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Management Accounting Prof. Dr. Filip Roodhooft

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Page 1: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

Management Accounting

Prof. Dr. Filip Roodhooft

Page 2: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

CONTENT

I. Management Accounting

II. Traditional costing systems

III. Activity Based Costing

IV. Total Cost of Ownership

V. Customer Profitability Analysis

VI. Target Costing

Page 3: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

I. MANAGEMENT ACCOUNTING

1. Content2. Major purposes3. Framework4. Cost drivers5. Stages6. Innovations

Page 4: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

1. ContentManagement accounting= system of reporting that enables managers at

different levels of the organization to make better decisions

- Measurement- Analysis- Interpretation- Communication- Planning and control

Different from financial accounting.Important interaction with strategy.

Page 5: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

2. Major purposes

Inventory valuationShort term decision makingPlanningControlStrategic decision making

Page 6: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

3. Framework

Key success factors• Cost• Quality• Time• Innovation

Total value chain analysis

Customersatisfaction

Dual internal/externalfocus

Continuous improvement

Page 7: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

3. Framework

Value chain

Support functions

Research Planning Production Marketing Distributionand and development design

Core activities

Page 8: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

4. Cost driversStructural and executional cost drivers Structural cost drivers:

– Scale – Scope– Experience– Technology– Complexity

Executional cost drivers: – Employee participation– Total quality management– Excess capacity– Plant lay-out– Product configuration– Supplier relationships

Page 9: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

Value Chain activities and cost driversStructural activityManage locationIntegrate verticallyIntegrate horizontallyManage technologyManage complexity of productsManage institutional structureGain experience, learn and manage skill sets

Possible cost driversFavorable locations, number of locationsNumber of industry segments in which the company is presentSales volume in units or dollars, number of different customersTypes of process technologiesNumber of different models

Debt level, debt capacity, favorable tax status

Cumulative number of units sold, cumulative number of individual sales

Procedural activity Providing quality

Managing employees

Managing capacity

Manage efficiency

Manage product complexityManaging plant layout

Possible cost driversEmployee training level, return merchandise rates, customer satisfaction ratingsEmployee morale level, turnover rates, a measure of the span of commandPercentage of capacity utilization, number of production or service facilitiesLead time from product concept to production, R&D cost compared to competitorNumber of parts per product, number of separate operations, flexibility of the production processThroughput time, ability to convert from one product/service to another

Operational activitiesProductionInbound logisticsQuality

Possible cost driversDirect labor hours, set-ups, machine hoursPurchase orders, number of partsNumber of inspections

Page 10: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

5. Stages

Stage 1– Inadequate for financial reporting

Stage 2– Financial reporting-driven

Stage 3– Managerial relevant - stand-alone

Stage 4– Integrated system

Page 11: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

5. Stages

Page 12: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

6. Innovations Activity Based Costing en Management Customer Profitability Analysis Total Cost of Ownership Vertical (de)integration Quality costs Balanced Scorecard Benchmarking Target Costing Life cycle costing Economic value added

Page 13: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

II.TRADITIONAL COSTING

SYSTEMS

1. Procedure

2. Example 1

3. Example 2

Page 14: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

1. Procedure

Direct costs– identify direct costs– estimate price per unit– estimate quantity used–multiply price by quantity– sum up direct costs

Page 15: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

1. Procedure Indirect costs

– identify indirect costs and cost pools– identify appropriate first and second stage

cost drivers– estimate cost driver rate– estimate quantity of cost driver used–multiply cost driver rates by quantity– sum up indirect costs

Page 16: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

2. Example 1 Cost objects

– Big tables: 800»sold 650 (price per unit 540)» inventory 150

– Medium tables: 1,500»sold 1,300 (price per unit 520)» inventory 200

– Small tables: 2,000»sold 1,750 (price per unit 500)» inventory 250

Page 17: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

2. Example 1

Costs (actual costing)

– Materials cost 740,000– Glue and nails 2,150– Direct labour 966,000– Supervision 120,000– Depreciation 70,000– Electricity 4,000– Fuel 4,800

