

the principles and methods of
determination of capacity with
reasonable accuracy.
CAS Overheads To bring uniformity and consistency in
3 the principles and methods of
determining the Production or Operation
Overheads with reasonable accuracy.
CAS 4 Captive Consumption To determine the assessable value of
excisable goods used for captive
consumption.
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CAS5 Average To determine averaged/equalized transportation
(equalized) cost
Cost of
Transportation
CAS6 Material Cost To bring uniformity and consistency in the
principles and methods of determining the
material cost with reasonable accuracy in an
economically feasible manner.
CAS7 Employee Cost To bring uniformity and consistency in the
principles and methods of determining the
Employee cost with reasonable accuracy.

CAS8 Cost of Utilities To bring uniformity and consistency in the

principles and methods of determining the Cost
of Utilities with reasonable accuracy.

CAS9 Packing Material To bring uniformity and consistency in the

Cost principles and methods of determining the
15 B V Subramaniam FCMA Packing Material Cost with reasonable
4-Jan-16
accuracy.
CAS10 Direct To bring uniformity and consistency in the principles
Expenses and methods of determining the Direct Expenses
with reasonable accuracy.

CAS11 Administrative To bring uniformity and consistency in the principles

Overheads and methods of determining the Administrative
Overheads with reasonable accuracy.

CAS12 Repairs And To bring uniformity and consistency in the principles

Maintenance and methods of determining the Repairs and
Cost Maintenance Cost with reasonable accuracy.

CAS13 Cost of Service To bring uniformity and consistency in the principles

Cost Centre and methods of determining the Cost of Service
Cost Centre with reasonable accuracy.

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CAS14 Pollution Control To bring uniformity and consistency in the
Cost principles and methods of determining the
Pollution Control Costs with reasonable
accuracy.
CAS15 Selling & To bring uniformity and consistency in the
Distribution principles and methods of determining the
Overhead Selling and Distribution Overheads with
reasonable accuracy.
CAS16 Depreciation & To bring uniformity and consistency in the
Amortization principles and methods of determining the
Depreciation and Amortization with reasonable
accuracy.
CAS17 Interest and To bring uniformity and consistency in the
Financing principles ,methods of determining and
Charges assigning the Interest and Financing Charges
with reasonable accuracy.
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CAS Research & To bring uniformity and consistency in the
18 Development principles and methods of determining the
Expenses Research, and Development Costs with
reasonable accuracy and presentation of the
same.
CAS19 Joint Costs To bring uniformity and consistency in the
principles and methods of determining the
Joint Costs.
CAS20 Royalty and Technical To bring uniformity and consistency in the
Know-How Fee principles and methods of determining the
amount of Royalty and Technical Know-how
Fee with reasonable accuracy.
CAS21 Quality Control To bring uniformity, consistency in the
principles, methods of determining and
assigning Quality Control cost with
reasonable accuracy.
CAS22 Manufacturing Cost To bring uniformity and consistency in the
principles and methods of determining the
18 B V Subramaniam FCMA Manufacturing Cost of excisable 4-Jan-16
goods
 Two Key Ideas in Managerial
Accounting
They are:

1. Decision making relies on incremental analysis—an

analysis of revenues and costs that increase or decrease if
a particular decision alternative is selected.

2. You get what you measure!

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 Decision Making Relies on Incremental
Analysis

Incremental means “difference.” Here decision

making looks at the difference between revenues
and expenses if selection (a) is made as opposed to
selection (b).

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 You Get What You Measure

Performance measurement impacts

management behavior.

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 Relationship of Financial, Management, & Cost
Accounting

Product
Costs

FINANCIAL COST MANAGEMENT

ACCOUNTING ACCOUNTING ACCOUNTING

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Over the last 15 years cost management practices

have been revolutionized. Spurred on by the

criticisms voiced by Thomas Johnson and Robert

Kaplan in Relevance Lost: The Rise and Fall of

Management Accounting, accounting practitioners

and academics have joined forces to create new

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forms of cost management that provide decision-

Beginning with activity-based costing in the late

1980s, the list of new cost management techniques

has grown to include activity-based management,
activity-based budgeting, target cost management,
life cycle costing, capacity cost management,
investment management, and strategic cost
management, etc.,

Efforts have also been made to link cost

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management to other key performance metrics,

At the same time that these changes have taken

place in cost management, there have been

parallel developments in the structure and focus

of organizations.

Process, or horizontal, management has

emerged as a key to improving the throughput

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and performance of an organization.
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The internal benefits of process thinking have

been extended to include an organization’s key

trading partners, resulting in the creation of
integrated supply chains that span an industry’s
value chain.

The driving force behind these rapid changes to

the information and management structures of

the organization is the customer.
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 New Management Trends to
Create Value

Encourage Management Accounting
Systems Redesign, for example.
◦ Customer focus
◦ Quality focus
◦ Delivery focus
◦ Outsourcing and the virtual company
◦ Communications
◦ Shortening product life cycles
◦ Team development
◦ Deregulation in the service sector
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 KEY PRINCIPLES
IN THE INTEGRATED COST MANAGEMENT
SYSTEM

Strategic orientation: A cost management system must

incorporate and reflect the strategies of the organization and

the core competencies that support the achievement of
strategic goals.

Customer driven: Information system design, integration, and

use must be centered around defining and meeting customer

requirements.

Value based: Competitive advantage and profitable growth

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stem from understanding how and where the organization
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creates value for its customers.


Process/horizontal focus: Integration must

incorporate the flows of materials and information

across and between organizations, highlighting

interdependencies.

Decision relevant: Information systems have to be

defined around and support the key decisions of

29 theB Vorganization.
Subramaniam FCMA 4-Jan-16

Cost effective: Integration should focus on the

essential 20 percent of data that support 80- 90

percent of the decisions made within an
organization rather than on comprehensive
integration of all of the organization’s available
data.

Relationship based: Integrated information

systems must be based on and highlight the
30 performance
B V Subramaniam FCMA of key transactions and
4-Jan-16

relationships across the value chain.

 Effective Cost Management in
Purchasing

Today, purchasing, procurement, contracting, and

supply management professionals must be the

most progressive group in the company.

Effective cost management in purchasing can be

your road map to achieving your most critical

organizational objectives.

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Analyze;

purchase spend history,

forecast price and market trends,

determine total costs of ownership,

analyze fixed and variable costs,

conduct best-buy analyses, and

utilize should cost analyses of prospective suppliers

for qualification of quotes, bids, tenders and

32 proposals.
B V Subramaniam FCMA 4-Jan-16

how learning curves,

break-even analysis,

value analysis,

total landed cost,

target costing, and

life cycle costing can help you make far more

accurate estimates of cost and value.

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 Learning Curves

Based on the premise that people and
organizations become better at their tasks
as the tasks are repeated.

Time to produce a unit decreases as more
units are produced.

Learning curves typically follow a negative
exponential distribution.

The rate of improvement decreases over
time.
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 Learning Curve Effect
Cost/time per repetition

0 Number of repetitions (volume)

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 Arithmetic Approach

Simplest approach

Labor cost declines at a constant rate, the
learning rate, as production doubles
Nth Unit Produced Hours for Nth Unit
1 100.0
2 80.0 = (.8 x 100)
4 64.0 = (.8 x 80)
8 51.2 = (.8 x 64)
16 41.0 = (.8 x 51.2)

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 Logarithmic Approach
Determine labor for any unit,
TN , by
TN = T1(N
b)
where th
TN = time for the N unit
T1 = hours to produce the first unit
b = (log of the learning rate)/(log 2)
= slope of the learning curve

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 Logarithmic Example
Learning
b
Rate (%)
Learning rate = 80% 70 – .515
First unit took 100 hours 75 – .415
For 3rd Unit 80 – .322
85 – .234
TN = T1(N b) 90 – .152
T3 = (100 hours)(3b)
= (100)(3log .8/log 2)
= (100)(3–.322)
= 70.2 labor hours
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 Breakeven Analysis

Breakeven analysis examines the short run

relationship between changes in volume and

changes in total sales revenue, expenses and net
profit.

Also known as C-V-P analysis (Cost Volume

Profit Analysis).
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 Uses of Breakeven Analysis

C-V-P analysis is an important tool in terms of

short-term planning and decision making

It looks at the relationship between costs, revenue,

output levels and profit

Short run decisions where C-V-P is used include

choice of sales mix, pricing policy etc.

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 Decision making and Breakeven Analysis:
Examples

How many units must be sold to breakeven?

How many units must be sold to achieve a target

profit?

Should a special order be accepted?

How will profits be affected if we introduce a new

product or service?

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 Key Terminology: Breakeven
Analysis

Break even point- the point at which a company makes

neither a profit or a loss.

Contribution per unit- the sales price minus the variable

cost per unit.

