M

A
N
A FINAL PROJECT
G
MANUFACTURING COMPANY
E
M
E
N
T
JOSHUA LAYER CAKE AND PASTRY

A
C CREATED BY:
C HADIANTO [ 1742091 ]
O NINI CARTINA [ 1742151 ]
RIZKY ILHAMRULLAH [ 1742204 ]
U RUSDI NOVERIANTO [ 1742202 ]
N
T
UNIVERSITAS
INTERNASIONAL BATAM
I
SEMESTER GENAP
N
TA 2018 2019
G
 Cost Management

PREFACE

Praise and thanks to Our Almighty God, we have been able to complete the final assignment
report of Management Accounting (Full Set Costing and Cost Management) in Joshua Layer Cake and
Pastry {Joshua cakes} . Author composed this final assignment report guided by the book of
Introduction to Cost Management Accounting & Control by Hansen/Mowen/Guan.

On this occasion, Author would like to thank all of those who have been involved in encouraging
and assisting Author in the preparation of this report. The Author are fully aware that the preparation of
this final report still have some mistakes that are far beyond from perfection. Therefore, the Author is
willingly to accept criticisms and suggestions from readers that will help the improvement and
perfection of this final assignment report.

At the end the Author hope that this final assignment can be beneficial to us all, especially for
the related companies and students of the Universitas Internasional Batam.

Batam, April 23, 2019

Author Team

1
 Cost Management

TABLE OF CONTENT

PREFACE......................................................................................................................................................... i

TABLE OF CONTENT..................................................................................................................................................ii

CHAPTER I PRELIMINARY....................................................................................................................................1

1.1 History.........................................................................................................................................................1

1.2 Mission and Objectives...............................................................................................................................2

1.3 Company Profile..........................................................................................................................................3

1.4 Organization Structure...............................................................................................................................4

CHAPTER II THEORY BASE AND POLICY..............................................................................................................5

2.1 Strategic Cost Management.......................................................................................................................5

2.2 Quality of Economic Order (Economic Order Quantity).............................................................................7

2.3 Activity Based Management.....................................................................................................................11

2.4 CVP Analysis..............................................................................................................................................16

2.5 Break Even Analysis..................................................................................................................................16

2.6 Pricing and Profitability Analysis...............................................................................................................17

2.7 Lean Manufacturing..................................................................................................................................27

2.8 Productivity Measurement.......................................................................................................................27

2.9 Budgeting..................................................................................................................................................34

2.10 Quality and Environmental Management..............................................................................................56

CHAPTER III ANALYSIS......................................................................................................................................57

CHAPTER IV CONCLUSION.....................................................................................................................80

1
 Cost Management

CHAPTER 1
PRELIMINARY

1.1. History

Joshua Layer Cake and Pastry {Joshua cakes} is a private company based in the city of Batam,
Indonesia and founded by Joshua in January 2018. The beginning of the company took place, the owner
named Joshua was interested in making cakes and then asked his grandmother to teach him to make
cakes, the results surprised the grandmother's cake and Joshua are very delicious and from here they
think to give the homemade cake to the neighbor's house, the response from the neighbors is very good,
they like the cake then from here small business is done.

Many neighbors ordered the cake, after walking long enough. Joshua invited his three college
friends to open a pretty big cake shop together and they agreed, then they prepared everything needed to
open the store, after all the stores were ready, they were immediately opened. The first day of the sale
seemed quiet, then the owner had the idea to make a brochure to promote their merchandise.

The results were also interesting, many buyers who came to buy the cake, the day the shop was
replaced was visited by buyers. Finally, the owner had the idea to expand their store, and the owner
succeeded in making the cake shop known to the public, to be available in various big cities.

1
 Cost Management

1.2. Mission and Objectives

We decided to open as many jobs as possible, serve customers very well and the most important thing is
to serve customers with smiles. The aim of our company is to create cakes of very good quality for our
esteemed customers.

In our journey to continue to make this company grow is the response from customers whether the cake
is of good quality or not, if not, the customer can give advice or input, because your suggestions and
input will make this cake company good and better in the future.

1
 Cost Management

1.3. Organization Structure

1
 Cost Management

1.4. Organization Structure

Owner

Director

Production Marketing Finance

Manager Manager Manager HRD

Purchasing Head of Marketing

Finance Staff
Staff Department Staff

Mix Depart Bak Depart Pack Depart

Staff Staff Staff

1
 Cost Management

CHAPTER II
THEORY BASE AND POLICY

2.1. Strategic Cost Management

Decision making that affects the long-term competitive position of a firm must explicitly
consider the strategic elements of a decision. The most important strategic elements for a firm
are its long-term growth and survival. Thus, strategic decision making is choosing among
alternative strategies with the goal of selecting a strategy, or strategies, that provides a company
with reasonable assurance of long-term growth and survival. The key to achieving this goal is to
gain a competitive advantage. Strategic cost management is the use of cost data to develop and
identify superior strategies that will produce a sustainable competitive advantage.

Competitive advantage is creating better customer value for the same or lower cost than
offered by competitors or creating equivalent or better value for lower cost than offered by
competitors. Customer value is the difference between what a customer receives (customer
realization) and what the customer gives up (customer sacrifice). What a customer receives is
more than simply the basic level of performance provided by a product.1 What is received is
called the total product. The total product is the complete range of tangible and intangible
benefits that a customer receives from a purchased product. Thus, customer realization includes
basic and special product features, service, quality, instructions for use, reputation, brand name,
and any other factors deemed important by customers. Customer sacrifice includes the cost of
purchasing the product, the time and effort spent acquiring and learning to use the product, and
postpurchase costs, which are the costs of using, maintaining, and disposing of the product.
Increasing customer value to achieve a competitive advantage is tied closely to judicious strategy
selection.

1
 Cost Management

Three general strategies have been identified: cost leadership, product differentiation, and focusing.

Differentiation

Cost General Focusing

Leadership Strategies

Strategic
Positioning

Value-Chain Framework, Linkages, and Activities Successful pursuit of a sound strategic

position mandates an understanding of the industrial value chain. The industrial value chain is
the linked set of value-creating activities from basic raw materials to the disposal of the finished
product by end-use customers. Thus, breaking down the value chain into its strategically relevant
activities is basic to successful implementation of cost leadership and differentiation strategies. A
value-chain framework is a compelling approach to understanding a firm’s strategically
important activities. Fundamental to a value-chain framework is the recognition that there exist
complex linkages and interrelationships among activities both within and beyond the firm. Two
types of linkages must be analyzed and understood: internal linkages and external linkages.

1
 Cost Management

Department Internal Material External

Purchasing linkages Production linkages

Department Internal Material External

Production linkages Distributor linkages

Department Internal Manufacturing External

Packing linkages Company linkages

Internal linkages are relationships among activities that are performed within a firm’s portion of
the value chain. External linkages, on the other hand, describe the relationship of a firm’s value-
chain activities that are performed with its suppliers and customers.

 Strategic Cost Management: Basic Concepts

Three general strategies have been identified:
• Cost leadership
To provide the same or better value to customers at a lower cost than
offered by competitors. A company might redesign a product so that fewer
parts are needed, lowering production costs and the costs of maintaining
the product after purchase.
• Product differentiation
Strives to increase customer value by increasing what the customer
receives (customer realization). A retailer of computers might offer on-site
repair service, a feature not offered by other rivals in the local market.

1
 Cost Management

• Focusing
A firm selects or emphasizes a market or customer segment in which to
compete. Paging Network, Inc., a paging services provider, has targeted
particular kinds of customers and is in the process of weeding out the
nontargeted customers.
• Structural activities
Activities that determine the underlying economic structure of the
organization.
• Executional activities
Activities that define the processes and capabilities of an organization and
thus are directly related to the ability of an organization to execute
successfully.

1
Cost Management

1
 Cost Management

 Value-Chain Analysis

1
 Cost Management

Internal Linkage Analysis Example

1
 Cost Management

Current Expected
Activity Activity Activity
Activities Activity Driver Capacity Demand Demand
Material usage Number of parts 200.000 200.000 80.000
Assembling parts
Additionally, the Direct
following labor
activity costhours
data are 10.000 10.000 5.000
Purchasing
provided: parts Number of orders 15.000 12.500 6.500
Warranty repair Number of defective products 1.000 800 500

Material usage: $3 per part used; no fixed activity cost.

Assembly: $12 per direct labor hour; no fixed activity cost

Purchasing: Three salaried clerks, each earning a $30,000 annual salary; each clerk is capable of
processing 5,000 purchase orders annually. Variable activity costs: $0.50 per purchase order processed
for forms, postage, etc.