Page 18: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

2. Example 1 Costing system

– direct costs» materials cost» direct labour

– materials (kilogram)» BT 3,600» MT 4,500» ST 3,000

– direct labour (hours)» BT 3,200» MT 9,000» ST 20,000

Page 19: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

2. Example 1 Costing system

– indirect costs»cost pool 1:

glue and nails/ depreciationallocation base: materials in kilogram

»cost pool 2: supervision/ electricity/ fuelallocation base: direct labour hours

Page 20: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

2. Example 1COSTS TOTAL COST POOLS COST OBJECTS

CP1 CP2 BT MT ST

materials cost 740.000 240.000 300.000 200.000

glue and nails 2.150 2.150

wages 96.000 270.000 600.000

direct labor 966.000

supervision 120000 120.000

depreciation 70.000 70.000

electricity 4.000 4.000

fuel 4.800 ________ 4.80072.150 23.400 29.250 19.500

________128.800 12.800 36.000 80.000

372.200 635.250 899.500

COSTS PER UNIT

BIG TABLE 372.200 / 800 = 465,25

MEDIUM TABLE 635.250 / 1.500 = 423,5

SMALL TABLE 899.500 / 2.000 = 449,75

Page 21: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

2. Example 1

Results– cost per unit

»BT 465.25»MT 423.5»ST 449.75

– profitability cost objects»BT 48,587.5»MT 125,450»ST 87,937.5» total 261,975

Page 22: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

3. Example 2 Cost objects

– product 1: 20 units– product 2: 40 units

Costs (standards)– direct materials (£15 per kilogram)– direct labor (£10 per hour)– supervision– cooling fluid– electricity– rags

Page 23: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

3. Example 2 Costs

Page 24: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

3. Example 2 Costs

Page 25: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

3. Example 2 Costing system

Page 26: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

3. Example 2

Results– direct costs

»P1 125»P2 145

– indirect costs»P1 75»P2 80

– total costs»P1 200»P2 225

Page 27: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

III. ACTIVITY BASED COSTING

1. Introduction2. Cost structure3. Example4. Need for a new system5. Usage versus Spending6. Activity hierarchy7. Implementation8. Optimal costing systems9. Activity Based Management

Page 28: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

1. Introduction ABC

A BBlue pens 1.000.000 100.000Other pens 0 900.000Direct Labor 0,1 0,1Direct Material 0,3 0,3Overhead 75.000 250.000

Cost blue A = 0,475 EURCost blue B = 0,65 EUR

(allocation base = number of pieces)

Page 29: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

2. Cost structure

Overhead

Direct costs

Overhead

Direct costs

Page 30: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

3. Example Activity Based Costing

DC COIC CP

AB AB

DC COIC ACT

RD AD

- Activities (ACT)

- Resource drivers (RD) - Activity drivers (AD)

- Cost objects (CO)

Page 31: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

Other indirect costs (IC)Indirect wages 330,000Depreciation 850,000Indirect materials 170,000

1,350,000

3. Example A B C

Units 20,000 15,000 5,000 Direct Material/ unit 25 23 20 Direct Labour/ unit 70 105 35

Labor hours 2 3 1 Machine hours 1 2 5

Batches 2 4 6 Sales orders 10 18 20

Purchase orders 20 15 25

Page 32: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

Cost price per unit

a) Traditional system

b) ABCActivities Activity driver

Reception purchase orders

Set-ups number of set-ups

Assembly machine-hours

Packing sales orders

A B C Direct material + direct labour 25 + 70 23 + 105 20 + 35 Indirect Costs 30 45 15 TOTAL 125 173 70

Page 33: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

The ABC-system

Purchase orders

Set-ups Machine-hours

Sales orders

Indirect wages Depreciation Indirect materials

Reception Set-up Assembly Packing

PRODUCTS

Direct materials Direct labor

Page 34: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

A B C Direct material + direct labour

25 + 70 23 + 105 20 + 35

Reception 2 2 10 Set-up 2 5.33 24 Assembly 10 20 50 Packing 2.5 6 20 TOTAL 111.5 161.33 159

Indirect wages

Depreciation Indirect materials

Total

Reception 90,000 20,000 10,000 120,000 Set-up 60,000 150,000 30,000 240,000 Assembly 20,000 580,000 50,000 750,000 Packing 60,000 100,000 80,000 240,000 TOTAL 330,000 850,000 170,000 1,350,000

Distribution of indirect costs over activities using resource drivers

Distribution of cost of activities over cost objects using activity drivers

Page 35: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

4. Need for a new costing system1. Products that are very difficult to produce are

reported to be very profitable even though they are not premium priced.