Margin of safety- a measure in which the budgeted volume

of sales is compared with the volume of sales required to

break even
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Marginal Cost – cost of producing one extra unit of output

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 Standard Costing

Standard costing is a control system for comparing the

planned costs and revenues with actual results in order

to report variances for the purpose of performance

measurement and control.

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Cost variances are usually reported to management

in cost reconciliation statements.

When sales variances are included the reconciliation

is usually in the form of a standard cost operating

statement.

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 Variance Analysis

Cost Variance: is the difference between the standard

cost and the actual costs.

Variance Analysis: is the resolution into constituent

parts and the explanation of the variances.

 Favorable & Unfavorable Variances.

 Controllable & Uncontrollable Variances

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 1. Material 2. Labour 3. Overhead 4. Other
Variance Variance Variance Variances

Material Cost Labour Cost Overhead Cost Calendar

variance Variance Variance Variance

Types of
Variances Material Price Labour Rate Variable Sales Value
Variance Variance overheads Var. variance

Labour
Material Usage Variable o/h Sales price
Efficiency
Variance efficiency var. variance
Variance

Labour Mix
Material Mix Variance Variable o/h Sales volume
Variance expenditure var. variance
Idle Time
Variance
Material Yield Fixed overhead
Profit Variance
Variance variance

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 Value Analysis
• Value Analysis is a disciplined approach which ensures

the necessary functions for the minimum cost without

diminishing quality, reliability, performance and

appearance.

• It is a creative approach to eliminate the unnecessary

costs which add neither to quality nor to the appearance

48 of the product.
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It is a systematic application of techniques to identify

the functions of a product or a component and to

provide the desired function at the lowest total cost.

‘Value’ is a word that is very often used by

individuals without being clearly understood.

Even different departments of the same organization

have different opinions of the ‘value’ of the product that

the company manufactures.

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The designer equates value with reliability;

purchase people with price paid for them;

production personnel with that of cost from the angle

of manufacture;

sales people with what customer is willing to pay.

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In the field of value investigation, value refers to economic value,
which itself can be sub-divided into four types as

Cost value:-Sum of all costs incurred in producing the product.

Exchange value:- the measure of all the qualities and features of

the product which make it possible of being traded for another

product or for money.

Use value :- the measure of properties, qualities and features

which make the product accomplish a use, work or service

Esteem value:- the price paid by the buyer or the cost incurred by

the manufacturer beyond the use value.

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 Steps in Value Analysis

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 Target Costing

Target Costing is defined as a cost management tool

for reducing the overall cost of a product over its
entire life-cycle with the help of production,
engineering, research and design.

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 Target Costing Concept

Present Future

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Target cost is the cost that can be incurred while

still earning the desired profit

Selling price – desired profit = target cost

The customer sets the price

Profit must be achieved through cost control

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 Target Costing Principles

• price-led costing.
• focus on customers.
• focus on design.
• cross-functional involvement.
• value-chain involvement.
• a life-cycle orientation..

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 Implementation
1. Price-led costing ~ market prices are used to
determine target costs

2. Focus on customers ~ value to the customer

must be greater than the cost of the product
itself

3. Focus on design ~ cost control must occur

before production

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 4. Cross-functional involvement ~ interfunctional
product and process teams

5. Life-cycle orientation ~ minimizing total life-

cycle costs

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 Control Points

Top management in case of establishing a new

product

Cost estimating group decomposing the preset

value

Cross-functional target costing teams analysing

the production process

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 Target Costing- Example

•Handy Appliance feels there is a niche for a hand

mixer with certain features.
•Marketing Department believes that price of Rs30
would be right and that about 40,000 mixers could be
sold.
•Rs2,000,000 invest required to gear up for
production.
•Company requires a 15 percent ROI on invested
funds.
Determine
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the target cost.
B V Subramaniam FCMA 4-Jan-16
 Target Cost

Projected sales (40,000 units × 30) 1,200,000

Desired profit (2,000,000 × 15%) 300,000
Target cost for 40,000 mixers 900,000

Target cost per mixer (900,000 ÷ 40,000) 23

Each functional area within Handy Appliance would

be responsible for keeping its actual costs within the
target established for that area.

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Tata Nano – Perfect Case of Target
Costing

Tata Nano idea struck in the mind of
Chairman when he saw a family of four
(a man, his wife and two kids) riding on
a scooter on a rainy day.

He felt that there was an unfulfilled

need of safe, affordable and an all
weather alternative.

Purpose from which the concept emanated, which stresses upon the fact
that agility and understanding the unstated/ unfulfilled need of customers is the
most important source of innovation.
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Tata Nano – Perfect Case of Target
Costing

Price got fixed at Rs 1 lakh without compromising

Aesthetics

Value to customer

Safety & environment requirements

Normally bikes cost about 50,000 Indian Rupees (1,250

USD).

The cheapest car in the market was Maruti 800 which costed
It was said that “The People’s Car” was impossible to produce. Tata
about 2Lakhs
just proved the naysayers wrong. The Tata Nano is the cheapest car
in the World!!

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 Tata Nano – Perfect Case of Target
Costing

Target Cost approach with cost savings

Smaller size of car & component (material cost savings)

Material substitution (e.g. engineering plastics)

Simplified component & design

Simplified manufacturing process

Tata Motors created breakthrough product changing the market

dynamics and helped in providing a new customer experience.

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Tata Nano – Perfect Case of Target
Costing

Target Cost approach with cost savings

Target price itself

became the source
of innovation, as
the big names in
the industry just
rubbished it as
false claims

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 Kanban

Kanban means many things.

Literally, Kanban is a Japanese word that means

"visual card".

At Toyota, Kanban is the term used for the visual &

physical signaling system that ties together the whole

Lean Production system.

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Kanban as used in Lean Production is over a half

century old.

It is being adopted newly to some disciplines as

software.

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 How Kanban works
There are many flavors, but the core of Kanban means:

Visualize the workflow

Split the work into pieces, write each item on a card and put on the wall.

Use named columns to illustrate where each item is in the workflow.

Limit WIP (work in progress) – assign explicit limits to how

many items may be in progress at each workflow state.

Measure the lead time (average time to complete one

item, sometimes called “cycle time”), optimize the process
to make lead time as small and predictable as possible.

This is a direct implementation of a lean pull scheduling

system.
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 Example Kanban

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 Kaizen

Kai + zen
(Change for the better)

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 Kaizen Defined

Continuous, incremental improvement of an activity

to create more value with less waste. A process of

continually making incremental, ongoing changes
and not as a single, separate event.

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 Kaizen

Small-scale improvements are easier and faster.

The risks are lower because they generally have

limited effect.

The accumulated effect is often greater than a

single large improvement

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 Change Management

The Lean journey is paved by kaizen events

Lean concepts are simple -- sustaining is hard

Lean as a business strategy and supported by top

mgt.

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 Kaizen Events
(Creativity before capitol)

Identify a problem

Brainstorm with employees

Make the improvement

Monitor results

Adjust as necessary

Apply to like processes

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 Effort and Impact Matrix

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 Follow-up

Ensure that all assigned tasks have been completed

(infrastructure)

Help build the habits and discipline of lean and

reinforces the concepts.

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 Life Cycle Costing

The process of identifying and documenting all

the costs involved over the life of an asset is

known as Life Cycle Costing (LCC)

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 Cost Considerations
Present Worth

Salvage
Costs
Initial Cost
Operating Cost Maintenance and
Costs

Inspection
Cost

Years

Salvage
Value

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 First (Initial) Cost

Initial cost of structure

Incentive/disincentive payments should

not be included since they would reflect
user benefits or costs prior to structure
going into service

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 Time Period of Analysis

Normally equal for all alternatives

Should include at least one major

rehabilitation

Needed to capture the true economic benefit
of each alternative

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 Operating costs

Annual cost associated with the upkeep of the

structure

Cost of failures

Cost of repairs

Cost for spares

Downtime costs

Loss of production
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 Maintenance costs

Cost of corrective maintenance

Cost of preventive maintenance

Cost for predictive maintenance

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 Salvage Value/Costs

Occurs once at end of life of structure

Difference between

Removal cost

Salvage value

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The conventional LCC techniques most widely used

by companies and/or governments is based on a

purely financial valuation.

Four main cost categories are assessed:

Initial investment,

operation,

maintenance and

end-of-life disposal expenses.

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 An Environmental LCC methodology takes into account the
above four main cost categories plus external
environmental costs.

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 Life Cycle Costing -Importance

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 Total Cost Management

Total Cost Management is a process of

managing the financial outcome of activities

internal and external to the process of a business
unit by developing the skills to use cost
information unit wide as both lag and lead
indicators.
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Total Cost Management (TCM) is a systematic

approach to managing cost throughout the life cycle of

any enterprise, program, facility, project, product or

service.

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The TCM Framework is a series of integrated,

annotated process maps.

For the first time, it ties all the Cost Engineering

skills and knowledge areas together into a single

process and

it establishes Cost Engineering as a unique

discipline that supports business and project
management alike.