Cost Reduction from Exploiting Internal Linkages

Material usage $ 360.000
(200,000 - 80,000)$3
Labor usage 60.000
(10,000 - 5,000)$12
Purchasing 33.000
[$30,000 + $0.50(12,500 - 6,500)]
Warranty repair 34.000
[$28,000 + $20(800 - 500)]
Total $ 487.000

Units 10.000
Unit savings $ 48,70
1
 Cost Management

(800 + 190 + 5 + 5) 1

Reworking rate =$200,000 ÷ 1,000

 Cost Management

(30 + 20)

Expediting rate =$50,000 ÷ 50

=$1,000 per late delivery

1
 Cost Management

One Large Ten Smaller

Units purchased
Orders placed
Manufacturing cost
Order-filling cost allocated*
Order cost per unit
Customer Customers
500.000 500.000
2 200
$ 3.000.000 $ 3.000.000
$ 303.000 $ 303.000
$ 0,6060 $ 0,6060

* Order-filling capacity is purchased in blocks of 45 (225 capacity), each block costing $40,400; variable
order-filling activity costs are $2,000 per order; thus, the cost is
[(5 × $40,400) + (202 × $2,000)]

 Life-Cycle Cost Management

• Marketing viewpoint

• Production viewpoint

1
 Cost Management

Cost Reduction Example

Cost Behavior
Functional-based system:
Variable conversion activity rate: $40 per
direct labor hour
Material usage rate: $8 per part
ABC system:
Labor usage $10 per direct labor hour
Material usage: $8 per part
Machining: $28 per machine hour
Purchasing activity: $60 per purchase 1order
Setup activity: $1,000 per setup hour
Warranty activity: $200 per returned unit
 Cost Management

Activity and Resource Information (annual estimates)

Design A Design B
United produced 10.000 10.000
Direct material usages 100.000 parts 60.000 parts
Labor usage 50.000 hours 80.000 hours
Machine hours 25.000 20.000
Purchase orders 300 200
Setup hours 200 100
Returned units 400 75
Repair time (customer) 800 150

JIT and Its Effect on the Cost Management System

JIT Traditional

1
 Cost Management

• Pull-through system • Push-through system

• Insignificant inventories
• Small supplier base
• Long-term supplier contracts
• Cellular structure
• Multiskilled labor
• Decentralized services
• High employee involvement
• Facilitating management style
• Total quality control
• Buyers’ market
• Value-chain focus
• Significant inventories
• Large supplier base
• Short-term supplier contracts
• Departmental structure
• Specialized labor
• Centralized services
• Low employee involvement
• Supervisory management
style
• Acceptable quality level
• Sellers’ market
• Value-added focus

2.2 Quality of Economic Order (Economic Order Quantity)

The formula to calculate this quantity can be easily derived. The formula is:

1
 Cost Management

EOQ =  2DP  C 
= (2  25,000
Assume 50)  $2
P= $40 per order
= 1,000,000 D= 25,000 units
C= $2 per unit
= 1,000
Information:
P = Purchasing Order Cost
D = Demand
C = Carrying Cost / Holding Cost

2.2.1 Point Booking Back (Reorder Point)

Reorder point is a point in time where a new order should be made. This is a
function of the EOQ, grace period, and the rate at which supplies are low. The grace
period is the time required to receive the economic order quantity after the order is placed
or in preparations began.

Knowing the level of use and the grace period will allow us to compute the
reorder point which meets the following objectives:

ROP = Rate x grace period of use

2.2.2 Uncertainty Demand and Point Booking Back

1
 Cost Management

Extra inventory safety stock is kept as collateral

to fluctuations in demand. Safety stock is calculated by multiplying the time limit to the
difference between the maximum usage level and the average level of use. In the
presence of safety stock, reorder point is calculated as follows:

ROP = (average rate of use of x grace period) + Inventories safety

2.2.3 EOQ and Inventory Management

Traditional approach to managing inventory system has been known as just-in-

case. In some situations, the system supplies just-in-case is really very appropriate. EOQ
model is very useful in identifying the optimal exchange between inventory storage costs
and preparation costs. EOQ model is also useful to overcome the problems associated
with uncertainty through the use of safety stock.

1
 Cost Management

2.2.4 JIT Inventory Management

Manufacturing JIT (just-in-time manufacturing) is a system based on a demand-

pull that require goods to be drawn through the system by the existing demand, not
pushed into the system at a given time based on the anticipated demand.

Purchases JIT requires the suppliers to send spare parts and raw materials just in
time for production. Relationship with suppliers is a very important thing. The supply of
spare parts should be connected with the production, which is associated with the request.

1
 Cost Management

2.2.5 Basic Characteristics of JIT

Factory Layout. The type and efficiency of the plant layout is managed differently
in the manufacturing process JIT. In a traditional job and batch manufacturing process,
the product is moved from one group of the same machine to another machine group.
Manufacturing cell consists of machines that are grouped into a collection, usually in the
form of a semicircle.

Grouping and Employee Empowerment. The other major structural differences

between JIT and traditional organizations related to the grouping and employee
responsibilities. As just indicated, each cell is seen as a mini factory.

Total Quality Control. Simply put, JIT cannot be implemented without a

commitment to total quality control. TQC is essentially a relentless pursuit for a perfect
quality, attempt to obtain a product design and manufacturing processes without
disabilities.

Overhead Costs. A financing system uses three methods to charge the individual
products: the direct search, search movers and allocation. Of the three methods, direct
search is the most accurate and, thus, is more preferable than the other two methods.

2.2.6 Avoid Termination of Production and Process Reliability: Approach

JIT

1
 Cost Management

Most of the production stoppage occurs for one of

three reasons: the failure of machinery, raw materials and the unavailability of raw
materials. Having inventory is a traditional solution to all these problems.

Total Preventive Maintenance: Failure zero machine is the total preventive

maintenance purposes. By paying more attention to preventive maintenance, the majority
of engine failures can be avoided.

Kanban systems: To ensure that the components or raw materials are available
when needed, use a system called kanban system. It is an information system that
controls production through the use of a sign or card. Kanban withdrawal quantity
detailing the next process that must be drawn from the previous process. Kanban
production of quality detailing that must be produced by a previous process. Kanban
supplier is used to notify suppliers to hand over more components; and also details the
components required

2.2.7 Discount and Price Increase: Purchase JIT versus Saving Supplies

Traditionally, supplies stored so that the company can take advantage of quantity
discounts and protect themselves from future price increases on goods purchased. The

aim is to reduce inventory costs. JIT systems achieve the same goal without
having to store inventory. JIT solution is to negotiate a long term contract with a small
number of selected suppliers located as close as possible to the production facilities and
build more intensively limitations supplier.

2.2.8 Limitations of JIT

1
 Cost Management

JIT is not an approach that can be purchased and

applied with immediate results. Implementation is an evolutionary process, not
revolutionary. Here it takes patience. JIT is often referred to as the simplification
program - but this does not mean he is easy or simple to implement.

2.3 Activity Based Management

Activity-based management is an integrated management approach and applied to the

activity with the aim of increasing customer value and profit achieved from the provision of
these values. From definition, there are two important phrases, which is :

 Focus on integrated management and applying to the activity

 Aims to enhance customer value and profit

1
 Cost Management

Usability of Activity Based Management As for a company

using Activity Based Management (ABM) with a view to:

 Reducing product prices and optimizing product design.

 Reducing company costs.
 Helping companies to consider business opportunities new.

Activity Based Management (ABM) is an umbrella for cultural change that is needed for global
competition. The components that support ABM's success include:

 Just In Time (JIT) Is a comprehensive production system and inventory management system
where raw materials and spare parts are purchased and produced as much as needed and at the
right time at each stage of the production process.
 Strategic Planning A comprehensive and integrated plan that links the advantages of corporate
strategy with environmental challenges and is designed to achieve company goals through proper
implementation by the company.

 Accounting Accounting Activity related to activities in the company's operations.

 Life Cycle Management Involves management activities starting from the development stage to
ensure that total life cycle costs are lower than competitors.
 Performance Management An activity that manages performance oriented to a strategic outlook
into the future so that performance can be used as a communication tool for those who need it.
 Investment Management How an investment manager manages money, which in this process
requires an understanding of various investment tools, and various strategies that can be used to
select these devices.
1
 Cost Management

 Continuous Improvement Management techniques where

managers and workers agree to continuous improvement programs in terms of quality and
critical success factors.
 Benchmarking The process of identifying success factors critical (critical success factor)
achieved by other companies or other units in the company with the aim of imposing them as
improvements in company processes to achieve performance well.
 Target Costing Determine the expected costs for aproducts based on competitive prices so that
the produce will be able to get the expected profit.
 Customer Value Analysis An analysis is carried out for  determine whether an activity has a
value for customer or not by looking at what is obtained customers compared to sacrifices to
obtain a product or service. These components are used to manage activities in order to eliminate
waste. For example eliminating waste by pressing inventory (zero inventory), eliminating
activities that no added value, streamline value-added activities inefficient, eliminating damage
(zero damage),eliminate rebuilding (zero rebuilding), reduce engine setup (into one), improve
skills employee.

2.3.1 The Two-Dimensional Activity-Based Management Model

Activity Based Management Linked to Activity Based Cost Calculation (ABC).

ABC is a major source of activity-based management information, so that the
management model based on two dimensions:

 Dimensions costs

1
 Cost Management

Provide information to resources, activities

and cost objects of concern such as products, customers, suppliers, and distribution
channels with the aim of improving the accuracy of charges that are useful for the
calculation of the cost of production, cost management strategic and tactical analysis.

 Dimensions process

Provides information on what activities are done, why it should be done and
how well these activities do. The goal is to reduce costs so that they can perform and
measure continuous improvement.

2.3.2 ABM relationship with ABC calculation

ABM involving ABC and use it as a primary source of information in order to
improve decision-making by informing accurate cost and reduce costs by encouraging
and supporting the continuous improvement efforts. ABC relationship with ABM, ABM
occurs because the needed information from ABC to do the analysis related to continuous
improvement ABM for marketing standards.

Marketing costs are the costs associated with the exchange of companies and
consumers. Which includes marketing costs include the cost of the promotion, physical
distribution costs, the cost of market research, product development costs.

2.3.3 Process Value Analysis

1
 Cost Management

Value analysis process is fundamental to the

accounting, which focuses on accountability of activities in terms of cost and this analysis
emphasizes maximizing overall system performance instead of individual performance.
Value analysis process is helping to change the concept of activity-based accounting
conceptual level becomes operational. Value analysis process makes it possible to
determine the competitive advantages consist of:

1. Increase the value for the consumer (customer value)

Business process (or value chain) are machines that generate value in the form
of products or services for consumers who want to buy. The increase in the effective
process must begin with a correct understanding of consumers and how to define the
value, in order to create a more efficient system of "garbage in, garbage out".

2. Improving the efficiency of the process (process efficiency)

The business process is a collection of activities that create value for

customers. By ignoring the industry or sector, organizations strive to provide more
value efficiently compared with rivals that have a distinct competitive advantage.
Improved process begins with an understanding of the customer and how to define the
value.

Based on the book Management Accounting (Hansen and Mowen), value

analysis process (process value analysis) defines accountability based on activity
rather than on costs, and emphasizes maximizing overall system performance instead
of individual performance.