2. Profit margins cannot be easily explained.3. Some products that are not sold by competitors have

high reported margins. 4. The results of bids are difficult to explain.

5. The competition’s high-volume products are priced at apparently unrealistically low levels.

6. Vendor bids for parts are considerably lower than expected.

Page 36: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

4. Need for a new costing system

7. Customers ignore price increases, even when there is no corresponding increase in costs.

8. Only direct labor hours (or dollars) are used to allocate overhead from cost pools to the product.

9. Only volume-related allocation bases are used to allocate overhead from cost pools to products

10. Cost pools are too large and contain machines that have very different overhead cost structures.

11. The cost of marketing and delivering the product varies dramatically by distribution channel, and yet the cost accounting system effectively ignores marketing costs.

Page 37: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

5. Usage versus SpendingCost of resources supplied

=Cost of resources used

+Cost of unused capacity

activity = handle customer order

budgeted cost = 280,000

driver = number of orders

expected number = 4,000 practical capacity = 5,000

cost per order = 56

Page 38: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

6. Activity hierarchy

Product-Line Channel Sustaining Sustaining

Brand Sustaining Customer Sustaining

Product Sustaining Order Related

Batch

Unit

Source: Kaplan & Cooper (1997), ‘Cost and Effect’, Harvard Business School Press, p.89

Page 39: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

7. Implementation Steps1. Develop activity dictionary2. Determine how much the organization is spending

on each of its activities– resource drivers– activity attributes – hierarchy of activities

3. Identify cost objects4. Determine cost of cost objects using activity drivers

transaction drivers duration drivers

intensity drivers

Page 40: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

Implementation: Pitfalls1. Individual resistance due to fear2. Departmental resistance to change3. People’s resistance to changing their beliefs and value

systems4. Environmental barriers to change5. Failure to formalize plans to act on the data provided by

the ABM system6. Lack of clear, concise, and easily understandable reports7. Problems with reporting frequency8. ABM is not implemented in a profit centre9. Company is too profitable10. System is too costly to maintain

Page 41: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

Implementation: Chrysler

Turning to ABC Internal resistance Getting acceptance Training the workforce The rollout Final integration

Page 42: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

8. Optimal costing systems

High

Low

Cos

t

Costof errors

Cost ofMeasurement

Total Cost

Optimal CostSystem(Stage III ABC system)

Accuracy

Low High(Stage II cost system)

Source: Kaplan & Cooper (1997), ‘Cost and Effect’, Harvard Business School Press, p.104

Page 43: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

9. Activity based ManagementActivity Based Costing

Operational ABM Strategic ABM Doing Things Right Doing the Right Things Performing activities Choosing the activities more efficiently we should perform

• Activity management• Business process

reengineering• Total quality• Performance

measurement

• Product design• Product-line and customer mix• Supplier relationships• Customer relationships

Pricing, Order size, Delivery, Packaging• Market segmentation• Distribution channels

Source: Kaplan & Cooper (1997), ‘Cost and Effect’, Harvard Business School Press, p.4

Page 44: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

Activity Based ManagementDayton: Value-Added decision rankings

Value-added

VA1: Is the activity of value to external customer?

VA2: Is the activity required to meet corporate requirements?

Nonvalue-added

VA3: Is the activity required for sound business practices?

VA4: Is the activity of value to internal customer?

VA5: Is the activity a waste?

Page 45: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

Dayton: Activity-Based Cost reduction decision model

Activity based onimpact upon main (magnitude frequency)

No immediate opportunity, but review during the next

Is the activity VA1 or VA2?

Can activity be improved

Improve by combination, training, scheduling, integration

Can the frequency be reduced?

Reduce frequency/eliminate

Eliminate

Is the activity VA3 or VA4?

yes

yes yes

no

no

no

no

yes

Activity Based Management

Page 46: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

TOTAL COST OF OWNERSHIP APPROACH

IN PURCHASING MANAGEMENT

IV. TOTAL COST OF OWNERSHIP

Page 47: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

1. Facts and issues

2. Possible improvements

3. Shell’s vision

4. Value Chain

5. Criteria of supplier selection

6. Existing models for supplier selection

7. Definition of the Total Cost of Ownership

8. Examples of Cost Elements

9. Approach

10. Flexible vs. committed resources

11. Hierarchy of activities

12. Use

Content

Page 48: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

1. Facts and issuesFACTS

External purchases are a substantial expenditure: 50%-60% of total costs

Outsourcing is important

THEORY AND PRACTICE Simple and inaccurate decision models in purchasing Major improvements are possible