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 Cost Is Everything
“It costs time”
“It costs resources”
“ It costs money”

EVERYTHING
invested in assets and projects is a
COST

That is why it is called

TOTAL COST Management
(TCM)

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In TCM and Cost Engineering, cost includes money,

time, and resources of all types.

TCM is at heart a quality management process.

Each and every TCM process map is based on the

PDCA quality management/continuous process
improvement model (i.e., the Deming or Shewhart
model).

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 The PDCA cycle in TCM includes the
following steps:

Plan - plan asset solutions or project activities

Do (i.e., execute) - initiate and perform the project or

project activities in accordance with the plan

Check (i.e., measure) - making measurements of asset,

project, or activity performance

Assess (i.e., act) - assessing performance variances

from the plan and taking action to correct or improve

performance to bring it in line with the plan or to improve

92
the plan.
B V Subramaniam FCMA 4-Jan-16
 Plan-Do-Check-Assess
(PDCA)

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 TCM Attributes

Continuous Improvement

Every TCM process employs feedback and

improvement!

Integrated

Every TCM process has P,D,C & A steps that

are All linked back to business strategy!
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TCM is an integrating process that not only maps the

fields of practice of cost engineering, but also

provides links to the fields of project management,
resource management, and management accounting
practice.

TCM provides a unique technical perspective that is

often missing from financially focused approaches

(hence the term cost “engineering”)

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The Figure in next slide illustrates how TCM, with

roots and emphasis in project management and

project control, has a balanced focus on

product and capital costs,

project and operational work processes, and

resources of all types

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97 B V Subramaniam FCMA 4-Jan-16
98 B V Subramaniam FCMA 4-Jan-16
 TIME DRIVEN ACTIVITY BASED
COSTING

Originally introduced in 1980s, ABC corrected serious

deficiencies in traditional standard-cost systems.

Traditional systems typically used three categories

namely material, labour and overhead.

Allocation of indirect costs with measures of direct

labor hours or direct labor costs

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Customer focused strategy attempted to attract,

retain and grow business by offering services

such as the following.

Producing and stocking greater variety of

products

Supporting more order-entry and order tracking

100 channels
B V Subramaniam FCMA 4-Jan-16

Delivering directly to customers end –use locations ,
often in expedited and narrow time windows.

Providing specialized technical applications support.

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All these activities created value and loyalty among

customers but has cost implications.

Companies has to add overhead resources for

engineering, packaging, distributing, order handling,

marketing, and selling.

102 B V Subramaniam FCMA 4-Jan-16


Overhead costs increased both relatively and absolutely

as companies diversified into more product lines,

customers, channels and regions and offered specialized

features and services.

Standard cost systems designed during scientific

management no longer reflected the current economic

reality.
103 B V Subramaniam FCMA 4-Jan-16

Companies are operating with distorted information

about profitability of their orders, products and

customers.

Traditional cost systems may show all products as

profitable.

Economic reality is minority of products earned 150 to

300 percent of profits and unprofitable customers lost

104 B V Subramaniam FCMA 4-Jan-16

50 to 200 percent profits.

 Activity Based Costing

Activity Based Costing traces the indirect and

support costs first to activities performed by the

organizations shared resources and then

assigning the activity cost down to orders,

products and customers on the basis of each

105 organizational
B V Subramaniam FCMAactivities consumed. 4-Jan-16

Managers used the more accurate ABC and

profitability information to make better decisions about

process improvements, order acceptance, and
rejection, pricing and customer relationships.

The decision led to near term and sustainable

improvements in product and customer profitability.

106 B V Subramaniam FCMA 4-Jan-16

 ABC pitfalls

Interviewing and surveying process was time

consuming and costly.

The data for ABC was subjective and difficult to

validate

The data were expensive to store , process and

report.

Most ABC models were local and did not provide an

107 integrated
B V Subramaniamview
FCMA of enterprise profitability 4-Jan-16

opportunities

The ABC model could not be easily updated to

accommodate changing circumstances.

The model was theoretically incorrect when it ignored

the potential for unused capacity.

108 B V Subramaniam FCMA 4-Jan-16

 Time driven- ABC
An elegant more accurate
approach

TDABC simplifies the costing process by eliminating

the need to interview and survey employees for

allocating resource costs t activities before driving
them to cost objects (orders, products, customers).

TDABC assigns resource costs directly to cost

objects using two set of estimates .

109 B V Subramaniam FCMA 4-Jan-16


TDABC model calculates the cost of all resources-

personnel, supervision, occupancy equipment and

technology supplied to department or process.

This is divided by the capacity – the time available

from the employees actually performing the work of

the department to obtain the capacity cost rate.

110 B V Subramaniam FCMA 4-Jan-16

 Traditional ABC calculation
Activity Time Assign--ed Cost Cost
spend cost Driver Driver
(%) (Rs) Quantity Rate(Rs)
Process 70 396900 49000 8.10 per
Customer order
order
Handle 10 56700 1400 40.50
Customer perenquiry
enquiries
Perform 20 113400 2500 45.36per
credit credit
check check
Total 100 567000

111 B V Subramaniam FCMA 4-Jan-16


The ABC project team uses these cost driver rates

to assign the customer service departmental

expenses to individual customer on the basis of

number of orders handled , complaints processed

and credit check performed on each customer.

112 B V Subramaniam FCMA 4-Jan-16


TDABC uses time equations that directly and

automatically assign resource costs to the

activities performed and resources consumed.

Only two parameters needed to be calculated i.e.

capacity cost rate for the department and the

capacity usage by each transaction processed in

113 theB Vdepartment.

Subramaniam FCMA 4-Jan-16

Capacity cost rate=

Cost of capacity supplied /

Practical capacity of
resources
supplied

114 B V Subramaniam FCMA 4-Jan-16

 TDABC-INPUTS

Cost of capacity is Rs. 5,67,000

No of frontline people is 28

Front line employee works on average of 20 days

per month (60 days per quarter)

Paid for 7.5 hours of work each day.

Each employee show up for work for

20*7.5*3=450 hrs or 27000 minutes

115 B V Subramaniam FCMA 4-Jan-16


75 minutes in a day is spend for in breaks ,

training and education.

Practical capacity per employee is 375 minutes

per day multiplied by 60 per quarter

For 28 frontline employee the department has

practical capacity of 630,000 minutes.

116 B V Subramaniam FCMA 4-Jan-16


The cost rate (per minute) of supplying capacity ,

the first estimate for TDABC is calculated as

follows.

Capacity cost rate= Rs.567,000/630,000mts

=0.90/minute

117 B V Subramaniam FCMA 4-Jan-16

 Activity Unit time TDABC Cost (Rs)
(minutes) Cost
driver
Proces 8 0.90 7.20
customer
order
Handle 44 0.90 39.60
customer
enquiry

Perform credit 50 0.90 45

check
B V Subramaniam FCMA
118 4-Jan-16

Customer Service time (minutes)

=8*(number of orders processed)+

44*(number of customer enquires)+

50*(number of customer credit checks)

119 B V Subramaniam FCMA 4-Jan-16

 Cost of performing the Activities
Activity Unit Quantity Total TDABC Total cost
time minutes RATE
Process 8 49,000 392,000 0.90 352800
customer cost
Handle 44 1,400 61,600 0.90 55,440
customer
enquiry
Perform credit 50 2500 125,000 0.90 112,500
check
Used capacity 578,600 0.90 520,740

Unused 51,400 0.90 46,260

capacity
Total 630,000 0.90 567,000

120 B V Subramaniam FCMA 4-Jan-16

 TIME EQUATIONS

Packaging time=0.5 +6.5(special handling

required)+0.2(if shipped by air)

ERP system already store data on order, packaging,

distribution, and other characteristics.

Order transaction specific data enables data

capturing seamlessly.

121 B V Subramaniam FCMA 4-Jan-16

 ESTIMATING PROCESS TIMES

TDABC uses time as its primary cost drivers since

most resources such as personnel and equipment

have capacities that can be readily measured by the
amount of time they are available to perform work

122 B V Subramaniam FCMA 4-Jan-16


Resources as shown below measure capacity with
other units

Resource Capacity measure

Vehicle Cubic meters
capacity/warehouse
space
Vehicle capacity Kilograms

Data storage capacity Gigabytes

Data badwidth Bauds

123 B V Subramaniam FCMA 4-Jan-16


ERP systems today collect and store transaction

data such as order header, customer identity , order

detail , bills of material, and order features.

Advanced companies use Global positioning system

and radio frequency identification(RFID)

technologies to track the movemnt of trucks and

inventory.
124 B V Subramaniam FCMA 4-Jan-16
 • TDABC can easily tap into these databases to estimate

the resource demands on process triggered by a

production, sales distribution , delivery, or payment

event.

