MANAGING INFORMATION
Businesses thrive on data – so all businesses; big or small, need systems and procedures that help them collect, process, store and share data
In today’s digital world, instead of maintaining paper based records, the collection, processing, storing and sharing of data is also automated
Businesses invest in information systems to ensure data is readily accessible and formatted for effective decision-making When utilized effectively, these systems can significantly enhance an organization's performance and increase revenue.
This comprises of a set of components, namely hardware, software, telecommunications network etc., that work together to deal with the data requirements of the business
These requirements include, communication, record-keeping, decision making, data analysis etc
Automated systems for data collection and processing, free up employees to focus on more core areas of their work
An effective information system provides users with the ‘information’ they need on a timely basis, supporting the decision making process
Some hardware components are dedicated to data collection, while software and telecommunications networks transform this data into meaningful information tailored for the user.
Different users have different information needs and having an effective information system means that users can access the custom information
Accessing an information system provides businesses with real-time and archived data, enabling them to respond swiftly to operational needs This immediate availability of information is crucial for effective decision-making and strategic action.
Business Intelligence systems transform data into valuable insights, enabling effective data visualization that allows users to interpret vast amounts of information By predicting future events and identifying patterns in historical data, these systems facilitate informed decision-making and provide businesses with a competitive advantage.
Enterprise Resource Planning (ERP) software (discussed later) provides users with a bird’s eye view of the business operations Some examples are: NetSuite ERP, PeopleSoft etc
Costs and Benefits of Information Systems
Organizations typically assess the anticipated benefits of an information system throughout its lifespan while estimating the initial development costs and ongoing operational expenses This comparison helps determine the overall value of the system to the business.
Some generic benefits and costs associated with the implementation of an Information System are discussed below:
Academic studies have proven that Information Systems support operational benefits such as cost reduction and increase competitive capability of businesses
Provided there are no challenges in the data collection phase, the information generated by the systems normally has less chances of ‘human error’
Information systems depend on software that can be modified or reprogrammed to adapt to users' evolving needs Thanks to advancements in programming, organizations can update specific components without causing widespread disruption to their overall functions.
Normally the major cost associated with a custom Information system is the labour cost – which covers the salaries of the system analysts and programmers
In this context, an additional cost factor is the time required from employees who must collaborate closely with programmers to create software that effectively meets user needs.
Off-the-shelf software can serve as a cost-effective alternative to customized information systems; however, it often fails to meet specific business requirements, potentially leading to unmet information needs for the company.
Regardless of what information system is finalised, there are costs related to the hardware and telecommunications network associated with its use
Additionally businesses have to bear the cost of training employees in the use of the information systems
The business also needs to budget for repairs and maintenance expenses of the system implemented – also taking into account the rapidly changing environment
Although not a tangible cost with immediate impact, a risk associated with automated information systems is that of its security – physical or in the form of virus or malware
Some Components of Information Systems
Although both terms are used extensively today, the Intranet is only a part of the Internet
The Internet is a vast network that connects various public, private, and organizational systems, enabling global communication Through diverse technologies, devices around the world are linked to form a cohesive internet network.
These technologies include optical fiber, wired, wireless or electronics circuitry The internet carries huge amounts of data available on World Wide Web
E-mails – the most common way of communicating the written word across the globe
Ease of research into factors affecting the business and expanding the business network
E-meetings help do away the need for travelling for work
Sharing files, images, videos etc
An intranet is a private network that connects devices exclusively for authorized users, ensuring that access is restricted and not available to the public.
Businesses can set up security policies specific to the user, group or device The users within intranet can connect to the internet, a public network through firewalls
The major uses of intranet include faster sharing of information within an organization This helps streamline activities
Improved internal communication leads to enhanced collaboration and promotion of corporate culture
Businesses are able to centralise and organise company data into a single database
The main differences between the internet and intranet can be summarised as follows:
Available to all across the globe Only the employees of organization can access it Data traveling across the internet or the web is Less Secure
Intranet is more secure due to presence of robust security systems
No login credentials are required to access the information from internet
A user account is must to access the devices of intranet
Any number of users can access the internet services and documents
There is a limit to the number of users that can access internet resources
No rules or policies are defined to access internet resources
There are certain policies and regulations which you have to comply within the intranet
[Extract from: http://www.it4nextgen.com/difference-between-internet-and-intranet/]
Wireless technology is communication technology that is not dependent upon cables or wires as communication mediums
Wireless communications can be available all of the time, almost anywhere They have several advantages including:
Communication has enhanced to convey the information quickly to the consumers
Working professionals can enhance their productivity by accessing the Internet anytime and anywhere without the hassle of cables or wires This flexibility allows them to complete tasks on time, regardless of their location.
Urgent situation can be alerted through wireless communication
Wireless networks are cheaper to install and maintain
Wireless networks are computer networks that are not connected by cables of any kind
The use of a wireless network enables enterprises to avoid the costly process of introducing cables into buildings or as a connection between different equipment locations
The basis of wireless systems are radio waves, an implementation that takes place at the physical level of network structure
There are two main types of wireless networks:
Wi-Fi Network: This is a technology that allows smart phones, tablets, printers etc to communicate with the internet
Cellular Network: This technology allows electronic devices to communicate over long distances
Businesses must implement specific controls when generating and distributing information, regardless of whether it is for internal use These controls may differ depending on whether the information is routine or ad-hoc.