ISSUESMinimise total cost of ownership

Supplier rationalisation Selection of suppliers Improvements: at supplier (external) and purchasing (internal)

company Dynamic perspective Purchasing strategy

Page 49: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

2. Possible improvements5% DECREASE IN TCO

10% INCREASE IN SALES

Sales 100 100External purchases 60 57Other variable costs 10 10Fixed costs 20 20Profit 10 13

Sales 100 110External purchases 60 66Other variable costs 10 11Fixed costs 20 20Profit 10 13

Page 50: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

3. Shell’s vision“For many years procurement has been an undervalued activity in its contribution to

corporate performance improvement and value for money management. Inadequate planning, poor communication between departments involved in the procurement of materials and equipment and weak performance measurement have resulted in delays and compromise on requested specifications. The acceptance of total procurement as a business process that embraces all disciplines involved in the activities of the operating companies directly addresses these issues.…

Procurement covers the series of activities which need to be performed to acquire and deliver to a user an item or a material or a service. It covers the whole cycle of activities from conception of the need, through designing, purchasing, storage and delivery to the user, monitoring and feeding back operational experience and ultimately disposal…

It therefore follows that procurement does not lie within the domain of one department or discipline but is a process which requires inter-disciplinary co-ordination....”

Source: Procurement Business Strategy, Shell International Oil Company 1991

Page 51: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

4. Value chain

The supplier’s performance influences the activities in the value chain of the company

Transactions Financial Mgmt. Business Plan. Treasury/Risk Processing & Reporting &Analysis Mgmt. (Production/ MIS Sales) Technology Research, Development and Design Human Resource Management and Development Purchasing Production Warehousing Sales/ Customer Inventory & Distribution Marketing Service Holding, Materials Handling

INFRASTRUCTURE ACTIVITIES M

AR

GIN

PR

IMA

RY

AC

TIV

ITIE

S

S

UPP

OR

T A

CT

IVIT

IES

Page 52: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

5. Criteria of supplier selection Net price Quality Customer services Delivery Geographic location Financial position Production facilities Amount of past business Technical capability Management Future purchases Communication systems

Operational controls Position in the industry Labor relations record Attitude Desire for your business Warranties and claims policies Packaging Impression Aids to the purchasing function Compliance with your procedures Performance history

Page 53: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

6. Existing models for supplier selection

S1 S2 S3quality 35% price 25%on time delivery 15%delivered amount 15%administration 10%

= weighted point plan+ other models

price onlyeven more subjective

Page 54: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

7. Definition of the Total Cost of Ownership

True cost of buying a particular good or service from a given internal or external supplier

Goes beyond price to consider all other cost elements using Activity Based Costing

Page 55: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

8. Examples of cost elementsQUALITYCost of inspectionsCost of returns (labour, paperwork,

logistics, etc.)Cost of line falloutCost to train supplier in quality methodsCost of reworksTaguchi cost function

DELIVERYCost of early or late ordersTransportation costsCost of expeditingOpen/back orders due to partial

shipment

CUSTOMER SERVICESDelays due to slow response to

problemsCost of adapting company system to

supplierCost of extra inventory due to

unreliabilitySavings from supplier engineering

supportTime spent straightening out problem

PRICE OR COSTPrice paidTerms like quantity discountsCost reduction due to process

improvements

Page 56: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

TOTAL COST OF OWNERSHIP MATRIXThe concept of the TCO was merged with the ABC cost drivers

concept and the cash/non cash aspects of the cost elements.

