Topics

 

In this section I will deal with some issues in a detailed and, at the same time, simple way about the world of controlling, its topics, both strategic and operating ones, both the current approaches and the future trends, that is the way the companies "do it" and are going to do it and, of course, my advice.

 

44. The Strategic Cost of Quality

43. The Rule of Thumb doesn’t exist

42. Why is the  Healthcare Cost Accounting so peculiar?

41. The strategic sides of Target Costing 

40. The great implications of the true Capacity Costs (PART TWO)

39. Which is the Most Profitable Customer? 

38. The Game of the Ending Inventory

37. How the "work" of the Support dpts affects the Cost Accounting Settings

36. Only Just In Time?

35. The "Way" to spot the real profitability by product

34. Risk Management: some important metrics

33. Another useful "piece" of variance analysis for the BU

32. Budgeting process: not only a numerical issue 

31. The great implications of the true Capacity Costs (PART ONE)

30. How does the Lean Accounting support the decision making?

29. The strategic interpretation of the productivity measurement (PREVIEW)

28. How deep you can dig and some strategic aspects in the variance analysis

27. Strategic distortions in the capital-budgeting project evaluation

26. Some errors in the capital-budgeting analysis

25. How and why to try to understand the real trend of the overheads

24. The cost variance analysis in the project control (INTRODUCTION)

23. The cost management and the customer-driven value model (PREVIEW)

22. What if you compete on timeliness and speed to customers?

21. The Strategic Fixed Overheads

20. The assessment of the State of the Work according to the activities

19. The choice of an appropriate costing system

18. How to deal with the uncertainty in the estimation process

17. The importance of the Product/Service Life Cycle costs

16. Resource Consumption Accounting: a comprehensive management accounting system

15. Strategic Transfer Pricing: Cost-based and Negotiated Price Methods

14. Motivation and other strategic factors in the Transfer Pricing: Market Price

13. Strategic sides of ROI

12. SBU manager evaluation: - Nonfinancial measures and strategic structure

11. How can you evaluate your business? 

10. How do you deal with the indirect costs? 

9. A very useful "piece" of variance analysis for the BU  

8. Are you getting right about the estimation of the overheads? 

7. Constraints? Here is the way to make decisions 

6. Are you customer-oriented? Here's how you can know about that 

5. Global succes indicator

4. Which kind of standard cost is it convenient to set? 

3. Joint products: how the  contribution margin is calculated  

2. ABC: - Great difference in calculating the financial variances versus the traditional costing systems 

1. The cost of the complexity

 

Gary Cokins

Carlo Attademo

 

Quality!? 

How many times we hear of this word and the related concepts and standards needed to be met in order to be certified as an ISO 9000 (and following…) organization.

But are we sure about the meaning of Quality? 

Are we sure about its strategic importance for a company to be profitable? 

 

The former question involves some considerations about how we are accustomed to perceiving quality.

Most of us take it as a concept strictly linked to the high performance of making  products and delivering services with reference to the processes to make and deliver them.

It looks like only the business pursuing a Differentiation strategy would embrace the quality concept.

It isn’t always this way.

Quality is the ability of an organization to arrange all of its internal processes and to make all of its products/services to meet (at a minimum) the expectations of its customers. 

That means that even a firm adopting a low-cost strategy can also embed the quality concept into its processes and products/services.

 Last but not least, the firms nowadays are being affected by aggressive competitors to increase the quality standards of their products/services and lower their costs, thus adopting as a result a mixed strategy.

That means that it’s even more insightful how this subject is “across-the-board”.

 

The second question about the Profitabilty?  

 

You can find the full article in the file attached below

 

CFOs very often lead the choice of a Cost Accounting and related Reporting System based on the opinions, very detailed and introduced  with in-depth specific topics, of the vendors of the related softwares.

I will be as straightforward as possible.

Most costing system implementations focus mainly on the decision to set either a standard mechanism or not and once this decision is made by the persons in charge of this task (usually the CFOs) great importance is attributed to the role of the software vendors.

In the end many CFOs choose the Cost Accounting and Reporting System related to that software that enables the best business cost breakdown by cost object and gives an immediate perception of those results, considering the information requirements independent on the kind of business processes, products and the strategy of the business.