Determine if the benefits of the information generated will be higher than the costs incurred to prepare it
Ensure that the desired information will be of use to the decision makers before the information is gathered
To ensure consistency and clarity, standardized formats for information preparation should be established, particularly when multiple individuals are involved in the process These formats must prioritize user-friendliness to enhance the experience for end users.
The limitations of the information gathered should be communicated to the users as well as the details of the preparer/ originator, so that any queries can be directly forwarded
The usefulness of the information should be reviewed on a regular basis to assess the need for its continuity
Apart from the guidelines above, when dealing with ad-hoc reports, the following should additional measures should be incorporated:
Ensure that information is not being duplicated and that it’s relevant to the user requesting it
Ensure that most up-to-date data is utilised for these reports
A procedures manual should be in place This would indicate what reports are to be prepared and issued to whom
Confidential information should be highlighted as such and users guided on how to deal with sensitive information
E-mail policy should be established specifying the do’s and donts’ for on-line communication
Internal security should be established Senior management should specify which user can have access to which assets and information
External security through firewalls should be established, as they can be used to protect data and databases from being accessed by unauthorised people
To protect highly confidential information intended solely for internal use, organizations can implement several security measures, including strong passwords, firewalls, database controls, and data encryption These procedures are essential for safeguarding sensitive data from unauthorized access and ensuring its integrity.
Additionally businesses can ensure that the security of the information stored is maintained by entrusting limited people with its access
SOURCES OF INFORMATION
Data collected anywhere can be categorised as either of the following:
Secondary data: this is data not directly collected from the source by the user but reached at through second-hand mediums such as news reports, government reports etc
Primary data: this is normally gathered through market research and is more tailored to the user's exact needs
Relevant data can be collected by businesses through either internal or external sources
Informal communication between management and staff
Research & Development and Marketing departments
Information from suppliers (product details, pricing etc.)
Information is primarily used in an organisation, broadly, for the following purposes:
Effective planning at all organizational levels relies on external information and current performance metrics Understanding the business environment is crucial for maximizing the organization's full potential.
Control: Control measures can be implemented as these are dependent upon the feedback of the actual performance, which can be easily accessed from the information system in place
The quality of information can be compromised due to limitations in the parameters set for data collection, the methods employed, and the age of the data, leading to concerns about its accuracy.
The data may not be relevant to the research objectives as it has originally been collated by someone else
However cost savings can be substantial because secondary external data is cheaper than gathering primary data
Although some external information is expensive to access and may not be easily accessible
The following are some examples of costs that are incurred in gathering, recording and storing data:
Cost of a marketing research survey
Subscriptions to online information, surveys etc
Time spent by employees on unsuccessful searches for information
Time spent on sifting through possibly inaccurate data to extract useful facts
Recording, processing and dissemination of external information
Installation and maintenance of systems – communication, internet etc to facilitate flow of information
Wasted time caused by abuse of internet and email access facilities
INFORMATION SYSTEMS AND DATA ANALYTICS
Management Accounting Information is information that is used to support strategic planning, control and decision making
Strategic Planning: These are long term planning decisions that define the objectives of the organisation
Features of Management Accounting Information:
Management Accounting information is primarily used for strategic level planning i.e plans for long periods of the future and so relies on forecasts and estimates
Management accounting information also therefore incorporates some risk and uncertainty analysis
The management accountant requires information for:
Project assessments: at the time of decision making and post implementation feedback
Handling cash and operational matters
Management accounting information is primarily derived from internal sources but also takes into impact of external factors
This information has the following limitations:
It may provide misleading information, leading to ineffective decisions
It is internally focused as it focuses on performance targets and ignores market competition and demand
Data is inflexible as it is often just based on historical performance, so the challenge lies in providing more relevant information for strategic planning, control and decision making
Strategic Management Accounting focuses on external factors, non-financial and internally generated information
It takes into account the following:
Competitive edge by understanding customer demands and competitors USP (unique selling point)
Input from many different areas of the organisation to ensure that the goals and targets link together smoothly
Brings together comparable information regarding different strategies
Ensures business operations are focused on meeting shareholder’s needs
It provides information about: pricing of product, product profitability, cashflows; customer analysis; market analysis etc
Management Control is the process of utilising resources, efficiently and effectively with the aim of achieving the strategic objectives of the organisation
This is also known as Tactical Planning and managers at this level are required to ensure that their decision making reflects the following:
Efficiency in the use of resources means that optimum output is achieved from the input resources used
Effectiveness in the use of resources means that the outputs obtained are according to set objectives or targets
The time horizon involved in management control will be shorter than at the strategic decisions level and these are considered short-term non-strategic activities
Features of management control information:
Summarised at a relatively low level
Relevant to the short and medium terms
Commonly expressed in money terms
Operational Control is the routine processing of transactions as per directions laid down in the Tactical plans
This includes scheduling of unexpected or 'ad hoc' work as this must be done at short notice
Operation control decisions are termed as short-term non-strategic activities
Information requirements for decisions taken at this level include:
Transaction data which is needed for the conduct of day-to-day implementation of plans
Detail of information provided depends upon the purpose, it is required for
Operational information, although quantitative, is expressed in terms of units, hours, quantities of material, and so on
Transaction Processing Systems (TPS) collect, store, modify and retrieve the transactions of an organisation
The four important characteristics of a TPS are as follows
The processing is controlled as it supports the organisations operations
All transactions are recorded in a pre-defined manner or format
Provides rapid response to support customer satisfaction
Back-up and recovery procedures are in place as organisations rely heavily on TPS
These are mainly of two types:
Batch transaction processing (BTP) collects transaction data as a group and processes it after a time delay Information is entered in batches
Real time transaction processing (RTTP) is the immediate processing of data
Management information systems (MIS) convert data from mainly internal sources into information, which enables managers to make timely and effective decisions for planning and controlling the activities
MIS have the following characteristics
Supports structured decisions at operational and management control levels and is internally focused
Designed to report on existing operations rather than analyse data
Executive information systems (EIS) provides a quick and efficient computing and communication environment for senior managers to support strategic decisions
Executive information systems draw data from the MIS and allow communication with external sources of information
Executive resource planning (ERP) systems are modular software solutions that integrate essential organizational processes, enabling a unified system to meet the information requirements of all functional areas.