Supplier level costs

Sales discount

Other ASP

Payment delay

Other AOP

Price Price

evolution Product

discounts

Service cost

Testing cost

Other AUP

Supplier quotation cost

Contract cost

Supplier follow-up cost

Supplier change cost

Other ASO

Order cost

Other AOO

Other AUO

Cash

Non cash

Other

Cash

Non cash

Other

Cash

Non cash

Other

Other RSP

Transporta-tion cost

Other ROP

Other RUP

Other RSO

Invoicing cost

Quantitative reception cost

Qualitative reception cost

Litigation cost

Other ROO

Other RUO

Order level costs

Inventory cost

Other PUP

Other PUO

Other USP

Other UOP

Consumption

Intrinsic efficiency

Replacement cost

Costs linked to production failure

Costs linked to product failure

Maintenance

Installation cost

Other UUP

Other USO

Other UOO

Cost of quality control

Cost of personnel training

Cost of adaptations

Other UUO

Reception Possession UtilizationAcquisitionCosts linked to

P/SCosts linked to

the OCosts linked to

P/SCosts linked to

the OCosts linked to

P/SCosts linked to

the OCosts linked to

P/SCosts linked to

the O

Other ESP

Other EOP

Waste valorisation

Other EUP

Other ESO

Other EOO

Other EUO

Costs linked to P/S

Elimination

Unit level costs

Costs linked to the O

Othercosts

Other general supplier level costs

Other general order level cost

Other general unit level costs

Page 57: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

9. Approach

Current Resources

Current Activities

Current Suppliers

Model

Future Resources

Future Activities

Future Suppliers

Page 58: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

10. Flexible vs. committed resourcesFLEXIBLE RESOURCES lead to flexible costs= resources for which no capacity is defined since adjustment is always

possible– external purchases– temporary labour– electricity

no capacity problem

COMMITTED RESOURCES lead to committed costs= resources for which capacity is defined since they are acquired in

advance of when the activity is done– buildings and machinery– personnel– computer and telecommunication

capacity problem reduction only after reengineering exercise

Page 59: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

11. Hierarchy of activitiesSUPPLIER LEVEL

cost of dedicated purchasing manager for suppliersadditional R&D cost due to using suppliers

ORDER LEVELreception cost per orderinvoice cost per ordertransportation cost per orderorder cost per order

UNIT LEVELset up costinventory holding costsprice

Page 60: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

12. Use= PURCHASING STRATEGY ON THE BASIS OF ALL TCO ELEMENTS

Supplier selection (mostly reduction) + evaluation NegotiationsProcess improvements

buying firmselling firm

between organisations (cfr. partnerships)Budgets + budget controlBuyers work following the same philosophySensitivityThinking process on current decisionsMakes purchasing objective

situation of purchaserTeamwork

throughout the whole company

Page 61: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

SUPPLIER SELECTION MODEL FOR

STRATEGIC SOURCING

Page 62: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

Content1. Strategic and Operational Aspects

2. Essentials

3. Mathematical decision model

4. Total Cost of Ownership Matrix

5. Methodology

6. Heating Electrode Case

7. Ball Bearings Case

8. Conclusion

Page 63: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

1. Strategic and operational aspects

STRATEGIC ASPECT

Supplier choice is strategic, long term

OPERATIONAL ASPECT

Costs are incurred by working with suppliers day to day

CONSEQUENTLY

For supplier selection, we need a tool that models the operational aspect of the problem to yield the strategic insights

Page 64: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

2. EssentialsJanuary February … December

1 2 3 4 5 6 7 8 K 49 50 51 52

59 62 12 8 82 36 33 68

48

31 17 5 7

Supplier IProduct JPeriod K

1JKS

IJKX

Inventory

Amount purchased

JKD

KJJKJK

KJIIJKIJK

KIIKIK

III

IKIJIJK

JKJKI

IJKJK

SHXCYFZGMIN

levelupplierslevelorderYMX

levelunitSDXS

,,,,

IIK

1

ZY

Page 65: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

3. Mathematical decision modelObjective: Minimisation of the Total Cost of Ownership under constraints

Min (slc + olc + ulc)

Quality auditFollow-upR&DServiceEtc.

SUPPLIER LEVEL COSTS

When a supplier is used

ORDER LEVEL COSTS

When an order is placed

ReceiptInvoiceTransportOrderEtc.

PriceInventoryEfficiencyWaste valorisationEtc.

UNIT LEVEL COST CONSTRAINTSLot SizeSafety stockMaximum stockNumber of suppliersMarket sharesProduction capacityEtc.

Selection of a combination of suppliersMinimisation of the Total Cost of OwnershipDynamic processProblem mainly:

Multi suppliers Multi products Multi periods

Description of the problemDescription of theTotal Cost of Ownership

Ordering over Time

Differentiation among Suppliers

Page 66: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

4. TOTAL COST OF OWNERSHIP MATRIXThe concept of the TCO was merged with the ABC cost drivers

concept and the cash/non cash aspects of the cost elements.