2.3.4 Activities Performance Measures

1
 Cost Management

Assess how well the activities and processes

carried out are the cornerstone of management efforts to improve profitability. The
performance measure is centered on three main dimensions of the efficiency, quality and
time.

Knowing how well we are currently in an activity should unlock the potential to
do well. Because many non-financial measure that will be discussed in the perspective of
the balanced scorecard (accounting-based strategy) also applies at the level of activity,
we will also emphasize on the size of the financial performance of the activity. Financial
measures for the efficiency of the activities include:

Expense report value added and non value-added

Reporting is a way of improving the efficiency of the activity. A company's

accounting system should distinguish between the cost of value-added and non value-
added activities for improving the performance requires the removal of non value
added and optimize the value-added activities. Knowing the amount of the cost
savings are important for strategic purposes. For example, if an activity is removed,
then the cost savings should be traced to individual products. These savings can
result in reduced prices for customers and make the company more competitive.

By comparing actual cost with the cost of value-added activities,

management can assess the level of inefficiency of activity and determine the
potential for value-added Repair Cost (standard quantities - SQ) can be calculated by
multiplying a standard quantity of value-added to the standard price (standard price -
SP). No value-added costs can be calculated as the differential between the actual
output level of activity (activity quantity - AQ) and the level of value-added (SQ)
multiplied by the standard cost per unit.

Cost value added = SQ x SP

Charges value-added = (AQ- SQ) SP

1
 Cost Management

Where,

SQ = level value-added output to an activity

SP = standard price per unit of output measure activity

AQ = actual quantity of output activity that is used quantity of activity

This report states that the cost reduction work as expected. Almost half the
expense was worth abolished. As a note of concern, the actual cost comparison of
two periods will be declared the same reduction. However, reporting of value-added
charges not only states but also reductions in which it appears. It provides
information to managers about how much potential decline in prices is still possible.
Of this report at least the managers do not become complacent, but should be an
ongoing search for a higher level of efficiency.

Standard Setting Kaizen

Counting the cost of kaizen refers to the cost reduction of existing products
and processes. In operational terms, this is translated into the reduction of value-
added charges. Management cost reduction process is accomplished through the use
of repetition are two main cycles:

1. Cycle of continuous improvement or kaizen and

2. Maintenance cycle. Kaizen cycle is defined by the order plans → do → Examine

→ action (plan-do-check-act). Standard kaizen reflects the improvements planned
for the following period.

Maintenance cycle follows the standard rules → do → check → act

(standard-do-check-act). A standard created by a previous fix. then the action taken
and the results check to ensure that the performance achieved at this new level. If not,
then corrective action will be taken to restore the performance.

1
 Cost Management

Benchmarking

This step uses best practices as the standard for evaluating the performance of
the activity. The purpose of benchmarking is to become the best in their daily
activities and processes. Thus, benchmarking should also involve comparing with
competitors or other industries.

Calculation of Life Cycle Costs

Product planning stage can have a significant effect on the cost of the activity.
In fact, at least 90 percent or more of the costs associated with a product included in
the development phase of the product life cycle. Product life cycles are simply the
time of the existence of a product, from drafting to unused. Life cycle costs are all the
costs associated with the entire product life cycle.

Due to total customer satisfaction has become a vital issue in the preparation
of the new business, the overall cost of living has become a major focus of cost
management lifecycle. The cost of living is the overall lifecycle cost of a product
plus the cost of post-purchase by the customer which includes operations, support,
maintenance and disposal. Counting the cost of living overall emphasis on all
management value chain. The value chain is a set of activities required to design,
develop, manufacture, market and serving of a product. Thus, the life cycle cost
management focuses on value chain management activities to form a long-term
competitive advantage. To achieve this, managers must balance the cost of the whole
life of products, methods of delivery, innovation and variety of product attributes
including performance, features offered, reliability, compatibility, durability, beauty
and quality it has.

1
 Cost Management

2.4 CVP Analysis

CVP analysis examines the interaction of the company's sales volume, price, cost
structure and profitability of selling. It is a powerful tool in making managerial decisions,
including marketing, production, investment and financing decisions.

Basic Concept of CVP

CVP analysis is formulated from a simple concept of calculating profit. Profit is calculated from
the reduction between total revenue and the total cost.

In break-even conditions, profit equals zero, then:

Information:

P = Price

VC = Variable cost per unit

FC = Fixed cost

And simple formula: Fixed Cost / Contribution Cost per Unit

2.5 Break Even Analysis

Break-even analysis can be divided in two ways:

1
 Cost Management

2.5.1 Equation Method

Profits = (Sales - Variable expenses) - Fixed expenses or Sales = Variable expenses +
Fixed expenses + Profits

Notes: profit at break even point is equal to 0

2.5.2 Contribution Margin method

Contribution Margin has two key equation is: Break-even point in units sold = Fixed
expenses / Unit contribution margin or Break-even point in total sales dollars = Fixed
expenses / CM ratio.

2.5.3 Operating Leverage

Operating leverage is a measurement of the extent to which the company or the project
lead to a combination of fixed and variable costs.
Degree Of Operating Leverage (DOL) = Contribution Margin / Operating Income or
Percentage Increase in profits = DOL * Percentage in Sales.

2.6 Pricing and Profitability Analysis

2.6.1 Factors Influencing the Price of a Product

Influence Explanation/Example
1
 Cost Management

Price sensitivity Sensitivity to price levels will vary amongst purchasers. Those
that can pass on the cost of purchases will be the least sensitive
and will therefore respond more to other elements of perceived
value. For example, a business traveller will be more concerned
about the level of service in looking for an hotel than price,
provided that it fits the corporate budget. In contrast, a family
on holiday are likely to be very price sensitive when choosing
an overnight stay.
Price perception Price perception is the way customers react to prices. For
example, customers may react to a price increase by buying
more. This could be because they expect further price increases
to follow (they are 'stocking up').
Quality This is an aspect of price perception. In the absence of other
information, customers tend to judge quality by price. Thus a
price rise may indicate improvements in quality, a price
reduction may signal reduced quality.
Intermediaries If an organisation distributes products or services to the market
through independent intermediaries, such intermediaries are
likely to deal with a range of suppliers and their aims concern
their own profits rather than those of suppliers.
Competitors In some industries (such as petrol retailing) pricing moves in
unison; in others, price changes by one supplier may initiate a
price war. Competition is discussed in more detail below.
Suppliers If an organisation's suppliers notice a price rise for the
organisation's products, they may seek a rise in the price for
1
 Cost Management

their supplies to the organisation.

Inflation In periods of inflation the organisation may need to change
prices to reflect increases in the prices of supplies, labour, rent
and so on.
Newness When a new product is introduced for the first time there are no
existing reference points such as customer or competitor
behaviour; pricing decisions are most difficult to make in such
circumstances. It may be possible to seek alternative reference
points, such as the price in another market where the new
product has already been launched, or the price set by a
competitor.
Incomes If incomes are rising, price may be a less important marketing
variable than product quality and convenience of access
(distribution). When income levels are falling and/or
unemployment levels rising, price will be more important.
Product range Products are often interrelated, being complements to each
other or substitutes for one another. The management of the
pricing function is likely to focus on the profit from the whole
range rather than the profit on each single product. For
example, a very low price is charged for a loss leader to make
consumers buy additional products in the range which carry
higher profit margins (eg selling razors at very low prices
whilst selling the blades for them at a higher profit margin).
Product life cycle During the life of an individual product, several stages are
apparent: introduction, growth, maturity and decline. The
duration of each stage of the life cycle varies according to the
type of product, but the concept is nevertheless important as

1
 Cost Management

each stage is likely to influence the firm’s pricing policy.

2.6.2 Markets
1. Perfect competition – many buyers and many sellers all dealing in an identical
product. Neither producer nor user has any market power and both must accept the
prevailing market price.

2. Monopoly – one seller who dominates many buyers. The monopolist can use his
market power to set a profit-maximising price.

3. Monopolistic competition – a large number of suppliers offer similar, but not

identical, products. The similarities ensure elastic demand whereas the slight
differences give some monopolistic power to the supplier.

4. Oligopoly – where relatively few competitive companies dominate the market.

Whilst each large firm has the ability to influence market prices, the unpredictable
reaction from the other giants makes the final industry price indeterminate. Cartels
(同業聯盟) are often formed.

2.6.3 Pricing Strategies

2.6.3.1 Cost – Plus Pricing

Full cost-plus pricing is a method of determining the sales price by

calculating the full cost of the product and adding a percentage mark-up for
profit.

In practice cost is one of the most important influences on price. Many

firms base price on simple cost-plus rules (costs are estimated and then a profit

1
 Cost Management

margin is added in order to set the price). The

'full cost' may be a fully absorbed production cost only, or it may include some
absorbed administration, selling and distribution overhead. A business might
have an idea of the percentage profit margin it would like to earn, and so might
decide on an average profit mark-up as a general guideline for pricing decisions.

Advantages of full cost-plus pricing

a. It is a quick, simple and cheap method of pricing which can be delegated to

junior managers.

b. Since the size of the profit margin can be varied, a decision based on a price
in excess of full cost should ensure that a company working at normal
capacity will cover all of its fixed costs and make a profit.

Disadvantages of full cost-plus pricing

a. It fails to recognise that since demand may be determining price, there will
be a profit-maximising combination of price and demand.

b. There may be a need to adjust prices to market and demand conditions.

c. Budgeted output volume needs to be established. Output volume is a key

factor in the overhead absorption rate.

d. A suitable basis for overhead absorption must be selected, especially where

a business produces more than one product.

2.6.3.2 Marginal Cost-Plus Pricing

1
 Cost Management

Marginal cost-plus pricing/mark-up

pricing involves adding a profit margin to the marginal cost of production/sales.

