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.

 

54. Zero-Based Budgeting and its Strategic Sides

53. How Many Kinds of Overhead Variance Analysis!

52. Project Control and some Risk Assessment Methodologies

51. When  the Operating Leverage is used as an excuse

50. A Common Manufacturing Accounting "Misundertanding"

49. Make the Right Price.

48. The Choice of the Kind of Bonus: Advantages and Risks

47. How Well is Your Company Using Its Money?

46. ROI: Some Strategic Sides about it and other financial performance metrics

45. Value Creation or Value "Invention"?

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's 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

 

How many times we come across some sort of resistance to the implementation of a new Cost Estimate Model within an organization to support the creation of a sound basis for the best possible decision making!

One way to give evidence of the great usefulness of this potential model could be focusing on the businesses discouraged by the great differences between Actual and Budget.

A lot of companies are facing many changes and will have to face many more due to new technologies and the customer preferences that impact not only the produc/service features but the business organization.

As a result many managers bring into question the need for the traditional Budget since in their opinion the Actual will be so different from the "estimated" because of a great deal of factors.

Instead of putting aside a guide for pursuing the goals of the company why not to abandon the traditional incremental-decremental way of building the budget and to start from scratch!!??

The "start from scratch" relates to a new Cost Estimate Model embedded into the Budget process.

 

Let's take a step back.

 

What do I mean by "incremental-decremental"?

 

The most used way to estimate the General Expenditures is to take as a basis for increasing or decreasing the amount of the past period.

After that according to the projects and to the strategy of the business that basis is taken as a start point either to increase or to diminish the outlay for the purchase of the related resources.

In other terms the "bare bones" of the indirect expenses, usually the majority of the business expenditures, aren't brought into question and your spending won't be ever kept up with the pace of the new challenging needs from the customer both with reference to the output and the related services.

 

How to do during these dynamic times not to miss out on the market requirements when planning?

 

Starting from Zero is the first essential step.

 

What do we mean by that when talking about planning and first of all about Budgeting?

 

 

We mean what is known as Zero-Based Budgeting, that is technique providing the cancellation of the amount of the expenditures of the past fiscal period as a basis for adding or taking off money to be spent on the related resources over the next period.

 

Every single dollar to spend on the resources needed by the business to work must be explained and justified.

That involves the lack of need to take something "obsolete" as a basis on which the business managers, each of them with reference to their business unit, start to reason.

 

To be more clear I think that a short list of the steps Zero-Based Budgeting consists of may be usefull and I will do this by highlithing as much as possible a strategic approach.

 

First Step

Identifying once more the strategic goals of the business by declining them into cost cut objectives and/or revenue increase ones.

 

Second Step

Quantifying these goals by assigning if possible (according to the business stage in its life cycle and its martket) a minimum reference target. Firstly for the business as a whole secondly for its Business Units and bring all the managers within the organization up to date with those "measures".

 

Third Step

Each BU manager must spot the decision activity packages that falls under their responsibilty and rank them according to their importance for the BU and the Value Added that those activities bring to the Customers (last but not least the internal customers, meaning by them the other BUs that give or take services to/from that BU).

The techniques used to rank these activities based one the costs and the benefites associated are different but the related dissertation goes beyond the goal of this article.

 

Fourth Step

Identifying the cost drivers that explain the consumption of the resources for each BU to do their job.

 

Fifth Step

Allocating the resources of the previous step to each BU so that one can forecast the respective amount.

 

Sixth Step

Cutting the excess spending, if any, by taking into consideration the ranking of the third step with reference to the strategic goal of the first step.

In other terms one can proceed just in consideration of the mere goal to cut cost or also of the Value that the activities being examined bring to the customers and their contribution to generate revenues.

 

Further Steps

All the steps contemplated within an organization concerning the negotiation and approval process between Top Managment and BU managers.

 

After seeing these steps some considerations can be made about the benefits and disadvantages about ZBB.

 

Main Benefits

 

The greatest advantage is the result of the total review of the business activities that enables the business to be responsive in a manner as timely as possible to new changes and advances in the technical as well as in other elements needed to be up to date with requirements from the customers.

The extent to which one can capitalize on this feature depends on the cost approach used to quantify the resources to be absorbed by the business activities.

