1. MANAGING COSTS AND REVENUES-2011 2-1 Managing Costs & Revenues Professor William F. O’Brien, MBA, CPA Spring 2011

2. MANAGING COSTS AND REVENUES-2011 2-2 Session 2 n Strategic Cost Management/Measurement Tools and Systems n Activity Based Costs and Management n The Balanced Scorecard n Tiajuana Bronze Case

3. MANAGING COSTS AND REVENUES-2011 2-3 Cost Measurement Systems n Focus on “…operating information for results.”

4. MANAGING COSTS AND REVENUES-2011 2-4 Strategic Mgt. Actg. System n Competitor cost information n Value Chain analysis n Strategic cost analysis…ABM n And others...

5. MANAGING COSTS AND REVENUES-2011 2-5 Ansari: MOA n Strategic Implications n Info @ the cost of features customers most value n Info @ the overall cost of the product n Reflects time considerations in the fulfillment process

6. MANAGING COSTS AND REVENUES-2011 2-6 MOA, cont. n Attribute Implications n Technical n Provides decision relevant information n Enhances process understanding n Behavioral n Cost structure visibility n Facilitates communication n Empowers employees n Risk of “failed expectations” re: “true” cost n Cultural n Supports process focus n Encourages cross-functional participation

7. MANAGING COSTS AND REVENUES-2011 2-7 Attribution vs. Allocation n “The Scarlet Letter” revisited n Attributions promote ownership and cost relationship understanding n Arbitrary allocations do not reflect direct consequences and, therefore, are often ignored.

8. MANAGING COSTS AND REVENUES-2011 2-8 Arbitrary Allocations n When all else fails…at least it forces managerial discussions and negotiations.

9. MANAGING COSTS AND REVENUES-2011 2-9 Activity Based Costing n Application to Final Cost Objectives (FCO’s) on the basis of actual activities employed n Estimations of actual, causal relationships are used…reasonably accurate costs of products, services and customers n Can include fixed and variable amts.

10. MANAGING COSTS AND REVENUES-2011 2-10 Types of Activities n Transaction…# of events n Time or duration…time of events n Cost per event

11. MANAGING COSTS AND REVENUES-2011 2-11 Hints for Implementation n K.I.S.S. n Focus on estimates n Start small n Close enough is good enough n Use Pareto’s law

12. MANAGING COSTS AND REVENUES-2011 2-12 ABC Implementation n Select an area n Identify primary activities (5-10) n Cost each activity n Determine one driver for each activity n Apply the costs to the final cost objectives on the basis of the drivers.

13. MANAGING COSTS AND REVENUES-2011 2-13 ABC/ABM Case- Gulfstream Recreation Gulf Stream Recreation, a major sporting goods firm in California has two major products--the Bobcat Racer and the Snidley Whiplash Cruiser. For the current year, overhead was planned at $850K. Overhead is applied on the basis of machine hours. Each racer uses 2 machine hours and each cruiser uses 1 machine hour. GSR planned to build 10K racers and 50K cruisers. The cost structure for each product is as follows: RacerCruiser Direct Material$35$50 Direct Labor 25 13 Machine Hours 2 1 GSR is considering some type of activity based costing system. Sandra Jones, the cost accounting manager, suggested the following drivers: Driver Relationship to FCO Driver Total Activity Cost Total Racer Cruiser Activity P.O.'s(#)$300K 2000 1250 750Purchasing Rework Hrs. (Hrs)$200 450 200 250 Quality Control Invoices (#)$200 600 150 450 Billing Change Orders (#)$150 300 150 150 Mfg. Eng. 1.Calculate the unit costs of each product under the traditional method. 2.Calculate the unit costs of each product under activity based costing. 3.What pricing implications are inherent in this example.

14. MANAGING COSTS AND REVENUES-2011 2-14 Gulfstream Recreation Solution Standard Overhead Rate: $850K/70K Mhrs. = $12.14 per machine hour Traditional Cost Structure: RacerCruiser Direct material$35$50 Direct labor$25$13 Overhead$24$12 Total$84$75

15. MANAGING COSTS AND REVENUES-2011 2-15 Gulfstream Solution, continued ABC Overhead Rate: RacerCruiser Purchasing$187.5$112.5 Quality control$ 88.9$111.1 Billing$ 50.0$150.0 Mfg. Engineering$ 75.0$ 75.0 Total$401.4$448.6 Per unit$40.10$ 8.97 Traditional Cost Structure: RacerCruiser Direct materials$35$50 Direct labor$25$13 Overhead$40$ 9 Total $100$72

16. MANAGING COSTS AND REVENUES-2011 2-16 Remember... n ABC does NOT yield “true” costs!

17. MANAGING COSTS AND REVENUES-2011 2-17 Ansari: ABM n Strategic Implications n Visibility on the efficiency & effectiveness (the quality) of activities n Visibility of costs for process redesign n Insight into timing consideration of actions

18. MANAGING COSTS AND REVENUES-2011 2-18 ABM, cont. n Attribute Implications n Technical n Greater focus on work n Provides cross-functional cost impact n Highlights operational interdependencies n Behavioral n Heightens importance of process knowledge n Reinforces continuous improvement n Empowers employees--be careful of “non-value” terminology n Cultural n Reorients focus on process not people n Challenges current thinking n May add cultural conflict

19. MANAGING COSTS AND REVENUES-2011 2-19 ABM, cont. n ABM Process (one approach) n Obtain existing cost information n Determine the major processes n Identify process inputs and outputs n Determine the specific activities n Identify the resources used n Define output measures (what we measure) n Define performance measures (how we measure it) n Assess performance through benchmarking n Brainstorm improvements

20. MANAGING COSTS AND REVENUES-2011 2-20 ABM-Schematic Inputs Resources Activities Outputs Quality Quantity

21. MANAGING COSTS AND REVENUES-2011 2-21 Balanced Scorecard Analysis

22. MANAGING COSTS AND REVENUES-2011 2-22 Balanced Scorecard Model Financial Perspective Customer Perspective Internal Business Process Perspective Learning & Growth Perspective Bscol.com

23. MANAGING COSTS AND REVENUES-2011 2-23 Balanced Scorecard Components n Financial Perspective n Customer Perspective n Internal Business Process Perspective n Learning and Growth Perspective

24. MANAGING COSTS AND REVENUES-2011 2-24 The Measures n Approximately 5-7 per section n Link the measures…cause & effect n Include outcomes and drivers n Strategic measures become part of the bal. scorecard; control system measures become “critical success factors” (or everyday measures)

25. MANAGING COSTS AND REVENUES-2011 2-25 Features of a Good Balanced Scorecard n It tells a story. n It helps communicate a strategy. n It preserves a financial focus. n It provides for metric focus. n It highlights sub-optimal tradeoffs.

26. MANAGING COSTS AND REVENUES-2011 2-26 Balanced Scorecard Pitfalls n Failure to allow the scorecard to evolve. n Emphasizing across the board improvement. n Focus on only objective measures. n Failure to focus on both costs and benefits. n Failure to include non-financial measures in evaluating employees.

27. MANAGING COSTS AND REVENUES-2011 2-27 BSC Future Options n BSC format as Management by Objective tool n Personal BSC n 4 F’s