Whereas a full cost-plus approach to pricing draws attention to net profit

and the net profit margin, a variable cost-plus approach to pricing draws attention
to gross profit and the gross profit margin, or contribution.

Advantages of marginal cost-plus pricing

a. It is a simple and easy method to use.

b. The mark-up percentage can be varied, and so mark-up pricing can be

adjusted to reflect demand conditions.

c. It draws management attention to contribution, and the effects of higher or

lower sales volumes on profit. For example, if a product costs $10 per unit and
a mark-up of 150% ($15) is added to reach a price of $25 per unit,
management should be clearly aware that every additional $1 of sales revenue
would add 60 cents to contribution and profit ($15 ÷ $25 = $0.60).

Disadvantages of marginal cost-plus pricing

a. Although the size of the mark-up can be varied in accordance with

demand conditions, it does not ensure that sufficient attention is paid to
demand conditions, competitors' prices and profit maximisation.

b. It ignores fixed overheads in the pricing decision, but the sales price must
be sufficiently high to ensure that a profit is made after covering fixed
costs.

2.6.3.3 Market Skimming Pricing

1
 Cost Management

Price skimming involves charging high

prices when a product is first launched in order to maximize short-term
profitability. Initially there is heavy spending on advertising and sales promotion
to obtain sales. As the product moves into the later stages of its life cycle (growth,
maturity and decline) progressively lower prices are charged. The profitable
'cream' is thus skimmed off in stages until sales can only be sustained at lower
prices.

The aim of market skimming is to gain high unit profits early in the
product's life. High unit prices make it more likely that competitors will enter the
market than if lower prices were to be charged.

Such a policy may be appropriate in the cases below.

a. The product is new and different, so that customers are prepared to pay high
prices so as to be one up on other people who do not own it.

b. The strength of demand and the sensitivity of demand to price are unknown. It
is better from the point of view of marketing to start by charging high prices
and then reduce them if the demand for the product turns out to be price
elastic than to start by charging low prices and then attempt to raise them
substantially if demand appears to be insensitive to higher prices.

c. High prices in the early stages of a product's life might generate high initial
cash flows. A firm with liquidity problems may prefer market-skimming for
this reason.

d. The firm can identify different market segments for the product, each prepared
to pay progressively lower prices. It may therefore be possible to continue to

1
 Cost Management

sell at higher prices to some market segments

when lower prices are charged in others.

e. Products may have a short life cycle, and so need to recover their development
costs and make a profit relatively quickly.

2.6.3.4 Market Penetration Pricing

Penetration pricing is a policy of low prices when a product is first

launched in order to obtain sufficient penetration into the market.

A penetration policy may be appropriate in the cases below.

a. The firm wishes to discourage new entrants into the market.

b. The firm wishes to shorten the initial period of the product's life cycle in order
to enter the growth and maturity stages as quickly as possible.

c. There are significant economies of scale to be achieved from a high volume

of output.

d. Demand is highly elastic and so would respond well to low prices.

2.6.3.5 Market discrimination

The use of price discrimination means that the same product can be sold at
different prices to different customers. This can be very difficult to implement in

1
 Cost Management

practice because it relies for success upon the

continued existence of certain market conditions.

There are number of bases on which such discriminating prices can be set.
a. By market segment. A cross-channel ferry company would market its services
at different prices in England and France, for example. Services such as
cinemas and hairdressers are often available at lower prices to old age
pensioners and/or juveniles.

b. By product version. Many car models have 'add on' extras which enable one
brand to appeal to a wider cross-section of customers. The final price need not
reflect the cost price of the add on extras directly: usually the top of the range
model would carry a price much in excess of the cost of provision of the
extras, as a prestige appeal.

c. By place. Theatre seats are usually sold according to their location so that
patrons pay different prices for the same performance according to the seat
type they occupy.

d. By time. This is perhaps the most popular type of price discrimination. Off-
peak travel bargains, hotel prices and telephone charges are all attempts to
increase sales revenue by covering variable but not necessarily average cost of
provision. Railway companies are successful price discriminators, charging

more to rush hour rail commuters whose demand is inelastic at certain times of
the day.

2.6.3.6 Profitability Analysis

1
 Cost Management

In running a business, management has to

know the profitability of their products, customers and other business segments as
they want to know what segment they should focus on. To achieve such purpose,
they should be able to distinguish between absolute profitability and relative
profitability.

Absolute profitability is measured by the segment’s incremental profit,

which represents the difference between the revenues from the segment and the
costs that could be avoided by dropping the segment. In other words, it measures
the effect of adding or dropping a segment on the company’s profits

Product and supplier profitability analysis allow the management to

identify the true costs associated with their products and supplies. Normally, it
takes into account those initial costs (such as purchase, transport, receiving and
reject cost), on going costs (such as storage and overheads), finance and customer
return costs for different product or product groups.

In general, it can be elaborated as follows (assuming two products groups);

Product A Product B Total

1
 Cost Management

$ $ $
150,000 250,000 400,000
Sales
-37.50% -62.50% -100%
Expenses  
Variable costs  
Materials & supplies 15,000 22,000 37,000
(% of revenue) -10% -8.80% -9.25%
Labour 2,000 3,500 5,500
(% of revenue) -1.33% -1.40% -1.38%
Distribution 3,000 5,000 8,000
(% of revenue) -2% -2% -2%
Marketing 12,000 10,000 22,000
(% of revenue) -8% -4% -5.50%
Other 5,000 5,000
-
(% of revenue) -2% -1.25%
32,000 45,500 77,500
Total variable costs
-21.30% -18.20% -19.40%
 
Fixed costs  
Location 10,000 10,000 20,000
(% of revenue) -6.67% -4% -5%
Administration 5,000 6,000 11,000
(% of revenue) -3.33% -2.40% -2.75%
Labour 3,000 3,000 6,000
(% of revenue) -2% -1.20% -1.50%
Others 2,000 3,000 5,000
(% of revenue) -1.33% -1.20% -1.25%
20,000 22,000 42,000
Total fixed costs
-13.30% -8.80% -10.50%
Operating profit 98,000 182,500 280,500
Operating surplus (%) 65% 73% 70.10%
Profit contribution (%) 34.90% 65.10% 100%
 

1
 Cost Management

When management considers the resource allocation and strategy formulation, it can
determine whether the company should put more emphasis on a particular product or
whether they would allocate the costs differently to get a better margin for the product
group.

1
 Cost Management

2.7 Lean Manufacturing

Lean manufacturing is is a systematic method for the elimination of waste within a

manufacturing system. Lean also takes into account waste created through overburden and waste
created through unevenness in work loads .Working from the perspective of the client who
consumes a product or service, "value" is any action or process that a customer would be willing
to pay for.
Essentially, lean is centered on making obvious what adds value by reducing everything else.
Lean manufacturing is a management philosophy derived mostly from the and identified as
"lean" only in the 1990s.
For many, lean is the set of "tools" that assist in the identification and steady elimination of
waste. As waste is eliminated quality improves while production time and cost are reduced.
Techniques to improve flow include production leveling, "pull" production (by means of kanban)
and the Heijunka box.

Lean implementation is therefore focused on getting the right things to the right place at the right
time in the right quantity to achieve perfect work flow, while minimizing waste and being
flexible and able to change. These concepts of flexibility and change are principally required to
allow production leveling (Heijunka), using tools like SMED, but have their analogues in other
processes such as research and development (R&D). Lean aims to make the work simple enough
to understand, do and manage.

2.8 Productivity Measurement

Productivity is commonly defined as a ratio of a volume measure of output to a volume
measure of input use. While there is no disagreement on this general notion, a look at the
productivity literature and its various applications reveals very quickly that there is neither a

1
 Cost Management

unique purpose for, nor a single measure of, productivity. The objectives of productivity
measurement is to trace technical change. Technology has been described as the currently known
ways of converting resources into outputs

The concept of productivity measurement involves ratios of outputs to inputs. A good

productivity measures need good measures of output and input. Among the best measures of
output is added value. Added value is a measure of the wealth generated by the collective efforts
of those work in the company namely employees and employers and those who provide the
capital namely investors and shareholders.

Added value represents the net output as produced by an enterprise or the actual result
attributed to the factors of production within the company. It also indicates the degree of success
of cooperation and efforts by the various parties involved in the production process. Basically,
there are two methods to calculate added value as shown below:

a. Subraction Method (Wealth Generation Approach)

Added Value = Total Output - Bought In Materials Services

It indicates how much added value can be generated by producing more output efficiently by
being more efficient in using bought-in materials and services.

b. Addition Method (Wealth Distribution Approach)

Added Value = Labour Cost + Despreciation + Taxes (Indirect) + Interest + Profit.

This approach shown how rewards for the employees, return to the investors and capital
providers are linked to the success of the company. This will motivate all parties concerned
in improving the performance of the company.

1
 Cost Management

The number of productivity indicators is numerous and varied. Which

indicator or indicators to be use will depend on the purpose of the analysis, on the economic level and
availability of data. At the firm level, the following indicators are appropriate and useful.

a) Labour Cost Competitiveness

Labour Cost Competitiveness indicates the comparability of the industry in producing products or
services at the lowest possible labour cost. There are three productivity ratios used to measures
competitiveness:

Added Value per Labour Cost

This ratio indicates how competitive the company is in term of

labour cost. It measures how much added value is generated by each unit of labour cost. A low ratio
indicates high labour cost which does not commensurate with added value creation and vice versa.

Labour Cost per Employee

This ratio refers to remuneration and benefits received by each

employee and commonly referred to as wage rate. A high ratio indicates high return to individual
worker and high wage rate for company. Lower ratio indicates otherwise.

The ratio reflects the amount of wealth created by the company in relative  to the number of
employees it has. It measures the amount of added value generated by each workers. A high ratio
indicates the favorable effects of labour factors in the wealth creation process.
Total Output per Employee

The ratio indicates the amount of output created by each employee in the company. It measures the
output generated by each employee and gives an indication of the efficiency and / or marketing
compatibility. A high ratio reflects a good marketing strategy adopted by the enterprise. 
 
a) Capital Productivity
1
 Cost Management

Capital Productivity indicates the degree of utilization of fixed

assets such as machinery and equipment and their efficiency with which assets are utilized. It can
measured by either added value per fixed assets or total output for fixed assets.