ERP systems have the principal benefit that the same data can easily be shared between different departments ERP systems work in real time
Easy access to shared real time information to support decision making
A lot of inefficiencies in the way things are done can be removed; as the company restructures its processes so that multiple departments can work together
Standardising Information and work practices so that the terminology used is similar
There are many definitions of the term ‘big data’ but most suggest something like the following:
'Extremely large collections of data (data sets) that may be analysed to reveal patterns, trends, and associations, especially relating to human behaviour and interactions.'
Big data encompasses vast and intricate data sets in various formats, including structured, semi-structured, and unstructured data This data originates from a diverse range of both new and existing sources, which are expanding as more individuals conduct their activities on electronic devices that capture this information Consequently, the potential value of data is significant.
Unused or unanalyzed data holds no value; however, it can gain significance through cleaning, processing, transformation, and analysis Consequently, collected data serves as raw material in a manufacturing-like process, where its value is enhanced through proper handling and interpretation.
Data cleaning and transformation are crucial steps in preparing data for analysis, as they enhance its value and convert it into a finished product This process ultimately results in useful information that can be effectively communicated to users.
In today's digital landscape, big data has emerged as a crucial asset for organizations Major tech companies like Facebook derive significant value from their vast data resources, continually analyzing this information to create and enhance new revenue opportunities.
In 2001 Doug Laney, an analyst with Gartner (a large US IT consultancy company) stated that big data has the following characteristics, known as the 3Vs:
These characteristics, and sometimes additional ones, have been generally adopted as the essential qualities of big data
Access to a large volume of data is crucial, as its true value can only be realized through proper structuring and utilization This data can originate from diverse sources such as social media interactions, website traffic, and consumer surveys or approval ratings However, organizations may struggle to manage this vast amount of information without the necessary capabilities, including sufficient storage and processing power.
The volume of big data significantly enhances the reliability of analyses conducted by data analysts Statisticians understand that a larger dataset leads to more dependable results, which in turn boosts confidence in utilizing these findings for informed decision-making.
Velocity refers to the speed at which data is processed and utilized, especially in today's fast-paced environment where transactions are recorded in real time With the rise of debit and credit card usage, along with mobile app transactions, updates occur instantaneously, reflecting the growing demand for immediate data handling.
Retailers have precise knowledge of their inventory levels and sales performance for each transaction, allowing them to analyze customer buying patterns through electronic transactions Similarly, banks can track fund transfers in real-time, monitoring when money leaves customer accounts and enters supplier accounts.
Variety refers to the many types and sources of data which are available Traditional data types were more structured With the rise of big data, data comes in new
PM STUDY NOTES unstructured types This also comes in a variety of forms These include numerical data, text, audio, pictures and videos
To effectively support decision-making, data requires additional processing to convert it into meaningful and useful information Accessing and utilizing this processed data offers business leaders richer insights, making the information derived from data analysis more relevant and significant than larger volumes of data from more structured sources.
The processing of big data is generally known as big data analytics and includes:
Data mining: analysing data to identify patterns and establish relationships such as associations (where several events are connected), sequences (where one event leads to another) and correlations
Predictive analytics: a type of data mining which aims to predict future events For example, the chance of someone being persuaded to upgrade a flight
Text analytics involves examining text from sources like emails and documents to extract valuable insights This process often focuses on identifying keywords that suggest interest in specific products or locations.
