COST APPROACHES. Cost Accounting. Managerial Accounting. Activity Based Costing/Management. Life Cycle Cost. Design to versus for Cost

Transcription

1 COST APPROACHES Cost Accounting Managerial Accounting Activity Based Costing/Management Life Cycle Cost Design to versus for Cost Total Ownership Cost Cost as an Independent Variable 11/18/98 1

2 COST ACCOUNTING - AN INTRODUCTION Accounting is not an end in itself, but only a means to help achieve business success. Specific accounting techniques or systems must be considered in terms of the role they are intended to play. Cost analysis traditionally is viewed as the process of assessing the financial impact of alternative business or managerial decisions. Thus we will consider the differences between Cost Accounting and Management Acounting. 11/18/98 2

3 Cost Accounting Cost Accounting serves two fairly distinct purposes, namely cost finding and managerial accounting. Cost accounting follows long established accounting rules to eventually prepare income statements and balance sheets. Traditional cost accounting is useful to financial people but are almost useless to managers of a company from the point of view of decision making. Cost accounting identifies, classifies, records and summarizes the monetary aspects of a business in a systematic and standard way (Generally Accepted Accounting Principles) to permit financial managers, investors and creditors to evaluate a company s business results and worth. 11/18/98 3

4 Management Accounting Management Accounting resulted from the fact that the data developed by cost accountants was not useful to managers in the day to day as well as long run business. Its purpose is to provide managers with information which aids decision making. There are no generally accepted principles which specify how management accounting information should be reported. While systems such as direct costing and standard costing are used in management accounting, each management accounting report should be customized to the needs of the decision and the decision maker. 11/18/98 4

5 Activity Based Costing/Management (ABC) Fundamentally, each component of overhead is caused by some activity. Therefore, each product should be charged for a share of the overhead component based on the proportion of the activity that it causes. An activity is the description of work that occurs in an organization and consumes resources. ABC is a method of measuring the cost and performance of activities and cost objects. Assigns cost to activities based on their use of resources and to cost objects based on their use of activities ABC empowers managers and other users with the information and tools to improve business performance ABC recognizes the causal relationship of cost drivers to activities 11/18/98 5

6 Activity Based Costing/Management (Continued) The ABC approach presumes that meaningful allocation of fixed costs is possible and worth doing. Cost object is the reason for performing an activity such as to make a product or serve a customer. Cost driver is an event of causal factor that influences the level and performance of activities and the resulting consumption of resources. Non-value added activity is an activity that is judged not to contribute to customer value. Conventional costing systems do not assist management to make world class decision making. In fact, conventional costing methods often cause the wrong decision to be made. 11/18/98 6

7 Activity Based Costing/Management (Continued) Conventional Cost System Based on approach that products consume costs uses historical and derived information not suited to measuring flow of work which moves across department boundaries Activity-Based Costing Based on approach that activities consume resources and products consume activities Uses predictive and causal information Can be used to measure cross department flow of work 11/18/98 7

8 Activity Based Costing/Management (Continued) Examples of ABC terms: Activity Release engineering drawing Function Engineering Process Design Activity The process of designing the system, Definition selecting the components, preparing and issuing the drawing Inputs Specifications and design standards Outputs Drawing Output Number of drawings per week Cost Driver Quantity and quality of material 11/18/98 8

9 Activity Based Costing/Management (Continued) ABC Characteristics Trace, assign and record activity cost to a product Improve cost by identifying non-value added activities Make visible the causes of complexity that does not contribute to customer value Focus and monitor continual cost improvement Provide meaningful information for product design and development decisions By mirroring manufacturing process, designers and production managers can easily determine how design changes will affect product costs. 11/18/98 9

10 Activity Based Costing/Management (Continued) 11/18/98 10

11 Activity Based Costing/Management (Continued) 11/18/98 11

12 Activity Based Costing/Management (Continued) 11/18/98 12

13 Activity Based Costing/Management (Continued) 11/18/98 13

14 Activity Based Costing/Management (Continued) 11/18/98 14

15 Activity Based Costing/Management (Continued) As an example, consider the case of two products A and B. A is a mature product and it requires very little of the overhead support. B is a new product and its complexity requires a lot of overhead support. The problem is that when overhead is taken as a percentage of direct hours it does not give the correct cost for the products. 11/18/98 15

