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Management Accounting andControl Systems:

Assessing Performance over

the Value ChainChapter 7


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Management Accountingand Control System

Generates and uses information to helpdecision makers assess whether an

organization is achieving its objectivesA cost management system is one of the

central performance measurement

systems at the core of a larger entityknown as a management accounting andcontrol system


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Control In ManagementAccounting And Control

A set of:Procedures

Tools

Performance measuresSystems

Used by organizations to guide and motivate

employees to achieve organizationalobjectives


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In Control

A system is in control if it is on the path toachieving its strategic objectives

For the process of control to have

meaning and credibility, the organizationmust have the knowledge and ability tocorrect situations that it identifies as out ofcontrol


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Five Stages Of Control

Planning Execution

Monitoring

Evaluation Correction


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Stages of Control: Planning

Developing an organizations objectives

Choosing activities to accomplish the objectives

Selecting measures to determine how well the

objectives were met


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Stages of Control: Execution andMonitoring

Execution

Implementing the planMonitoring

The process of measuring the systems current

level of performance


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Stages Of Control: Evaluation and Correcting

Evaluation

When feedback about the systems currentlevel of performance is compared to theplanned level so that any discrepancies can beidentified and corrective action prescribed

Correcting

Taking the appropriate actions to return the

system to a state of in control


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A Well-Designed MACS

Designers of management accounting andcontrol systems (MACS) have bothbehavioral and technical considerations tomeet

The technical considerations fall into twocategories

Relevance of the information generated

Scope of the system


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Characteristics of Well-defined MACS

Accurate

Timely

ConsistentFlexible


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Scope Of The System

Must be comprehensive and include all activitiesacross the entire value chain of the organization

If the MACS measures and assessesperformance in only the actual production

process, it ignores the performance of:Suppliers

Design activities

Postproduction activities associated with products

Without a comprehensive set of information,managers can only make limited decisions


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The Value Chain

A sequence of activities that should contributemore to the ultimate value of the product than toits cost

All products flow through the value chain:Begins with research, development, and engineering

Moves through manufacturing

Continues on to customers

Customers may require service and will either

consume the product

dispose of it after it has served its intended purpose


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The Value Chain The value chain may be divided into cycles, which

correspond to different cost control approaches

Research,Development& Engineering

Cycle

ManufacturingCycle

Post-SaleService andDisposal

Cycle

Target Costing& Value

Engineering

Kaizen Costing

Total-Life-Cycle Costing

EnvironmentalCosting

Benchmarking


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Total-Life-Cycle Costing (

Total-life-cycle costing (TLCC) is the nameof the process of managing all costs alongthe value chain

TLCC is also known as managing costsfrom the cradle to the grave


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A TLCC system provides information formanagers to understand and managecosts through a products stages


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Deciding how to allocate resources overthe life cycle usually is an iterative process

Opportunity costs play a heightened role ina total-life-cycle cost perspective


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Numerous life-cycle concepts haveemerged in various functional areas ofbusiness

A TLCC perspective integrates theconcepts so that they can be understoodin their entirety

From the manufacturers perspective,total-life-cycle product costing integratesfunctional life-cycle concepts:


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Research, Development, AndEngineering (RD&E) Cycle

The RD&E Cycle has three stages:

Market research

Product designProduct development


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Cost Control in the RD&E Cycle By some estimates, 80% to 85% of a products

total life costs are committed by decisions madein the RD&E cycle

Decisions made in this cycle are critical:

An additional dollar spent on activities that occurduring this cycle can save at least $8 to $10 onmanufacturing and post-manufacturing activities:

Design changes

Service costs


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Manufacturing Cycle

After the RD&E cycle, the company beginsthe manufacturing cycle

Usually at this stage there is not as muchroom for engineering flexibility to influenceproduct costs and product design becausethey have been set in the previous cycle


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Cost Control in theManufacturing Cycle

Operations management methods help toreduce manufacturing life-cycle product costs

Companies have begun to use managementaccounting methods such as activity-based costmanagement to identify and reduce non-value-added activities in an effort to reduce costs in

the manufacturing cycle


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Post-sale Service & Disposal Cycle

The service cycle begins once the first unitof a product is in the hands of the customer

Disposal occurs at the end of a productslife and lasts until the customer retires thefinal unit of a product

The costs for service and disposal arecommitted in the RD&E stage


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The Service Cycle The service cycle typically consists of three

stages:

Rapid growth

From the first time the product is shipped to the growthstage of its sales

Transition

From the peak of sales to the peak in the service cycle

Maturity

From the peak in the service cycle to the time of thelast shipment made to a customer


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The Disposal Cycle

Disposal occurs at the end of a products lifeand lasts until the customer retires the finalunit of a product

Disposal costs often include those associatedwith eliminating any harmful effects associatedwith the end of a products useful life

Products whose disposal could involve harmful

effects to the environment, such as nuclearwaste or toxic chemicals, often incur very highcosts


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Life-Cycle Costs The following table illustrates four types of

products and the percentage of life-cycle costsincurred in each cycle

CombatJets

CommercialAircraft

NuclearMissiles

ComputerSoftware

RD&E

Manufacturing

Service & Disposal

Average Years inLife Cycle

21%

45%

34%

30

20%

40%

40%

25

20%

60%

20%

2 to 25

75%*

*

25%

5


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Target CostingA method of profit planning and cost

management that focuses on products withdiscrete manufacturing processes

Its goal is to design costs out of products in theRD&E stage of a products total life cycle

It is a relevant example of:How a well-designed MACS can be used for strategic

purposes

How critical it is for organizations to have a system in

place that considers performance measurement acrossthe entire value chain


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The Traditional Method

Begins with market research into customerrequirements followed by productspecification