Statistical analytics: used to identify trends, correlations and changes in behaviour
The analytical findings can lead to:
Better customer service and relationship management
The discovery of new sources of revenue
Performance management involves managing the organisation in order to ensure that it meets its objectives Broadly, Big Data is relevant to performance management in the following ways:
Gaining insights (eg about customers’ preferences) which can then be used to improve marketing and sales, thus increasing profits and shareholders’ wealth
Forecasting better (eg customer’s future spending patterns, when machines will need replacing) so that more appropriate decisions can be made
Automating of high level business processes (eg lawyers scanning documents) which can lead to organisations becoming more efficient
Providing more detailed and up to date performance measurement
Some real world examples of the use of big data are as follows:
Netflix started as a DVD mailing service and evolved by developing algorithms to predict viewer preferences and habits Today, it streams films online, gathering data on viewing patterns, including when movies are watched, how often they are paused or abandoned, and user ratings This data enables Netflix to forecast which films will resonate with specific audiences Additionally, it leverages this information to confidently produce its own TV series, increasing the likelihood of creating successful hits.
Amazon, the leading global e-retailer, gathers extensive data on customer preferences and behaviors, enabling precise marketing strategies tailored to individual users For instance, the platform frequently suggests products, such as books or DVDs, based on previous purchases, enhancing the shopping experience.
Airlines possess extensive knowledge about their customers, including flight history, seat preferences, cabin class choices, and booking habits They track how often travelers search for flights, their sensitivity to price changes, and potential alternative airlines for future bookings Additionally, airlines monitor whether customers return with them after flying with a different carrier, past car hire purchases, and likely hotel class selections They analyze route popularity and seasonal trends to enhance their services This data allows airlines to prioritize assistance for their most valuable customers, especially in situations like flight cancellations.
This information allows airlines to design new routes and timings, match routes to planes and also to make individualised offers to each potential passenger
Detailed data analysis enhances organizational performance by improving customer understanding, revealing cost insights, and facilitating easier navigation on websites As companies explore innovative applications of the ever-growing data volumes, the importance of Big Data analysis as a strategic tool is set to increase significantly for many businesses.
SPECIALIST COST AND MANAGEMENT ACCOUNTING TECHNIQUES
TRADITIONAL COSTING
Costing: It is the process of determining the costs of products, services or activities Direct Cost: A cost that can be traced back in full to a product, service or department
Indirect production costs, commonly referred to as overheads, are expenses that cannot be directly attributed to the manufacturing of specific goods or the delivery of services For instance, consider the rent of a factory that produces five different products; determining how to allocate this rent among the various products poses a challenge, as it cannot be fully traced back to any single product or evenly distributed among all of them.
Indirect non-production costs, commonly known as overheads, are expenses associated with support functions that do not directly contribute to the manufacturing process or the delivery of primary services For instance, marketing expenses incurred by a television set manufacturer exemplify these costs Traditional costing systems often allocate these indirect costs to products, impacting overall pricing and profitability analysis.
Absorption Costing: a form of costing in which the costs of products are calculated by adding an amount for indirect production costs (overheads) to the direct costs of production
Marginal Costing: a form of costing where only the direct costs are considered relevant for the cost of a product Fixed costs are treated as Period Costs
Per Unit Product Cost Calculation
Direct Material Direct Labour Other Direct Expenses Variable Production Cost
Less : Full production cost of sale
(Full production cost per unit x number of units)
Less/Add: Under/Over absorbed
Less : Fixed non-production overhead
Less : Variable non production cost
Sales Less : Variable production cost (Variable production cost per unit x units sold)
Gross contribution Less : Variable non production cost Contribution
Less : Fixed non-production overhead
Less : Fixed production overhead Profit
Step 1: Allocate direct costs to a cost unit or cost centre
Step 2: Apportion general overheads amongst the cost centres, on a fair basis
Step 3: Re-apportion the costs of service cost centres’ amongst the production cost centres on a fair basis
Step 4: Determine Absorption rate for each production cost centre using the formula:
With one of the following bases for activity level:
Step 5: Absorbed Production Overheads: Actual activity level x Absorption rate
Step 6: Under/ Over Absorption: Absorbed Production Overheads – Actual Overheads Expenditure
Under-absorbed: Absorbed production overheads < Actual overheads expenditure Over-absorbed: Absorbed production overheads > Actual overheads expenditure
Arguments for Absorption Costing System:
Used for financial reporting purposes to comply with the Accounting standards and inventory valuations
Helpful in cases where companies attempt to set selling prices based on the full cost of production or sales of each product
Best practice in case of a company selling multiple products, to determine profitability of each product
Arguments for Marginal Costing System:
This system offers valuable insights for managers during the decision-making process, as the contribution is directly linked to sales volume This correlation provides a clearer understanding of how sales volume influences cash flows and profits.
Harp Plc manufactures and sells a single product The following budgeted/ actual information is provided in relation to the production of this product:
Variable production overheads per unit 3.00 Actual production and sales for the month of April, 2017 were 500 units
Fixed production overheads are budgeted at $6,000 per month and the budgeted level of production is 600 units
Variable sales commission - % of sales commission
Variable production overheads per unit 3.00
Fixed production overhead per unit ($6,000/ 600 units) 10.00
Less under-absorbed/ Add over-absorbed overheads
Actual overheads (budgeted are assumed to be actual) 6,000
Variable production overheads per unit 3.00
Less: Variable Cost of Sales (500 x $16) (8,000)
Less: Variable sales commission (10% of $25,000) (2,500)
When inventory levels remain unchanged due to consistent opening and closing balances, the profit calculated using both absorption costing and marginal costing methods will be identical.