16 Activity Based Costing/Management (Continued) PRODUCT A PRODUCT B 100 Units 100 Units Use of O/H $100 Use of O/H $500 3 direct Labor Hours 2 Direct Labor Hours CONVENTIONAL COSTING Labor 3 x $120 = $360 Labor 2 x $120 = $240 O/H 3 x $120 = $360 O/H 2 x $120 = $240 Total $760 Total $480 OR $7.20 each Unit $4.80 each Unit ACTIVITY BASED COSTING Labor 3 x $120 = $360 Labor 2 x $120 = $240 O/H = $120 O/H = $500 Total $480 Total $740 OR $4.80 each Unit $7.40 each Unit So if you sold more of B than A you would be losing money. This means that decision of quantities A and B would be incorrect based on conventional costing. 11/18/98 16

17 Activity Based Costing/Management (Continued) However, ABC is not the solution to all managerial financial decision making. A shipyard making only one product would not have any accounting benefit, but ABC could still show ineffective facility/equipment usage, and thus improve overhead by getting rid of such waste. ABC can be used to identify and eliminate non-value added activities. ABC has a number of basic problems with regard to a management decision tool for today. They are: Static view rather than dynamic. Obsolete distinction between Product and Period Costs. Costing with ABC assumes no change in strategy. Not enough attention to activity management rather than activity costing. The focus is too narrow 11/18/98 17

18 Activity Based Costing/Management (Continued) Activity Based Management (ABM) is a way to provide the missing dynamic capability to ABC. ABM is the management of the activities in order to improve those inefficient activities that add value and eliminate the activities that do not add value. Like all general-ledger based accounting systems, ABC is involved with inventory versus expensed costs. This has no relevance to any management purpose. In most companies large portions of product cost are incurred long before the product manufacture, such as R&D, design, and procurement. ABM can overcome the fact that ABC is based on a fixed product strategy by focusing on the activities that are being considered for change. 11/18/98 18

19 ACKNOWLEDGEMENT Most of the material for the remainder of this part of the cost presentation, including: and Total Ownership Cost Cost As An Independent Variable has been developed from NAVSEA documents. Full acknowledgement for this is given. However, the organization. Presentation and inferences are the responsibility of the presenter. 11/18/98 19

20 Life Cycle Cost The cost of ownership of a ship continues to increase. This causes problems to owners in obtaining initial financing for construction of the ship as well as adequate operating income to cover the cost of crewing, fuel, maintenance, etc. In traditional acquisitions, operation and support costs typically account for 60 to 80 % of the total LCC. Today, if ever, it is no longer acceptable for program managers and designers to consider only acquisition cost in making planning and design decisions. They must attempt to consider costs throughout the life of the ship. One way to do this is by considering life cycle costs (LCC). The LCC for s ship can be divided into fixed acquisition costs and a variable, often hard to predict life support cost. 11/18/98 20

21 Life Cycle Cost Life cycle costing is an economic assessment of either a single product or competing alternatives, considering all significant costs of ownership over the economic life of the single product or each alternative. For the single product approach it is important to consider a prediction of inflation over the life so that actual dollars are computed. For LCC trade-off analysis, especially if some of the alternatives have different lives, it is necessary to compute every thing in equivalent dollars, most likely by discounted to present year or year that product will enter service. 11/18/98 21

22 Life Cycle Cost (Continued) Life cycle costing is the systematic consideration of cost, time and quality. Life cycle costing is not new, but its need is greater today than ever due to desire to have an affordable ship in order to be competitive or to us public money well. The biggest problem with LCC is that the type of information it needs is not normally possessed by one person. Thus the teaming approach is almost a given. That does not mean that an individual designer should not attempt to apply it, but, simply that he will need help in developing the model and obtaining the information. LCC uses pre-construction, design, construction, operation, logistics, and disposal costs to derive the total LCC. 11/18/98 22