This operating side of the approach used is determinant to succeed in the goal of the ZBB that  in itself doesn't suffice in very dynamic markets if the most suitable cost technique is not used.

However, this may be the subject of a future article where an in-depth dissertation would be deployed.

 

Another great aspect of ZBB implementation is that it enables the strategy to soak into all the Business Units because of the Top-Down method.

As a matter of fact the starting points, as we have seen in step 1 and 2, consist of the strategic goal decisions of the Top Managers and the following communication to the other managers.

 

Some Disadvantages

 

It requires greater effort and is more time-consuming than the traditional Budget because all the activities are analyzed deeply and this can discourage the business people.

I would add that an appropriate people training to ensure the budgeting is implemented correctly could be the smart move.

Some advocate that when the work is so great the implementation of ZBB could occur not every year but every scheduled period (for instance 3-5 years) especially in the large-sized companies where a further remedy provides the business divisions/departments could adopt it by taking turns.

I don't see the latter remedy very positively when the operations between one division and another are recurring.

 

Some argue that ZBB "prefers" the short term because it aims mainly at cutting cost but we can state that the ranking of the activities if well done according to their capacity to generate revenues and to match the customer needs will yield great fruits in the long term, too.

Of course an approriate training is needed with reference also to this aspect.

 

Summing up, the ZBB is an evergreen approach that could help business have an useful guide to their activities without taking the risk to be late in matching the market trends and requirements.

Like any other business process should be enhanced in its operating aspects and in the way it is communicated within the organization environment that is an aspect not to be undervalued.

 

If you wish to debate even more on ZBB, you can resort to thestrategiccontroller.com with your questions, opinions and any other related feedback.

 

How many finance people jump on board of a company with a standard cost accounting system well-established and never looked closely!?

The result is the analyses come out automatically without knowing how they are achieved.

That is the case of the Overhead Variance Analysis, one of the most complex issues to explain to a future smart management accountant.

Thestrategiccontroller.com will make an overview to make the mechanisms clear to anyone who may be interested.

 

Let's start out from the main formula of the Overhead Variance Analysis.

 

Total Overhead Cost Variance = Actual Overheads - Budgeted Overheads

 

You know that the Overheads are both variable and fixed, so the companies that have in place a cost system able to distinguish these two categories may carry out the variances in a separate way that spot 3 or 4 of them.

The business not able to make this distinction can use a two-variance model.

 

At this point you will have understood one of the factors that makes this topic not so easy to be absorbed.

 

Here is the first and most detaile model.

 

Four-Variance Model

 

Total Overhead Cost Variance = (Actual Variable Overheads + Actual Fixed Overheads) - (Total Overhead Application Rate x Standard Driver Quantity)

 

Please note that the driver chosen as a basis for the overhead allocation to the products may be different and vary according also to the Volume-Based or Activity-Based Approach.

 

That is not the article for disserting about that and we prefer going on by a simple example.

 

That difference (Total Overhead Cost Variance) shows how far the related expenses went compared to the amount estimated in the Budget but what matters most is to evaluate the business performance considering the output achieved at the end of the period analysed in the best possible way and costing the products to the same degree and that's why we make use of the concept of Fllexible Budget by appling the unit cost of the driver chosen and the overhead rate (standard and actual) to the period's production.

 

We can see much better by starting from the following formula.

 

Total Overhead Cost Variance = Actual Overheads - Applied Overheads

 

At this point the previous formula becomes:

 

Overhead Cost Variance = Actual Overhead - Applied Overhead = (Variable Overhead + Fixed Overhead) - (Total Overhead application rate x Standard driver allowed for the production of the period).

 

Let's assume that the driver chosen for the imputation of the overheads to the products consists of the labour hour.

As a result the Standard driver allowed for the production of the period becomes Standard labour hours allowed for the production of the period.

 

As we are about to see the formulas for the Variable Overheads may look the same as those of the Direct Cost Variances but the interprepretation is different due to the subjective relationship between the driver chosen (in our case the Labour Hours) and tha varible overheads.

However this issues would require another article and that's why you can get in touch on page Contacts if you want dig deep

 

Let's turn to our topic and a table showing some numbers for an imaginary Manufacturing company with one product and with Labour Hours as the driver chosen  will be very useful to understand that formula.