Added Value per Fixed Assets

The ratio indicates the degree of utilization of tangible fixed assets. It  measured how much added
value generated per ringgit of fixed assets. A high ratio indicates the efficiency of assets utilization.
On the other hand, a low ratio reflects inefficiency in fixed assets utilization or over-investment in
fixed assets or investment in unproductive fixed assets.

Total Output per Fixed Assests (Capital Turnover)

The ratio indicates the efficiency in capital utilization and a marketing
system. A high ratio indicates efficiency in capital utilization and a good marketing system and low
ratio means low turnover of materials, high work-in-progress and fixed assets.
b) Capital Intensity 
Capital Intensity measures the amount of fixed assets allocated to each employee. It is also known
as fixed assets per employee or simply capital labour ratio.

Fixed Assets per Employee

The ratio indicates whether the company adopts a capital intensive or labour intensive policy. A
high ratio reflects high capital intensity and low ratio means dependence on labour intensive
methods or low technological inputs.
c)  Process Efficiency
Process Efficiency measures how efficiently the company utilizes its own resources namely labour,
plant and machinery and capital to generate added value and minimize the bought-in materials and
services.

1
 Cost Management

 
The ratio indicates the efficiency and effectiveness of the process, which is affected by production
techniques used, technology innovation, managerial and labour skills.

Even though labour productivity which measures the output per unit of labour input, is
widely used and practically synonymous with productivity itself, it is important to acknowledge that
productivity changes could also be attributed by other factors such as the substitution of labour with
capital, the economic of scale and technological changes. Therefore the analysis of productivity
changes should include the analysis of other factors affecting the productivity.

Compare Apples and Apple

Ultimately, any productivity measurement system is only helpful if it’s used appropriately.
Management carries the burden of usage almost entirely. Productivity indexes today are being used
to compare the performance of companies in an industry, plants in a company, and departments in a
plant. The results influence investment choices, judgments about factory closings, and decisions on
management compensation, so managers must be careful to make fair comparisons.
Measured productivity is the ratio of a measure of total outputs to a measure of inputs
used in the production of goods and services. Productivity growth is estimated by subtracting
the growth in inputs from the growth in output — it is the residual.
There are a number of ways to measure productivity. In Australia, the most common
productivity measures used are:

 multifactor productivity (MFP), which measures the growth in value added output (real
gross output less intermediate inputs) per unit of labour and capital input used; and
 labour productivity (LP), which measures the growth in value added output per unit of
labour used.

The calculation of MFP using the traditional accounting methods requires independent
measures of inputs and outputs. For Australia, this is calculated for 16 industries, which the
1
 Cost Management

ABS terms the market sector of the economy. Hence, economy-

wide MFP estimates reflect productivity growth in only around 80 per cent of the economy
(the share of the 16 industries in total GDP). LP can be measured for both the market and
non-market sectors of the economy. This is because labour input can be measured in real
volume terms as hours worked.

MFP is a measure closer to the concept of productive efficiency than LP as it removes

the contribution of capital deepening from the residual.

Two potential sources of change in measured productivity warrant special attention:

unmeasured inputs that affect real costs, and capacity utilisation. There are also a number of
measurement problems associated with estimating output and input volumes.

In some industries, inputs other than capital and labour (and knowledge) can have a
strong influence on output. Where these inputs are not purchased in the market, as is the case
with some natural resource inputs and volunteer effort, they are not included in the measure
of inputs. If the availability or quality of these inputs is changing then productivity estimates,
as the residual, will be affected.

Recent Commission research has identified Mining, Utilities, and Agriculture as

industries where the MFP estimates are affected by changes in unmeasured inputs. These
industries are all dependent on natural resource inputs. Deterioration in the quality of the
natural resource input, or more stringent regulatory restrictions on the uses of such inputs,
can reduce measured productivity despite the productive efficiency of the firms in the
industry remaining unchanged or even improving

Capacity utilization

Business output responds to market demand. As demand rises or falls over time with
the business cycle or other influences, firms adjust the output they produce. In the case of

1
 Cost Management

cyclical downturn, many firms will reduce output volumes, but

cannot easily reduce their capital and labour inputs as they need these inputs ready for when
demand recovers. As a result, firms are likely to underutilise their capital and labour inputs in
a downturn and productivity will be lower. When business is booming, firms will fully utilise
their capital and labour. Hence, measured productivity tends to be pro-cyclical as utilisation
rates of inputs rise in upswings and fall in downswings.

Many industries experience cycles in demand that affect capacity utilisation but
industries with high levels of fixed capital, such as manufacturing, tend to be more exposed
to the business cycle. This means that annual productivity estimates are likely to under or
overstate the underlying trend level of productivity depending on where the industry is in the
business cycle.

To assist users to interpret measured productivity, the ABS divides time series MFP
into productivity cycles for the market sector. The start and end points of the cycles
correspond to points where the levels of capacity utilisation are likely to be comparable.
Average productivity growth between these points is a more reliable measure of productivity
growth over a given period than those based on different years in the cycle.

Measurement problems

Problems in both the accuracy of the raw data and in the methodologies applied
generate measurement errors. Improvements in data quality and methodology are a part of the
ongoing function of the ABS, resulting in periodic revisions of the estimates of MFP.

Two problems in measuring inputs that can introduce errors into the estimates of
productivity are difficulties in measuring the volume of capital services, and lags between
investment (when it is counted as adding to the productive capital stock) and when it is
actually utilised in production. These issues arise mainly where there are large infrastructure
projects and when major new technology is introduced, such as ICT.

1
 Cost Management

2.9 Budgeting

Budgets can take many forms and serve many functions, providing the basis for detailed
sales targets, staffing plans, inventory production, cash investment/borrowing, capital
expenditures (for plant assets, etc.), and so on. Budgets provide benchmarks against which to
compare actual results and develop corrective measures; give managers “preapproval” for
execution of spending plans; and allow managers to provide forward-looking guidance to
investors and creditors. Budgets are necessary to persuade banks and other lenders to extend
credit. This chapter will illustrate the master budget, which is a comprehensive set of documents
specifying sales targets, production activities, and financing actions. These documents lead to
forward-looking financial statements (e.g., projected balance sheet). Other types of budgets (e.g.,
flexible budgets) are covered in subsequent chapters.

AVOIDING BUSINESS CHAOS

In small organizations, formal budgets are a rarity. The individual owner/manager likely
manages only by reference to a general mental budget. The person has a good sense of expected sales,
costs, financing, and asset needs. Each transaction is under direct oversight of this person and hopefully
he or she has the ability to keep things on a logical course. When things don’t go well, the
owner/manager can usually take up the slack by not taking a paycheck or engaging in some other form
of financial hardship. Of course, many small businesses ultimately fail anyway. Explanations for failure
are many and varied, but are often pinned on “undercapitalization” or “insufficient resources to sustain
operations.” Many of these postmortem assessments reflect a failure to adequately plan! Even in a small
business, an authentic business plan/budget can often result in anticipating and avoiding disastrous
outcomes.

1
 Cost Management

Medium and larger organizations invariably rely on budgets.

This is equally true in business, government, and not-for-profit organizations. The budget provides a
formal quantitative expression of expectations. It is an essential facet of the planning and control
process. Without a budget, an organization will be highly inefficient and ineffective.

BUDGETING case study.

Imagine that one has just been appointed as general manager of a newly constructed power plant.
Compensation and ultimately the manager’s job will depend on the financial success of the venture. The
manager would try to quickly get a handle on the business. How many customers will be served? What
are the peak electricity loads? What rate can be charged and will it be enough to cover expenses? How
much fuel will be necessary to produce the electricity? Will the cash supply always be sufficient to meet
needs? Furthermore, how will actions be executed and controlled?
Perhaps the above is too much to deal with. Instead the manager could spend time only on
marketing and personnel management. These efforts might sell a lot of electricity. Unfortunately, sales
growth could be such that the natural gas pipeline cannot deliver enough fuel to meet the plant’s

demand. More expensive fuel oils might need to be trucked in to produce the electricity.
Suppliers might become concerned, as they sense that revenues might be inadequate to cover the added
fuel cost. As a result, vendors might begin to insist on shortened payment terms, thereby pressuring the
company’s cash supply. To solve this problem, it could become necessary to reduce the workforce. A
downward spiral might ensue.
Rewind this unfortunate scenario, this time utilizing a plan. Careful studies are performed to
determine the most efficient levels of production for the plant, in conjunction with an assessment of
customer demand. The expected sales are translated into a schedule of expected daily electricity
production. Based on this information, long-term supply contracts are negotiated for natural gas
supplies. Staffing plans are developed that optimize the number of employees and their work times.
Contingency plans are developed for a variety of scenarios. Periods during which cash might be tight are

1
 Cost Management

noted and a line of credit is set up with a local bank to cover those
periods. All of these activities lead to a projected outcome.
Once the plan is in place, individuals will be authorized to act consistent with the plan. The
entire team will steer toward an expected outcome. The manager will monitor operations and take
corrective actions for deviations from the plan. The remainder of his time can be spent on public
relations marketing, employee interaction, and so forth.

BENEFITS OF BUDGETING

Budgets don’t guarantee success, but they certainly help to avoid failure. The budget is an
essential tool to translate general plans into specific, action-oriented goals and objectives. By adhering to
the budgetary guidelines, the expectation is that the identified goals and objectives can be fulfilled.

It is crucial to remember that a large organization consists of many people and parts. These
components need to be orchestrated to work together in a cohesive fashion. The budget is the tool that

communicates the expected outcome and provides a detailed script to coordinate all of the
individual parts to work in concert.