125 B V Subramaniam FCMA 4-Jan-16

 ORDER PROCESSING TIME EQUATION

ORDER PROCESSING TIME (minutes)
=10+5(if new customer)+
+2*number of line items
+4*number of rate quotes
+(if international order)
(2*(if customs form)
+5(if shipping declaration)
+10(if consular clearance))
+(if special services)
(5(if rush order)
+10 (if credit hold)
+2(if hazardous material))

126 B V Subramaniam FCMA 4-Jan-16

 BUILDING TIME EQUATION

Project teas use the following sequence to estimate

time

Begin with the most costly process

Define the scope of the process

Determine the key drivers of time

Use readily available time variables

Engage operational personnel to help build and

validate the model.

B V Subramaniam FCMA
127 4-Jan-16
 BENEFITS OF TIME EQUATION

Smaller and more scalable models-Process
complexity causes only linear increases in model
size as analysts add terms to existing time
equations.

Greater accuracy- data fed in by ERP, CRM and
General ledger.

Easy in building and maintaining models

Easy in roll out.

Ability to do capacity and predictive analysis.

Identification of process improvement
opportunities
128 B V Subramaniam FCMA 4-Jan-16
 Theory of Constraints

The Theory of Constraints (TOC) is a systems-

oriented process improvement methodology that is

based on the theory that a system has a single goal

(which is to make money, and that systems are

composed of multiple linked activities, one of which

acts as a constraint on the whole system.

129 B V Subramaniam FCMA 4-Jan-16

TOC is a methodology to focus on removing and

exploiting the constraint in order to optimize throughput.

Identification of constraints allows management to take

action to alleviate the constraint in the future

130 B V Subramaniam FCMA 4-Jan-16


A constraint is anything that limits a system from

achieving its goal or a level of performance desired. A

constraint can be viewed as a structural bottleneck
which determines the maximum capacity of a system.

131 B V Subramaniam FCMA 4-Jan-16

 Constraints

Any system can produce only as much as its

critically constrained resource
Constraint

60 units 70 units 40 units 60 units

Per day Per day Per day Per day

Maximum Throughput = 40 units per day

132 B V Subramaniam FCMA 4-Jan-16


Constraints can be internal to the company (i.e.

something which they company can easily control

or change) or external (i.e. a constraint for which
the company had no immediate control, but is often
something for which the company can take some
action to resolve in the medium to long term).

133 B V Subramaniam FCMA 4-Jan-16


Internal constraints may include:

capacity of particular machines or workstations;

salary levels or work environment within the

company which constrain the company’s ability to

hire capable employees;

transportation bottlenecks in the production

134 process;
B V Subramaniam FCMA 4-Jan-16

ability of the production management team to

manage certain production processes;

ability of the production planning team to

schedule/allocate production efficiently;

incorrect assumptions about maximum capacity by

relevant managers.

135 B V Subramaniam FCMA 4-Jan-16


External constraints may include:

availability of sufficient raw materials;

availability of labor or managers in a particular

location;

brand awareness of the company’s products;

distribution channels for the company’s products.

136 B V Subramaniam FCMA 4-Jan-16

 Five Steps Of TOC

1. Identifying the constraint

2. Decide how to exploit the constraint

3. Subordinate everything else to the decision in step

4. Elevate the constraint

5. Go back to step 1, but avoid inertia

137 B V Subramaniam FCMA 4-Jan-16

 Drum, Buffer, Rope
• Drum, Buffer, Rope is a method to identify and exploit

the constraints in a production system.

• It uses Process Mapping as a main tool to identify the

bottleneck and then apply solutions.

• Drum: This is the constraint itself since it sets the

drumbeat (pace) for the other processes. Also, the

drumbeat signals the upstream operations what to
produce and tells the downstream operations what to
expect.
138 B V Subramaniam FCMA 4-Jan-16

Buffer: This is the stockpile of WIP in front of the

constraint. It is a precaution to keep the constrained

resource running at the highest possible capacity since

it determines the output of the entire system. However,

to some degree this may conflict with lean

manufacturing principles which consider that buffers are

typically a source of waste so they should always be

139 B V Subramaniam FCMA 4-Jan-16
minimized to the extent possible.

Rope: Limitations placed on production in upstream

operations which are necessary to prevent flooding

the constraint with excess work-in-progress (WIP)
which are above its capacity.

140 B V Subramaniam FCMA 4-Jan-16

141 B V Subramaniam FCMA 4-Jan-16
 Throughput

The rate at which the system generates money through

sales.

(Or, the money coming into the organization.)

Building inventory is not throughput

Only $ generated by the system get counted; e.g., raw

materials and purchased parts are not throughput.

T = Selling Price - Materials

142 B V Subramaniam FCMA 4-Jan-16

 Throughput Ratios.

There are three main ratios that are calculated:

return per factory hour,

cost per factory hour and

the throughput accounting ratio

143 B V Subramaniam FCMA 4-Jan-16


Return per factory hour =

Throughput per unit/product time on bottleneck

resource.

The cost per factory hour =

Total factory costs/total time available on bottleneck

resource

Throughput accounting ratio=

144 Return per FCMA

B V Subramaniam factory hour/cost per factory hour 4-Jan-16
 Inventory

All the money the system has invested in

purchasing things which it intends to sell.

Inventory is a liability (not an asset)

Raw materials, work in process, finished goods

and scrap are inventory

145 B V Subramaniam FCMA 4-Jan-16

 Operating Expense

All the money the system spends in order to turn

inventory into throughput. (Or, the money coming

into the organization.)

All employee time (direct, indirect, operating, etc.)

Depreciation of a machine

Operating supplies

146 B V Subramaniam FCMA 4-Jan-16

 Sustaining TOC: Process Stability

The following steps will make production more stable

and predicable, therefore allowing for a greater level of

confidence in the impact of removing the most
significant constraint:

Measuring process and machine capacity and output in

order to define the constraint point;

Creating clearly defined production procedures and

processes;

147 B V Subramaniam FCMA 4-Jan-16


Implementing the 5S system at shop floor level;

Synchronizing the production layout to better

arrange workstations so as to minimize

transportation bottlenecks.

148 B V Subramaniam FCMA 4-Jan-16

 Comparison of Variable Costing
and Throughput Accounting
VARIABLE COSTING THROUGHPUT ACCOUNTING

Revenue Revenue
- Direct Materials - Direct Materials
- Direct Labor
- Variable Overhead - Variable Overhead
= Contribution Margin = Throughput
- Fixed Expenses - Operating Expenses
= Profit = Profit

149 B V Subramaniam FCMA 4-Jan-16

 Lean Accounting

Concepts designed to better reflect the financial

performance of a company that has implemented lean

manufacturing processes.

These may include

organizing costs by value stream,

changing inventory valuation techniques and

modifying financial statements to include nonfinancial

information.
150 B V Subramaniam FCMA 4-Jan-16
 Lean Manufacturing

A strategy designed to achieve the shortest

possible production cycle by eliminating waste.

The goal is to reduce inventory and produce only

to meet customer demand.

Benefits include lower costs, higher quality and

shorter lead times

151 B V Subramaniam FCMA 4-Jan-16

 Scope

The lean accounting concepts discussed in this

document apply to:

• large and small organizations,

• enterprises in the manufacturing and services

industries,

• public and private, and

• for-profit and not-for-profit organizations.

152 B V Subramaniam FCMA 4-Jan-16

Lean accounting practices are summarized in two

Statement on Management Accounting(SMAs).

This first lean accounting SMA, Accounting for the

Lean Enterprise: Major Changes to the Accounting

Paradigm, includes five topics:

153 B V Subramaniam FCMA 4-Jan-16

 1. Value stream costing introduces an income
statement format to control costs, promote lean
behavior, and monitor performance.

2. Decision-making methods summarize how to

make decisions, such as quotes, orders, and
outsourcing, without using standard costing as a
base.

3. Features and characteristics cost calculations

provide a product-family view of product costs.
154 B V Subramaniam FCMA 4-Jan-16
 4. Budgets and financial planning reflect a value

stream reporting structure including box score

format and/or value stream statements.

5. Transaction elimination challenges accounting to

readdress the value of collecting and recording

data using transactions and reports in favor of

155
simple visual management methods.
B V Subramaniam FCMA 4-Jan-16

The second SMA, Applying Lean Accounting

Fundamentals beyond the Manufacturing Floor,

strives to expand the lean accounting principles
discussed in this SMA to the entire enterprise.

156 B V Subramaniam FCMA 4-Jan-16

1. Performance Measurement Linkage: Key to the
success of any organization is the thoughtful and
explicit linkage of organizational goals and objectives to
the value stream and cell goals and measurements.

2. Accounting Organizations: Lean processes become a

part of the way all areas of the organization perform
their jobs.

157 B V Subramaniam FCMA 4-Jan-16

3. Service Organizations: The heart of lean is the
management of processes. Though it is easier to
visualize with a tangible product, lean principles also
address organizations that provide services to its
customers.

