1of 14 LEARNING OBJECTIVES. Topic 05. Cost management, capacity costing and capacity management

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1 1f 14 Kevin J Clark CDU Slide 1 Last Revisin 08/03/2015 Tpic 05 Cst management, capacity csting and capacity management Chapter 7 LEARNING OBJECTIVES Distinguish between market-based and cst-based pricing Set utput prices using the target-csting apprach Distinguish between value- and nn-value-added activities Apply the cncepts f cst incurrence and lcked-in csts Describe and apply varius capacity cncepts Select the apprpriate capacity cncept under differing circumstances Describe hw attempts t recver the csts f capacity (fixed csts) may lead t increases in price(s) and reductin in demand. Kevin J Clark CDU Slide 3 Last Revisin 08/03/2015

2 2 f 14 Cst management and pricing Hw cmpanies price a prduct r service ultimately depends n the demand and supply fr it. Three influences n demand and supply: custmers Sidetrack: Cnsider briefly: cmpetitrs Prter s Five Frces Prter's Cmpetitive Advantage Mdel csts. Kevin J Clark CDU Slide 4 Last Revisin 08/03/2015 Prter s Five Frces Cmpetitive Strategy: techniques fr analyzing industries and cmpetitr M. Prter. Free Press (1980). Cmpetitive advantage: creating and sustaining superir perfrmance, Michael Prter, Cllier Macmillian (1985) Kevin J Clark CDU Slide 5 Last Revisin 08/03/2015 Prter's Cmpetitive Advantage Mdel Cmpetitive Strategy: techniques fr analyzing industries and cmpetitr M. Prter. Free Press (1980). Cmpetitive advantage: creating and sustaining superir perfrmance, Michael Prter, Cllier Macmillian (1985) Kevin J Clark CDU Slide 6 Last Revisin 08/03/2015

3 3f 14 Cst management and pricing Market-based price charged is based n what custmers want and hw cmpetitrs react. Cst-based price charged is based n what it csts t prduce, cupled with the ability t recup the csts and still achieve a required rate f return. Pricing decisins and custmer-prfitability analysis is further discussed in Tpic 11 [Chapter 9] Kevin J Clark CDU Slide 7 Last Revisin 08/03/2015 Cst management and pricing web link Depending n the cmpetitive situatin, cmpanies wuld gravitate twards ne apprach r the ther. Fr example; In a highly cmpetitive market the market apprach wuld nrmally be utilised. These cmpanies must accept the prices set by the market. If the market were less cmpetitive, cst-plus pricing culd be used. This apprach is useful fr cmpanies ffering prducts r services that differ frm each ther legal services, incme tax preparatin, custm jewellery, t name a few. The Hw t build a pricing strategy prcess is described at: Kevin J Clark CDU Slide 8 Last Revisin 08/03/2015 Market-based pricing starts with a target price: Target price estimated price fr a prduct r service that ptential custmers will pay Estimated n custmers perceived value fr a prduct r service and hw cmpetitrs will price cmpeting prducts r services. Kevin J Clark CDU Slide 9 Last Revisin 08/03/2015

4 4f 14 Implementing target pricing and target csting: 1) develp a prduct that satisfies the needs f ptential custmers 2) chse a target price 3) derive a target cst per unit: target price per unit minus target perating incme (prfit) per unit 4) analyse the csts 5) apply value engineering t achieve target cst. Kevin J Clark CDU Slide 10 Last Revisin 08/03/2015 Kevin J Clark CDU Slide 11 Last Revisin 08/03/2015 Kevin J Clark CDU Slide 12 Last Revisin 08/03/2015

5 5f 14 Value engineering Value engineering is a systematic evaluatin f all aspects f the value-chain, with the bjective f reducing csts while imprving quality and satisfying custmer needs. Value engineering lks fr better ways t accmplish an bjective Managers must distinguish value-added activities and csts frm nn-value-added activities and csts. Kevin J Clark CDU Slide 13 Last Revisin 08/03/2015 The Value-chain A value chain is a chain f activities that a firm perating in a specific industry perfrms in rder t deliver a valuable prduct r service fr the market. Prter, Michael E. (1985). Cmpetitive Advantage: Creating and Sustaining Superir Perfrmance.. Kevin J Clark CDU Slide 14 Last Revisin 08/03/2015 Value-added csts a cst that, if eliminated, wuld reduce the actual r perceived value r utility (usefulness) custmers btain frm using the prduct r service. Nn-value-added csts a cst that, if eliminated, wuld nt reduce the actual r perceived value r utility custmers btain frm using the prduct r service. It is a cst the custmer is unwilling t pay fr. the distinctin between value-added csts and nn-value-added csts is frm the view f the custmer. Kevin J Clark CDU Slide 15 Last Revisin 08/03/2015