Supplier level costs

Sales discount

Other ASP

Payment delay

Other AOP

Price Price

evolution Product

discounts

Service cost

Testing cost

Other AUP

Supplier quotation cost

Contract cost

Supplier follow-up cost

Supplier change cost

Other ASO

Order cost

Other AOO

Other AUO

Cash

Non cash

Other

Cash

Non cash

Other

Cash

Non cash

Other

Other RSP

Transporta-tion cost

Other ROP

Other RUP

Other RSO

Invoicing cost

Quantitative reception cost

Qualitative reception cost

Litigation cost

Other ROO

Other RUO

Order level costs

Inventory cost

Other PUP

Other PUO

Other USP

Other UOP

Consumption

Intrinsic efficiency

Replacement cost

Costs linked to production failure

Costs linked to product failure

Maintenance

Installation cost

Other UUP

Other USO

Other UOO

Cost of quality control

Cost of personnel training

Cost of adaptations

Other UUO

Reception Possession UtilizationAcquisitionCosts linked to

P/SCosts linked to

the OCosts linked to

P/SCosts linked to

the OCosts linked to

P/SCosts linked to

the OCosts linked to

P/SCosts linked to

the O

Other ESP

Other EOP

Waste valorisation

Other EUP

Other ESO

Other EOO

Other EUO

Costs linked to P/S

Elimination

Unit level costs

Costs linked to the O

Othercosts

Other general supplier level costs

Other general order level cost

Other general unit level costs

Page 67: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

5. Methodology

· Determination of the objectives of the business case

· Determination of the optimisation scenarios

· Determination of the cost structure of the product group

· Preparation of the input data· Validation of the data

Lindo

Access(runtime)

Preparation of the business case

Analysis of the results

Phase 1 Phase 3Mercury

Phase 2

For each optimisation scenario :· Formatting of the business case· Input of the data· Solving

For each optimisation scenario :· Analysis of the output · Determination of a new

purchase strategy· File management

Page 68: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

6. Heating electrodes case

DESCRIPTIONAfter steel has been produced in the blast furnaces it is collected in a recipient and

circulated in vacuum reducing its carbon content, homogenising its compositionHeating electrodes provides constant high temperature, the steel is not cooled off too

much too quicklyLong cylindrical carbon rods of 2 M length, 80 mm diameterLooses its carbon content during useWhen fully consumed it is replaced by a new one

ISSUE Usage duration and failure rate are key determinants of the electrodes’ quality and

varies among suppliers

LiquidSteel

HeatingElectrode

Carbon

Vacuum

Page 69: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

6. Heating electrodes case (cont’d)

DIFFERENCES AMONG SUPPLIERS

QualityPrice per unitBatch sizeSafety timePayment delayPurchasing manager

COMMENTS

Quality differential causes extra set-upsLarge batch :

Reduces inventory flexibility Decreases reception costs per unit

Payment delay modelled as a discount of 1% per periodReception and invoicing costs are internal costs, affect

order quantities not supplier choice

LiquidSteel

HeatingElectrode

Carbon

Vacuum

Page 70: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

6. Heating electrodes case (cont’d)

CURRENT POLICY OPTIMAL POLICY PREFERRED POLICY

Supplier selected S1

S2

S3

S1 S1S2

Ordering Policy Supplier Month Batches Supplier Month Batches Supplier Month Batches

S1 2 - 4 - 9 2 - 1 - 2 S1 1 - 2 - 3 - 4 1 - 1 - 1 - 1 - 1 S1 0 - 3 - 4 - 5 - 8 1 - 1 - 1 - 1 - 1

S2 0 - 5 - 6 - 10 1 - 2 - 1 - 2 5 - 6 - 8 - 9 1 - 1 - 1 - 1 9 - 10 - 11 -12 1 - 1 - 1 - 1

S3 0 2 10 - 11 - 12 1 - 1 - 1 S2 1 - 2 - 6 1 - 1 - 1

Supplier level costs 35,000 10,000 20,000

Order level costs 12,608 18,912 18,912

Batch level costs 9,750 9,000 9,000

Unit level costs 7,127,439 6,107,386 6,464,162

Purchasing costs 7,077,418 6,825,988 6,874,891

Additional costs 452,500 450,000 450,000

Inventory holding costs 110,643 62,890 62,890

Additional revenue 513,122 1,231,492 923,619

Total cost of ownership 7,184,797 6,145,298 14.5% savings 6,512,074 9.4% savings

Page 71: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

7. Ball bearings case

DESCRIPTION

The ball bearings are mainly used for transportation of the hot steel slabs after steel has been produced in the blast furnaces and collected to form the slabs