23 Life Cycle Cost (Continued) A major component of LCC is Operating and Support (O&S) cost. For Naval ships the major components of O&S cost are: Crew 30 to 45 % Fuel 12 to 17 % Maintenance 40 to 50% For commercial ships it is: Crew 20 to 30% Fuel 40 to 50% Maintenance 20 to 30% 11/18/98 23

24 Life Cycle Cost (Continued) Navy tools for O&S Cost Analysis consist of: Visibility and Management of O&S Costs (VAMOS) This consists of a database of ship and ship system O&S Costs O&S Cost Analysis Model (OSCAM) Model predicts ship and ship system O&S Costs for different ship types. Cost of Manpower Estimating Tool (COMET) Tool predicts the cost of naval and civilian crew 11/18/98 24

25 DESIGN TO VERSUS FOR COST Most design is performance driven. This has led to escalating cost in constant year dollars. Initial attempts to deal with this have focused on holding to cost, such as Design to Cost. Only recently has the approach been to reduce cost but maintain performance. Design for Cost is an approach that can accomplish this. 11/18/98 25

26 DESIGN TO VERSUS FOR COST (Continued) Design to Cost is the iterative redesign of a project until the estimated cost of the project meets a given budget cost. Design for Cost is the deliberate use of engineering process technology to reduce life cycle cost. Design to cost usually reduces performance until the budget is met. Design for Cost seeks to improve performance while reducing cost. Design to Cost reduces the level by which customer demands are satisfied until the cost budget is met. Design for Cost is an engineering driven process. Design to Cost is a management driven process. 11/18/98 26

27 DESIGN TO VERSUS FOR COST (Continued) Design for Cost engineers the product once and is not an iterative process. Design for Cost minimizes the Life Cycle Cost by design superior quality into the product. Design for Cost involves designing both the product and the production process for simplicity. Design for Cost should therefore be an integral part of the engineering process, not an add on. Low cost cannot be managed into a product. It must be designed into it. Design for Cost uses the engineering process to reduce Life Cycle Cost while satisfying customer requirements. 11/18/98 27

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29 DESIGN TO VERSUS FOR COST (Continued) Design for Cost uses many tools and there are more that could be applied. Such tools include Established Rules of Thumb Total Quality Management Concurrent Engineering Quality Function Deployment Taguchi Methods Analytical Hierarchy Process Process Mapping and Flow Activity Based Costing Each of these tools have demonstrated that they can reduce cost if used in the engineering process 11/18/98 29

30 DESIGN TO VERSUS FOR COST (Continued) Design for Cost can only be applied by knowledgeable engineers. This means that engineers be willing and able to accept this additional responsibility to gain and use the knowledge. How often have you heard people say that you should not try to find ways to reduce structure man hours in naval ships as they have less percentage man hours for structure than the typical cargo ship? It is a correct end statement but the wrong conclusion. Naval Ship Commercial Ship % ManHrs % Manhrs Structure , ,000 Machinery and Outfit , ,000 11/18/98 30

31 DESIGN TO VERSUS FOR COST (Continued) TYPICAL MAN HOUR PERCENTAGE BREAKDOWN PRODUCTION SYSTEM OSV VLCC NAVAL STEEL OUTFIT MACHINERY PIPING ELECTRICAL LABOR/MATERIAL 40/60 45/55 35/65 ENGINEERING STEEL OUTFIT MACHINERY PIPING ELECTRICAL % OF PRODUCTION /18/98 31

32 Total Ownership Cost Total Ownership Cost (TOC) is the cost of research, development, design, construction, operations, maintenance and follow-on logistics support of the product and its associated support systems, including the costs associated with modification, environmental considerations, and disposal. The difference between LCC and TOC is that the latter includes linked-indirect costs, such as: Common support items Common support systems Infrastructure for planning, managing, operating and executing 11/18/98 32

33 Total Ownership Cost (Continued) The TOC Strategic Initiative is to reduce the TOC of US Navy products. TOC establishes an affordable price for a product and then trade-offs either performance or schedule to meet the price. TOC requires a behavioral paradigm shift in which costs are not accepted, but challenged. TOC involves all Navy departments including Program Executive Officers, Program Managers, Field Support Team, Fleet, Depots, NAVICP, OPNAV and SYSCOM. 11/18/98 33