6 6 f 14 Cst incurrence and lcked-in csts Cst incurrence describes when a resurce is cnsumed (r benefit fregne) t meet a specific bjective. Lcked-in csts (designed-in csts) are csts that have nt yet been incurred but, based n decisins that have already been made, will be incurred in the future. T manage activities (csts) well, a cmpany must identify hw design chices lck in csts befre the csts are incurred. Kevin J Clark CDU Slide 16 Last Revisin 08/03/2015 Cst incurrence and lcked-in csts Design chices affect lcked-in csts. Once the design f the prduct is finalised, the cst f the prduct is determined t a large degree.. As the prduct is manufactured, it becmes an incurred cst and can be avided nly by a redesign r by nt manufacturing the prduct. Since csts are incurred at all pints in the value-chain, but frequently lcked in during the design phase, cst reductins can be mst readily attained thrugh value-chain analysis and the use f crss-functinal teams Kevin J Clark CDU Slide 17 Last Revisin 08/03/2015 Kevin J Clark CDU Slide 18 Last Revisin 08/03/2015

7 7f 14 Value chain analysis and crss-functinal teams There are five key aspects t the target pricing, target csting, and valueengineering prcess: understanding custmer requirements and cmpetitr actins selecting a target price and determining a target cst anticipating hw csts are lcked in befre they are incurred imprving prduct and prcess designs and efficiency t achieve target csts and better quality using crss-functinal teams t crdinate actins that need t be taken thrughut the value chain. Kevin J Clark CDU Slide 19 Last Revisin 08/03/2015 If it is nt prperly managed, value engineering and target csting can have undesirable effects: Emplyees may feel frustrated if they fail t attain targets. A crss-functinal team may add t many features just t accmmdate the wishes f team members. A prduct may be in develpment fr a lng time as alternative designs are repeatedly evaluated. Organisatinal cnflicts may develp as the burden f cutting csts falls unequally n different business functins in the firm s value chain. Kevin J Clark CDU Slide 20 Last Revisin 08/03/2015 Kevin J Clark CDU Slide 21 Last Revisin 08/03/2015

8 8f 14 Kevin J Clark CDU Slide 22 Last Revisin 08/03/2015 web links Target Csting Apprach t Pricing is an explanatin with examples f the prcess. It can be fund at: d_services.htm#example%20f%20target%20csting Best Practices in Target Csting. Hw Being, Caterpillar, DaimlerChrysler and Cntinental Teves apply target csting can be fund at: ctices.pdf Kevin J Clark CDU Slide 23 Last Revisin 08/03/2015 web link Target Csting Vs. Cst-Plus in Pricing, plus sme related articles, can be fund at: Kevin J Clark CDU Slide 24 Last Revisin 08/03/2015

9 9f 14 Life-cycle prduct budgeting and csting (briefly study this issue it is dealt with in depth in CMA302) Prduct life cycle spans the time frm initial R&D n a prduct t when custmer service and supprt are n lng ffered n that prduct. Life-cycle budgeting invlves estimating the revenues and business functin csts f the value chain attributable t each prduct frm its initial R&D t its final custmer service and supprt. Life-cycle csting tracks and accumulates business functin csts f the value chain attributable t each prduct frm initial R&D t final custmer service and supprt. Kevin J Clark CDU Slide 25 Last Revisin 08/03/2015 Life-cycle prduct budgeting and csting (briefly study this issue it is dealt with in depth in CMA302) Life-cycle budgeting and pricing decisins: nn-prductin csts are large develpment perid fr R&D and design is lng and cstly many csts are lcked in at the R&D and design stages, even if R&D and design csts are themselves small. Kevin J Clark CDU Slide 26 Last Revisin 08/03/2015 Life-cycle prduct budgeting and csting (briefly study this issue it is dealt with in depth in CMA302) Custmer life-cycle csting: Custmer life-cycle csts fcus n the ttal csts incurred by a custmer t:» acquire a prduct r service» use a prduct r service» maintain a prduct r service, and» dispse f a prduct r service. Kevin J Clark CDU Slide 27 Last Revisin 08/03/2015

10 10 f 14 Capacity csting and capacity management Capacity cncepts Fur different capacity cncepts are used t calculate the budgeted fixed manufacturing cst rate. They are: theretical capacity practical capacity nrmal capacity utilisatin master-budget capacity utilisatin. Kevin J Clark CDU Slide 28 Last Revisin 08/03/2015 Kevin J Clark CDU Slide 29 Last Revisin 08/03/2015 Capacity csting and capacity management Capacity is nt a hard number, but depends n many factrs. FOUR DIFFERENT MEASURES OF ACTIVITY LEVEL: Kevin J Clark CDU Slide 30 Last Revisin 08/03/2015

