Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010 Ed Blocher University of North Carolina, Chapel Hill Teaching Strategic

Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010

Ed Blocher

University of North Carolina, Chapel Hill

Teaching Strategic Cost Management


Overview1. The Strategic Approach: an Introduction

2. Tools for Integrating Strategy: Value Chain Analysis, The Strategy Map, and the Balanced Scorecard (BSC)

3. Sample Course Outlines

4. Sample Course Topic: Activity-Based Costing (ABC), Time-Drive ABC (TDABC), and ABM

5. Sample Course Topic: Customer Profitability Analysis

6. Sample Course Topic: The Management and Control of Quality and Accounting for Lean

7. Sample Course Topic: Performance Measurement

8. Using Software in the Cost Management Course


Part 1: the Strategic Approach to Teaching

Cost/Management Accounting Topics—An

Introduction


Teaching Strategic Cost Management

What?

Why?

How?


Three Levels to Teaching…

First Level: Explain the topic

Second Level: As above, plus require homework

Third Level: As above, plus include the topic on exams


Strategic Cost Management

• Focus on Financial Focus on Financial ReportingReporting

• Common emphasis on Common emphasis on standardization and standardization and standard costsstandard costs

• The accountant as The accountant as functional expert and functional expert and financial scorekeeperfinancial scorekeeper

• Focus on Financial Focus on Financial ReportingReporting

• Common emphasis on Common emphasis on standardization and standardization and standard costsstandard costs

• The accountant as The accountant as functional expert and functional expert and financial scorekeeperfinancial scorekeeper

Prior PerspectivePrior PerspectivePrior PerspectivePrior Perspective The Strategic The Strategic PerspectivePerspective

The Strategic The Strategic PerspectivePerspective

# View cost # View cost management as a management as a tool for developing tool for developing and implementing and implementing business strategybusiness strategy

# The accountant as a # The accountant as a business partnerbusiness partner

# Focus on cost # Focus on cost management management

# View cost # View cost management as a management as a tool for developing tool for developing and implementing and implementing business strategybusiness strategy

# The accountant as a # The accountant as a business partnerbusiness partner

# Focus on cost # Focus on cost management management


Consequences of Lack of Strategic Cost-Management Information

Decision-making based on guess and intuition

Lack of clarity about direction and goals

Over time, lack of a clear and favorable perception of the firm by customers and suppliers

Incorrect decisions: choosing products, markets, or manufacturing processes that are inconsistent with the organization’s strategy

For control purposes, cannot link performance effectively to strategic goals

…


Definition of Management Accounting: IMA

Management accounting is a profession that involves partnering in management decision making, devising planning and performance management systems, and providing expertise in financial reporting and control to assist management in the formulation and implementation of an organization’s strategy.


Introducing Strategy

ValueChain

StrategicPositioning

StrategyMap

Balanced Scorecard

(BSC)

OpportunitiesThreats

StrengthsWeaknesses


Michael Porter: Strategic Positioning

Cost Leadership—outperform competitors by producing at the lowest cost, consistent with quality demanded by the consumer

Differentiation—creating value for the customer through product innovation, product features, customer service, etc. that the customer is willing to pay for


Aspects of the Two Competitive Strategies

Aspect Cost Leadership DifferentiationBasis of competitive advantage

Lowest cost in the industry

Unique product or service

Product lineOften, a limited selection

Wide variety, differentiating features

Production emphasis

Lowest possible cost with high quality and essential product features

Innovation in differentiating products

Marketing emphasis Low price

Premium price and innovative, differentiating features


Part 2: Tools for Integrating Strategy into Cost

Accounting/Cost Management Courses

-- The Value Chain

-- Strategy Maps & the Balanced Scorecard (BSC)


o “Upstream” Activities

o Manufacturing/Operations

o “Downstream” Activities

Value Chain Analysis:A Detailed Look at Strategy…

The Value Chain is a linked set of value-adding activities used by an organization to deliver its value proposition to its customers. It consists of:


Value-Chain Analysis Identify value-chain activities

Develop competitive advantage by: Identifying opportunities for adding value for

the customer

Identifying opportunities for eliminating non-value added activities and reducing cost

Understand linkages among suppliers, the entity, and customers


Strategy Maps & the Balanced Scorecard (BSC)

The BSC and Strategy Map are used to align the organization’s activities with achieving strategic goals, using the four perspectives:

•Financial

•Customer

•Internal Processes

•Learning and Growth


Exceed shareholderexpectations

Improve profitmargins

Increase salesvolume

Diversify incomestream

Increase sales toexisting customers

Diversify customer base

Attract newcustomers

Target profitablemarket segments

Develop newproducts

Optimize internalprocesses

Attract newcustomers

Developemployee skills

Integratesystems

vision &mission

Learning & Growth

Internal Process

Customer

Financial


ValueChain

StrategicPositioning

StrategyMap

Balanced Scorecard

(BSC)

The Balanced Scorecard (BSC): Feedback to Strategy


Educational Resource: Tartan Manufacturing Case

Key Issues:

• Tartan emphasizes product leadership and quality

• Limited manufacturing capacity

• Fast sales growth in certain lines

• The “Classic” Line has falling sales and is increasingly difficult to manufacture


Part 3: Sample Course Outlines

• Management Accounting

• Cost Accounting

• Advanced Management Accounting


Introduction to Management Accounting Strategic Positioning Ethics

Implementing Strategy

Product Costing

Cost Behavior (Planning and Operational Control)

Product Life Cycle

The Value Chain

The

Balanced Scorecard

Volume Based (Job Costing)

Activity -

based Costing

Cost Estimation CVP Analysis Master Budget Decision

Making Flexible Budgets

Target Costing

Life

Cycle Costing

Management Control


Cost Accounting Strategic Positioning Ethics


Product Costing

Cost Behavior (Planning and Operational Control)

Product Life Cycle

The Value Chain

The Balanced

Scorecard

Job Costing ABC Costing Process Cost Joint Costs Standard

Costing

Cost Estimation CVP Analysis (ABC)

Master Budget (ABC)

Decision

Making (ABC)

Target Costing

Life Cycle

Costing

Managing Constraints


Advanced Management Accounting Strategic Positioning Ethics


Cost Behavior (ABC-based) Product Life

Cycle

The Value Chain

The Balanced Scorecard (BSC)

Cost Estimation (Regression)

CVP Analysis Master Budget Decision

Making (LP)

Target Costing

Life

Cycle Costing Management Control (TP)

Executive Compensation Business Valuation


Part 4: Sample Course Topic—Activity-Based Costing (ABC),

RCA, and TDABC


Evolution of Cost Accounting Systems

TraditionalCosting

Resources

Cost Objects

Allocatedto

ABC(simple &minimal)

Resources

Activities

Consumedby

Cost Objects

Consumedby

ABC(multidimensional)

Resources

ActivitiesActivities

Consumedby

outputs

Consumedby

channels

UsersCost Objects


ABC/M Framework

RootCauses of Costs

Work Activities Performance Measures

•Cost Reduction•Process reengineering•Cost of quality•Continuous

improvement•Waste elimination•Benchmarking

What Things Cost

ResourceCosts

Cost Objects

ResourceDrivers

Activity Drivers

Better Decision Making

Why Things Cost

•Design for manufacturing•Make versus Buy

Activity Cost Assignment


Resource Consumption Accounting (RCA)

Resource consumption accounting (RCA) is an adaption of ABC that emphasizes resource consumption by greatly increasing the number of resource cost pools, which allows more direct tracing of resource costs to cost objects than an ABC system with fewer cost centers.8 RCA is particularly appropriate for large organizations with repetitive operations and high-level information systems such as those provided by SAP, Oracle, and SAS.


Time-Driven ABC When a substantial amount of the cost of a company’s activities are in a highly repetitive process (much like in the RCA example above), the cost assignment can be based on the average time required for each activity.