4. Sales and Marketing: Critical to the continuing growth of

the business, sales and marketing must be attuned to
the changes and opportunities within the value streams
158 B V Subramaniam FCMA 4-Jan-16
5. Target Costing: In lean organizations, target costing is
a major driver of change and improvement throughout
the value streams.

6. Implementing Lean Accounting Practices: As

operations demonstrate control over specific processes,
the accounting practices that support each of those
processes can adapt as well, eliminating a myriad of
non-value-added transactions.
159 B V Subramaniam FCMA 4-Jan-16
 Principles

Lean production is a term used to describe a

manufacturing approach that combines the best

elements of craft and mass production while seeking to
avoid the high cost of the craft setting and the rigidity of
mass production.

160 B V Subramaniam FCMA 4-Jan-16


Value: Lean starts with a definition of what constitutes

value from the customer’s standpoint in terms of the

features and characteristics of the product or service.

Implication: Rather than targeting a predetermined

standard product cost and motivating managers to

overproduce in an effort to reduce variances, a lean

enterprise continually redefines value based on the

customer rather than an internal standard

B V Subramaniam FCMA
161 4-Jan-16

Value Stream: The value stream is the sequence of

processes through which a product is transformed from

raw material to delivery at the customer’s site.

Implication: Traditional accounting seeks to calculate

standard costs for a product or service by assessing the
labor and other (so called) direct costs required to
provide the service or make the product, and then
allocating associated support costs to the individual
product or service.

162 B V Subramaniam FCMA 4-Jan-16


Flow and Pull: The production process is designed to

maximize the flow of the product through the value

stream, initiated by the pull of customer demand.

Implication; Performing to budget rather than customer

demand is a key performance metric. This results in
excess inventory that utilizes resources and increases
risk.

163 B V Subramaniam FCMA 4-Jan-16


Empowerment: The system of measurements and

controls provides each employee with the information

and authority to take necessary action at the time it is
required.

Implication: Lean techniques help facilitate this

evolution by providing information that is real-time-
developed and maintained by those using the
information in daily decisions.

164 B V Subramaniam FCMA 4-Jan-16


Perfection: Perfection is defined as 100% quality flowing in

an unbroken flow at the pull of the customer. In a lean

structure, empowered teams at every level within the value
stream strive to continuously improve their processes so as
to provide perfect, high-value products and/or services to
their customers.

Implication: A lean structure, empowered teams at every level

within the value stream strive to continuously improve their
processes so as to provide perfect, high-value products
and/or services to their customers.
165 B V Subramaniam FCMA 4-Jan-16
166 B V Subramaniam FCMA 4-Jan-16
Customer focus and leadership are
two key elements of the value
principle.

Customer focus;

Lean companies speak of the “voice of the

customer” as the driver of everything they do.

In lean organizations, customer demand sets

the pace of demand fulfillment.

167 B V Subramaniam FCMA 4-Jan-16


Leadership;

Leadership is the management team’s ability

to translate customer requirements into

concrete policies,

organizational structures, and

production strengths.

168 B V Subramaniam FCMA 4-Jan-16

 Elements of the value stream
principle

Lean Organization;

In traditional organizations, problems often exist

at organizational boundaries.

This is because each organization focuses on

optimizing its self-interest rather than trying to

optimize the total organizational needs.

169 B V Subramaniam FCMA 4-Jan-16


Improvement Culture;

Lean producers equip teams and individual

employees to analyze strategic gaps and quality

problems to find root causes and then conceive,
implement, and standardize effective solutions.

170 B V Subramaniam FCMA 4-Jan-16


Mapping Value Streams;

Value stream mapping is a technique that assists

the visualization of the entire process,

documenting time, waste, and cost.

The objective of value stream mapping is to find

waste, quantify throughput time, determine value-

added ratio, and provide baseline for a future
state map.
171 B V Subramaniam FCMA 4-Jan-16

Work Cells;

A work cell is a group of dissimilar operations formed to

produce a product family.

Benefits of Cellular Manufacturing including high quality
and efficiency,

result from the work cell’s lack of material movement,

small batches,

quality at source,

flexibility, and

self-correcting processes

172 B V Subramaniam FCMA 4-Jan-16

 Elements of Flow and Pull Principle

Partnering;

Effective lean production requires the effective

deployment of a set of cooperative, trust-based
relationships between employees and suppliers.

Instead of maintaining an arms-length contractual
relationship with suppliers, lean manufacturers
think of suppliers as an extension of the factory or
office.
173 B V Subramaniam FCMA 4-Jan-16

Single-Piece Flow Production;

Lot sizing affects manufacturing competitive advantage

because it influences the cost, quality, lead time, and

flexibility of manufacturing.

The drawback of large lot sizes is that even when they

minimize dollar costs, they lead to greater non-dollar costs

associated with increased production lead times, hidden
defects, and reduced scheduling flexibility.

Lean production acknowledges the problems and wastes

connected with using large lot sizes

174 B V Subramaniam FCMA 4-Jan-16

Setup-Time Reduction;

Simplified setup and reduced setup time permit

reduced-lot-size production and result in

increased production capacity,

flexibility, and

resource utilization, as well as improved product

quality and

customer satisfaction.

175 B V Subramaniam FCMA 4-Jan-16


Pull-Production System;

Pull production is a way of controlling a process

and reacting quickly to changes without relying

on inventory.

In a pull system, each stage of a process

produces exactly what the immediate

downstream stage requests; in effect, material is
pulled through the process by each stage,
producing only what is demanded of it from the
176 B V Subramaniam FCMA 4-Jan-16
next stage.

Lean Equipment Management;

One of the outcomes of lean production is the

recognition that reliability is an essential element

of a stable, effective flow.

Total preventative maintenance (TPM) or the

scheduled analysis, repair, and adjustment of

machines are used to reduce the risk of
unscheduled downtime.

177 B V Subramaniam FCMA 4-Jan-16


Empowerment;

The involvement of line and shop-floor workers is

fundamental to lean production initiatives.

For this reason, companies should elicit and listen to

workers’ ideas about improvement and empower

them to make more decisions and perform tasks that
are improvement related.

178 B V Subramaniam FCMA 4-Jan-16


Information Architecture;

Lean processes necessitate the creation of a

framework that supports a team-based lean

organization and distributes information
efficiently.

179 B V Subramaniam FCMA 4-Jan-16


Standard Operations;

Without standard operations, improvement

potential is very limited.

Things will fall back into a chaotic state.

Standard operations are the work procedures,

sequences of tasks, and times prescribed for

production of a unit of output.

180 B V Subramaniam FCMA 4-Jan-16

 Major Changes to Accounting Paradigm

Traditional accounting systems present a “frozen” view

of operations that doesn’t reflect the continuous

improvement goals of the lean enterprise.

1. Lean and simple business accounting applies lean

methods to accounting processes eliminating waste

embedded in transaction processes, reports, and

accounting
181 methods.
B V Subramaniam FCMA 4-Jan-16
 2. Accounting processes that support lean transformation

focus on measuring and understanding the value

created for the customer by concentrating on the entire

value stream rather than individual products or

services.

182 B V Subramaniam FCMA 4-Jan-16

 3. Clear and timely communication of information is
evidenced by easy-to-understand accounting reports that
are provided frequently and not locked in to a monthly
reporting cycle.

4. Planning from a lean perspective involves people who

are responsible for achieving results and are actively
involved in setting goals.

5. Strengthen
183 B V Subramaniam internal
FCMA accounting control when eliminating
4-Jan-16

transactions through prudent planning.

 Value Stream Costing

Value Stream Costing facilitates in growing the

business, increasing customer value, eliminating

waste from every process, and increasing cash flow

and profitability.

184 B V Subramaniam FCMA 4-Jan-16

 Value Stream Income Statements

Traditional income statements present information on

cost of goods sold, applied overhead, and

manufacturing variances, value stream statements

highlight material purchases, employee and equipment

costs, and facility costs.

185 B V Subramaniam FCMA 4-Jan-16


Whenever possible, costs are assigned directly to value

streams rather than allocating to cost objects.

This includes costs associated both with personnel and

with machines.

186 B V Subramaniam FCMA 4-Jan-16

187 B V Subramaniam FCMA 4-Jan-16
188 B V Subramaniam FCMA 4-Jan-16
 Decision Making in VSC
In value stream costing, we cost the value stream, not the
products. It may be difficult to see how a business can be
run without knowing the cost of its products.
These are some of the reasons companies use standard
product costs:
• Margin and profitability analysis,
• Product pricing and quoting,
• Make vs. buy decisions,

189 B V Subramaniam FCMA 4-Jan-16


Performance measurement,

Financial reporting,

Product or customer rationalization,

Measuring cost improvements,

Transfer pricing, and

Valuing inventory.

190 B V Subramaniam FCMA 4-Jan-16


Decision Making in Lean Accounting

When using lean accounting, regular decisions relating to

such things as profitability, make vs. buy, sourcing, product

and customer rationalization, and so forth, are made using
value stream cost and profitability information, not the
costs of individual products.