 

Table 1 - Standard Cost Sheet (Manufacturing Company A) 

 

Cost Category	Quantity per unit	Unit Cost or Standard Overhead rate (for Overhead)	Cost Category Amount	Total
Direct Materials	6	$ 25	$ 150
Direct Labour	5	50	250
Variable Factory Overhead	5 hours	14	70
Variable Manufacturing Cost				470
Fixed Manufactiring Cost	5 hours	26	130	130
Standard Cost per Unit				$ 600

 

 

 After adding these further data:

 

Actual Output: 1,000 Units

Budget Output:1,200 Units

Actual Variable Overhead Costs: $ 56,000

Actual Fixed Overhead Costs: $ 150,000

 

We turn that formula into numbers.

 

Total Overhead Cost Variance = Actual Overheads - Applied Overheads = (Variable Overheads + Fixed Overheads) - (Total Overhead application rate x Standard driver allowed for the production of the period).

 

 

Total Overhead Cost Variance = (56,000 + 150,000) - ((Standard Variable Overh. Application Rate + Standard Fixed Overh. Application Rate) x (Standard Labor Hours per Unit x Actual Output)

 

Total Overhead Cost Variance = (56,000 + 150,000) - ((14+ 26) x (5 x 1000)) = (206,000 -200,000)  =  $ 6,000

 

In this case the actual is higher than the second member of the equation by $ 6,000 and that means that the overheads were underapplied to the production because each output unit has absorbed a higher overhead share than the expeced one.

 

In order to understand the causes we are going on to breakdown this Total Overhead Cost Variance.

 

Let's go with the Total Variable Overhead Variance and see that it is equal to:

 

Total Variable Overhad Cost Variance = Actual Variable Overheads - Standard Variable Overheads Applied to Production =  $ 56,000  (Standard Variable Overh. Application Rate X Standard Labor Hours per Unit x Actual Output) = 56,000 - (14 x 5 x 1000) = 56,000 - 70,000 = -14,000 

 

That means that these Oveheads have been overapplied because each output unit has absorbed a lower variable overhead share than the expeced one

 

On the opposite side the Fixed Overhead Costs have been underapplied by 20,000 as a result of this equation:

 

Total Fixed Overhead Cost Variance = Actual Fixed Overheads - Standard Fixed Overheads Applied to Production =  $ 150,000 -  (Standard Fixed Overh. Application Rate X Standard Labor Hours per Unit x Actual Output) = 150,000 - (26 x 5 x 1000) = 150,000 - 130,000 = 20,000

 

 

Variable Overhead Cost Variance 

 

When talking about a four variance model, we are going to see the first two variances that are those related to the Variable Overhead Costs.

 

First of all, let's show the full data table that will help us to break them down.

 

 

Actual Labour Hours per Unit = 5,6

Standard Labour Hours per Unit = 5

LA = Labour Hours applied to production: 5,000

AW = Actual Labour Hours worked: 5,600

APv = Actual Variable Overhead Application rate:  $ 10

SPv = Standard Variable Overhead Application Rate: $ 14

 

Now we can analyse the first variance, the Spending one, that is the difference between the Actual Overhead Costs and the socalled Flexible Budget of the Variable Overheads based on period's inputs.

 

Variable Overhead Spending Variance = Actual Variable Overhead Costs - Flexible Budget of the Variable Overheads based on the period's inputs = (AW X APv) - (AW x SPv) = (5,600 X 10) - (5,600 X 14) = 56,000 - 78,400 = -22,400

In other terms: (AP - SPv) X AW = (10 - 14) X 5,600 = $ -22,400

 

It is Favourable since the company should have spent more by applying the Standard Variable Overhead Rate (14) at the Actual Labour Hours worked (5,600 Direct Labour Hours).

In some cases, for some cost categories, this variance could be further decomposed in Price and Efficiency variances needed to dig deep into the causes of it, but that will be explained on request (if interested) on page Contacts.

 

As to the Efficiency Variance we'll calculate the difference between the Flexible Budget of the Variable Overheads based on period's inputs and Flexible Budget of the Variable Overheads based on the period's outputs. 