Time-Driven Activity-Based Costing (TDABC) assigns resource costs directly to cost objects using the cost per time unit of supplying the resource, rather than first assigning costs to activities and then from activities to cost objects.


TDABC ExampleTDABC computes the cost per minute of the resources performing the work activity. Assume 2 clerical workers paid $45,000 annually perform a certain activity that is expected to require 17 minutes. TDABC calculates the total cost as $45,000 x 2 = $90,000; TDABC then calculates the total time available for the activity as 180,000 minutes (assuming 30 hours per week with two weeks vacation: 2 workers x 50 weeks x 30 hours x 60 minutes per hour = 180,000 minutes per year).

The TDAC rate for the activity is $0.50 per minute ($90,000 / 180,000). The cost of a unit of activity is $0.50 x 17 min = $8.50; if the activity required 20 min, then the allocation would be $.50 x 20 = $10.


Part 5: Sample Course Topic—Customer Profitability

Analysis


• Activity Based Costing (ABC)

• Customer Relationship Management (CRM):

• Customer Lifetime Value (CLV)

• Customer Equity

Overview of Customer Profitability Analysis


The Whale Curve: 80% from the top 20% (or more!)

Most Profitable Least Profitable

Cumulative Profits

50 %

100 %

100 %20%

300 %

Customer Profitability Analysis: The Whale Curve


Less profitable customers Small order quantities Special products ordered Heavy discounting Unpredictable demands Delivery times change High technical support Slow payment (imputed

interest)

Profitable and unprofitable customers are distinguished

by the demands they place on the organization

Profitable and unprofitable customers are distinguished

by the demands they place on the organization

More profitable customers Large order sizes Standard products ordered Little discounting Predictable demands Delivery times standard Low technical support On-time payment (imputed

interest)

These demands can be estimated by activity costs and activity cost drivers

What Makes for a Profitable Customer?


Types of CustomersTypes of Customers

33

HighHigh(Creamy)(Creamy)

LowLow(Low Fat)(Low Fat)

LowLow HighHighCost-to-ServeCost-to-Serve

Product MixProduct MixMarginMargin

Very

Profitable

VeryVeryunprofitableunprofitable

Profitable

Profitable

Unprofitable

Unprofitable

Migrating Customers to Higher Profitability – A Strategic Analysis


Customer Relationship Management (CRM) Requires Strategic Cost Management Data

Who is more important to pursue with the scarce resources of our marketing budget? Our most profitable customers? Our most valuable customers? What is the difference? The “customer lifetime value” (CLV) measure is intended to answer this question.


You are a pharmaceutical supplier:which customer is more important?

Dentist A

Sales = $750,000

profits = $100,000

Age 61

Dentist B

Sales = $375,000

profits = $40,000

Age 25

Which is more profitable?Which is more valuable?


What is it?

The projected economic value of customer relationships during the whole period of the relationship between the customer and company.

The Measure

The net present value (NPV) of all future profits from that customer; it is a projection, from when the customer is acquired or from the current date.

Customer Lifetime Value (CLV)


What is it?

The economic value of ALL customer relationships.

The Measure

The sum of the CLVs for all customers.

How Used

Provides a measure of the value of the company from the perspective of customer profitability.

Customer Equity


Part 6: Sample Course Topic—The Management & Control

of Quality (including Six-Sigma and Lean)


Relationship between TQM & Financial Performance


A Strategic Model for Managing Quality


Lean Manufacturing At the heart of lean manufacturing is the Toyota Production

System (TPS):• a long-term focus on relationships with suppliers and

coordination with these suppliers; • an emphasis on balanced, continuous flow manufacturing

with stable production levels; • continuous improvement in product design and manufacturing

processes with the objective of eliminating waste ; and • flexible manufacturing systems in which different vehicles

are produced on the same assembly line and employees are trained for a variety of tasks


Accounting for LeanThere are three reasons why the improvements in financial results typically appear later than the operating improvements from implementing lean.