34 Cost as an Independent Variable STRATEGIC GOAL Understand and manage Total Ownership Costs over the entire life cycle to produce savings for recapitalization and modernization. (This implies an urgency for reducing nearterm operating & support costs.) STRATEGY Develop processes, tool-sets, and models to support OPNAV force level decisions and the affordability decisions made by Program Managers and Industry from system concept through disposal. John Douglass, ASN (RDA) Strategic Plan 11/18/98 34

35 Cost as an Independent Variable (Continued) Cost as an Independent Variable (CAIV) is a U.S. DOD initiative. CAIV has many of he same tenets as Design to Cost which is based on the concept of establishing a cost budget and using it as a design constraint. CAIV however, recognized that program managers considered cost as a DEPENDENT variable which would change in order for other variables to remain more constant. CAIV actually is more like the Design for Cost approach in that the design is developed so that the cost does not increase with other changes and may even decrease. CAIV is a way to manage Total Ownership Cost. 11/18/98 35

36 Cost as an Independent Variable (Continued) CAIV changes the Program Managers focus to one of establishing aggressive, but achievable objectives for the total life cycle cost of the program and then making management decisions to achieve the objectives. This requires a change from the DTC average unit cost to a total life cycle cost. Basically CAIV is an acquisition philosophy intended to integrate proven successful, business-related practices with promising new DoD initiatives to obtain superior, yet affordable, war-fighting capabilities. Specifically, CAIV philosophy means that cost should be treated as an independent variable among the three traditional variables - cost, schedule and performance. 11/18/98 36

37 Cost as an Independent Variable (Continued) CAIV means picking the right, affordable cost objective and sticking with it. If the war-fighting requirement cannot be met after exhausting the available range of cost-performance trade-offs, the milestone decision authority will determine if cost targets should b raised or if the program should be cancelled as unaffordable. CAIV will only work if the other acquisition reform streamlining initiatives it is built on are successful. These include: Stating requirements in terms of performance, rather than detailed, design specific military specifications. The adoption of commercial practices and the use of commercial products. The use of IPT Management. 11/18/98 37

38 Cost as an Independent Variable (Continued) CAIV PROCESS Establish Cost/Performance Integrated Process Team Develop Cost Baseline Identify Process/Mission Cost Drivers Identify Hardware/Software Cost Drivers Establish Life Cycle Cost Metrics Set Realistic Cost Reduction Goals Set incentives Develop TOC Reduction Plan Pursue Cost Reduction Opportunities and Manage to Goals Monitor and Update TOC Goals 11/18/98 38

39 Cost as an Independent Variable (Continued) CAIV is a DoN strategic management process. CAIV is both a top-down and bottom-up, continuous and comprehensive approach. CAIV recognizes that limited resource availability drives Total Ownership Cost target. CAIV employs a hierarchy of cost reduction activities, expanding the potential trade-off space. CAIV requires risk management due to the aggressive but realistic cost objectives CAIV is applied to an end item, from cradle to grave. CAIV is evolving into Affordability Readiness. 11/18/98 39

40 Cost as an Independent Variable (Continued) Incentives are key to the success of CAIV. CAIV recognizes that there must be incentives to both Program personnel as well as contractors. Without them there is no motivation for change. CAIV must use existing incentives such as value engineering and other cost saving sharing as well as new ones yet to be developed, especially for program personnel. Program Managers and their staff must not only be allowed, but encouraged, to take risks to gain high future benefits. Navy headquarters will need to change how they measure Program Manager performance to one based on best effort rather than just success. Contractors will like-wise need to be encouraged. 11/18/98 40