 

Variable Overhead Efficiency Variance = Flexible Budget of the Variable Overheads based on period's inputs - Flexible Budget of the Variable Overheads based on period's outputs =  (AW x SPv) - (LA X SPv) = (5,600 X 14) - (5.000 X 14)  = 8,400

 

In other terms: (AW - LA) X SPv = (5,600 - 5,000) X 14 = $ 8,400

 

Please note that in this Variance for Variable Overheads the Flexible Budget of the Variable Overheads based on period's outputs is equal to Standard Variable Overheads Applied to production ($ 70,000).

 

It is Unfavourable since the company should have spent less by working at the Standard Labour Hours per Unit for the period's units, 1,000, and applying the Standard Variable Overhead Application Rate.

 

What I feel like specifying about this Variance is that the inefficiency or efficiency one can derive from its analysis is linked toward the same direction of the inefficiency or efficiency of the driver chosen (in our case the Direct Labour Hours) as a basis for the allocation of the Overheads to products/services to the extent of the validity of the relationship between Variable Overheads and the driver.

As a result the person in charge of the subject driver, taken for good that relationship, is also responsible the efficiency of Variable Overheads,

 

Furthermore, the correct relationship between the driver used to allocate this kind of Overheads makes the manager in charge of the driver (machine hours, labour hours,...) responsible for the same overheads.

As a result, if you make the wrong choice, that will cause problems of fairness and motivation that will translate into a bad effectiveness of the actions taken to decrease the same Overheads.

 

Fairness because a manager could be held responsible for something that is out of his control and remunerated, in case of compensation partially linked to the financial results of his Business Unit, less than deserved when the Variable Overheads increase.

Motivation because other managers, whose behaviour really impact the amount of the Variable Overheads, won't be pushed to act in the same interest of the Business as a whole and in the end they will make decisions that will cause that expenses to grow and grow.

 

At this point the debate could be shift to the most suitable approach to allocate the Overheads we are dealing with but this is not the article dedicated to this topic and go on to the other variance left.

 

 

Fixed Overhead Cost Variance

 

As we have seen above the Total Fixed Overhead Cost Variance adds up to $ 20,000 and that means that for product-costing purposes they were underapplied in the meaning we repeated many times in the previous lines.

Yet prior to starting the dissertation over these variances, I want to remember some basic concepts in the end that will help the reader to better interprete them.

The Application rate for the Fixed Overheads is not like that for the Variable ones an immutable amount per unit of the driver chosen (in our example the Direct Labour Hours) that makes the related Overhead Costs increase in direct proportion to the increase in the driver quantity (taken for granted the validity of the relantioship).

It is an amount per unit of driver that increases or decreases following the opposite direction of the increase in the driver quantity because the Fixed Overheads don't vary within a large interval of the driver quantity.

In other terms we are recalling the concept of the variable and fixed costs and their different impact on the product cost.

 

That said, let's go in-depth with the breakdown of the Fixed Overhead Cost Variance by saying that just like the Variable Overhead Variance it can be broken down into two categories.

They are called Production Volume Variance (PVV) and the Spending Variance.

 

PVV = Budgeted Fixed Overhead Costs - Standard Fixed Overhead Costs Applied to Production

 

In our example:

 

SPf: Standard Fixed Overhead Application Rate

LS: Standard Labour Hours

LA: Labours Hours Applied To Production

 

 

This article wants to pay homage to the Project Control and the role the Risk assessment plays therein.

The uncertainty is a typical issue of any business decision to be made but it takes even more importance when the projects take time and the technical steps as well as the related resources may be impacted by the occurence of some events, both positive and negative ones.

That's why any firm operating on project must be well-shelled against the Risk of these events and its operating "way" is so peculiar.

 
The steps a company makes in analysing the risks related to a potential project and are 4: 

 

1. Risk Identification.

2. Assessment

3. Planning

4. Monitoring

 

We are going to deal with the Assessment step, focusing on two ways that can be followed in order to weigh the consequences of some events if and when they occur.

The existing approches are generally categorized into qualitative and quantitative ones, each of them is broken down in different methodologies.

We want to pay attention to one method per approach.

 

Prior to getting started let's give a short definition of the quantitative and qualitative techniques.

