Unit -ll (Advanced management accounting)

Techniques of cost reduction :

1. Just in time ( JIT system) :  The main aim of JIT is to produce the required items, at the required quality & quantity at the precise time they are required. JIT purchasing requires for the items where too much carrying cost associated with holding high inventory levels, purchasing system reduces the investments in inventories because of frequent order of small quantities.

2. Target costing :   Target costing refers to the design of the product & it processes used to produce it. So, that ultimately the product can be manufactured at a cost that will enable the firm to make profit when the product is sold at an estimated market- driven price. The estimated price is called target price.

3. Activity based management :  ABM is a method of identifying & evaluating activities that a business performs using activity based costing to carry out a value chain analysis / a re-engeneering initiate to improve strategic & operational decisions in an organisation.

4.  Life cycle costing :  It estimates & accumulates the cost  over a products entire life cycle in order to determine whether the profits earned during the manufacturing phase will cover the costs incurred during the Pre&post manufacturing stage.

5. Kaizen costing :  It is process of cost reduction during the manufacturing phase of an existing product . The japanees word kaizen refers to continual & gradual improvement through small activities , rather than large /radical improvement through innovation / large investment technology.

6. Business process re-engineering :  Re- engineering is a complete redesign of process with an emphasis on finding creative new ways to accomplish an objective. The aim is to improve the key business process in an organisation by focussing on simplication, cost reduction, quality improvement & enhance customer satisfaction.

7. Total quality management (TQM) :  Under TQM approach all business functions are involved in a process of continuous quality improvement.

8. Value chain analysis :   Value chain analysis is a means of achieving higher customer satisfaction & managing cost more effectively. The value chain is the linked set of value creating activities all the way from basic raw materials sources, component suppliers to the ultimate end use product / service delivered to the customer.

9. Bench marking :  It is a continuous search for the most effective method of acheiving a task by comparing the existing methods & performance levels with those of organisations/ other sub units within the organisation.

10. Management audits :   These are known as performance audits they can be used to facilitate cost reduction in both profit & non profit organisations. Management audits are intendent to help management to do a better job by identifying waste & inefficiency & recommending a corrective action.


                 Activity Based Costing 

           Activity based  costing is a method which , at present ,is used to control costs. The cost of a product is classified as fixed cost & variable cost. The varuable cost is allocated as per the volume of output& fixed cost is also divided among different products on suitable basis. Under the traditional method it is assumed that output volume is the only factor which influence costs. Besides volume , there are other factors also which influence behaviour of cost. So the method 'ABC' explains other factors which are driving the costs.
Meaning :  ABC is a new term used for finding out costs. Its focus is on activities as the fundamental cost objects. It uses activities as the basis for calculating the cost of goods & services.

Characteristics :   The important characteristics of ABC are given as follows.

• The traditional system of classifying overheads into fixed & variable cost is not enough to design a cost system.
• The cost behaviour patterns are related to volume (scale), diversity(scope)& time.
• There is a need to identify cost drivers. A cost driver is a structural determinant of cost related activity . In tracing overhead cost to product , cost behaviour pattern must be understood so that appropriate cost driver be identified.

Steps :   
   Following steps are involved in implementing ABC.

• The first thing in implementing ABC is to identify of functional areas such as manufacturing , assembling etc, as well as support activities like purchasing, packing & despatching.
• Identifying the relative activities involved in each area.
• Collect accurate data on labour, material& overhead costs.
• Allocate the common expenditure to various activities in functional areas &support areas.
• Identify the most suitable cost driver in each activity.
• Establish the demands made by particular products on activities, using the cost drivers as a measure of demand.
• Absorb overhead expenses on the basis of rate/ cost driver.

Activity & cost driver  :

         Activity                                  Cost driver

1.Purchasing material    No.of orders placed

2.Warehousing                  Items in stock

3.Machine set up           No.of production hrs

4.Material handling      No.of parts

5.Inspection                    Inspection per item

6.Quality testing             Hours of test time

7.Receiving
material                         No.of receiving order

8.Packing                        No.of packing orders

9.Stores delivery           No.of stores delivery

Benefits :
1.Determination of cost
2.Helps improving performance
3. Helpful in strategic decision
4. Make/ buy decisions
5. Formulating budgets
6. Helpful in target costing

           
                       Target  Costing  

What is Target Costing?

Target costing is not just a method of costing, but rather a management technique wherein prices are determined by market conditions brought about by several factors, such as homogeneous products, level of competition, no/low  switching costs for the end customer, etc. When these factors come into the picture, management wants to control the costs, as they have no or little control over the selling price.

         CIMA defines target cost as “a product cost estimate derived from a competitive market price.”

Target Costing = Selling Price – Profit Margin

Why Target Costing?

In industries such as FMCG, construction, healthcare, and energy, competition is so intense that prices are determined by supply and demand in the market, and hence producers can’t control selling prices. They can only control the costs, so management’s focus is to influence every component of the costs.

The key objective of target costing is to enable management to use proactive cost planning, cost management and cost reduction practices where costs are planned and calculated early in the design and development cycle, rather than during the later stages of product development and production.

      Key  Features of Target Costing:

• The price of the product is determined by market conditions. The company is a price taker rather than a price maker.
• The minimum required profit margin is already included in the target selling price.
• It is part of management strategy wherein the focus is on cost reduction and effective cost management.
• Product design, specifications, and customer expectations are already built in while formulating the total selling price.
• The difference between the current cost and the target cost is the “cost reduction,” which management wants to achieve.
• A team is formed to integrate activities such as designing, purchasing, manufacturing, marketing, etc. to find the target cost.

  Advantages of Target Costing:

  • It shows management’s commitment to process improvements and product innovation to gain competitive advantage.
  • The product is created from the expectation of the customer and hence cost is also based on similar lines. Thus, the customer feels more value is delivered.
  • With the passage of time, the company’s operations improve drastically.
  • The company’s approach to designing and manufacturing products becomes market-driven.
  • New market opportunities can be converted into real savings to achieve the best value for money rather than to simply realize the lowest cost.

  
  

  Example:

  ABC Inc. is a big FMCG player that operates in a very competitive market. It sells packaged food to end customers. ABC can only charge $20 per unit. If the company’s intended profit margin is 10% on the selling price, calculate the target cost per unit.

  Solution:

  Target Profit Margin = 10% of 20 = $2 per unit

  Target Cost = Selling Price – Profit Margin ($20 – $2)

  
  

  Target Cost = $18 per unit