PERFORMANCE MANAGEMENT (P2)

UNIT 1 – MANAGING THE COSTS OF CREATING VALUE

(ABC, ABM & QUALITY MANAGEMENT)
LESSON 1
CHAPTER 1:
Activity based costing & management
Activity Based Costing &
Management
Apply cost management and cost
transformation methodology to
manage costs and improve profitability

• Activity based management (ABM)

methodology and
• Cost transformation techniques.

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ACTIVITY BASED COSTING – RECAP
ABC Process (Stage 1&2)

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Activity Based Management
ABM
ACTIVITY BASED MANAGEMENT
CIMA Definition:

Activity-based management is a system of management which uses activity-based cost

information for a variety of purposes including cost reduction, cost modelling and customer
profitability analysis.

ABM is simply using information derived from an ABC analysis for cost management.

 ABM supports the quest for continued organisational improvement.

Ultimately management and staff must decide which activities are critical to success.

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DIRECT PRODUCT PROFITABILITY
DPP
DIRECT PRODUCT PROFITABILITY
ABC principles can be used to determine the profitability of products in the retail sector. This is
referred to as DPP.

CIMA Definition:
Direct product profitability is used primarily within the retail sector…
DPP involves attribution of both the purchase price and other indirect costs (for example
distribution, warehousing and retailing) to each product line.
Thus, a net profit, as opposed to a gross profit, can be identified for each product.
DPP = gross profit – (warehouse costs + transport costs + shop floor costs)

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 DPP -
Report
CONSIDER THE FOLLOWING:

Selling Price
Gross Profit
Costs
Net Profit
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 DIRECT PRODUCT PROFITABILITY – EXAMPLE

Solution:
Only general IT costs and senior management staff wages would not be included in
calculation of DPP.

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CUSTOMER PROFITABILITY ANALYSIS
CPA
CUSTOMER PROFITABILITY ANALYSIS
ABC principles can be used to determine the profitability of key customers. This is referred to as CPA.

Definition:
Not all customers place equal demands on the business, CPA will highlight the impact of
this and identify the most profitable customers by analysing the activities required to
‘serve’ customers.

Pareto analysis: 80/20 rule often evident with respect to profits/customers

The output from CPA can then be used to assist in decision making e.g. reducing the
costs to serve customers or rationalising which customers

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CPA - REPORT

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CUSTOMER PROFITABILITY ANALYSIS - EXAMPLE
From the options below, select the statements that are NOT true in the context of utilising both Customer
Profitability Analysis (CPA) and Pareto analysis.

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CUSTOMER PROFITABILITY ANALYSIS - EXAMPLE

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RECAP:
ABM – DPP - CPA
ABM – the use of ABC information in order to aid
business improvements

DPP – used in the retail industry to determine the

true profitability of products

CPA – allows the true profitability of customers to be

calculated/ analysed
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CHAPTER 2:
The modern business environment
(TQM)
TOTAL QUALITY MANAGEMENT (TQM)

Two fundamental principles of TQM

Right first time: cost of prevention < cost of detection

Focus on suppliers / internal stakeholders / product and process
design

Continuous improvement: improvement via

small/incremental step
Use of quality circles and Kaizen costing

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 TOTAL QUALITY MANAGEMENT (TQM) - EXAMPLE

Solution:

TQM is the process of embracing a QUALITY conscious PHILOSOPHY or culture, as well as adopting
quality STANDARDS and procedures within an organisation, aiming towards PERFECTION and
CONTINUOUS improvement.

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COSTS OF QUALITY
CoQ
TQM: COST OF QUALITY (CoQ)

Conformance costs
Conformance costs are the total cost of
ensuring that the output provided to
customers is of good quality. They include
prevention and appraisal costs.

Non-conformance costs
Non-conformance costs are the total costs
incurred as a result of failing to meet quality
standards. They include internal failure
costs and external failure costs.

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 TQM: COST OF QUALITY (CoQ) - EXAMPLE

Solution:
(i) Delivery costs of replacement products sent to customers –EXT. FAILURE COST
(ii) Quality inspection equipment maintenance costs –APPRAISAL COST
(iii) Costs incurred for production staff training –PREVENTION COST
(iv) Costs incurred to repair a faulty batch of part-completed products –INT. FAILURE COST

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Throughput accounting and
Theory of constraints
TOC: THROUGHPUT ACCOUNTING
TOC is defined by CIMA as:

‘A procedure based on identifying bottlenecks

(constraints), maximising their use, subordinating
other facilities to the demands of the bottleneck
facilities, alleviating bottlenecks and re-evaluating the
whole system.’

JIT environment: the aim is to maximise throughput

Throughput = sales revenue – direct material cost

A similar concept to contribution
Assumption: direct materials are the only variable cost

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TOC: THROUGHPUT ACCOUNTING – EXAMPLE 1
Calculate the costs per factory hour
assuming the following:
 Total factory costs = $5m
 Total bottle neck time available =
50,000 hours

STEP 1: Cost per factory hour

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TOC: THROUGHPUT ACCOUNTING – EXAMPLE 1
STEP 2: Return per factory hour (given)
STEP 3: Throughput accounting ration (TPAR)

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TOC: THROUGHPUT ACCOUNTING – EXAMPLE 2

Increase selling price

Decrease material costs
Reduce time per unit required in the bottleneck process
Increase material costs
Increase total factory costs
Reducing labour costs

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TOC: THROUGHPUT ACCOUNTING – EXAMPLE 2

 Increase selling price – this would increase TPAR

 Decrease material costs - this would increase TPAR
 Reduce time per unit required in the bottleneck process - this would increase TPAR
 Increase material costs - this would decrease TPAR
 Increase total factory costs - this would decrease TPAR
 Reducing labour costs - this would increase TPAR

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THURSDAY – ONLINE (LECTURE 2)
Chapter 2