1. Chapter 16 Managing costs and quality
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2. Outline Cost management Activity-based management (ABM)
Business process re-engineering (BPR)
Life cycle costing and budgeting
Target costing
Managing throughput
Managing quality
Total quality management (TQM)
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3. Cost management
Contemporary management accounting systems include a range of tools and techniques that provide information for cost management
Cost management
Improvement of an organisation’s cost effectiveness through understanding and managing the real causes of cost
Main focus is on cost reduction, but also on improving other aspects of performance such as quality and delivery
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4. Conventional versus contemporary approaches
Drivers of cost
Conventional approach: managers control costs by bringing them into line with some predetermined goal
Contemporary approach: reduce costs by identifying waste and eliminating it through identifying the real cost drivers
Strategic perspective
Conventional approach: control costs within the organisation
Contemporary approach: cost management also concerned with achieving value for the customer
(cont.)
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5. Conventional versus contemporary approaches (cont.)
Process perspective
Conventional approach: control costs by reporting results for responsibility centres
Contemporary approach: recognise that customers’ needs are met by processes which flow across the business
Contemporary approaches include
Activity-based management
Business process re-engineering
Life cycle costing
Target costing
Throughput accounting
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6. Activity-based management (ABM)
Process of using information from activity-based costing to analyse activities, cost drivers and performance so that customer value and profitability are improved
Customer value
The value a customer places on particular features of a product
Addresses the vertical view on the activity-based costing model
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8. Using ABM to reduce costs
Identify the major opportunities for cost reduction
Determine the real causes of these costs
Develop a program to eliminate the causes (and therefore, the costs)
Introduce new performance measures to monitor the effectiveness of cost reduction efforts
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9. Identifying the major opportunities for cost reduction
Activities
The units of work performed
Undertake value analysis
Classification of activities
Value-added activities
Provide essential value to the customer, or essential to the functioning of the business
Non-value-added activities
Do not add value to a product or service from the customers’ perspective or for the business and, therefore, can be eliminated
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10. Determining the real causes of non-value-added costs
Building activities into processes
Eliminating non-value-added activities requires a clear understanding of the way work is done in an organisation
A series of activities that are linked together to achieve a specific objective
Processes may cross the boundaries of responsibility centres, such as functional departments
Activities in various processes may share common cost drivers and performance measures
(cont.)
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11. Determining the real causes of non-value-added costs (cont.)
Cost driver analysis
Identification of root cause cost drivers for the major non-value-added activities
Analysis of root cause cost drivers of value-added activities may also lead to more efficient use of resources
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12. Measuring performance in cost reduction
Activity-based performance measures can be used to monitor the effectiveness of cost reduction efforts
Performance measures may reflect both costs and cost drivers
Targets may be set
Corrective actions taken when targets not achieved
Performance monitored over time
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13. Business process re-engineering (BPR)
The fundamental rethinking and radical redesign of business processes to achieve dramatic improvements in critical areas of performance such as cost, quality and delivery
Focus is on strategic processes
Processes that focus on achieving a company’s business objectives and strategies
Reorganise the way in which work is done by identifying and eliminating non-value-added activities
(cont.)
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14. Business process re-engineering (cont.)
Prepare a business process map
A flowchart of activities
Establish goals
Based on customer value
Quality, cost, delivery performance
Reorganise work flow
To enable goals to be achieved
Implement the program
Involves substantial change so careful implementation is required to minimise resistance to change and business disruption
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15. Is BPR the same as ABM?
ABM focuses on incremental, continuous improvement of processes
Business process re-engineering involves fundamental changes to the way processes are structured
Both use activity analysis to identify processes and activities
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16. Life cycle costing
Accumulate and manage costs over the life cycle of the product
Four stages of the product life cycle
Product planning and initial concept design
Product design and development
Production
Distribution and customer (logistic) support
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17. Life cycle budgeting
Involves estimating the expected costs and revenues for each year of the expected life of a product
Comparison between budgeted cost and revenue with actual costs and revenues
Considers all relevant costs over the value chain
Useful in product mix or pricing decisions
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18. Managing costs through a life cycle perspective
Concepts of life cycle costing not widely used
because
There is a lack of awareness, or uncertainty about how to calculate life cycle costs
Not easy for products with longer lives as it is more difficult to assess
Changes in consumer tastes
Impact of competitors’ actions
Effects of inflation
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20. Target costing
A system of profit planning and cost management that determines the life cycle cost at which a proposed product must be produced to generate the desired level of profit
It is cost management technique, not a costing technique
The cost target for a product is driven by the need to sell the product at a certain market price and to achieve a target profit margin
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22. The target costing process
Estimate the target selling price based on market considerations, customer needs and expectations and competitor behaviour
Determine target profit margin and the target cost
Identify the cost reduction objective – difference between the current product cost and target cost
Reduce cost and enhance customer value
Value engineering to eliminate non-value adding elements in product design
Value analysis of manufacturing processes
Work with suppliers to reduce component/material costs
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23. Target costing for cost management
It is price led
Focuses on customer expectations
Based on principles of life cycle management, placing primary emphasis on managing downstream and manufacturing costs
Cross-functional– involving managers from across the value chain
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24. Managing throughput The theory of constraints Throughput accounting
Focuses on identifying and removing bottlenecks to improve the rate of throughput
Recognises the rate of production is limited to the capacity of the constraints (or bottlenecks) that exist
Throughput accounting
Measures effects of bottlenecks and other operational decisions using measures of throughput, inventory and operating expenses
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25. Managing quality What is quality? Quality of design
Degree to which a product’s design specifications meet customers’ expectations
Quality of conformance
Degree to which a product meets formal design specifications
A clear understanding of customer value is needed to provide customers with a high-quality product
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26. The costs of quality Internal failure costs External failure costs
Incurred when defective products or services are detected before they leave the firm
External failure costs
Incurred as a result of defective products or services being delivered to customers
Appraisal costs
Incurred to determine whether defects exist
Prevention costs
Incurred to prevent internal or external failures and to minimise appraisal activities
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27. Using cost of quality information
Helps managers reduce cost and improve quality
Places a dollar figure on the costs of poor quality
Helps prioritise quality improvement programs
Helps managers monitor the effects of the ‘quality effort’
Helps identify the optimal level of quality for the firm
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29. Total quality management (TQM) and a quality culture
TQM is a management approach that focuses on meeting customer requirements by achieving continuous improvement in goods or services
TQM is
Organisation-wide
Customer-driven
Involves empowerment
Has a process perspective
Is supported by a quality management system
Involves continuous improvement
(cont.)
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30. Total quality management (TQM) and a quality culture (cont.)
Six Sigma is a rigorous business improvement methodology that focuses on improving business processes through identifying and eliminating defects
Organisations may achieve quality accreditation by meeting international ISO 9000 quality standards
Systems, quality documentation, process controls and delivery methods that a firm has in place to deliver quality goods and services
May provide assurance to customers that a firm has high levels of quality
Expensive to implement and maintain
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31. Summary
Modern cost management techniques focus on identifying and managing the causes of costs and eliminating waste, while managing customer value
Techniques include ABM, BPR, life cycle costing, target costing and throughput accounting
The management of quality contributes to customer value
TQM, Six Sigma and ISO quality accreditation provide ways of developing and reinforcing a quality culture
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