ACTIVITY BASED COSTING (ABC)
To effectively manage fixed production costs, a practical approach is to aggregate all production overheads and establish a single overhead absorption rate based on labor hours or machine hours.
As production processes increasingly automate, traditional methods of handling fixed overheads with simplistic bases are inadequate, particularly for organizations producing multiple products It is essential for companies to understand the drivers of overhead expenses and to allocate costs to products or services based on the resources they utilize.
To accurately estimate the cost of producing each unit, it is essential to analyze the activities involved in the production process, as these activities typically incur costs This principle is the foundation of Activity Based Costing (ABC).
1 Identify a distinct ‘fixed’ overhead cost, also termed as a Cost Pool
2 Identify the activity that causes this cost This activity is the ‘Cost Driver’
3 For each cost pool, calculate an absorption rate per cost driver
This is calculated by manipulating the traditional overhead absorption rate formula: Total cost pool expense
To effectively allocate overhead costs to each product, determine the extent to which each product utilizes specific cost drivers This analysis allows for the conversion of overhead costs into a per-unit charge for each product, ensuring accurate cost distribution.
Absorbed from cost centres into:
Absorbed from cost centres into:
An organisation manufactures 3 different products In a year, its Fixed Production Overheads comprise of:
Machine Handling Costs $20,000 500 machine hours
Production Scheduling Costs $14,000 100 production runs Total Fixed Overheads $34,000 100 labour hoours
Activity (cost pool) Activity (cost pool)
Assuming that the manufacturing of Product A requires:
Under the traditional Absorption costing method, Fixed Overheads cost for Product A will be:
Under the ABC method, the working will change to:
Based on the information made available, the following types of decision making processes will be supported:
1 Accurate cost calculation(Fair distribution of Overheads)
2 Accurate selling price(Better costing information)
4 Better decision making for the continuation/discontinuation of products if incurring losses
5 Better planning- activity based budgeting
1 ABC is time consuming and expensive
2 Many judgmental decisions still required in the construction of an ABC system
Choosing a cost driver can be challenging, as a single driver may not effectively capture the behavior of all items within a cost pool It's important to recognize that multiple cost drivers may be necessary for accurately representing an activity.
4 The cost of implementing and maintaining an ABC system can exceed the benefits of
‘improved accuracy’ in product costs ABC will be of limited benefit if overhead costs are primarily volume related
5 Reduced benefit if the company is producing only one product or a range of products with similar costs
6 Some arbitrary apportionment may still exist
Implementing an Activity-Based Costing (ABC) system should be justified by its ability to deliver valuable product cost insights or additional information that management can utilize If the insights from ABC are not going to be practically applied by management, then a traditional absorption costing system would be easier to manage and equally effective.
ABC should be utilized in scenarios where production overheads significantly exceed prime costs, such as in the service sector It is also beneficial when there is a wide variety of products, as well as when there are substantial differences in resource usage among those products Additionally, ABC is appropriate in cases where resource consumption is not primarily influenced by volume.
A company manufactures two products, C and D, for which the following information is available:
Labour hours per unit/in total 8 10 48,000
Number of production runs required 13 15 28
Number of inspections during production 5 3 8
Total production set up costs $140,000
Other overhead costs are absorbed on the basis of labour hours per unit Using activity- based costing, what is the budgeted overhead cost per unit of product D? a) $43ã84 b) $46ã25 c) $131ã00 d) $140ã64
Set-up costs per production run = $140,000/28 = $5,000
Other overhead costs per labour hour = $96,000/48,000 = $2
A company makes two products using the same type of materials and skilled workers The following information is available:
Fixed costs relating to material handling amount to $100,000 The cost driver for these costs is the volume of material purchased
General fixed costs, absorbed on the basis of labour hours, amount to $180,000
Using activity-based costing, what is the total fixed overhead amount to be absorbed into each unit of product B (to the nearest whole $)?
Total material budget ((1,000 units x $10) + (2,000 units x $20)) = $50,000
Fixed costs related to material handling = $100,000
Total labour budget ((1,000 units x $5) + (2,000 units x $20) = $45,000
Total fixed overhead cost per unit of Product B ($40 + $80) = $120
TARGET COSTING
Traditionally, product pricing involves adding a profit margin to the cost; however, manufacturers may struggle to find buyers at this set price if the product lacks valued features or if competitors offer cheaper, more appealing options Target costing addresses this challenge by helping businesses establish a price point that aligns with consumer expectations and market conditions.
Target costing is a marketing approach to costing, as it involves setting a selling price for the product by reference to the market
Instead of setting prices based solely on production costs, suppliers conduct market research to determine the price that potential customers are willing to pay for their products or services.