In other terms they believe to get the most suitable system on the basis of the detail level and visualization ease.

But are that business cost breakdown and its results so easy to be monitored consistent with their information requirements?

 

Please listen to the Management Accountants or to the Controllers that are very knowledgeable  about cost issues and are able to find the right “fit”.

 

In the following lines I am going to summarize the most used kinds of Cost Accounting Systems and related Reporting that a CFO may be deciding to implement into his business according to different criteria.

 

Let’s start.

 

As I said in the lines above, the main choice goes either to a Standard Cost system or to an Actual one, but between those measurement kinds of the costs there is another halfway.

Its name is Normal Costing.

 

Having said that, let’s take into consideration the resources and the related costs  that are the basis of this choice: Direct Labor, Direct Materials and Industrial Overheads (I mean the Manufacturing ones while for the Service Industry those incurred for giving the Services to the customers)

When a portion of them is “predictable” about their  amount as well as the unit cost with reference to each product/service referred to in a reasonable way under given and presumably steady conditions of efficiency of the  manufacturing/delivery processes, the Standard Costing system is fully applicable.

 

Its usefulness goes to the cost control purposes, performance evaluation and continuous improvement when comparing the actual results (costs) to the standard amount and costs set a basis to look at.

 

As to the Actual System all we know that each product/service is charged with the expenses once they are incurred.

Very accurate for the decision-making purposes but it doesn’t allow an immediate perception of how things are going as quickly as Standard System does.

Of course, when there aren’t conditions that enable the Standard Costing adoption, the choice of the Actual one is mandatory

 

Then, what about the Normal Costing System and what are the main reasons leading to its use?

 

Take the case when your products have their own direct materials (also direct labour if the workforce is specialized in that specific make), differing very much from those concerning other products while all the manufacturing processes are instead similar.

In this case the Normal Costing provides the Actual system for the direct materials and an estimated unit cost per product/service of the other indirect expenses.

Whether you are using a Standard Cost Accounting or Actual one or Normal one, you are moving within either a Job Costing System or a Process Costing one or an Operation Costing one.

 

As a matter of fact, another canonical classification concerns the way  one can attribute the costs to the cost objects.

When all the costs are charged directly to the product/service, you will be in a Job Costing method; when you attribute all the expenses to the process of manufacturing/providing the product/service (to be successfully allocated to the products/services), you will be in a Process Costing.

In the end, if you attribute the Material Costs (together or not with the Direct Labour ones or other Special Fixed Costs) to the cost objects and all the others to the process (eventually allocated to the products/services), then you are moving within the Operation Costing.

 

Of course the choice lays in the features of the products and processes and the specifity of the resources consumed with reference to the cost objects.

In making the kind of choice we have indicated, we have neglected the horizon of the business profitability, wheter its strategy is focused on the long term or on the short term.

In the former case the Activity approach comes up as one of the most indicated to meet the information requirements of the management (in particular when the industrial processes are not so uniform when referring to the products/services/customers/distribution channels).

As we all know, when the horizon is the long term, the fixed costs (with reference to the output volume) get much importance and the accuracy of their imputation to the cost objects is lifted to the highest degree.

At this point you can choose for instance GPK cost management technique that is very suitable for the business with multiple cost centers characterized by different capacity-related resources.

It enables the construction of many financial intermediate results, even distinguishing between short-run fixed resources and long-run ones.

If your fixed overheads (with reference to the long term) are the most part of the expenses, then the classical ABC (Activity-Based Costing) is the most appropriate tool, by identifying the right drivers of the consumption of the resources (when the time is the most appropriate driver, the Time-Driven ABC is a further option).

If your intention goes salso to the assessment of the Unused Capacity, a mix of ABC and GPK, the RCA (Resource Consumption Accounting), can also meet your needs.

Not to mention the in-depth applications of the Activity approaches dedicated to the concept of the Value such as the Capacity Cost Management and the Activity- Based Management.

 

In the former case the system is very useful  to many decision-making purposes and very suitable in particular for the businesses adopting a Price Leadership Strategy (when the Price determination follows a mark-up method), by allowing the identification of the time and the costs of the Idle and Non-productive capacity and as a result the potential increase of the denominator (productive capacity) to which dividing the fixed costs and the calculation of a lower unit fixed cost to be charged to each product/service.

