Determine Purpose and Characteristics of Output Based Cost Management and Control © Dale R Geiger 2011 All Ins and Outs Can be Thought of as $: The Language of Management © Dale R Geiger 2011 Terminal Learning Objective • Task: Determine Purpose and Characteristics of Output Based Cost Management and Control • Condition: You are training to become an ACE with access to ICAM course handouts, readings, and spreadsheet tools and awareness of Operational Environment (OE)/Contemporary Operational Environment (COE) variables and actors • Standard: with at least 80% accuracy • Identify suitable organizations for output based control • Discuss the four dimensions of cost in relation to output based control • Apply basic cost measurement and management principles to an output based control scenario © Dale R Geiger 2011 Different Types of CMOs Output Based vs Org Based Control • Organization based control exploits the reporting relationship of the org chart • Sometimes we wish to add an additional level of control that focuses on outputs for: • Organizations seeking to reduce the cost of their outputs • Organizations that are funded on the basis of their outputs © Dale R Geiger 2011 What Kinds of Organizations are Funded on the Basis of Outputs? • All for profit organizations must sell their products or services • Revenue represents the funding or cash inflow and is entirely based on priced outputs • If the cost of producing outputs exceeds revenue the company eventually goes out of business • This issue’s importance is why most texts and writing on cost control has an output focus © Dale R Geiger 2011 What Kinds of Organizations are Funded on the Basis of Outputs? • Most government organizations are not funded on the basis of what they output • They are funded via appropriation • Some government organizations are funded on the basis of their outputs • These are typically called revolving funded organizations • They may also be called • • • • Non-appropriated Enterprise Internal service Or even Category C in the case of some MWR organizations © Dale R Geiger 2011 The Army Materiel Command www.amc.army.mil • Army Materiel Command uses the revolving funded mechanism extensively • Depots, laboratories, arsenals, etc all must “price” their outputs • Revenue must be sufficient to support the organization’s cost structure • The price list is also used for purposes like foreign military sales Watch the short video at http://www.amc.army.mil/pa/about.asp © Dale R Geiger 2011 The Army Materiel Command www.amc.army.mil • The U.S Army Materiel Command is the Army’s premier provider of materiel readiness – technology, acquisition support, materiel development, logistics power projection, and sustainment – to the total force, across the spectrum of joint military operations • If a Soldier shoots it, drives it, flies it, wears it, eats it or communicates with it, AMC provides it © Dale R Geiger 2011 The Army Materiel Command www.amc.army.mil • AMC is headquartered at Redstone Arsenal, AL., and impacts or has a presence in all 50 states and 155 countries • Manning these organizations is a work force of more than 70,000 dedicated military and civilian employees, many with highly developed specialties in weapons development, manufacturing and logistics © Dale R Geiger 2011 10 Let’s Build a More Complex Costing System • Assume: • We produce two types of stamps: • Fancy commemoratives and bulk flag stamps • Direct costs are known for It is very common to have multiple outputs • Raw materials • Engraving • Printing • Simple direct allocations needed for support • Quality control is allocated on the basis of printing cost • Production control is allocated on the basis of printing cost • Administration is allocated on the basis of all other cost © Dale R Geiger 2011 37 Costing Exercise Two Output Stamp Production Quality Control 2500 Product Control 2000 Admin Print $ Print $ Other $ Indirect Costs Commemorative Direct Costs Commemorative 7780 Indirect Costs Flag Direct Costs Flag 5170 2010 6000 2000 9000 6000 Material Engraving Printing © Dale R Geiger 2011 38 Individual Exercise • Determine the total cost of • Commemorative stamps • Flag stamps • (This requires allocation of the indirect costs) © Dale R Geiger 2011 39 Solution: Two Product Cost Note: total cost didn’t change © Dale R Geiger 2011 40 Group Exercise • The costs in the last exercise were based on last period where we had 20000 billion stamp sales • 7000 billion commemorative • 13000 billion flag • This period we also had 20000 billion stamp sales • 13000 billion commemorative • 7000 billion flag • Assume that no changes in variable costs per unit for commemoratives, variable costs per unit for flag stamps, or fixed costs occurred • Determine the P&L for this period • Hint: remember that variable costs (the direct costs in this case) vary with the number of units • Prepare a reconciliation to present to class that explains results â Dale R Geiger 2011 41 Solution It should be obvious that the variable costs per unit are quite different for the two stamp types • In other words the “average” is not representative of either © Dale R Geiger 2011 42 Solution: Variable Costs (Direct) • More commemorative units add cost at a high rate • Fewer flag units reduce cost at a low rate changes weighted average © Dale R Geiger 2011 43 Solution: Fixed Costs (Indirect) • Fixed costs not change in total • However, the allocations change changes distribution © Dale R Geiger 2011 44 Solution: Variance Analysis Stamps © Dale R Geiger 2011 45 Solution: Stamp Analysis • A variance analysis of stamps makes it look like variable cost performance degraded • Yet, we know that variable cost didn’t change for commemoratives or flag stamps • What happened?? • See next two slides for variance analysis of each output © Dale R Geiger 2011 46 Solution: Flag Analysis © Dale R Geiger 2011 47 Solution: Commemorative Analysis © Dale R Geiger 2011 48 Car Analogy • Imagine if General Motors sold all cars at the same price based on the average cost of all its models • Wouldn’t this be a great opportunity to buy that Corvette?? • What would happen to GM’s profitability if their mix of sales shifted to Corvettes? • Take note: average cost can be a very dangerous concept • This is why GM uses an output based cost management and control process © Dale R Geiger 2011 49 Solution: Reconciliation • This is a classic “mix” shift as performance did not change • Commemoratives were actually being sold at a loss when priced based on average cost: selling more had drastic effects • Flag stamps were actually making an enormous profit, inviting competition negative contribution margin © Dale R Geiger 2011 50 Conclusions • The output based cost management and control process follows the same template as role based and org based • The issues are more complex because the scope is much broader • The cost measurement is much more complicated because of the existence of: • Multiple outputs and potential mix shifts • Allocation of support costs to the outputs that consume them © Dale R Geiger 2011 51 ... Ins and Outs Can be Thought of as $: The Language of Management © Dale R Geiger 2 011 Terminal Learning Objective • Task: Determine Purpose and Characteristics of Output Based Cost Management and. .. manufacturing and logistics © Dale R Geiger 2 011 10 11 12 Output Based Control • Builds the after action cost review and accountabilities around outputs • Fits many government organizations where outputs... that focuses on outputs for: • Organizations seeking to reduce the cost of their outputs • Organizations that are funded on the basis of their outputs © Dale R Geiger 2 011 What Kinds of Organizations