From the target selling price identified, the desired profit margin is deducted to arrive at a target cost
1 Determine product specification and possible sales volume
2 Decide on a Target Selling Price at which the product can be successfully sold
4 Calculate Target Cost: Target Selling Price – Target Profit
5 Based on product specification and costs level, determine the estimated Production Cost
6 Calculate Target Cost Gap: Estimated Production Cost – Target Cost
7 Make efforts to reduce the Target Cost Gap, before production commences
Worked Example – extract from September 2016 attempt:
Helot Co is a prominent developer and seller of computer games, renowned for its innovative and interactive role-playing titles The gaming community eagerly anticipates each new release, appreciating the technical excellence and durability of both the games and their packaging.
Helot Co, which has relied on traditional absorption costing and full cost plus pricing for product costing and pricing, is exploring a shift to target costing under the guidance of its new finance director The director is enthusiastic about applying this innovative method to a newly approved game concept named Spartan.
Following discussions with the board, the finance director conducted market research to gather customer feedback on the new game concept and evaluate competitor offerings This research led to the establishment of a target selling price of $45 for Spartan, with an anticipated sales volume of 350,000 units Helot Co aims to achieve a target profit margin of 35%.
Target selling price – Target profit
The finance director has also begun collecting cost data for the new game and has projected the following:
Non-production cost per unit = ($2,500,000 + 1,700,000 + 1,400,000) / 350,000 units $16
Closing the Target Cost Gap:
Organizations can create multifunctional teams that include marketing experts, cost accountants, production managers, and quality control professionals These teams play a crucial role in making design and manufacturing decisions, helping to identify the price and feature combinations that will most attract potential buyers.
The planning and design stage is crucial for minimizing production costs, as strategic decisions made during this phase can significantly impact the overall expense of a product.
Arranging cheaper labour/ training existing staff
Acquiring new and efficient technology etc
To enhance cost control, the total target cost can be divided into key functional categories Utilizing Value Engineering Techniques is essential for effective product development.
Value engineering aims to reduce costs by identifying those parts of a product or service which do not add value – where ‘value’ is made up of both:
Use value (the ability of the product or service to perform its function)
Esteem value (the status that ownership or use confers)
When selling perfume, the packaging design plays a crucial role in its appeal While a plain glass bottle may not affect the product's functionality, it can significantly diminish its perceived value Companies should avoid cutting costs excessively on packaging, as this can harm the overall brand image and customer perception.
Target Costing in Service Industries:
Because of the characteristics and information requirements, it is difficult to use Target Costing in service industries Examples of service businesses include:
(a) Mass service e.g the banking sector, transportation (rail, air), mass entertainment (b) Either / or e.g fast food, teaching, hotels and holidays, psychotherapy
(c) Personal service e.g pensions and financial advice, car maintenance
There are five major characteristics of services that distinguish it from manufacturing
Intangibility There is no substantial material or physical aspects to a service
Many services, such as dental treatment, are characterized by inseparability and simultaneity, meaning they are produced and consumed at the same time This implies that a service only exists when it is actively experienced by the consumer, highlighting the unique nature of service delivery.
Variability/heterogeneity It is hard to attain precise standardisation of the service offered
Perishability Services are time bound
No transfer of ownership Services do not result in the transfer of property but only access to or a right to use a facility
Services do not have any material content (tangibility) making it difficult to reduce target cost gap through material cost reduction
Services vary each time resulting in there being an estimated average cost for each service but not a specific standard cost that can be reduced
Target costing is a pricing strategy that identifies the market price of a product and subtracts a desired profit margin to determine the target cost This method ensures that product costs align with market expectations while maintaining profitability It is distinct from other costing methods, such as overhead allocation or cost-plus pricing, as it focuses on market-driven pricing strategies By implementing target costing, businesses can effectively manage costs and enhance competitive advantage across different markets.
A target cost is arrived at by identifying the market price of a product and then subtracting a desired profit margin from it
Which of the following techniques is NOT relevant to target costing?
Variance analysis is not applicable to target costing because it serves as a cost control method during the production phase of the product life cycle While variance analysis acts as a feedback control tool, target costing operates as a feed-forward approach.
Value analysis can be used to identify where small cost reductions can be applied to close a cost gap once production commences
Functional analysis plays a crucial role in the product design stage by identifying and eliminating cost gaps, ensuring that the final design incorporates only the features desired by customers.
Activity analysis identifies and describes activities in an organisation and evaluates their impact on operations to assess where improvements can be made
LIFECYCLE COSTING
Traditional costing methods focus solely on current costs, which include marginal costs and a portion of fixed costs, while neglecting essential expenses like Research and Development costs that are crucial for the production of goods.
To accurately evaluate a product's profitability, it is essential to compare the total revenue generated throughout its lifecycle with the total costs incurred, regardless of when those costs occur—before, during, or after production This comprehensive assessment is known as lifecycle costing.
There are four principal lessons to be learned from lifecycle costing:
1 All costs should be taken into account when working out the cost of a product and its profitability
2 Attention to all costs will help reduce the cost per unit and will help an organisation achieve its target cost
3 Many costs will be linked For example, more attention to design can reduce manufacturing and warranty costs
Costs are categorized into committed and incurred, with committed costs representing future expenses based on prior decisions, while incurred costs arise only when resources are utilized.