Instead of calculating the margins for a product or an

order, decisions can be made based on the effect on the

value stream as a whole.
191 B V Subramaniam FCMA 4-Jan-16

The value stream information is better for decision

making because:

• It is real information and does not contain the complex

(often baffling) assumptions of full absorption product
costing.

• The cost and revenue information is clearly

understood by the people using the information,
which enables them to make more informed
decisions.

• TheB Vfinancial
192
information is up to date, often to the4-Jan-16
Subramaniam FCMA

current week.
193 B V Subramaniam FCMA 4-Jan-16
194 B V Subramaniam FCMA 4-Jan-16
195 B V Subramaniam FCMA 4-Jan-16
196 B V Subramaniam FCMA 4-Jan-16
 Business Analytics

Business Analytics (BA) is the study of data through

statistical and operations analysis, the formation of

predictive models, application of optimization
techniques and the communication of these results
to customers, business partners and colleague
executives.

197 B V Subramaniam FCMA 4-Jan-16

 Business Intelligence

Business intelligence (BI) can be defined as a set of

processes and technologies that convert data into

meaningful and useful information for business

purposes

198 B V Subramaniam FCMA 4-Jan-16


BI is focused on querying and reporting, but it can

include reported information from a BA analysis.

BI seeks to answer questions such as what is

happening now and where, and also what business

actions are needed based on prior experience.

BA, on the other hand, can answer questions like why

something is happening, what new trends may exist,

what will happen next, and what is the best course for
the future.
199 B V Subramaniam FCMA 4-Jan-16
 The Business Analytics (BA) Field: An
Overview

200 B V Subramaniam FCMA 4-Jan-16

 Relationship of BA Process and
Organization
Decision-Making Process

The BA process can solve problems and identify

opportunities to improve business performance.

In the process, organizations may also determine

strategies to guide operations and help achieve

competitive advantages.

Typically, solving problems and identifying strategic

opportunities to follow are organization decision-

B V Subramaniam FCMA
making
201
tasks. 4-Jan-16
 Organization Decision-Making
Process

The organization decision-making process (ODMP)

developed by Elbing(1970) and is focused on

decision making to solve problems but could also
be applied to finding opportunities in data and
deciding what is the best course of action to take
advantage of them.

202 B V Subramaniam FCMA 4-Jan-16

203 B V Subramaniam FCMA 4-Jan-16
 Value Chain Management

Development of a set of functional-level strategies

that support a company’s business-level strategy

and strengthen its competitive advantage

204 B V Subramaniam FCMA 4-Jan-16

 Value chain

Coordinated series or sequence of functional

activities necessary to transform inputs into

finished goods or services customers value and
want to buy.

Porter’s value chain consists of a “set of activities

that are performed to design, produce and

market, deliver and support its product”.
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 Porter’s value chain

Porter distinguishes Value Chain between

primary activities and

support activities

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Primary activities: inbound logistics, operations,

outbound logistics, marketing and sales, service in

the core value chain creating directly value

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Support activities: procurement, technology

development, human resource management, firm

infrastructure supporting the value creation in the
core value chain

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209 B V Subramaniam FCMA 4-Jan-16
 Concepts to Manage the Value Chain

Three research areas with respective sub-topics

are relevant to the problem

of managing a global value chain end-to-end by
volume and value:
• Concepts to manage values in the value chain
• Concepts to manage demand in the value chain
• Concepts to manage supply in the value chain

210 B V Subramaniam FCMA 4-Jan-16

 Value-based management indicators
Indicato Formula Descriptions
r
ROCE EBIT/ Indicator to measure pre-tax interest rate
(Total on total
assets - invested capital excluding current short-
current term liabilities.
liabilities)
ROA Net profit/ Indicator to compare total profit return on
Total assets assets
specifically in asset-intensive industries.
EVA NOPAT Profit indicator deducting capital costs
– (NOA * from net
WACC) operating profit after taxes excluding
interests;
211 B V Subramaniam FCMA consideration of financing structure4-Jan-16
of
the company.
 Supply Chain Management
Supply Chain Management is the design and
management of processes across organizational
boundaries with the goal of matching supply and
demand in the most cost effective way.
Supply Demand

212 B V Subramaniam FCMA 4-Jan-16

 SCM Generated Value

Minimizing supply chain costs

while keeping a reasonable service level
customer satisfaction/quality/on time
delivery, etc.

This is how SCM contributes to the bottom line

SCM is not strictly a cost reduction paradigm!

213 B V Subramaniam FCMA 4-Jan-16
 A picture is better than 1000 words!
- A supply chain consists of
Supplier Manufacturer Distributor Retailer Customer

Upstream
Downstream

- aims to Match Supply and Demand,

profitably for products and services

- achieves

The right
Product
+ + + +
The right
Price
The right
Store
The right
Quantity
The right
Customer
+ The right
Time
= Higher
Profits

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 Flows in a Supply Chain

Material

Information
Supplier Customer
Funds

The flows resemble a chain reaction.

215 B V Subramaniam FCMA 4-Jan-16

 Push vs. Pull System

What instigates the movement of the work in the system?

In Push systems, work release is based on downstream

demand forecasts
Keeps inventory to meet actual demand
Acts proactively

e.g. Making generic job application resumes today (e.g.:
exempli gratia)

In Pull systems, work release is based on actual demand or

the actual status of the downstream customers
May cause long delivery lead times
Acts reactively

e.g. Making a specific resume for a company after talking
B V Subramaniam FCMA
216 to the recruiter 4-Jan-16
 Push/Pull View of Supply Chains
Procurement, Customer Order
Manufacturing and Cycle
Replenishment cycles

PUSH PROCESSES PULL PROCESSES

Customer

217 B V Subramaniam FCMA 4-Jan-16

 Supply Chain Management

Strategic, tactical and operating issues

Strategic - long term and dealing with supply chain design

Determining the number, location and capacity of facilities

Make or buy decisions

Forming strategic alliances

Tactical - intermediate term

Determining inventory levels

Quality-related decisions

Logistics decisions

Operating - near term

Production planning and control decisions

Goods and service delivery scheduling

Some make or buy decisions

218 B V Subramaniam FCMA 4-Jan-16


Key issues in supply chain management
include

Distribution network configuration

How many warehouses do we need?

Where should these warehouses be located?

What should the production levels be at each of our
plants?

What should the transportation flows be between
plants and warehouses?

Inventory control

Why are we holding inventory? Uncertainty in
customer demand? Uncertainty in the supply
process? Some other reason?

If the problem is uncertainty, how can we reduce it?
219
B How
V Subramaniam FCMA
good is our forecasting method? 4-Jan-16

Distribution strategies

Direct shipping to customers?

Classical distribution in which inventory is held in
warehouses and then shipped as needed?

Cross-docking in which transshipment points are
used to take stock from suppliers’ deliveries and
immediately distribute to point of usage?

Supply chain integration and strategic partnering

Should information be shared with supply chain
partners?

What information should be shared?

With what partners should information be shared?

What are the benefits to be gained?

220 B V Subramaniam FCMA 4-Jan-16

 Supply Chain Alternatives
Manufacturer Manufacturer Manufacturer Manufacturer Manufacturer

Distributor Distributor

Retailer Retailer Retailer Retailer

Customer Customer Customer Customer Customer

Barnes & Noble

Amazo
Dover Varsity Amazon Borders
n
Books resellers Small
BN.co
Bookstores
m

221 B V Subramaniam FCMA 4-Jan-16

 Examples of Supply Chains
Dell / Compaq

Dell buys some components for a product from its suppliers
after that product is purchased by a customer. Extreme
case of a pull process

Zara, Spain’s answer to Italy’s Benetton

Sells apparel with a short design-to-sale cycle, avoids markdowns.

Toyota / GM / Volkswagen, in the course notes

McMaster Carr / W.W. Grainger, sell auto parts

Amazon / Barnes and Noble

Frozen food industry/Fast food industry/5 star
restaurants
222 B V Subramaniam FCMA 4-Jan-16

Internet shopping: Webvan / Peapod
 Balanced Scorecard

The balanced scorecard is a strategic planning and

management system that is used extensively in

business and industry, government, and nonprofit
organizations worldwide to align business activities to
the vision and strategy of the organization, improve
internal and external communications, and monitor
organization performance against strategic goals.

223 B V Subramaniam FCMA 4-Jan-16

 Balanced Scorecard Perspectives

Learning and Growth
◦ Use the organization’s intellectual capital to adapt to changing
customer needs or to influence new customers’ needs and
expectations through product or service innovations

Internal Business
◦ Things to do well to meet customer needs and expectations

Customer Value
◦ How well the organization is doing relative to important customer
criteria

Financial
◦ Address stockholders/stakeholders concerns about profitability and
organizational growth
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225 B V Subramaniam FCMA 4-Jan-16

Kaplan and Norton recommend a nine-step process for

creating and implementing the balanced scorecard in

an organization.