41 Cost as an Independent Variable (Continued) TENETS APPROACH Warfighter Participatation - early and continuous role in setting and adjusting program goals Requirements - stated as a set of capabilities, or performances, and the are fungible Capabilities - established at the system level, not at lower levels Cost Objective - define the trade space and realistic, but aggressive, set early and update at each acquisition phase Set realistic, but aggressive cost objectives: based on cost-performance tradeoffs consistent with out-year resources Manage risks to achieve cost, schedule and performance objectives Devise metrics for tracking progress in setting and meeting cost objectives Motivate government and industry to achieve objectives Implement incentives for fielded systems to reduce O&S costs 11/18/98 41

42 Cost as an Independent Variable (Continued) CAIV METRIC Are Cost objectives defined and consistent with requirements programmed and projected fiscal resources? CAIV OBSERVATIONS Out-year resourcces identifed? ($) Production and O&S cost objectives included in the RFP? Key trade-off issues addressed? (e.g. In COEA) Is DoD managing to achieve cost objectives? RFP contains a strict minimum number of performance specifications? (#) CP-IPT functioning: trade-off space identified in program baseline and RFP? Risks to achieve cost objectives identified and program steps to address thes defined? (Risk Plan) Incentives for achieving cost objectives included in RFP and contract? (% related to total contract $s) Mechanism for contracting suggestions to reduce production and O&S costs in place and operating? Allocation of cost objectives provided to IPTs and key suppliers? Measurement and estimation of reliability and maintainability in place? Robust contractor incentives plan in place? Are contractors managing to achieve cost objectives? Providing appropriate tools for cost-performance trade-ffs (including incentives for corporate management) and participates in cost-performance trade-off process? Identifying (and when appropriate implements) new technologies and manufacturing processes that can reduce cost? Identifying procedural/process impediments to cost reduction measures? Establishing strong relationship with vendor base, including sound incentive structure? 11/18/98 42

43 COST ESTIMATING Not a lot of literature on marine cost estimating but the first book goes back to the 1920 s (DESIGN AND COST OF SHIPS, by Kari). Approaches vary depending on type of bid, and available information. Approaches continue to evolve with the developments in manufacturing technology. Cost estimates are prepared by people not by machines. Before a person can develop an estimate, they must acquire pertinent knowledge 11/18/98 43

44 COST ESTIMATING (Continued) Acronyms BCC Basic Construction/Conversion BOM Bill of Material COA Chart of Accounts CER Cost Estimating Relationship EBS Estimating Breakdown Structure ESWBS Extended Ship Work Breakdown Structure GFM Government Furnished Material OFE Owner Furnished Equipment PODAC Product Oriented Design and Construction ROM Rough Order of Magnitude 11/18/98 44

45 COST ESTIMATING (Continued) Marine Cost Estimating is not an exact science. It has grown through application of methods and historical data. It is an area where significant improvement would help all shipbuilders. World Class shipbuilders use more parametric estimating than the U.S. shipbuilders. Why? In U.S. it is really pricing of estimated quantities of raw material and equipment. A shipbuilder can be asked to give Rough order of Magnitude (ROM), Preliminary or Contract (Detailed) estimates. 11/18/98 45

46 COST ESTIMATING (Continued) Before an estimate will be started the shipbuilder first has to decide to bid. Because of the time and cost of preparing designs, estimates and bids, shipbuilders are usually selective on what they will bid on. Most shipbuilders have a Bid-No Bid meeting for each invitation to bid. The bid decision is based on many factors, including: Shipowner s reputation Ongoing work Product fit to facilities and capabilities Extent of perceived competition 11/18/98 46

47 COST ESTIMATING (Continued) In most shipyards Engineering is very involved in the estimating process, usually responsible for the material takeoff and definition of system design and associated equipment. In addition, Engineering must estimate how much man hours and material it will require to design the ship. To facilitate the estimating process a product breakdown structure is used. In the U.S. the two best know structures are the Navy s SWBS and the MarAd SBS. These are both system based and recent work on cost estimating is to apply product and process based approaches 11/18/98 47

48 COST ESTIMATING (Continued) ROM Estimates Based on high level parameters such as ship type, displacement and speed. Preliminary Estimates Based on weights of the major systems such as First Digit SWBS. May be divided into labor and material. Recent development is trying to introduce process based estimates at this stage. Treats labor rate, overhead and profit as individual inputs which can be varied to see impact. 11/18/98 48

