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After this unit you should be able to answer following questions

A. Concept Questions & B. Short notes

1. Activity Based Costing
2. Trade Off Points Between Costs Of Logistical Functions
3. Outsourcing Considerations
4. Total Cost Approach leads to ignoring of individual inputs to Supply Chain
5. Mission based costing in logistics
C. Section II descriptive questions [10 marks each]
1.What is meant by total cost approach? What are its basic features and elements?
2.What is conventional approach to costing? Explain the concept and implications.
3.Explain the strengths and applicability of Mission based costing [or budgeting] in
4.What difficulties are encountered in practicing Activity Based Costing? How can
these be overcome?
5.What factors are taken into consideration while outsourcing?
Logistical cost analysis …[Logistics and Supply Chain Management by Martin
Christopher, Page # 72,73]
Conventional approach to costing fails to provide information on the impact of cost of
an individual function on the system. Logistics costs are traditionally apportioned to
the function handling that particular logistics activity. As a result these costs get
submerged and competitive edge is lost by the organization. Total cost analysis
comprises of identifying such impact on system due to change in cost of individual
If we add a warehouse to the network, certainly this cost will have an impact on
transportation, inventory and so on. If we have the total cost of delivering the service
to the customer with this warehouse and without this warehouse we shall know the
impact of introducing the new warehouse on the system. Total cost analysis is
measuring this incremental cost to the system on account of changes to the system. In

the absence of this approach impact of decisions at various levels, on system is
ignored which may lead to customer dissatisfaction.
Traditional approach to costing …[Physical distribution Management: Logistical
approach by K.K.Khanna – page # 48]
Highly compartmentalized, impact of policy decisions of one function on other
functions and on system out put is ignored.
a. Cost information is biased, cost elements tend to get hidden out of fear that they
expose functional weakness.
b. Costs in no man’s land are never owned
c. Cost cutting is fragmented so doesn’t reduce system cost
d. Focus is on input function. Hence attempt is to reduce function cost in isolation.
Total cost approach
a. Focus on output of the system. Hence attempt is to reduce cost of output of the
b. Provides competitive edge to the company.
c. Several trade off points in the system are established. Further areas of
improvement can be identified from this approach even beyond trade off.
Total cost analysis
[Bowersox- pages 643 to 649]
Total cost is the cost of all logistical components incurred in delivering the product to
customer and these cost components are the resources expended in performing the
logistical functions for meeting the customer service objective.
Important features of this concept are
1. Total cost reduces as all logistical functions are integrated
2. Sub optimization increases total cost
3. Increase in one cost element may reduce the cost of another element thereby
reducing overall cost. If air transport is used warehousing costs and inventory costs
will reduce. If purchase costs are reduced inventory costs may escalate
4. A trade off exists between cost elements that minimizes total costs

Above analysis emphasizes redesigning logistic system as an integrated performance
system. In making total cost concept operational main hurdle is non-availability of
critical logistical cost data elements in conventional financial accounting practice
Public accounting systems: the two main financial reports of a business house are
balance sheet and profit and loss account. Balance sheet reflects the financial position
of the firm during a particular span of time. It also states the assets and liabilities of
the firm and the net worth of the ownership is established by balance sheet. Profit and
loss account of company shows revenues and costs associated with specific operations
during a period of time. As we see both statements reveal the financial success of the
operations. Logistical operations are part of company’s activities and logistical
functions are part of these basic statements.
Accountants in a firm prepare these financial statements. Logistical costs and activities
lose their cost benefit relationship in accounting systems adopted in a firm.
Traditionally, various elements of costs are bundled and allocated to budget heads in
accounting practices. This kind of grouping of cost elements make them lose their
logistical identities and analysis of logistical costs becomes impractical. Main reason
for this situation is that management does not attach enough importance to logistical
analysis. In the changed management situation, efforts are on to remedy this basic flaw
in the accounting system so that costs and benefits of logistics function are correctly
identified and management focus is placed on reducing total cost of logistics.
Eg. inventory carrying costs and transportation costs are grouped under the cost head
plant ‘A’. as these two elements of logistical costs lose their individuality effect of
each on other is lost and their cumulative influence on cost of delivering the product is
completely submerged.
Mission based costing [or budgeting] in logistics…………………[Logistics and
Supply Chain Management by Martin Christopher, Page # 75,76]
Traditionally managers have tried to minimize costs of individual logistical function
inputs, believing that they are contributing to achieving the cost [QCD] objective of
the company. But minimizing these costs in isolation has a negative impact on cost of
the deliverable output. Hence a new approach to costing, namely, mission based
costing is becoming popular.