When things don’t go as planned, the budget is the tool that provides a mechanism for
identifying and focusing on departures from the plan. The budget provides the benchmarks against
which to judge success or failure in reaching goals and facilitates timely corrective measures.

Operations and responsibilities are normally divided among different segments and managers.
This introduces the concept of “responsibility accounting.” Under this concept, units and their managers
are held accountable for transactions and events under their direct influence and control.

Budgets should provide sufficient detail to reflect anticipated revenues and costs for each unit.
This philosophy pushes the budget down to a personal level, and mitigates attempts to pass blame to
1
 Cost Management

others. Without the harsh reality of an enforced system of responsibility,

an organization will quickly become less efficient. Deviations do not always suggest the need for
imposition of penalties. Poor management and bad execution are not the only reasons things don’t
always go according to plan. But, deviations should be examined and unit managers need to
explain/justify them.

Within most organizations it becomes very common for managers to argue and compete for
allocations of limited resources. Each business unit likely has employees deserving of compensation
adjustments, projects needing to be funded, equipment needing to be replaced, and so forth. This
naturally creates strain within an organization, as the sum of the individual resource requests will usually
be greater than the available pool of funds. Successful managers will learn to make a strong case for the
resources needed by their units.

But, successful managers also understand that their individual needs are subservient to the larger
organizational goals. Once the plan for resource allocation is determined, a good manager will support
the overall plan and move ahead to maximize results for the overall entity. Personal managerial ethics

demands loyalty to an ethical organization, and success requires teamwork. Here, the budget
process is the device by which the greater goals are mutually agreed upon, and the budget reflects the
specific strategy that is to be followed in striving to reach those goals. Without a budget, an organization
can be destroyed by constant bickering about case-by-case resource allocation decisions.

Another advantage of budgets is that they can be instrumental in identifying constraints and
bottlenecks. The earlier example of the power plant well illustrated this point. Efficient operation of the
power plant was limited by the supply of natural gas. A carefully developed budget will always consider
capacity constraints. Managers can learn well in advance of looming production and distribution
bottlenecks. Knowledge of these sorts of potential problems is the first step to resolving or avoiding
them.

1
 Cost Management

Budget Processes and Human Behavior

A comprehensive budget usually involves all segments of a business. As a result, representatives

from each unit are typically included throughout the process. The process is likely to be lead by a budget
committee consisting of senior-level personnel. Such individuals bring valuable insights about all
aspects of sales, production, financing, and other phases of operations. Not only are these individuals
ideally positioned to provide the best possible information relative to their respective units, but they are
also needed to effectively advocate for the opportunities and resource needs within their unit.

The budget committee’s work is not necessarily complete once the budget document is prepared
and approved. A remaining responsibility for many committees is to continually monitor progress
against the budget and potentially recommend mid-course corrections. The budget committee’s
decisions can greatly impact the fate of specific business units, in terms of resources made available as
well as setting the benchmarks that will be used to assess performance. As a result, members of the
budget committee will generally take their task very seriously.

The budget construction process will normally follow the organizational chart. Each component
of the entity will be involved in preparing budget information relative to its unit. This information is
successively compiled together as it is passed through the organization until an overall budget plan is
achieved. But, beyond the data compilation, there is a critical difference in how budgets are actually
developed among different organizations. Some entities follow a top-down, or mandated approach.
Others utilize a bottom-up, or participative philosophy.

top-down BUDGET
Some entities will follow a top-down mandated approach to budgeting. These budgets will begin
with upper-level management establishing parameters under which the budget is to be prepared. These
parameters can be general or specific. They can cover sales goals, expenditure levels, guidelines for
compensation, and more. Lower-level personnel have very little input in setting the overall goals of the
organization. The upper-level executives call the shots, and lower-level units are essentially reduced to
doing the basic budget calculations consistent with directives. Mid-level executives may unite the
1
 Cost Management

budget process by refining the leadership directives as the budget

information is passed down through the organization.

1
 Cost Management

One disadvantage of the top-down approach is that lower-level

managers may view the budget as a dictatorial standard. Resentment can be fostered in such an
environment. Further, such budgets can sometimes provide ethical challenges, as lower-level managers
may find themselves put in a position of ever-reaching to attain unrealistic targets for their units.

On the positive side, top-down budgets can set a tone for the organization. They signal expected
sales and production activity that the organization is supposed to reach. Some of the most efficient and
successful organizations have a hallmark strategy of being “lean and mean.” The budget is a most
effective communication device in getting employees to hear the message and perform accordingly.

bottom-up BUDGET
The bottom-up participative approach is driven by involving lower-level employees in the
budget development process. Top management may initiate the budget process with general budget
guidelines, but it is the lower-level units that drive the development of budgets for their units. These
individual budgets are then grouped and regrouped to form a divisional budget with mid-level
executives adding their input along the way.

1
 Cost Management

Eventually top management and the budget committee will

receive the overall plan. As one might suspect, the budget committee must then review the budget

components for consistency and coordination. This may require several iterations of passing the budget
back down the ladder for revision by lower units. Ultimately, a final budget is reached.

The participative budget approach is viewed as self-imposed. As a result, it is argued that it

improves employee morale and job satisfaction. It fosters the “team-based” management philosophy that
has proven to be very effective for modern organizations. Furthermore, the budget is prepared by those
who have the best knowledge of their own specific areas of operation. This should allow for a more
accurate budget.

On the negative side, a bottom-up approach is generally more time-consuming and expensive to
develop and administer. This occurs because of the repetitious process needed for its development and
coordination. Another potential shortcoming has to do with the fact that some managers may try to
“pad” their budget, giving them more room for mistakes and inefficiency.

data flow
It is very important for managers at all levels to understand how data are transformed as it passes
through an organization. As budget information is transferred up and down an organization, the
“message” will inevitably be influenced by the beliefs and preferences of the communicators. There is

1
 Cost Management

always a chance that information can be transformed and lose its

original intent. Top management can lose touch with information originating on the front line, and front-
line employees may not always get a clear picture of the goals and objectives originating with senior
management.
There are staggering differences in the organization charts of different entities. Business growth
is a natural incubator for expansion of the number of levels within an organization; as a result, great care
must be taken to preserve the efficiency and effectiveness of growing entities. Sometimes the very
attributes that contribute to growth can be undone by the growth itself. The charts of some entities
consume many pages and involve potentially dozens of “levels.” Other companies may have worked to
“flatten” their organizational chart to minimize the number of links in the chain of command.
While these endeavors are often seen as attempts to reduce the cost of middle-level management,
the overriding issue is to allow top management more clear and direct access to vital information
originating with front-line employees (and vice versa). In addition to focusing on revenues and costs, the
budget process should also be taken as an opportunity for continuous monitoring of the organizational
structure of an entity.

BUDGET ESTIMATION
Budgets involve a good deal of forward-looking projection. As a result, a certain amount of error
is inevitable. Accordingly, it is easy to slip into a trap of becoming inattentive about the estimates that
form the basis for a budget. This should be avoided.
Budget estimates should be given careful consideration. They should have a basis in reason and
logically be expected to occur. Haphazardness should be replaced by study and statistical evaluation of
historical information, as this provides a good starting point for predictions. Changing economic
conditions and trends need to be carefully evaluated

1
 Cost Management

Because budgets frequently form an important part of

performance evaluation, human behavior suggests that participants in the budget process are going to try
to create “breathing room” for themselves by overestimating expenses and underestimating sales.
This deliberate effort to affect the budget is known as creating budget slack or “padding the
budget.” This is done in an attempt to create an environment where budgeted goals are met or exceeded.
However, this does little to advance the goals of the organization.
When slack is introduced into a budget, employees may fail to maximize sales and minimize
costs. For example, once it is clear that budgeted sales goals will be met, there may be a reduction in
incentive to push ahead. In fact, there may be some concern about beating sales goals within a period for
fear that a new higher benchmark will be established that must be exceeded in a subsequent period. This
can result in a natural desire to push pending transactions to future periods. Likewise, padding the
planned level of expenses can actually provide incentive to overspend, as managers fear losing money in
subsequent budgets if they don’t spend all of the currently budgeted funds. This has the undesirable
consequence of encouraging waste.

ZERO-BASED BUDGETING
The problem of budgetary slack is particularly acute when the prior year’s budget is used as the
starting point for preparing the current budget. This is called incremental budgeting. It is presumed that
established levels from previous budgets are an acceptable baseline, and changes are made based on new
information. This usually means that budgeted amounts are incrementally increased. The alternative to
incremental budgeting is called “zero-based budgeting.”
With zero-based budgeting, each expenditure item must be justified for the new budget period.
No expenditure is presumed to be acceptable simply because it is reflective of the status quo. This
approach may have its genesis in governmental units that struggle to control costs. Governmental units
usually do not face a market test; they rarely fail to exist if they do not perform with optimum efficiency.
Instead, governmental entities tend to sustain their existence by passing along costs in the form of
mandatory taxes and fees. This gives rise to considerable frustration in trying to control spending. Some

1
 Cost Management

governmental leaders push for zero-based budgeting concepts in an

attempt to filter necessary services from those that simply evolve under the incremental budgeting
process. Business entities may also utilize zero-based budgeting concepts to reexamine every
expenditure during each budget cycle.
While this is good in theory, zero-based budgeting can become very time-consuming and
expensive to implement. In business, the opportunity for gross inefficiency is kept in check by market
forces, and there may not be sufficient savings to offset the cost of a serious zero-based budgeting
exercise. Nevertheless, business managers should be familiar with zero-based budgeting concepts as one
tool to identify and weed out budgetary slack. There is nothing to suggest that every unit must engage in
zero-based budgeting every year. Instead, a rolling schedule that thoroughly reexamines each unit once
every few years may provide a cost-effective alternative.