The latter is consistent with the value as it is perceived by the customers with reference to the attributes/functionalities of the product/service.

 

Putting aside the traditional dichotomy between Volume-Based methods and Actity-Based ones, we cannot neglect the Lean Accounting System.

That is good in particular when you have many product models whose manufacturing/providing processes are very similar so that you can build some homogeneous bundles (Value Streams) by grouping some of the numerous models, whose profitability can be built and perceived at once through  less detailed reports.

This methodology is also a very good basis for continuous improvement purposes intended to cut waste and improve the efficiency in general of the business processes.

 

Of course this dissertation hasn’t the goal  to analyze each Costing technique as in-depth as possible but to highlight the need for the CFOs to hang upon the professional opinions of their Management Accountants (or Controlling professionals) when deciding the implementation of a particulas Costing method in order to be able to make the best analyses and decisions

As a result this article isn’t the right “place” where listing all the advantages and disadvantages of the above-mentioned methodologies.

 

If you wish to read more about a particular technique you may find some articles on this page and get in touch with thestrategiccontroller.com for further details

As you may have understood after these lines, there are many factors, objective (about the products/services and the business processes) and subjective (about the strategy) ones, to be carefully considered.

This leads to the conclusion that the Rule of Thumb doesn’t exist.

 

Controlling issues have their own characteristics for every industry and some of their tools require the appropriate adjustments to those features and the strategy of the companies.

Indicators, budgeting, cost accounting settings and others are the instruments that attract the attention of the management for enhancing their informative and predictive importance.

 

There are cases where such matters present even more peculiarities that make the tasks of the management more demanding at the setting stage and require the need for an in-depth knowledge of the internal processes.

A full cross-functional expertise and/or availability to acquire it are as essential as ever for "getting the things right".

 

One of this cases is without a doubt that of the healthcare companies as a result of the needs their output should meet. The good health of the patients is the goal that unavoidably puts the level of the healtcare services at a high quality ranking.

 

Nonetheless, it goes without saying that another feature of the healthcare industry that affects the controlling tools is the limited autonomy of the private organizations about the price in function of the public value of their services that attract the intervention of the regulator.

 

That intervention concerns directly the public healthcare, in most countries it is the predominant system,  and has also a great influence in countries where the health insurance system is used.

In fact, the private hospitals cannot deviate very much from the prices "imposed" by the regulator  through different ways to each of the services concerned falling into their "influence" and should rely on the high quality and the timeliness in providing the services in order to achieve as many as customers possible, by focusing at the same time on the search of the best efficiency possible in the cost management.

 

However, the subject at issue is not short and takes long time and attention to dedicate to every kind of the related dissertations; on this reason I make up my mind to focus on just one topic: the strategic cost accounting of the healthcare companies.

 

We all know that the cost accounting helps companies understand where and how the resources  are consumed, identifying the processes more expensive in comparison with those cheaper.

 At the same time the services/products and the responsibility centers are valued and classified according to their costs.

 

Let's get started with the main peculiarities:

 

 1) With particular focus on the healthcare companies organizations, we can see they are genarally structured  in costing centers and that number of  the primary operating costing ones is high (identifying some centers as profit ones is very unusual in consideration of the difficulty of leveraging the revenue side as we wrote earlier).

 

2) Another feature is that usually the Labour Costs are the only ones classified as direct center costs.

Many expenses are general and are incurred for helping all the centers work.

 

In order to explain the impact of these peculiarities on the cost accounting, let's go deeper.

 

What are the primary operating centers? 

 

Hospital wards (each of them dedicated to a medicine speciality), out-patients departments, day hospitals and others.

If we look into them, we can see the reason why the direct costs consist mainly of the labor ones.

 

 Materials (every kind of consumables) are made available for each dpt and their consumption is only indirectly linked to the number of beds. In facts, the beds are just in few cases all occupied and the lenght of the patient stay is always different.

This combined with the high number of departments (costing centers) makes any attempt to attribute the related costs in a direct way hard enough.

 Furthermore only a few drugs can be attributed directly to some costing centers and the respective patients in a timely and precise way.