Logistical mission contains a set of well-defined objectives at the organizational level
logistics management wants to fulfill. Fulfillment of these objectives incurs costs at
various logistical management functions. Logistical functions required to perform the
missions are integrated under individual logistical heads. The visual displayed below
shows how the costs of individual logistical functions are to be budgeted to meet the
Mission based costing is initially identifying the logistical costs to deliver the mission
goals clearly and then working backwards to budget the logistical function costs to
meet the overall mission costs. High cost of one functional area has to be compensated
by another area keeping overall mission objectives in mind.
Mission costing differs from traditional costing in its approach. Traditional costing
approach is to work out cost of providing various functional inputs to the system and
then determining the cost of out put. In the new approach mission goals are set before
hand in terms of deliverables of the system and costs of functional inputs are worked
out to meet the system deliverables. Ref Fig below

transportation Material
Ware housing
Customer service
Mission C1 goals [QCD]
A 15 5 5 =Rs. 25/- At market type A
Customer service
Mission C1 goals [QCD]
B =Rs. 100/- At market type B
45 35 20
Customer service
Mission C1 goals [QCD]
C =Rs. 30/- At market type C
10 10 10

70 50 35
Functional Inputs to Logistical Management

Activity Based Costing
[Bowersox pages 643 to 649]
Basic difference in activity based costing as compared to traditional costing is that in
ABC [activity based costing] cost is assigned to the activity that consumes the
resource rather than to an accounting head. When a function is performed several
activities are naturally performed. If the resource consumed by each activity is
allocated to the activity we would easily know the cost of performing a logistical
function. If a firm produces two products and the logistical cost elements are allocated
to these products based on proportion of sales then the logistical performance can
never be revealed to the management. But ABC would correctly point performance of
logistical mission. Two main concerns of ABC are identification of cost elements and
the time cost frame.
Cost identification: one has to look at logistical environment to identify costs from
three dimensions. They are direct costs, indirect costs and overhead costs.
Direct or operational costs: these are costs of performing logistical work. Such costs
are easy to identify. Transportation, material handling, warehousing and some aspects
of order processing and inventory can easily be identified or extracted form traditional
systems. Even the administration costs can also be identified to logistics.
Indirect costs: indirect costs are cost of capital resources of logistics. How to allocate
this expense to a particular customer order is managerial discretion.
Overhead costs: an organization spends quite a lot of money centrally. The benefits
are availed by all entities in the organization. These resource expenditures are to be
allocated to specific functions as per their share. Any wrong allocation will distort the
total cost of logistical mission, giving wrong signal to decision-maker. Hence
logistical total cost approach may decide to ignore this component at the time of
analysis if realistic allocation is not possible. Hence a common rule followed is do not
allocate a cost unless it is under the managerial control of logistical organization. This
subjectivity in allocation makes total costs reported by various organizations not
comparable. A lower reported does not necessarily mean that the organization is
efficient logistically.

Cost time frame: identification of time span over which costs are to be collected for
measurement. Apportioning to activities performed.
To determine profitability of a customer order identify functional activities associated
with this order

• Identify cost elements for allocation

• based on type of activities time frame requires fixing
• raw material purchase and all inbound activities are performed at a time far removed
from the time of product delivery

• such activities are performed even before particular order is procured

• to overcome this difficulty accountants split these costs into two groups, namely
costs assigned to a particular product and costs assigned to passage of time

• Activities are required to be captured as and when they tale place in the value chain
for meeting the customer’s order. Resources expended are also recorded along with the
activities. This chain of activities and costs forms a base for calculating the logistical
costs. There can be some logistical costs that we can not allocate specifically to a
customer order. These costs may be the costs associated with inbound logistics of raw
materials that are purchased in huge bulk [imported materials in ship].
Outsourcing considerations
An organization is faced with a decision-making environment when a new product or
service is needed in the organization. The decision to be made is whether to make the
operation in house or to buy the service from outside. Traditional approach has always
been focused on cost of making or buying. Now business explores areas outside this
focus before arriving at a decision. This exploration is into economic factors and
strategic factors.

Strategic factors: when a company is faced with a choice between doing the
transportation on their own or assigning the task to an outside source factors other than
cost are considered.
 The strategic core competency of our company. What will this be in future? Where
should we be concentrating on?
 Ability to provide superior service and not only the cost of making the product or
 Costs and cost trend on the long run
 Special skills developed by a service organization, which are preferred by the
clients. Our company can do outsourcing and get the benefit of specialized skills.
E.g. satelite-tracking system developed by Schneider National Inc. It is obviously
beneficial to hire this service rather than reinvent the wheel! Another example can
be the daba wallahs in mumbai.
Economic factors: economic factors are those, which influence business operations as
a consequence to outsourcing decisions.
 An organization looses direct control on the operation when outsourcing is done.
 Service providers behave opportunistically when they gain control. They can hike
the rates when business conditions are favorable to them
 Service providers withholding critical information internal to the service
organization but has an impact on the performance of the final product. This can
result into unsatisfactory behavior of product.
 Free market conditions vanish when the service provider has no competition
 Some times the service needed requires special capital assets. This service may not
be demanded by other outsourcing organizations. Now this becomes a customer
specific asset, which will remain unutilized if the specific customer does not have
demand for his products. Hence outsourcing is not possible, as service
organizations would hesitate to invest additional funds for one customer.