The transportation lines consist of several rows of steel cylindersThe steel cylinders and the ball bearings are used in very rough conditions

under extremely high temperatures. This causes the surface of the steel cylinders to deteriorate quickly such that they have to be replaced frequently and brought to a maintenance department for remodelling

At the time of replacement of the steel cylinders, the ball bearings are also replaced in anticipation of potential problems and thus before they have been used for their full useful live

BALLBEARINGS

Page 72: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

7. Ball bearings case (cont’d)

DIFFERENCES AMONG SUPPLIERS

Prices differences for 33 itemsService levels for suppliers

S1 and S2 highest levelS5 lowest level

S1 and S2: ordering and invoicing with EDI

COMMENTS

Payment delay modelled as a discount of 1% per period

BALLBEARINGS

Page 73: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

7. Ball bearings case (cont’d)CASE 1 :

CURRENT POLICYS1 S2 S3 S4 S5 S6

Supplier Level -1,818,160 Sales Volume

38,706,206

5,861,042 31,918,164 0.0 0.0 0.0 927,000

Order Level 438,504 Market Share 15.1% 82.5% 0.0% 0.0% 0.0% 2.4%

Unit Level 53,624,630

Total 52,244,974 Total Savings 0.0% Sales Savings 0.0%

CASE 2 :OPTIMAL POLICY

S1 S2 S3 S4 S5 S6

Supplier Level -889,383 Sales Volume31,451,

322

0 16,178,339 563,496 0 11,039,618 3,669,869

Order Level 609,312 Market Share 0.0% 51.4% 1.8% 0.0% 35.1% 11.7%

Unit Level 46,489,100

Total 46,209,029 Total Savings 11.5% Sales Savings 18.7%

CASE 3 :3 SUPPLIERS NOT S5

S1 S2 S3 S4 S5 S6

Supplier Level -1,287,870 Sales Volume

33,109,034

0 17,091,794 1,133,736 0 0 14,883,504

Order Level 609,312 Market Share 0.0% 51.6% 3.4% 0.0% 0.0% 44.9%Unit Level 48,081,740

Total 47,403,182 Total Savings 9.3% Sales Savings 14.5%

Page 74: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

7. Ball bearings case (cont’d)CASE 4:2 SUPPLIERS

S1 S2 S3 S4 S5 S6

Supplier Level -1,007,515Sales Volume

33,166,937

0 20,650,300 0 0 12,516,637 0

Order Level 505,296 Market Share 0.0% 62.3% 0.0% 0.0% 37.7% 0.0%

Unit Level 48,015,910

Total 47,513,691Total Savings 9.1% Sales Savings 14.3%

CASE 5 :

SINGLE SOURCING S2

S1 S2 S3 S4 S5 S6

Supplier Level -1,954,976Sales Volume

39,499,519

0 39,499,519 0 0 0 0

Order Level 193,248 Market Share 0.0% 100.0% 0.0% 0.0% 0.0% 0.0%

Unit Level 54,347,010

Total 52,585,282Total Savings -0.7% Sales Savings -2.0%

Page 75: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

8.Conclusion KEY ADVANTAGES

Substantial proposition of savingsGeneration of negotiation argumentsIdentification of key productsSensitivity analysis (scenario building)Developement of a unique and standard

approach of the TCOFlexibilityChallenge the current decisions and

strategiesQuantification of intangible elementsOblige the buyers to define the cost

structure of a market

DECISION TOOLMarket strategySelection of suppliersDetermination of market sharesDetermination of ordering policy

MANAGEMENT TOOLBudgetReportingStrategy follow-up

CHANGE MANAGEMENT TOOLPratice of the TCOTraining of the BuyersDay to day practice of theoritical conceptsDevelopment of a TCO history/market and

of a knowledge database

TCO Objective

ResourcesUsed

Reduction of

PurchasingCosts

PurchasingProcesses

SupplierManagement

PurchasingStrategy

Supply ChainManagement

PURCHASINGMANAGEMENT

Page 76: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

V. CUSTOMER PROFITABILITY ANALYSIS

Customer profitability analysis

= identification and analysis of the costs and revenues for a customer or group of customers

– Based on ABC-system – Cost object = customer

also include customer related acitivities– To know the profitability so that actions can be based on it

Page 77: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

Information

– Revenues per (group of) customers– Costs directly assignable to (group of) customers– Indirect costs that are linked with activities

Based on this, the actual contribution of the different (groups of) customers can be determined.