Worked Example – extract from September 2016 attempt:
A manufacturing company which produces a range of products has developed a budget for the life-cycle of a new product, P The information in the following table relates exclusively to product P:
The company budgets $72 million annually for total fixed production overheads, with an estimated 96 million machine hours Overheads are allocated based on machine hours, ensuring an efficient cost absorption strategy.
What is the budgeted life-cycle cost per unit for product P?
OAR for fixed production overheads ($72 million/96 million hours) = $0ã75 per hour Total manufacturing costs (300,000 units x $20) = $6,000,000
Total design, depreciation and decommissioning costs = $1,320,000
Total fixed production overheads (300,000 units x 4 hours x $0ã75) = $900,000
Life-cycle cost per unit ($8,220,000/300,000 units) = $27ã40
Stages of Life cycle (product life cycle)
Development stage The product has a research and development stage where costs are incurred but no revenue is generated
Examples: R&D costs; Capital Expenditure decisions
The product is introduced to the market The organisation will spend on advertising to bring the product or service to the attention of the potential customers
Examples: Operating costs; Marketing and advertising; Set up and expansion of distribution channels
Growth stage At this stage, the product becomes well-known in the market
Due to increase in demand, it captures a bigger market and starts to make a profit At this stage, cost of the initial investment is progressively recovered
Examples: Costs of increasing capacity; Maybe learning effect and economies of scale; Increased costs of working capital
During the maturity stage, product demand stabilizes and growth rates slow, yet profitability remains intact At this point, marketing and distribution expenses can be reduced, allowing for cost efficiency To maintain demand, it may be necessary to differentiate or modify the product.
Examples: Incur costs to maintain manufacturing capacity; Marketing and product enhancement costs to extend maturity
As a product reaches market saturation, sales begin to decline, leading to reduced demand and increased marketing costs At this critical juncture, the organization may face losses and consider discontinuing the current product while focusing on the development of a new one.
Examples: Asset decommissioning costs; Possible restructuring costs; Remaining warranties to be supported
A summarised analysis of the revenue and costs involved at the different stages is:
Stages Cost Demand Revenue Profit
Marketing cost if long life cycle product
The Importance of early stage in Lifecycle:
In advanced manufacturing technology, around 90% of a product's life cycle cost is influenced by early design stage decisions, making life cycle costing an essential approach for organizations in this sector.
Reducing costs during the planning, design, and development stages of a product's life cycle is crucial for minimizing overall product expenses, rather than waiting until the production phase.
How to maximize return over the product life cycle:
Careful design of product(can save design and manufacturing costs)
Take the product to market as soon as possible
Maximize the length of the life span
Through a heavy advertisement cost at the maturity
Benefits of Life cycle costing:
The potential profitability of product can be assessed before major development of the product is carried out and costs incurred and non-profit-making products can be abandoned
Techniques can be used to reduce costs over the life of the product
Pricing strategy can be determined before the product enters production
Attention can be focused on reducing the research and development phase to get the product to market as quickly as possible
By monitoring the actual performance of products against plans, lessons can be learnt to improve the performance of future products
An understanding of the product life cycle can also assist management with decisions about:
As a product progresses through its lifecycle stages, adjusting the pricing strategy becomes essential to sustain market share and recoup associated costs.
Performance management: Understanding the changes in the financial performance of the product as it moves from one stage to another and being prepared for the changes
Decision-making: Helps with decision about making new investments in the product (new capital expenditure) or withdrawing a product from the market
In service lifecycles, the R&D stages differ significantly and do not influence subsequent costs uniformly It is essential to plan and organize services proactively to minimize expenses effectively.
Projects, which typically take years to complete, rely on discounted cash flow calculations to assess their costs throughout their life cycle These projects are closely monitored to ensure they stay on schedule and avoid cost overruns.
Customers experience life cycles, and organizations strive to optimize the return on investment from each customer throughout this period The primary goal is to prolong the customer life cycle by fostering loyalty and engagement.
The initial cost is high but once customers get used to a supplier they tend to use them more frequently, bringing in the benefit to the company
The projected cash flows over the full lives of customers or customer segments can be analysed to highlight the worth of customers and the importance of customer retention
THROUGHPUT ACCOUNTING
Throughput accounting focuses on maximizing throughput, defined as sales revenue minus material costs, within the production process This system complements the Just in Time methodology by minimizing inventory costs and effectively reducing operational expenses.
It works on the principle that sooner or later, an organisation will face a bottleneck resource, a resource that slows down the production process
Throughput Accounting, grounded in the Theory of Constraints, aims to maximize throughput by focusing on sales revenue minus material costs, while considering the organization's bottleneck resources It emphasizes minimizing operational costs, which encompass all expenses aside from material costs.
The theory of constraints – extract from ACCA technical article
The theory of constraints is implemented in organizations through five focusing steps, designed to address bottlenecks within the entire system rather than isolated units.
Step 1: Identify the system’s bottlenecks
A bottleneck resource is a crucial factor that hinders the efficient delivery of products or services within an organization For instance, if a company faces a market demand of 50,000 units for a product that undergoes three stages—cutting, heating, and assembly—the time taken for each process and the total available hours play a significant role in determining overall productivity.