1. Perform an overall organizational assessment.

2. Identify strategic themes.

3. Define perspectives and strategic objectives.

4. Develop a strategy map.

226 B V Subramaniam FCMA 4-Jan-16


5. Drive performance metrics.

6. Refine and prioritize strategic initiatives.

7. Automate and communicate.

8. Implement the balanced scorecard throughout the

organization.

9. Collect data, evaluate, and revise

227 B V Subramaniam FCMA 4-Jan-16

 Strategy Maps

A strategy map provides a visual framework for an
organization’s strategy – how it intends to create
value.

Specifically, a good strategy map will link together:

1. The desired productivity and growth outcomes.

2. The customer value proposition which will be
needed.

3. Outstanding performance in internal processes.

4. The capabilities required from intangible assets.

228 B V Subramaniam FCMA 4-Jan-16

 Strategy Mapping

229 B V Subramaniam FCMA 4-Jan-16

 Balanced Scorecard Measures

Short-term and long-term

Internal and external

Financial and nonfinancial

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 Total Capacity management

Capacity is the maximum output or producing

ability of a machine, person, factory, etc.

Capacity can be measured in physical terms

Measure of the amount of work done

Capacity is the measure of the maximum amount

of work that can be done in a given time

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Capacity has a cost

Cost to acquire or rent the facility,

machine, operating costs, wages, utilities,

insurance, etc.

The cost is incurred even if capacity is

232
underused
B V Subramaniam FCMA 4-Jan-16
 The Basic Economies of
Business

233 B V Subramaniam FCMA 4-Jan-16


The market price represents an upper boundary on the

amount of resources a company can use in providing

goods and services to it customers.

If the company uses excess resources, then it suffers a

loss.

The logic of the market dominates, whether the

organization operates in the public or private sector.

234 B V Subramaniam FCMA 4-Jan-16
 Measuring the Cost of Capacity

Traditional measures do not reflect the cost of capacity usage

or over capacity

Costs are part of overhead and allocated to production

Focus is on inventory valuation, not managing capacity

Allocation base is chosen from five alternatives

Theoretical
o Maximum output when operating continuously at
maximum efficiency
235 B V Subramaniam FCMA 4-Jan-16

Practical

oLevel of output under current conditions,

allowing for normal downtime for setups,
maintenance, vacations, etc.

Normal

oAverage level of output achieved or anticipated

over several years

Budget

oLevel of output anticipated for the current year

Actual

oLevel of output actually achieved in the current

236 Byear
V Subramaniam FCMA 4-Jan-16
 Managing Capacity Costs

Capacity costs may be fixed, but can still be

managed

Reduction of idle capacity

Increasing sales to use unused capacity

Renting unused capacity to others

B Reduction in “days off”

V Subramaniam FCMA
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Reduction of nonproductive capacity

Reduction of setup time, defects, etc.

Reduction of rated capacity

Replace the asset with one having less capacity

Lower capacity asset can be more fully utilized

238 B V Subramaniam FCMA 4-Jan-16

 Practical Considerations in Measuring
Capacity

How is capacity defined?

Worker, machine, factory, etc.

Higher-level capacity (process, factory, etc.) is
determined by the lowest capacity component

Capacity may change over time

Assets slowing with age

Technological improvements to assets

239 B V Subramaniam FCMA 4-Jan-16


Capacity may depend on the mix of work

processed on the asset.

The machine may take longer to stamp one type

of product than it takes to stamp another type

240 B V Subramaniam FCMA 4-Jan-16


Six key issues that combine to create the basic

language of capacity cost measurement are:

resource capability;

baseline capacity measures;

capacity deployment;

capacity utilization measures;

time frame of analysis; and

organizational focus.

241 B V Subramaniam FCMA 4-Jan-16

 DIAGNOSING CAPACITY
UTILIZATION

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 Total Quality Management

Total Quality Management means that the

organization's culture is defined by and supports the

constant attainment of customer satisfaction through
an integrated system of tools, techniques, and
training.

This involves the continuous improvement of

organizational processes, resulting in high quality

products and services.
243 B V Subramaniam FCMA 4-Jan-16
 Basic Concepts of TQM

Customer Focus

Continuous Process Improvement - Kaizen

Employee Empowerment – Everyone is responsible

for quality

Quality is free - focus on defect prevention rather

244
than defect detection for it is always cheaper to4-Jan-16
B V Subramaniam FCMA
do it
right the first time

Benchmarking – Legally stealing other people’s

ideas

Customer-Supplier Partnerships

Management by fact..by numbers..by data –

Balanced scoreboard (financial, customer, process,

learning)

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 Quality Lever

246 B V Subramaniam FCMA 4-Jan-16

 TOTAL QUALITY MANAGEMENT

247 B V Subramaniam FCMA 4-Jan-16

 Cost of Quality

The Cost of Quality is a measure of what an

organization is spending for its overall quality.

It can be viewed as the difference between the actual

cost of making and selling products and services and

the cost if there were no failures of the products and
services during manufacture or use.

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The Cost of Quality has two basic components:

A) Cost of conformance, i.e.,

cost of prevention

cost of appraisal

249 B V Subramaniam FCMA 4-Jan-16

 B) Cost of non-conformance or failures, i.e.,

cost of internal failure

cost of external failure or lost opportunity

250 B V Subramaniam FCMA 4-Jan-16

 Cost of Prevention

The cost of prevention is the cost to ensure that

customer requirements are met.

It is associated with maintaining quality systems, such

as quality control systems.

These are incurred prior to or during production to

prevent defective units of output.

251 B V Subramaniam FCMA 4-Jan-16


Examples of preventive actions include:

quality planning

quality engineering

training to improve quality

maintenance and calibration of production and

inspection of equipment

supplier assurance.

252 B V Subramaniam FCMA 4-Jan-16


Cost of Appraisal

The cost of appraisal is the cost to ensure the work

processes are producing outputs that meet customer

needs or requirements, such as the inspection of raw
materials.

These are incurred after production, but before sales, to

identify defective items.

253 B V Subramaniam FCMA 4-Jan-16


Examples include:

quality data acquisition and analysis

quality measurement criteria

quality audits

laboratory acceptance testing

field evaluation and testing

inspection and testing

raw materials testing

in-process testing

review of test and inspection data.

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Cost of Internal Failure

These are costs of not meeting customer requirements,

such as the cost of having to do work again (rework).

These are easy to identify because many accounting

systems already track them.

They are incurred to fix or dispose of the defective items

before they are sold.

Unlike the cost of prevention and appraisal, these costs

are not value added and never necessary.

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Examples include:

scrap

rework or repair

trouble shooting

re-inspect and re-test.

256 B V Subramaniam FCMA 4-Jan-16


Cost of External Failure or Lost Opportunity

These costs represent the lost profits associated with

not meeting external customer needs or requirements.

If the external customers become dissatisfied with an
enterprise’s offerings, they are likely to return the
product, not buy from the firm again and, more
importantly, tell other potential customers about their
experience.

The cost of lost opportunity, therefore, includes lost
profits from order cancellations and market share loss.
257 B V Subramaniam FCMA 4-Jan-16

Examples include:

customer service faults

products or services rejected and returned

products or services recalled for modification

repairs and replacements or added service

provided under warranty

admitted repairs beyond warranty

product liability

customer losses due to poor quality.

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 OPTIMAL QUALITY COST

259 B V Subramaniam FCMA 4-Jan-16

260 B V Subramaniam FCMA 4-Jan-16
 Process Capability (Cp, Cpk) and
Process Performance (Pp, Ppk)

Process Capability Measurement:

A measurement to determine if a process can produce

output that is both centered on the target and well

within the specifications limits.

A process is “capable” if it fully conforms to customer

requirements; meets predetermined levels of centering

on the target value and variability within the
specifications limits; and is in control.
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Process Quality Assurance:

A system that verifies that the process is being

followed, that the enablers for the process are in

place, and that the process is consistently capable
of achieving specified outputs.

262 B V Subramaniam FCMA 4-Jan-16


Way to report process capability and process

performance is through the statistical

measurements of Cp, Cpk, Pp, and Ppk.

Cp= Process Capability.

A simple and straightforward indicator of process

capability.
Cpk= Process Capability Index.

Adjustment of Cp for the effect of non-centered

263 B V Subramaniam FCMA 4-Jan-16
distribution.

Pp= Process Performance.

A simple and straightforward indicator of process

performance.

Ppk= Process Performance Index.