Page 78: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

Use

– Relation between activities and customers– Understanding how activities are driven by customers– Possibilities for

» generation of revenues» reduction of costs

– Emphasis on the right customers– Emphasis on the profit and not on the turnover– Information to give discounts– Information to fire customers

Page 79: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

Profitable versus non-profitable customers

10020

Cumulative % of customers

100

150

Cum

ulat

i ve

% o

f pr

ofits

Page 80: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

CustomerA

CustomerB

Traditional Costing Activity-Based Costing

Customer Customer A B

ApparentProfits

Hiddencosts

Hidden Profits

Costs

Revenues

Source: Kaplan & Cooper (1997), ‘Cost and Effect’, Harvard Business School Press, p.191

Hidden profits and hidden costs of customers

Page 81: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

High cost-to-serve customers Low cost-to-serve customers1. Order custom products 1. Order standard products2. Small order quantities 2. High order quantities3. Unpredictable order arrivals 3. Predictable order arrivals4. Customised delivery 4. Standard delivery5. Change delivery requirements 5. No changes in delivery

requirements6. Manual processing 6. Electronic processing (EDI)7. Large amounts of presales support 7. Little to no presales support (marketing, technical and sales (standard pricing and ordering) resources)8. Large amounts of postsales support 8. No postsales support (installation, training, warranty, field service)9. Require company to hold inventory 9. Replenish as produced10. Pay slowly (high accounts 10. Pay on time receivable)

Source: Kaplan & Cooper (1997), ‘Cost and Effect’, Harvard Business School Press, p.191

Characteristics of customers with high and low service costs

Page 82: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

Market potential

High

LowLow High

Compatibility

Life cycle of a customer

Page 83: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

VI. TARGET COSTING

1. Introduction

2. Definition

3. Methodology

4. Target costing versus traditional techniques

5. Characteristics

6. Role ABC in Target Costing

Page 84: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

1. Introduction

Cost commitment %

Product and ProcessPlanning and DesignPhase

Product Manufacturingand product salesand service phase

Cost incidence %

ProductAbandonmentPhase

Perc

ent c

omm

itte

d

100%

0%

Product Life Cycle Phase

Percent Committed Life Cycle Costs

Source: Cooper & Kaplan (1998),’The design of Cost Management Systems’, pg.396, Exhibit 8-1, Cost Commitment vs Incidence

Page 85: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

1. Introduction

Page 86: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

2. Definition

Definition 1Target Costing represents a set of management tools and methods designed to direct design and planning activities for new products, provide a basis for controlling subsequent operational phases and ensure that products achieve given profitability targets throughout their life cycle

Page 87: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

2. Definition

Definition 2The purpose of Target Costing is to identify the production cost for a proposed product such that the product, when sold, generates the desired profit margin. The focus of Target Costing is to reduce the cost of a product through changes in its design. It is therefore applied during the design phase of a product’s life cycle

Page 88: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

3. Methodology

Methodology target costing

Product characteristics

Estimated Allowed cost cost

Target cost

Production

Market research and competition analysis

Page 89: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

3. Methodology

Page 90: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

4. Target Costing versus traditional techniques

Target costing Traditional

Step 1 Target price Product design

Step 2 Target profit Estimated cost

Step 3 Target cost Target profit

Step 4 Product design Price

Page 91: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft
Page 92: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

5. Characteristics Advantages

– flexibility– market orientation– cost savings– future oriented– attention for design

Disadvantages– longer time of development– burn-out of employees– confusion on the market– organizational conflicts

Page 93: Management Accounting Prof. Dr. Filip Roodhooft Prof. Dr. Filip Roodhooft

6. Role of ABC in Target Costing

Traditional : Japan Unit level -material

-labour-assembly

ABC Also non-unit level activities

Unit LevelBatch LevelProduct Level