Companies engage in product design andengineering and obtain prices fromsuppliers

After the engineers and designers have

determined product design, cost isestimate


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Target Costing Method (Although the initial steps appear similar to

traditional costing, there are some notabledifferences:Marketing research is customer-driven

Costs are managed using concurrent design and

engineeringThe total-life-cycle concept is used by making it a key

goal to minimize the cost of ownership of a productover its useful life


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The Target Costing Method

Price-lead costing used to determine a targetselling price and target product volume based onthe companys perceived value of the product to

the customer The target profit margin results from a long-run

profit analysis, often based on return on sales

The target cost is the difference between thetarget selling price and the target profit margin


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The Target Costing MethodOnce the target cost has been set, the company

must determine target costs for each component

The value engineering process includesexamination of each component of a product to

determine whether it is possible to reduce costswhile maintaining functionality and performance

Several iterations usually are needed before it ispossible to determine the final target cost


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The Target Costing Method

Two other differences characterize theprocess:

Cross-functional product teamsmake up of individuals representing theentire value chain guide the processthroughout

Suppliers play a critical role in makingtarget costing work


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Cost Analysis - example

Cost analysis requires 5 sub-activities:

1. Develop a list of product components andfunctions

2. Do a functional cost breakdown

3. Determine a relative ranking of customerrequirements

4. Relate features to functions5. Develop relative functional rankings


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Conduct Value Engineering - example

Value engineering organized effortdirected at the various components for thepurpose of achieving these functions at

the lowest overall cost without reductionsin required performance, reliability,maintainability, quality, safety,

recyclability, and usability


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Conduct Value Engineering - example

Two sub-activities:

Identify components for cost reduction bycomputing a value index (ratio of the value to

the customer and the percentage of total costdevoted to each component)

Generate cost reduction ideas


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Concerns About Target Costing Some studies of target costing in Japan indicate

that there are potential problems inimplementing the system

Companies may manage many of these factors


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Examples of Problems with TargetCosting

Lack of understanding of the targetcosting concept

Poor implementation of the teamworkconcept

Employee burnout

Overly-long development time


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Kaizen Costing

Also focused on cost-reduction

Focuses on reducing costs during themanufacturing stage of the total life cycleof a product

Kaizen is the Japanese term for makingimprovements to a process through small,

incremental amounts rather than throughlarge innovations


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Kaizen Costing (2 of 2)

Kaizen costings goal is to ensure that

actual production costs are less than theprior year cost

Kaizens goals are tied to the profit-planning system

If the cost of disruptions to production are

greater than the savings due to kaizencosting, then it will not be applied


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Example From Auto PlantAn annual budgeted profit target is

allocated to each plant

Each automobile has a predeterminedcost base, which is equal to the actual cost

of that automobile in the previous yearAll cost reductions use this cost base as

their starting point

The targeted cost reduction is the amountthe cost base must be reduced to reachthe profit target


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Example From Auto Plant

The target reduction rate is the ratio of the targetreduction amount to the cost base

This rate is applied over time to all variable costs Then management makes comparisons of

actual reduction amounts across all variablecosts to the pre-established targeted reductionamounts

If differences exist, variances for the plant are

determined


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Concerns About Kaizen Costing

The system places enormous pressure onemployees to reduce every conceivablecost

Kaizen costing leads to incremental ratherthan radical process improvements

This can cause myopia as management tendsto focus on the details rather than the overall

system


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Environmental Costing

Environmental remediation, compliance,and management have become criticalaspects of many businesses

All parts of the value chain, and their costs,

are affected by environmental issuesThese issues are being incorporated into

cost management systems and overallMACS design


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Controlling Environmental Costs

Only when managers and employeesbecome aware of how the activities in whichthey engage create environmental costs willthey be able to control and reduce them

The activities that cause environmental costshave to be identified

The costs associated with the activities have tobe determined

These costs must be assigned to the mostappropriate products, distribution channels, andcustomers


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Types of Environmental Costs

Environmental costs fall into twocategories:

Explicit costs

Implicit costs


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BenchmarkingA way for organizations to gather information

regarding the best practices of othersOften highly cost effective

Selecting appropriate benchmarking partners is

a critical aspect of the process The process typically consists of five stages


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Stage 1

Internal study and preliminary competitiveanalyses

The organization decides which key areas tobenchmark for study

The company determines how it currentlyperforms on these dimensions by initiating

Preliminary internal competitive analysis

Preliminary external competitive analyses

Both types of analyses will determine thescope and significance of the study for eacharea


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Stage 2 (1 of 2)Developing long-term commitment to the

benchmarking project and coalescing thebenchmarking team

the level of commitment to benchmarking mustbe long term Long-term commitment requires

Obtaining the support of senior managementto give the benchmarking team the authorityto spearhead the changes

Developing a clear set of objectives to guidethe benchmarking effortEmpowering employees to make change


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Stage 2The benchmarking team should include

individuals from all functional areas in theorganization

An experienced coordinator is usually

necessary to organize the team and developtraining in benchmarking methods

Lack of training often will lead to the failure

of the implementation


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Stage 3 ( Identifying benchmarking partnerswilling

participants who know the process Some critical factors are as follows:

Size of the partners

Number of partners Relative position within and across industries

Degree of trust among partners


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Stage 4 Information gathering and sharing methods

Two related dimensions emerge from theliterature:

Type of information that benchmarking

organizations collectMethods of information collection


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Stage 5 Taking action to meet or exceed the benchmark

The organization takes action and begins to changeAfter implementing the change, the organization

makes comparisons to the specific performancemeasures selected

The decision may be to perform better than thebenchmark to be more competitive

The implementation stage is perhaps the most difficultstage of the benchmarking process, as the buy-in of

members is critical for success

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