 

The quantitative method weighs the risks by means of given measurement units and it is used for different purposes ranging from the financial consequence assessment to the determination of the success probability of the project without forgetting the determination of the effects of potential forced changes in the work schedule.

 

The qualitative approach is intended to rank the total risk of the project without resorting to any unit of measurement, by defining the criteria enabling the assessment of the consequences resulting from the occurrence of the risky events.

 

That said, let's start with a methodology of the qualitative approach.

 

Let's guess a matrix where the projects are classified and ranked according to their positioning with reference to the extent (the higher, the greater extent) of the consequencies of a particular event and the occurence probability of the same event (the more on the right, the less probable the risky event).

 

Matrix 1 - Risk Exposure Matrix

	Occurrence Probability
Extent	a
		b
	c
		d	e	f

 

The projects d, e and f are positioned beyond an Attention Threshold that causes the project manager to pay more attention to these than to a, b and c.

 

The size of this Matrix depends on the levels (number of columns and rows) spotted as appropriated in order to assess the projects according to the usual features of the company projects with reference to some criteria such as:

1. Internal features of the project: skills requested and available, technologies requested, characteristichs of the materials and timing of the supply,....).

2. Financial dimension of the project: presence of subcontracts and/or partners, entity of the investments to be made...).

3. Category of the project: importance of the client, impact on the whole business, contract clauses,...).

 

As you can notice the ranking of the project under the qualitative approach is subjective since it depends on the judjment of the project manager that relies on his ability and the experience of the business about  similar projects that are never the same with reference to the features above exemplified.

On the opposite side the ranking is rather fast and easily comprehensible through that matrix.

 

If you want to be more detailed and professionally appropriate about the definition of the level of the risk, Exposure, for that event you are looking over, you have to spot some categories the risk level falls in and that depends on the combination of the degrees of each variable.

 

Here are the levels of the risk (Exposure) that we suppose are four:

 

1. Absent

2. Moderate

3. Outstanding

4. Alarming

 

At the same time, turning back to our example of the Matrix 1, the variables, whose classification convergengy determine the level of the risk (Absent, Moderate, High, Alarming) are weighed this way:

 

Extent:

1. Irrelevant

2. Reasonable

3. Strong

4. Disastrous

 

Occurrence Probability:

1. Low

2. Average

3. High

4. Very High

 

After that here is the Risk Exposure Matrix in its detailed configuration.

 

Matrix 2- Risk Exposure Matrix (Full Version)

 

PROBABILITY   EXTENT	Very High	High	Average	Low
Disastrous	Alarming	Alarming	Outstanding	Moderate
Strong	Alarming	Outstanding	Outstanding	Moderate
Reasonable	Outstanding	Moderate	Moderate	Absent
Irrelevant	Moderate	Moderate	Absent	Absent

 

 

Once you place your project into one of the Matrix cells its exposure will be immediately ranked and if it lies in the Alarming/Outstanding cells (above an imaginary Attention Threshold Line), it will need all the precautions and consideration of the project manager and his team with reference to that given event under "investigation".

 

If many risky event may occur, as many Risky Exposure Matrixes should be drawn and the classifification of the business projects with reference to the whole exposure comes out as a anatural consequence according to the number of the most risky placements of each project.

 

There is the chance of getting a most accurate classification but that means passing to an intermediate form between quantitative and qualitative approach; nonetheless that isn't the goal of this article and if you want to know more, you can reach to thestrategiccontroller.com on page Contacts.

 

Having dealt with that specic qualitative technique, let's move on to one of the quantitative ones.

The Earnings Matrix is one of the application of the Decision Theory and is particularly useful when assigning a percent probability to a very unusual or even Unprecedented event to assess the Risk Exposure of a project/decision is hard. 

As a matter of fact this is a very current recurring issue and it turns out to be a  very useful way to estimate according to your strategy and your risk aversion.

When the attribution of a percentage to a given scenario/event yhe Bayes' Theory shows up as the best technique we know.

It has previously been "dealt with" in the article n. 18 of this page, "How to deal with the uncertainty in the estimation process", under the paragraph Scenario Analysis.

 

Now let's turn our attention to the Earnings Matrix and draw a matrix where Dx is a specific decision (comparable to a project) and Sy is the state (comparable to an event) you come across when that decision/event comes true.