THE IMPOSSIBLE BUDGET

At the opposite end of budgetary slack is the phenomenon of unattainable budget standards. If
employees feel that budgets are not possibly achievable, they may become frustrated or disenchanted.
Such a condition may actually reduce employee performance and morale. Good managers should be as
alert to this problem as they are to budgetary slack. Suffice it to say that preparing a budget involves
more than just number crunching; there is a fair amount of organizational psychology that a good
manager must take into account in the process.

ETHICAL CHALLENGES

Investors often press management to provide forward-looking earnings guidance. Many financial
reporting frauds have their origin in overly optimistic budgets and forecasts that subsequently lead to an
environment of “cooking the books” to reach unrealistic goals. These events usually start small, with the
expectation that time will make up for a temporary problem. The initial seemingly harmless act is
frequently followed by an ever-escalating pattern of deception that ultimately leads to collapse.

1
 Cost Management

To maintain organizational integrity, senior-level managers need

to be careful to provide realistic budget directives. Lower-level managers need to be truthful in reporting
“bad news” relative to performance against a budget, even if they find fault with the budget guidelines.
All too often, the carnage that follows a business collapse will be marked by management claims that
they were misled by lower-level employees who hid the truth. And, lower-level employees will claim
that they were pressured by management to hide the truth.

Components of the Budget

Business processes are highly complex and require considerable effort to coordinate. Managers
frequently cite coordination as one of the greatest leadership challenges. The comprehensive or master
budget is an essential part of the coordinating effort. Such budgets consist of many individual building
blocks that are tied together in logical harmony and reflect the organization’s financial plan.

The base or foundation for the master budget is an assessment of anticipated sales volume via the
sales budget. The expected sales level drives both the production plans and the selling, general, and
administrative budget. Production drives the need for materials and labor. Factory overhead may be
applied based on labor, but it is ultimately driven by overall production. The accompanying graphic is a
simplified illustration of these budget
building blocks.

The planned business activities must be

considered in terms of their cash flow and
financial statement impacts. It is quite
easy to plan production that can outstrip
the resources of a company. In addition,
a business should develop plans that have
a successful outcome; the
budgeted financial statements are key
measures of that objective. It would be very easy to expand the illustration to reflect additional
1
 Cost Management

interactions and budgets (e.g., the coordination of a long-term capital

spending budget).

Comprehensive budgeting entails coordination and interconnection of various components.

Electronic spreadsheets are useful in compiling a budget. If care is used in constructing the embedded
formulas, it becomes very easy to amend the budget to examine the impact of different assumptions
about sales, sales price, expenses, and so forth.

1. SALES BUDGET
The budgeting process usually begins with a sales budget. The sales budget reflects forecasted
sales volume and is influenced by previous sales patterns, current and expected economic conditions,
activities of competitors, and so forth. The sales budget is complemented by an analysis of the
resulting expected cash collections. Sales often occur on account, so there can be a delay between the
time of a sale and the actual conversion of the transaction to cash. For the budget to be useful, careful
consideration must also be given to the timing and pattern of cash collections.
Mezan Shehadeh recently perfected a low-cost vinyl product that was very durable and could
be used outdoors in conjunction with rear-screen projection equipment. This product enables movie
theaters to replace the usual lettered signs with actual videos to promote the “now showing” movies.
Mezan’s company, Shehadeh Movie Screens, is rapidly growing. The sales budget for 20X9 follows.
Review the sales budget closely, noting the expected pattern of sales. The fall and winter
seasons are typically the best for the release of new movies, and the anticipated pattern of screen sales
aligns with this industry-wide business cycle. The screens are sold through a network of
dealers/installers at a very
low price point of $175 per
unit.

Note that the lower portion

of the sales budget converts
the expected sales to expected

1
 Cost Management

collections. Shehadeh’s dealers are normally given credit terms of 30

days, and the result is that roughly two-thirds of sales are collected in the same quarter as the sale itself.
The other third is collected in the following quarter. Shehadeh started 20X9 with $100,000 in
receivables, which is assumed to be collected in the first quarter of 20X9. Shehadeh’s dealer network
has been carefully selected and the company has very few problems with late payments or uncollectible
accounts. Shehadeh will end the year with $140,000 in receivables, determined as one-third of the final
quarter’s expected sales ($420,000 X 1/3 = $140,000).

PRODUCTION BUDGET

Sales drive the level of production. Production is also a function of the beginning finished goods
inventory and the desired ending finished goods inventory. The budgeted units of production can be
calculated as the number of units sold, plus the desired ending finished goods inventory, minus the
beginning finished goods inventory. In planning production, one must give careful consideration to the
productive capacity, availability of raw materials, and similar considerations.

Next is the production budget of Shehadeh Movie Screens. Shehadeh plans to end each quarter
with sufficient inventory to cover 25% of the following quarter’s planned sales. Shehadeh started the
new year with 525 units
in stock, and
planned to end the year
with 700 units in stock.

Following is a
quarter-by-quarter
determination of the
necessary
production.
Carefully examine this information, paying very close attention to how each quarter’s desired ending
finished goods can be tied to the following quarter’s planned sales. In case it is not obvious, the
1
 Cost Management

estimated units sold information was taken from the sales budget;
utilizing the power of the spreadsheet, the values in the cells on row 5 of this Production sheet were
simply taken from the corresponding values in row 5 of the Sales sheet (“=Sales!B5”, “=Sales!C5”,
etc.).

DIRECT MATERIAL PURCHASES BUDGET

Each movie screen requires 35 square feet of raw material. For example, the scheduled
production of 1,875 units for the second quarter will require 65,625 square feet of raw material.
Shehadeh maintains raw material inventory equal to 20% of the following quarter’s production needs.
Thus, Shehadeh plans to start the second quarter with 13,125 square feet (65,625 X 20%) and end the
quarter with 19,950 square feet (99,750 X 20%). Budgeted purchases can be calculated as direct
materials needed in planned production, plus the desired ending direct material inventory, minus the
beginning direct materials inventory (65,625 + 19,950 - 13,125 = 72,450). This fundamental calculation
is repeated for each quarter. The upper portion of the following Materials spreadsheet illustrates these
calculations. Once again, the electronic spreadsheet draws data from preceding sheets via embedded
links.

The direct material purchases budget provides the necessary framework to plan cash payments
for materials. The lower portion of the spreadsheet shows that the raw material is slated to cost $1.40 per
square foot. Shehadeh pays for 80% of each quarter’s purchases in the quarter of purchase. The
remaining 20% is paid in the
following period.

The direct materials budget

also reveals a planned end of year inventory
of 19,600 square feet, which has a cost of
$27,440 (19,600 X $1.40). As shown

1
 Cost Management

later, this value will also be needed to prepare the budgeted ending
balance sheet.

LABOR, overhead, and SG&A BUDGET

The direct labor budget provides the framework for planning staffing needs and costs. Each of
Shehadeh’s screens requires three direct labor hours to produce. As revealed by the Labor sheet, the
scheduled production is
multiplied by the number of hours
necessary to produce each unit. The
resulting total direct labor hours
are multiplied by the expected hourly
cost of labor. Shehadeh assumes
that the cost of direct labor will be
funded in the quarter incurred.

The factory overhead budget applies overhead based on direct labor hours. Based on an analysis,
the annual factory overhead is anticipated at a fixed amount of $220,200, plus $5 per direct labor hour.
The fixed portion includes
depreciation of $3,000 per quarter
for the first half of the year and $7,000
per quarter for the last half of the year (the
increase is due to a planned purchase
of equipment at the end of the second
quarter). The bottom portion of the
budget reconciles the total factory
overhead with the cash paid for
overhead (depreciation is subtracted because it is a noncash expense).
1
 Cost Management

The direct labor hours used in the Factory Overhead sheet are
drawn from the Direct Labor budget. Further, the sidebar notes also indicate that the average overhead
rate (fixed and variable together,
applied to the total labor hours for the
year) is $13 per hour. This
information is useful in
assigning costs to ending
inventory. Assuming an average-
cost method, ending finished goods
inventory can be valued as shown on the Finished Goods spreadsheet.

Companies must also plan an SG&A

budget. SG&A consists of variable and
fixed components. The expected
quarterly sales are multiplied by the variable
cost per unit. Most fixed items will be the same
each quarter, although some fixed costs,
such as an advertising campaign, can fluctuate
periodically.

Cash budget

Cash is an essential
resource. Without an adequate supply
of cash to meet obligations as they come
due, a business will quickly crash. Even
the most successful businesses can get
caught by cash crunches
attributable to delays in collecting

1
 Cost Management

receivables, capital expenditures, and so on. These types of cash crises

can usually be avoided. The cash budget provides the necessary tool to anticipate cash receipts and
disbursements, along with planned borrowings and repayments.

Shehadeh’s cash budget follows. In reviewing this document, notice that the data in most rows
are drawn from earlier budget components (the beginning of year cash is assumed to be $50,000). The
cash received from customers is taken from the Sales spreadsheet, the cash paid for materials is taken
from the Materials spreadsheet, and so on.

The tax information is assumed; usually a tax accountant would perform an extensive analysis of
the overall plan and provide this anticipated data. As mentioned earlier, it is also assumed that Shehadeh
is planning to purchase new production equipment at the end of the second quarter, as shown on row 15.

Look carefully at the Cash budget, and notice that the company is on track to end the second
quarter with a cash deficit of $85,584 (before financing activities). To offset this problem, Shehadeh
plans to borrow $150,000 at the beginning of the quarter. Much of this borrowing will be repaid from
the positive cash flow that is anticipated by the end of the third and fourth quarters, but the company will
still end the year with a $25,000 debt ($150,000 - $75,000 - $50,000)

Interest on the borrowing is calculated at 8% per year, with the interest payment coinciding with
the repayment of principal (i.e., $75,000 X 8% X 6/12 = $3,000; $50,000 X 8% X 9/12 = $3,000). Take
note that accrued interest at the end of the year will relate to the unpaid debt of $25,000 ($25,000 X 8%
X 9/12 = $1,500); this will be included in the subsequent income statement and balance sheet, but does
not consume cash during 20X9.

