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Performance Evaluation

Week 8 Cost Management

Objectives

To distinguish the difference between traditional management accounting control systems and cost management Review different approaches to cost management This area will be continued next week

• Many of the approaches that fall within the area of cost management do not rely exclusively on accounting techniques Aim is to reduce cost but increase customer satisfaction Drury 2008 .1a • Traditional management accounting control techniques tend to focus on cost containment whereas cost management concentrates on cost reduction.21. • Traditional management accounting control techniques are routinely applied on a continuous basis whereas cost management tends to be applied on an ad hoc basis.

• Tracks and accumulates the actual costs and revenues attributable to each product from inception to abandonment.Life cycle costing • Is the profiling of cost over a product’s life. • Enables a product’s true profitability to be determined at the end of its economic life. including the pre-production stage. Slide 4 .

1 on sheet 21.2). • LCC focuses on costs over the product ’s entire life cycle to determine whether profits earned during the manufacturing phase will cover the costs incurred during the pre-and post-manufacturing stages.21. • Cost management can be most effectively exercised during the planning and design stage.1b Life-cycle costing (LCC) • Traditional management accounting procedures have focused primarily on the manufacturing stage of a product ’s life cycle. Drury 2008 . • A large proportion of a product ’s costs can be committed or ‘locked in ’during the planning and design stage (see Figure 21.

Product Lifecycle volumes Maturity Growth Decline Introduce Develop Sales revenue Profit time Slide 6 .

21.2 Decisions made on materials and labour in the design phase are hard to change at a later date Drury 2008 .

Lifecycle Impact Shorter product lifecycles Clear Planning needed 80% cost incurred before product reaches market Slide 8 Need to ensure return can be achieved in the timescale .

such as R&D.Life cycle costing costs to products over their entire life cycles. Slide 9 .Lifecycle costing reinforces the importance of tight control over locked-in costs. • Performance reporting . • Decision making . • Control . to aid comparison with product revenues generated in later periods.Implications of Lifecycle costing • Pricing decisions can be based on total lifecycle costs rather than simply the costs for the current period.a timetable of life cycle costs helps show what costs need to be recovered.

 Slide 10 .Summary  All costs and revenues measured throughout product life Price to manipulate demand / Product Life Cycle stage For example if a product is coming to the end of it’s life then the price may be dropped to stimulate demand.Lifecycle costing .

.Lifecycle costing example Units manufactured and sold Year 1 2000 Year 2 15000 £100.000 The company is looking to set a sales price of £500 per unit.000 £450 £45 £250.000 Marketing costs £150. R equired: C alculate the cost per unit across the whole lifecycle and comment on the sales price.000 P roduction cost per unit £555 C ustomer services cost per unit £55 Disposal of specialist equipment £45.000 £80.500.000 £430 £45 Year 3 20000 Year 4 5000 R &D C osts £2.000 £390 £45 £10.

450.910.000 £55 2000 £110.110.000 £6.000 £450 5000 £2.610 £1.910 £250 £22.500 + £100 Marketing cos ts £150 + £80 + £45 +£10 P roduction cos t per unit s ee below C us tomer s ervices cos t per unit D is pos al of s pecialis t equipment T otal number of units 000's C os t per unit £000's £2.655 42 £539.000 £45 15000 £675.Lifecycle example solution L ifec yc le c os ts R &D C os ts £2.610.250.000 £1.000 £45 5000 £225.000 £45 20000 £900.000 £17.800.40 Working s P roduction cos ts per unit Units T otal cos ts T otal C us tomer s ervices C us tomer s ervices per unit Units T otal cos ts T otal £555 £430 £390 2000 15000 20000 £1.000 £7.600 £285 £17.000 .

Determine the target price which customers will be prepared to pay for the product. If estimated actual cost exceeds the target cost investigate ways of driving down the actual cost to the target cost. 3.3a Target costing • • Focuses on managing costs during a product/service’s planning and design phase. 2. Involves the following stages: 1.21. Estimate the actual cost of the product. Drury 2008 . 4. Deduct a target profit margin from the target price to determine the target cost.

Tear-down analysis Examine a competitors product for ideas on cost savings 2.21. Value analysis and functional analysis Eliminate any extras that customers are not willing to pay for It is important that target costing is supported by an accurate costing system using appropriate cause-and-effect cost drivers. Drury 2008 .3a Target costing • Iterative process involving: 1.

Target costing Traditionally: mark-up (2nd) selling price (3rd) The focus is internal Cost (1st) Slide 15 .

Target costing Target costing: Profit (2nd) The focus is external target cost (3rd) selling price (1st) Slide 16 .

50 Target cost 30.Example If target profit is £1.50 Slide 17 .000 = £37.50 37. units sold 40000 and Selling price is £67.500.50 what is the target cost? Target price Target profit (w) £/unit 67.5m.000 / 40.00 (w)Target profit per unit = £1.

Target Costing Estimated cost - Target cost = Cost Gap How do companies close a cost gap? Slide 18 .

The selling price less the profit margin is far less than the cost of the car. What can they do to reduce this gap? .Car manufacturing activity: A mid range car manufacturer has a cost gap with their latest four door saloon model.

Summary Selling price set with reference to market Desired profit subtracted to calculate target cost Cost gaps closed via design & development of product Slide 20 .Target costing .

Making continuous small changes to processes to improve them rather than huge innovative changes Drury 2008 .3b Kaizen Costing • Kaizen costing is applied during manufacturing stage whereas target costing is during planning stage.21. • Kaizen costing focuses on production processes whereas target costing focuses on the product. • Kaizen costing aims to reduce costs of processes by a pre-specified amount relying on employee empowerment.

3.6 for an illustration). Traditional control reports analyze costs by types of expenses for each responsibility centre whereas ABM analyses costs by activities (See sheet 21. 2.5a Activity-based management (ABM) • Involves the following stages: 1. Assigning costs to cost pools/cost centres for each activity. Determining the cost driver for each activity. • • Drury 2008 . • ABM focuses on managing the business on the basis of the activities that make up the organization — by managing the activities costs are managed in the long term. Knowing the cost of activities is a catalyst for triggering action to become competitive. Identifying the major activities that take place in an organization.21.

Surveys also suggest that many organizations use cost driver rates as measures of cost efficiency Example Cost of purchasing activity = £100.5b Activity-based management (ABM) . • 1.000 Orders processed =10. 2. Activities can be classified: As value-added or non-value-added.contd. trend and budget comparisons). Activity-based systems can also be used to manage costs at the design stage using behavioural drivers.000 Cost per order = £10 (Used for relative. According to a scale similar to that advocated by Kaplan and Cooper. • • Activity cost information is useful for prioritizing those activities that need to be studied more closely.21. Drury 2008 .

21.6 Example Customer order processing activity Traditional analysis (customer order processing department) Salaries Stationery Travel Telephone Depreciation of equipment £000 ’s 320 40 140 40 40 580 120 190 100 80 90 580 ABM analysis Preparing quotations Receiving customer orders Assessing the credit-worthiness of customers Expediting Resolving customer problems Why are we spending £90k resolving problems – we can’t see this in the traditional method Drury 2008 .

Tutorial Preparation  May 2012 Q5 Strategic management accounting includes techniques that are different from the traditional view. Critically evaluate the use of target costing and lifecycle costing in a mobile phone manufacturer. 25 Marks .