The combinations of Dx and Sy result in an amount that can be either a gain or a loss and we indicate as P (when negative - P)

 

An example will make the concept more clear.

 

D1 = Launch of a busines product into a single new country

D2 = Launch of a business product into two new countries

D3 = Increasing the sales of the existing products through a larger commercial network in the usual market.

 

 

S1 = Scenario with some Entry barriers into one country.

S2 = Scenario with some Entry barriers into two countries.

S3 = No Entry Barriers into the countries involved. 

 

Matrix 3 - The Earnings Matrix

 

State Decision	S1	S2	S3
D1	140,000	140,000	200,000
D2	220,000	155,000	280,000
D3	200,000	200,000	200,000

 

At this point you can apply your personal Risk Aversion by adopting one of these criteria:

 

Optimistic Criterion: you will choose the decision that realizes the highest potential earnings (in our case D2 with the P (profit) of 280,000 under the Column "S3").

Minimax Criterion: you will choose the decision when the lowest earnigs are the highest possible (in our case D3).

Halfway Criterion: you will choose the decision when the average earnings are the highest possible (in our case D2 with the average is worth 218,000).

 

 See you on the n. 53.

 

We all know the considerations the managers should make when planning their costs based on the concept of the Operating Leverage.

Operating Leverage: Fixed costs/Total Costs

 

Once we have recalled that it is the ratio between Fixed Costs and Total Costs of a business the practical result from this magical formula is that

the higher it is the higher the potential Operating Profit, the higher the potential Loss (if the Sales Units are lower than the Break Even Point).

 

Another ratio we are used to taking into account is the Degree of the Operating Leverage.

 

DOL = Contribution Margin/Operating Profit

 

Let's make an example to explain this concept.

 

Sales Units: 3,000 

Contribution Margin: $ 120,000

Operating Profit: $  30,000

 

DOL = 120,000/30,000 = 4

 

What does it mean?

 

That means that (when everything else is constant: Fixed Costs, Total Costs) each increase in the Sales of 1% would bring about a 4 % increase in the Operating Profit.

It goes without saying the higher the Fixed Costs portion the higher is the potential increase in the Operating Profit.

Why?

Because the denominator will decrease if the fixed costs increase and as a result the DOL will be higher.

 

In some cases you come across the strange thing the Fixed Costs planned are higher than the level some could expect based on the prospects of the market demand.

In some other other cases throughout the Budget period  you may have witnessed the persistence of some Business Units' managers, justified for instance by a need for a technology upgrade, in asking during the resource negotiation process for a high level of investment in Long-lived assets (as a matter of fact mainly Fixed costs)  compared to the level of the Variable costs even if the projections of the Sales Units aren't very good.

 

Be aware that the Operating Leverage and the related DOL, that when high promise great results if the planned Sales are higher than the Break Even Point, can be a good excuse for this persistence.

 

Let's make a distinction.

 

When the company has a great competitive advantage (of any kind) over the competitors, no doubt about that behaviour is needed.

For instance, if your company produces a sort of "unique and advanced" exciter that goes into the airbags of the automobiles, no further "doubt" is needed.

As a matter of fact the safety standards concerning the cars are increasing and increasing over the years and that will make the need for the Airbags constant.

As a result the planned Sales Units of that exciter are not only a plan but an "actual".

 

Instead the doubt will arise in all the cases the responsibility of the Fixed Costs are held under the sphere of the whole Company and the managers of some Cost Centers will be held accountable only for the Variable Costs that are considered controllable by them.

 

In this context when the certainty degree of the customer demand for your products is not so optimistic, the persistence of some Managers towards an exagerated amount of Fixer Costs compared to the total costs of the company should be investigated.

What is this case called?

 

Cost Shifting

 

Some remedies are possible and don't consist just in putting the Fixed assets under the responsibility of the Cost Centers Managers

In fact some nonfinancial indicators to assess the performance of the cost centers involved could be used (I invite you to take a look at the article n. 12, SBU manager evaluation: - Nonfinancial measures and strategic structure,  of this webpage).

In case of Share Assets (those used by more than a single cost center) appropriate cost drivers for the fair allocation the fixed costs to the differnt centers are very advisable.

 

In any case an in-depth analysis of the investment requests will be always an appropriate way of proceeding.