49 COST ESTIMATING (Continued) Detailed Estimates Line item listing for every system and purchased component. Material cost based on estimated quantities of raw material and quotes for most of the equipment. Labor man hours based on historical CERs, usually based on weight or linear feet. Direct labor cost results from applying labor rate to total man hours. Sometimes divided into different trades in order to differentiate different labor rates. Overhead applied as a percentage of direct labor cost. Material, direct labor and overhead, as well as some incidental service costs, are summed and a profit percentage applied to determine bid price. 11/18/98 49

50 COST ESTIMATING (Continued) Commonly Used Approach Comparison and estimation of Differences Extrapolation Parametric/Statistical Detailed Selection of Approach Based On Purpose of Estimate Program Phase Level of Product Definition Availability of relevant cost data Quality of cost data Time to prepare 11/18/98 50

51 COST ESTIMATING (Continued) Comparison of U.S. Shipbuilding with World Shipbuilders Most foreign shipbuilders use parametric cost estimating for their final estimate. They are able to do this because: Small well defined product range Building many ships per year Better organized and developed estimating system Cost collection directly compatible with estimating system Use of re-use modules Comparison with other industries Manufacturing and construction industries use very similar approaches, except that they use more standards including the approach throughout the industry. 11/18/98 51

52 COST ESTIMATING (Continued) Re-use Modules and Estimating Standard method in software industry New products are designed by re-using a maximum number of existing parts or assemblies Known costs of re-use modules are summed to give new cost Fast development of new products and estimates Computer Aided Estimating Can be for either detailed or parametric estimates Estimator completes input cost elements, usually within a specific template Can be linked to CAD/CAM Systems Can incorporate probability calculations presenting cost estimates as a distribution to aid in price decisions. 11/18/98 52

53 COST ESTIMATING (Continued) Cost in Preliminary Design and Trade-off Analysis In preliminary ship design naval architects normally want to predict the economics of large numbers of alternative designs. This means that the estimating methods should be relatively simple. The alternatives under consideration usually exist only as imaginary concepts about which few details have been established. This, too, suggests that the techniques must be relatively simple. Moreover, except in rare cases, one need not worry about exact costs; relative costs are what matter. The estimating methods should strive to emphasize differences in costs between the various alternatives. Absolutely accurate costs are not necessary. For Trade-off analysis, which usually looks a a few differences, the same arguments apply. 11/18/98 53

54 COST ESTIMATING (Continued) The Estimate is a predicted cost of a body of work under anticipated conditions of performance. The estimate requires a greater proportion of the shipyard s resources to accomplish than all other elements of he bidding process combined. It is the single most important input to the pricing decision. The estimate provides the point of departure and essential tools for the shipyard s budgeting and cost control and scheduling. The pricing is an instrument and expression of the shipyard s business and marketing policies and a principal means of establishing and maintaining its competitive position. The price is a forecast of market conditions and a pricing decision, which is based, in part, on this forecast and in part on the cost estimate. 11/18/98 54

55 COST ESTIMATING (Continued) When the cost estimate is complete it must be resented to management. Suggested points to be presented are: Type of estimate Percentage of material pricing from quotes Percentage of labor from detailed take-off parameters Comparison of new design with other similar ships built by the shipyard. Labor and overhead rates used. 11/18/98 55

56 COST ESTIMATING (Continued) Management must use the cost estimate, along with the following considerations to decide the bid price: Does the projected work fit in well with available labor resources, facilities and ongoing work? Can they make desired profit at prevailing competitive prices? Have the risks been adequately analyzed and covered? Does the shipyard have the necessary financial resources to successfully perform the contract? 11/18/98 56

57 COST ESTIMATING (Continued) After the project is awarded it is always necessary to conduct a post bid review, whether your shipyard won or lost the contract. This is a very important activity to ensure the competitiveness of the shipyard. It is essential for future pricing decisions. To do this it is necessary to attempt to get the prices bid by other shipyards. This is not as easy as it used to be with the MarAd Open Bid Meeting. However, it is possible to find out. 11/18/98 57