 

Not to say that medical equipments are available for the use of all the departments which may need them according to the progress of the disease of the  patients and are not of exclusive use of only some of them.

 Of course, these are general indications and some exceptions can be found depending on the width of the care given to the patients by the businesses.

 

After a large-scale analysis of the healtcare organizations, the main result is that the indirect variable expenses are predominant and when we state this, we refer to the costing centers that provide their own services to the patients.

 

These overheads, as I wrote before, are incurred for the functioning of the all the organizations.

 

What does it mean?

 

First of all, we should choose the most appropriate cost drivers linking as realistically as possible the resource consumption to the costing centers (that concerns also the assessment of the "work" from the support centers to the primary ones).

 The solution on the side of the cost accounting could be the use of statistical techniques that show these drivers up as best as possible.

 Many state the use of the activity-based costing approach could be a good solution.

 

In my opinion the use of ABC is appropriate when the services provided to the customers are very heterogeneous and the fixed overheads are not neglegible so that a mapping and breakdown of the activities are even more important.

 

Another aspect resulting from the preceding lines is that the controllability of the costs by the respective dpt managers, just because of their features, is limited and if we consider that when the doctors work as employees, that involves "protected" work contracts,  the influence is even more restricted.

 

It's very advisable linking a part of the compensation to some performance indicators, allowing a better control over the costs (another peculiar facet of the healthcare business controlling is that of the nonfinancial KPIs that isn't dealt with in this article).

 

LAST BUT NOT LEAST the great use by each costing center of the medical advice from doctors working in the same organization but within other dpts.

This brings up the issue of the right internal transfer price (more appropriately transfer cost in the healthcare company case) that the managers of the receiving center could see as an unfair way to be charged with the inefficiency of the origin center of the doctor that gives the advice, since the latter's costs are those to be taken into account.

The advisable choice might be the use of an hourly standard cost of the origin center set as a basis for the advice evaluation to be taken as an additional cost of the receiving center.

 

Further aspects show up about the cost accounting when it comes to dealing with the healtcare system and that's why if you wish to know more, you can get in touch with me on page Contacts.

 

 

One of the most used customer-oriented cost management approaches is without a doubt what is called Target Costing.

Nonetheless not all of its users take it as a deep, synergetic and interactive method between the firm and its market, either by focusing only on the market price or not taking into account the preferences of the customers about the functionalities of the product/service.

Even when they look at the preferences of the customers, the managers don't put on a customer perspective. They take their "feelings" about the customer needs as the most important reference for taking the right cost cuts.

However, in order to dig deep into these facets of the matter we need to make a step back and explain as best as possible the main features of this cost management approach.

 

Here we go!

 

We should know most of the costs a business incurs at the manufacturing/providing phase of the product/service's cost life cycle depend on how the product/service itself is designed/planned.

At the same time the after-sales service costs concerning a product may be a consequence of the choices made at the Design step.

Just at this step Target Costing comes up to help the managers accountable for the expenses to incur in many of the costs centers of the business.

 

How does it work?

 

The starting point is the magical formula:

 

Market Price - Desired Profit = Target Cost

 

The first term of the equation is as well the first to be determined by the businesses and that is made through different methods that I don't explain here.

 

Secondly a desired profit is set and the difference achieved is the reference for the main decisions and actions of the business.

We can easily see how this approach is not a mark-up based one that determines first of all the cost per unit of product service and then apply the share of the desired profit per unit (usually a percentage).

 

Having said that, now we can go on with the following steps without neglecting to do some considerations.

 

During my experiences I encountered both firms operating in luxury markets and ones manufacturing large consumption products that started from the price to get to the Target Cost.

 At this point I could state that the businesses more suitable to make use of this method are the formers just because they have usually customers less sensitive to the price and that gives less pressure to operate on the costs.

I said "at this point" because I haven't exposed yet the additional steps of the Target Costing that highlight the functionalities of the product/service that are the main features that the customers of the large consumption products look at (more than the "rich" do).

In other terms if we focus only on the magical formula, we can take this cost management technique just as a maths equation and nothing more, without putting the customer needs at the hearth of our business and furthermore missing out on the great adaptability of this method to all the industries.

 

Instead, if a consumer analysis is made and it refers exclusively to the preferences expressed by the customers about the criteria used as the main drivers for their purchase, Target Costing is one of the most successful cost management techniques.