Adjustment of Pp for the effect of non-centered

distribution.
264 B V Subramaniam FCMA 4-Jan-16

“Cp should always be greater than 2.0 for a good
process which is under statistical control. For a
good process under statistical control, Cpk should
be greater than 1.5.”
- Ranganadha
Kumar

265 B V Subramaniam FCMA 4-Jan-16

 List of Quality measurements in manufacturing
industries

Installation failures

Scrap and rework

Re-inspection and retest

Redesign and engineering changes

Soft toolings

Abandoned programs

266 B V Subramaniam FCMA 4-Jan-16


Billing errors

Bad debts

Premium shipping costs

Supplier cancellation costs

Overdue accounts receivable

Off-spec/waivers

Excess inventory

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 Process Capability (Cp)

268 B V Subramaniam FCMA 4-Jan-16

 Process Capability (Cp)

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 Frugal Innovation or Frugal
Engineering

The Frugal Engineering (FE) philosophy involves

breaking up and rebuilding a cycle that culminates in a

simpler, more robust, easier-to-handle final process and
cost-effective final product.

FE has been leveraged by several industries to reduce

overheads and develop products that meet the critical-to

quality requirements, by eliminating requirements that
B V Subramaniam FCMA
270 4-Jan-16

are not must-haves.

271 B V Subramaniam FCMA 4-Jan-16

Frugal Engineering (FE) involves the breaking up and
rebuilding cycle that culminates in a final product that equals
more expensive, complex equivalents.

In recent times, Value Engineering (VE) has gained
prominence as a methodology adopted by manufacturers
for developing innovative and cost-effective products.

VE is a systematic approach aimed at obtaining the desired
functions of a product at minimum cost, providing maximum
value while maintaining or enhancing performance, quality,
reliability, and safety, and adhering to environmental norms.

272 B V Subramaniam FCMA 4-Jan-16

273 B V Subramaniam FCMA 4-Jan-16
 Frugal innovation Six success factors
1. Fitness check:

Define target markets and customer segments.

First, ask whether the current product or service

range is suitable for new markets and what potential it
has.

274 B V Subramaniam FCMA 4-Jan-16

2. Market analysis:

Look at the defined target markets and target customer

segments in detail. What do the new customers really
need? And especially, what don't they need? How much
are they willing to spend on which product features?

275 B V Subramaniam FCMA 4-Jan-16

3. Product design:

Image you are designing the product. What is its core?

What is indispensable? What extra features do you
need? What fits the desired user behavior and what
doesn't? All these questions can be answered by a
technological concept including target costs and a bill of
materials

276 B V Subramaniam FCMA 4-Jan-16

 4. Value chain integration:

This involves deciding how much to outsource and

creating a tailored solution for each stage of the

value chain — from development (where will the
product be made?) to marketing and sales (is a
dual brand strategy best?).

277 B V Subramaniam FCMA 4-Jan-16

6. Change management:

Frugal innovation transforms thinking at all levels.

Executives and employees often meet such changes

with incomprehension and skepticism, or they create
obstacles.

That wastes time and money. Change management

processes accompany the transformation; not just to

overcome reservations, but also to create enthusiasm
for the new idea.
278 B V Subramaniam FCMA 4-Jan-16
 5. Roadmap:

The roadmap doesn't just describe the situation; it

also includes the conclusions and the preferred

solution. It is a straightforward business case — with
an honest risk assessment, implementation plan and
clearly allocated responsibilities.

279 B V Subramaniam FCMA 4-Jan-16

 Example

The application of FE principles is the Jaipur Leg- low cost

artificial leg that was developed in Jaipur, India.

The prosthetic is a rubber-based alternative to the

composite carbon fiber variant. It was designed to be

inexpensive, water-resistant, and quick to manufacture and
fit.

The primary material used was polyurethane, which is

water-proof, increases the durability and enables

convenience of use.
280 B V Subramaniam FCMA 4-Jan-16

The choice of materials and mechanisms helped to mimic a
 Preventive maintenance

PM program emphasizes the need to

Maintain normal operating requirements,

Maintain equipment requirements

Keep equipment facilities clean and organized ,

monitor equipment daily , schedule preventive

maintenance , manage business information ,use
Predictive maintenance.

281 B V Subramaniam FCMA 4-Jan-16

 Failure Mode Effects Analysis (FMEA)

Failure modes and effects analysis (FMEA) is a step-

by-step approach for identifying all possible failures in a

design, a manufacturing or assembly process, or a

product or service.

282 B V Subramaniam FCMA 4-Jan-16

 FEMA -Example

283 B V Subramaniam FCMA 4-Jan-16

 Cost Tables

A cost table is a computerized multidimensional data

base in which cost is captured for several levels of a

number of attributes for either the parts or functions of
a product

284 B V Subramaniam FCMA 4-Jan-16

 CLASSIFICATION OF COST TABLES

 Design Cost Tables:

Cost Tables are used during various stages in

the design process e.g.

Concept design cost table

Basic design cost table
Detailed design cost table
Manufacturing process design cost table
 Production cost Table:

Production cost table help managers to

decide the most beneficial production methods. E.g.

Purchasing and subcontracting cost Table

Moulds and Tools Cost Table
 Distribution Cost Table:

Distribution cost table gives

managers a financial basis for choosing between
alternative channels of distribution.
 Another classification of cost table

Bottom - Up or Addition Method:
This table makes easy to compare the cost of each
process stages in the production. There are two methods namely,
concentrating on Physical product (Parts of a product) or the Functions
of a product.

o The basic rule for the bottom - up approach is that the greater detail in

which the cost of product is to be estimated, the more subdivisions are

required of the cost items.
The following diagrams indicate the detail involved in some cost items

Direct material cost

• Net spending volume of

Net Volume material consumption
of Material
Consumption • Volume allowance of material
consumption

Volume of Material
Consumption

• Material loss from tests

Excess
Volume of
• Yield loss
Material
consumption
• Small quantities loss
Development and Design cost

• Depreciation
• Preventive maintenance
Capacity • Insurance
cost Rate
• Lighting and air conditioning
• Others

Machine hour
rate

• Direct electric power

Operating • Material supplies
cost Rate • Tool Supplies
• Others
Top - down approach
The top down approach to cost tables can be based
either on the physical product or on the functions of a product.

Based on Physical Product:

> Uses Group Technology
> It involves grouping products together on the basis of size,
shape, quality, manufacturing method.
> Helps to take decision about how far to break down the
products into its various components

Based on Function:

> Determines the relationship between the functions(Properties)

of the estimation object (Product)and its actual cost.

> Usually this relationship is expressed by a chart or mathematical

formula.
o Cost tables based on functions of a product or service classified into,

Using Theoretical values

Using Actual Values
 Compiling Cost Tables

The compiling of cost table vary depending on

whether the cost table based on the physical

product, function, bottom-up or top down
approach.
Practical Application of Cost Tables
 Cost Table for Engine System
SI No Products/Components Number of units Unit Price Product life (km) Quantity /km Value /km
1 Cylinder Head 1 900000 0.00000111
2 Cylinder Head Gasket 1 300000 0.00000333
3 Cylinder liner set 6 300000 0.00002000
4 Piston Set 1 400000 0.00000250
5 Piston ring set 1 400000 0.00000250
6 Cam Shaft bush kit 1 300000 0.00000333
7 Connect rod assy 1 900000 0.00000111
8 Crossed fan belt 3 100000 0.00003000
9 Housing 1 900000 0.00000111
10 Fly wheel ring 1 100000 0.00001000
11 Main bearing set 1 300000 0.00000333
12 Connecting rod bearings 1 300000 0.00000333
13 Oil cooler 1 900000 0.00000111
14 Oil filter 1 24000 0.00004167
15 Rocker arm shift 1 500000 0.00000200
16 Water pump assy 1 400000 0.00000250
17 Rocker lever 1 400000 0.00000250
18 Overhaul gasket kit 1 900000 0.00000111
19 Compressor valve kit 1 400000 0.00000250
20 Sun gasket 4 300000 0.00001333
21 Material costs
22 Trade discounts
23 Material costs
24 KVAT 1 100000 0.00001000
Total Cost
 Total Cost of Operation/Km

Variable Cost Table

Fuel Cost
Lubrication
A Fuel Aggregates

B Tyres and Tubes Aggregates

Material Cost
Engine System
Fuel Injection System
Exhaust System
Electrical System
Clutch system
gear box system
propeller Shaft system
brake system
Body & Frames
Power Steering System
Suspension system
C Material Maintenance Cost Aggregates

Labour
Engine system
Clutch system
Brake system
Electrical System
Steering system
Wheel system
Suspension system
Front axle housing
Rear axle housing
Propeller shaft
Gear box

D Labour Maintenance Aggregates

Total Variable Cost Aggregates

Fixed Cost Table

Salaries and Allowances

Depreciation
Financing Cost
Insurance
Motor Vehicle tax
General Overheads

Working capital interest

Total Fixed Costs

Fixed cost /km

 Acknowledgement;

Institute of Cost Accounts of India

CII Cost Congress Presentations - 2015

Institute of Management Accountants, USA
(Guidelines)

Chartered Institute of Management Accountants, UK

International federation of Accountants

CAM I

299 B V Subramaniam FCMA 4-Jan-16

300 B V Subramaniam FCMA 4-Jan-16