11 11 f 14 Capacity csting and capacity management Theretical capacity and practical capacity: Theretical capacity is the level f capacity based n prducing at full efficiency all the time. Practical capacity recgnises the need fr unavidable perating interruptins, fr example:» scheduled maintenance time» shutdwns fr hlidays. Engineering and human resurce factrs are bth imprtant when estimating theretical r practical capacity. Kevin J Clark CDU Slide 31 Last Revisin 08/03/2015 Capacity csting and capacity management Nrmal capacity utilisatin and master-budget capacity utilisatin: nrmal capacity utilisatin is the level f capacity utilisatin that satisfies average custmer demand ver a perid (say, 2 t 5 years). It includes seasnal, cyclical, and trend factrs master-budget capacity utilisatin is the level f capacity utilisatin that managers expect fr the current budget perid, which is typically ne year. Kevin J Clark CDU Slide 32 Last Revisin 08/03/2015 Capacity csting and capacity management Effect n budgeted fixed manufacturing cst rate If budgeted fixed manufacturing verhead csts are $1,080,000, the budgeted fixed manufacturing cst rates fr each f the fur capacity cncepts are: The significant difference in cst rates (frm $60 t $135) arises because f large differences in budgeted capacity levels under the different capacity cncepts.. Kevin J Clark CDU Slide 33 Last Revisin 08/03/2015

12 12 f 14 Capacity csting and capacity management If budgeted variable manufacturing cst is $200 per unit, the ttal budgeted manufacturing cst per unit fr capacity cncepts is: Kevin J Clark CDU Slide 34 Last Revisin 08/03/2015 Capacity csting and capacity management web link A summary f the article Wh is accunting fr the cst f capacity? in Management Accunting February, 1997, can be fund at: Kevin J Clark CDU Slide 35 Last Revisin 08/03/2015 Chsing a capacity cncept fr capacity management Cnsider the effects f different capacity cncepts n: prduct csting pricing perfrmance evaluatin external reprting requirements f the Australian Taxatin Office frecasting chsen denminatr-level cncept. Kevin J Clark CDU Slide 36 Last Revisin 08/03/2015

13 13 f 14 Chsing a capacity cncept fr capacity management prduct csting Theretical capacity is rarely used t calculate budgeted fixed manufacturing cst per unit because it is significantly different frm the real capacity available t a cmpany. Practical capacity is frequently used t calculate budgeted fixed manufacturing cst per unit. This apprach sets the cst f capacity at the cst f supplying the capacity regardless f demand. Practical capacity, then, highlights the cst f capacity acquired but nt used and may serve t direct managers attentin tward mre effective capacity management. Kevin J Clark CDU Slide 37 Last Revisin 08/03/2015 Chsing a capacity cncept fr capacity management Pricing: using cst-based pricing, and selecting master-budget capacity utilisatin as the capacity cncept, may lead t a dwnward demand spiral as demand drps, unit csts becme increasingly higher resulting in an increased reluctance t meet cmpetitrs prices as the cmpany increases prices t cver fixed csts, demand drps due t the higher price, resulting in anther price increase t cver still higher per-unit csts. Kevin J Clark CDU Slide 38 Last Revisin 08/03/2015 Chsing a capacity cncept fr capacity management in perfrmance evaluatin managers must guard against using a lng-run measure such as nrmal capacity usage fr a shrt-run purpse such as annual bnuses. Master-budget utilisatin wuld be mre effective in this situatin. Fr external reprting purpses, the chice f capacity measure will affect the magnitude f the prductin-vlume variance. Hw this variance is dispsed f at the end f the year will impact the cmpany s perating incme. The adjusted allcatin-rate apprach restates all amunts in the ledgers using actual rather than budgeted cst rates. This has the effect f switching t actual csting at the end f the year. The prratin apprach spreads the balance ver the accunts cntaining verhead wrk-in-prcess, finished gds, and cst f gds sld in prprtin t the balances in these accunts. The write-ff t cst f gds sld apprach simply writes the balance f the variance ff t cst f gds sld. This can be utilised when the balance is immaterial. This methd is als the simplest t utilise. Kevin J Clark CDU Slide 39 Last Revisin 08/03/2015

14 14 f 14 Mre issues regarding capacity csts and capacity cncepts Csting systems, such as nrmal csting r standard csting, d nt recgnise uncertainty the way managers recgnise it. The fixed manufacturing cst rate is based n a numeratr (budgeted fixed manufacturing csts), and a denminatr (sme measure f capacity r capacity utilisatin). Challenging issues arise with the chices f bth the numeratr and the denminatr. Capacity csts als arise in nn-manufacturing parts f the value chain. Fr simplicity it has been assumed that all fixed manufacturing csts had a single cst driver. Activity-based csting systems have multiple verhead cst pls, each with its wn cst driver. Kevin J Clark CDU Slide 40 Last Revisin 08/03/2015