 

As you may have noticed, I have written in the previous sentence "it refers exclusively to the preferences expressed" because in many cases the opinions of the managers about the needs of the customers replace the results of the customer surveys as a starting point of the Target Costing, that is the great error of every kind of business.

As a matter of fact, in particular when you are running a firm operating in a fast-changing environment, the feelings/opinions of the managers are not so timely and accurate.

The marketing managers should read the results from those surveys as best as they can, by leveraging their expertise, but the starting poing should always be the voice of the market.

 

However, after this considerations let's go back to the subject of the article and resume just from the result of the customer surveys.

 

The preferences showed there require some activities and related costs being carried out and incurred by the business to manufacture or provide the functionalities/features meeting with those preferences.

In order to target the desired Cost identified by the "magical formula", an analysis on the relationships between functionality and costs must be made.

 

Some methods come up to spot these links in terms of costs spent by the companies on each of these functionalities.

I bear in mind the Activity-Based Management and the Cost Function Development.

 

 The former requires the adoption of an Activity-Based costing method that is linked to the customer-driven value concept.

The latter (see article 6 of this webpage, "Are you customer-oriented? Here's how you can know about that") can be used when the components of the products are material, in other terms,  important "cost aggregates". The calculation of the indirect costs attributed to each of the components may be made both on Volume-based approaches and Activity-Based Costing.

 

What have we to point out about the effects on the work organization?

 

Target Costing requires a strong interaction among various dpts such as R&D, Marketing and Finance.

Only this interaction makes accessible and workable different kinds of data that would otherwise be useless.

An in-depth coordination work by the top management is needed and the setting of databases gathering a lot of data is important to the same extent.

 

Once the relationships between functionalities and costs have been spot the socalled Value Engineering comes up.

It is the fourth step of Target Costing and has the goal to look over the tradeoff between those elements and see what its best level is.

 

The articulation of Value Engineering depends on the editability of the product features.

 

If the features and related functionalities can be easily added or modified singularly, we'll have the Functionality Analysis that considers the above mentioned tradeoff for each of the features of the product/service.

One example of the industries concerned is the fashion one that is the opposite of the automotive sector where the features of the product are dealt with in a bundle related to a given model.

In this case the Engineers design (Design Analysis) different models of product, each of them with a group of functionalities and related performances together with a given amount of costs.

 

Don't forget the costs taken into account cover all the product's life cycle including the after-sales service whose expenses may be a consequence of the choices made at the Design step.

 

One example?

Amongst the different solutions you may have also the possibility to include a same component of other models into the one you are analyzing in order to reduce the manufacturing costs but what happens for the whole business if the part is defective?

The warranty costs will increase importantly.

 

 After this further specification, the choice in both cases (Functionality and Design analyses) goes toward the solution that satisfies the customers as best as possible and at the same time doesn't go beyond the Target Cost.

 

Of course the cost drivers, the elements related to each functionalities that explain the extent and the direction of the expenses, can be better identified statistically by the use of some techniques whose discussion doesn't fall within the reach of this "strategic" article and if you want to know of them, you can resort to page Contacts.

 

At this point we can state Target Costing is suitable particularly for the businesses with a strategy that falls halfway between Differentiation an Price Leadership.

 

Nonetheless this conclusion is not complete because this costing approach when combined with the Continous Improvement "philosophy" is its best guidance possible because it gives a very good direction to it.

 

What do I mean by that?

 

In consideration that Kaizen (Continuos Improvement) is adopted to a great extent by the manufacturing companies with a Price Leadership strategy and that are in continuous search for manufacturing cost reduction methods, we cannot help but stating the universal usefulness of the Target Costing that fits every company and every industry (including service one)

 

Last point.

 

What stage of the Sales Life Cycle is Target Costing fit best?

 

Remembering that Sales Life Cycle of every product/service consists of 4 steps (Introduction, Growth, Maturity, Decline), my opinion is that, considering the level of knowledge of the product/service acquired by the customers at that stage and taking into account the interaction between them and company, the use of Target Costing, always important, shouldn't be underestimated at the Maturity stage.

 

You want to dig deep within Target Costing!!?? 

 

Page Contacts of this website