Budgeted financial statements

Each of the budgets/worksheets

presented thus far are important in their own
right. They will guide numerous operating

1
 Cost Management

decisions about raw materials acquisition, staffing, and so forth. But, at

this point, it is very difficult to assess the success or failure of Shehadeh’s plans!

It is essential that all of these individual budgets be drawn together into a set of reports that
provides for outcome assessments. This part of the
budgeting process will result in the
development of pro forma financial statements. Almost
every item in the budgeted income statement is drawn
directly from another element of the master budget,
as identified in the “notes” column.

The following budgeted balance sheet includes

columns for 20X9 and 20X8. The 20X8 data are
assumed. The 20X9 amounts are logically deduced
by reference to the beginning balances and
information found in the details of the master budget. The notes in column H are intended to help one
trace the resulting 20X9 balance for each account. For example, ending accounts receivable of $140,000
would relate to the uncollected sales during the fourth quarter ($420,000 sales - $280,000 collected =
$140,000), found on the Sales sheet.

EXTERNAL USE
Projected financial statements are often requested by external financial statement users. Lenders,
potential investors, and others have a keen interest in such information. While these documents are very
common and heavily used for internal planning purposes, great care must be taken in allowing them to
be viewed by persons outside of the entity.
The accountant who is involved with external use reports has a duty to utilize appropriate care in
preparing them; there must be a reasonable basis for the underlying assumptions. In addition,
professional standards dictate the reporting that must accompany such reports if they are to be released

1
 Cost Management

for external use. Those reporting standards become fairly complex, and
the specifics will depend on the nature of external use. But, those reports will necessarily include
language that makes it very clear that the participating accountant is not certifying their achievability.
Managers must also be careful in external communications of forward-looking information. U.S.
securities laws can hold managers accountable if they fail to include appropriate cautionary language to
accompany forward-looking comments, and the comments are later shown to be faulty. In addition,
other regulations (Reg FD) may require “full disclosure” to everyone when such information is made
available to anyone. As a result, many managers are reticent to make any forward-looking statements. It
is no wonder that many budgetary documents are prominently marked “internal use only.”

APPRAISAL

This chapter has made several references to the fact that budgets will be used for performance
evaluations. Actual results will be compared to budgeted results. These comparisons will help identify
strengths and weaknesses, areas for improvements, and potential staffing changes. But, the process for
performance appraisal is far more complex than simply comparing budget to actual results. Much of the
next chapter is devoted to this subject.

Budget Periods and Adjustments

Budgets usually relate to specific future periods of time, such as an annual reporting year or a
natural business cycle. For example, a car producer may release the 20X8 models in the middle of 20X7.
In such a case, the budget cycle may be more logically geared to match the model year of the cars.

There is nothing to suggest that budgets are only for one-year intervals. For purposes of
monitoring performance, annual budgets are frequently divided into monthly and quarterly components.

1
 Cost Management

This is helpful in monitoring performance on a timely basis. Sometimes,

specific amounts within a monthly/quarterly budget are merely proportional amounts of the annual total.

For instance, monthly rent might be 1/12 of annual rent. But, other costs do not behave as
uniformly. For instance, utilities costs can vary considerably with changes in the weather, and
businesses need sufficiently detailed budgets to plan accordingly. Major capital expenditure budgets
may transcend many years. A manufacturer may have 10 facilities in need of major overhauls. It is
unlikely they could all be upgraded in just 1 or 2 years; capital expenditure budgets may cover as much
as a 5- to 10-year horizon.

CONTINUOUS BUDGETS
Computer technology permits companies to employ continuous or perpetual budgets. These
budgets may be constantly updated to relate to the next 12 months or next 4 quarters, etc. As one period
is completed, another is added to the forward-looking budgetary information. This approach provides for
continuous monitoring and planning and allows managers more insight and reaction time to adapt to
changing conditions.
Continuous budgeting is analogous to driving a vehicle. A bad driver might focus only on getting
from one intersection to the next. A good driver will constantly monitor conditions well beyond the
upcoming intersection, anticipating the need to change lanes as soon as distant events first come into
view.

FLEXIBLE BUDGETS
The discussion in this chapter has largely presumed a static budget. A static budget is not
designed to change with fluctuations in activity level. Once sales and expenses are estimated, they
become the relevant benchmarks. An alternative that has some compelling advantages is the flexible
budget.

1
 Cost Management

Flexible budgets relate anticipated expenses to observed

revenue. To illustrate, if a business greatly exceeded the sales goal, it is reasonable to expect certain
costs to also exceed planned levels. After all, some items like cost of sales, sales commissions, and
shipping costs are directly related to volume. How ridiculous would it be to fault the manager of this
business for having cost overruns? Conversely, failing to meet sales goals should be accompanied by a
reduction in variable costs. Certainly it would make no sense to congratulate a manager for holding costs
down in this case! A flexible budget is one that reflects expected costs as a function of business volume;
when sales rise so do certain budgeted costs, and vice versa.

2.10 Quality and Environmental Management

In general, the dictionary defines quality as "the degree or perfection". Operationally, quality
products and services are that meet or exceed customer expectations. In other words, quality is
customer satisfaction. Quality cost categories: costs of prevention (prevention costs), cost
appraisal (appraisal costs), costs of internal failure (internal failure costs), and external (external
failure costs)

Prevention costs (Prevention Cost): It is far better to prevent defects rather than finding and
removing them from the product. Costs incurred to avoid or minimize the number of defects in
the first place is known as the cost of prevention. Some examples of the cost of prevention is a
manufacturing process improvements, training workers, quality engineering, statistical process
control etc.

1
 Cost Management

Cost assessment (Appraisal Cost): Cost assessment (also known

as the examination fee) are those costs incurred to identify defective products before they are
shipped to customers. All costs associated with the activities carried out during the
manufacturing process to ensure quality standards required are also included in this category.
Identification of defective products involves maintaining inspectors. It may be very expensive
for some organizations. Internal failure costs (Internal Failure Cost): The costs incurred to
remove defects from the product prior to shipment to the customer. Examples of internal failure
costs include the cost of rework, rejected products, scrap etc. External failure costs (External
Failure Cost): If a defective product has been shipped

1
 Cost Management

CHAPTER III
ANALYSIS

 Strategic Cost Management

Companies choose suppliers with expenditure costs can be minimized. Like when the company
is faced with 2 choices of suppliers to order raw materials, between Ari Corp or Igin Corp. The
company can do it through analysis:

 Purchase Cost

 Dispsose Cost

 Expediting Cost

1
 Cost Management

After the analysis is done, it can be immediately determined which supplier will be selected. If
these analyzes are not carried out, it will be difficult to determine the costs to be incurred when
the company will order raw materials. This company implements a cost strategy, one of which is
the above analysis, where the strategy focuses on the supplier trigger.

 Quality of Economic Order (EOQ)

The company currently still uses traditional systems for the inventory of raw materials. Therefore
the company implements EOQ system to assist in managing its production costs, maximizing the
fixed cost as well as possible. The above calculation data is enough to explain the application of
EOQ systems to this company.

 Activity Based Management

1
 Cost Management

This company has costs that

add to its production value,
namely the fixed costs
incurred. But besides that this
company also has costs that
do not add to the production
value at all, which this cost
should be eliminated. And the
severity of these costs is
completely unknown to what
needs, and these costs are
actually recorded as expenses.

1
 Cost Management

 CVP & Break Even Point Analysis

In reality, the company will have difficulty analyzing the BEP because the imposition of
Production Costs continues to enter COGS. But if the company does not implement the loading
system, it can be analyzed by the company to be able to find out a number of things, namely,
how many sales targets should not be profitable so as not to lose. The company has fixed costs
which are quite expensive as evidenced by the high sales target of the product unit. If sales
cannot reach the target, the company will suffer losses.

1
 Cost Management

 Pricing and Profitability Analysis

The company has a pricing system using the markup on cost method with a predetermined
percentage of markup. With this method, the company has minimized the risk of unpredictable
inflation on its production costs. The level of company profitability is better when implementing
this markup system. On the other hand, the company has also imposed fixed overhead costs in
the form of depreciation on assets directly related to its production, these costs have become part
of the COGS product.

 Lean Accounting

Lean Accounting for the leaders of this company adheres to this principle, namely, the need for a
process or a good way of working to get maximum production results so that the cost of
production failure does not arise. With such a process or work method, it is expected that
workers will be more nimble so that production targets can be achieved. Companies can find out
various sources of problems related to production, through employees and then can ask for
ideas / ideas / solutions from these employees as well. After the information is obtained, then
decision making can be done immediately.

 Productivity Measurement
1
 Cost Management

If analyzed from the input and output of the company, it can be

said to be good. Because spoilage product is not found in production activities, which means that
the production costs incurred can be properly charged to production activities, this proves the
effect of ABM in determining how well the results of this Production Measurement are. The
company has the opportunity to increase its output by maximizing its fixed cost.

 Budgeting

The results of the company's budgeting process can be seen that there is a variance between those
that have been budgeted with reality. But this difference is known to be good, because it relates
to the company's sales target which in fact is higher in reality. Obviously the company gets high
profits outside of those estimated through the budgeting process. But when an increase in sales
occurs, the effect will also increase costs automatically. Then need attention to the budgeting
process so that the estimation is more maximal.

 Quality and Enviromental Management

If analyzed from this point of view, the company has determined that the costs to be incurred to
improve product quality will not be charged to the COGS costs of the product considering that it
will automatically affect the markup of the selling price, consumers will certainly consider the
selling price. However, the company was prepared to accept these fees as a burden on the
company.

1
 Cost Management

1
 Cost Management

CHAPTER IV
CONCLUSION

Based on the results of the above analysis, it can be concluded that the company's weaknesses are in the
Activity Based Management problem which should be repaired with the help of Activity Based Costing
implementation on its production activities, then the company must be able to improve its budgeting
process so that there are no future risks related to production costs.