• Customers will benefit from the improved manufacturing flexibility by ordering in smaller, more diverse quantities.

• Improvements in productivity will create excess capacity; as equipment and facilities are used more efficiently, some will become idle.

• The decrease in inventory that results from lean means that, using full cost accounting, the fixed costs incurred in prior periods flow through the income statement when inventory is decreasing.


Accounting for Lean

Lean accounting uses value streams to measure the financial benefits of a firm’s progress in implementing lean manufacturing.

Each value stream is a group of related products or services.

Accounting for value streams significantly reduces the need for cost allocations (since the products are aggregated into value streams) which can help the firm to better understand the profitability of its process improvements and product groups.


Lean Accounting – Value Streams

Rimmer CompanyValue Stream Income Statement

Total

Sales 585,000$ 540,000$ 1,125,000$ Operating Costs Materials 25,200$ 12,800$ Labor 168,000 88,000 Equipment related costs 92,400 - 48,400 Occupancy costs 11,200 4,800 Total Operating Costs 296,800 154,000 450,800$ Less Other Value Stream Costs Manufacturing 120,000 240,000 Selling and Administration 10,000 130,000 10,000 250,000 380,000

Value Stream Profit before inventory change 158,200 136,000 294,200 Less: Cost of decrease in inventory (10,000) (20,000) (30,000)

Value Stream Profit 148,200$ 116,000$ 264,200$

Less Nontraceable Costs Manufacturing 155,000 Selling and Administration 54,000

Total Nontraceable Fixed Costs 209,000

Operating Income 55,200$

Digital Cameras Video Cameras


Part 7: Sample Course Topic— Operational and Management-level

Performance Measurement


Performance Measurement

• Motivation and Evaluation– Incentives: right decisions

• Align performance measurement with strategy

– Incentives: working hard• Compensation and bonus plans

– Equity/fairness• Controllability• Cost allocations

• Operational-level and Management-level


Operational Performance Measurementwith a Flexible Budget

Schmidt Machinery CompanyAnalysis of Operations

For the period ended October 31, 20X6

Data Item for Analysis Actual

Flexible Budget

VarianceFlexible Budget

Sales Volume

(Activity) Variance

Master (Static) Budget

Units Sold 780 0 780 220 U 1000

Sales $639,600 $15,600 F $624,000 $176,000 U $800,000Variable Expenses 350,950 50 F 351,000 99,000 F 450,000Contribution Margin $288,650 $15,650 F $273,000 $77,000 U $350,000Fixed Expenses $160,650 $10,650 U $150,000 $0 $150,000Operating Income $128,000 $5,000 F $123,000 $77,000 U $200,000

20102010


Management Performance Measurement

Cost Centers• Engineered Cost (cost driver: volume based)

•Flexible Budget • Discretionary Cost (cost driver?)

•Master Budget• “Profit Center” – one step from outsourcing…


Management Performance Measurement

• Profit Centers:• Variable costing income statements• Issue of transfer pricing• Role and importance of nonfinancial performance indicators

• Investment Centers:• ROI vs. RI vs. EVA®

•Measurement issues• Issue of transfer pricing• Role and importance of non-financial performance indicators


Management –Level Performance Measurement:

When to Use Profit or Cost Center

Customer Plant

Warehouse


Part 8: Using Software in the Strategic Cost

Management Course


Using Software in the Strategic Cost Management

Course1. Excel:

Goal Seek

Solver

2. ABC: OROS (SAS), SAP, …

Excel

3. Simulation:Crystal Ball, @Risk, Excel(Formulas/Functions)


ABC Software: OROS Quick (from SAS)

• Comprehensive: resources through objects

• Allow a couple of classes

• Short Tutorial, 13 pages, couple of hours

• Blue Ridge Manufacturing Case


Have a great Meeting and Visit in San Francisco!

Documents

Teaching Strategic Cost Management: Ed Blocher AAA Annual Meeting, August 2010 Ed Blocher University of North Carolina, Chapel Hill Teaching Strategic