The total time required to make 50,000 units of the product can be calculated and compared to the time available in order to identify the bottleneck
Total hours required for 50,000 units 100,000 150,000 200,000
It is clear that the heating process is the bottleneck The organisation will in fact only be able to produce 40,000 units (120,000/3) as things stand
Step 2: Decide how to exploit the system’s bottlenecks
To maximize efficiency, it is crucial to ensure that the bottleneck resource is utilized to its fullest potential, producing the highest possible output Therefore, focusing on 'productivity' and 'utilization' is essential for optimizing resource management.
Step 3: Subordinate everything else to the decisions made in Step 2
The main objective is that production capacity of the bottleneck resource should determine the production schedule for the organisation as a whole
Idle time is a natural part of any system and should be acknowledged Overloading the system beyond its constraints leads to increased work-in-progress, longer lead times, and the illusion of new bottlenecks, ultimately causing system congestion Non-bottleneck resources do not need to operate at full capacity, resulting in periods of inactivity.
Step 4: Elevate the system’s bottlenecks
Organizations should prioritize exploiting existing bottlenecks before investing in capital expenditure for elevation Often, companies overlook this crucial step and rush to remove constraints Elevation should only be pursued after thorough exploitation of current resources and processes.
Step 5: If a new constraint is broken in Step 4, go back to Step 1, but do not let inertia become the system’s new bottleneck
When a bottleneck is resolved, a new one often emerges, potentially in the form of another machine that processes fewer units than the previous bottleneck Ultimately, market demand is likely to become the primary constraint on the system Continuous improvement is essential, as conditions are always changing.
Throughput accounting is an accounting method It actually involves assessing how effectively a firm utilises its constraints while its working on removing those
Activity-based costing (ABC) closely resembles marginal costing but is more suitable for long-term production capacity decisions This method serves as an alternative approach to cost and management accounting, particularly in a Just-In-Time (JIT) environment.
TA emphasizes throughput, inventory minimization and cost control
Throughput Accounting emphasizes that in the short term, only material costs are variable while all other factory costs remain fixed In a Just-In-Time (JIT) environment, holding inventory is discouraged; ideally, inventory levels should be zero, and production should only occur in response to customer demand This approach may require accepting some idle time in non-bottleneck operations Additionally, Work In Progress (WIP) should be valued solely at material costs, ensuring that profit is not recognized until a sale occurs Ultimately, profit is driven by the speed at which throughput is generated, meaning that raw materials must be quickly converted into sales to produce cash flow Therefore, producing solely to increase inventory is counterproductive and should be avoided.
Throughput is the rate at which a firm generates money by spending an hour of a bottleneck resource
Throughput contribution = Sales price – Material cost per unit
Coco Company specializes in the manufacturing and sale of a single product, achieving a contribution of $553,000 in a year The contribution-to-sales ratio stands at 70%, while the material cost accounts for 10% of total sales.
Throughput for the company is calculated as follows:
Throughput = Sales revenue – Material cost
Limiting factor analysis and throughput accounting
Once an organisation has identified its bottleneck resource, it then has to decide how to get the most out of that resource
Many businesses offer multiple products or services, necessitating the development of an optimal production plan as a crucial part of the exploitation process.
This is based on maximising throughput per unit of bottleneck resource
In key factor analysis, the initial step involves calculating the contribution per unit for each product Subsequently, the contribution per unit of a scarce resource is determined by assessing the amount of that scarce resource required for the production of each unit.
In throughput accounting, the focus shifts to calculating the throughput return per unit of bottleneck resource, rather than the contribution per unit of scarce resource This approach emphasizes optimizing resource allocation to enhance overall profitability.
Beta Co produces 3 products, E, F and G, details of which are shown below:
Direct material cost per unit 60 70 85
Time required on the bottleneck resource (hours per unit) 5 4 3
There are 320,000 bottleneck hours available each month Calculate the optimum product mix each month
A few simple steps can be followed:
1 Calculate the throughput per unit for each product
2 Calculate the throughput return per hour of bottleneck resource
3 Rank the products in order of the priority in which they should be produced, starting with the product that generates the highest return per hour first
4 Calculate the optimum production plan, allocating the bottleneck resource to each one in order, being sure not to exceed the maximum demand for any of the products
Direct material cost per unit 60 70 85
Time required on the bottleneck resource (hours per unit) 5 4 3
Initially, product E seemed the most profitable due to its high throughput per unit However, by applying the theory of constraints, it becomes clear that the system's bottleneck should be prioritized to maximize throughput per hour Consequently, product G should be produced before product E to optimize overall profitability.
Product No of units Hrs per unit Total hrs
Throughput per hr Total throughput
ENVIRONMENTAL ACCOUNTING
Environmental accounting is becoming increasingly topical in the modern business environment due to increased regulation and media coverage
This is the generation and analysis of both financial and non-financial information in order to support environmental management processes
Identifying environmental costs associated with individual products and services can assist with pricing decisions
Ensuring compliance with regulatory standards to prevent legal repercussions
But the management of environmental costs can be a difficult process
1 This is because first, just as EMA is difficult to define, so too are the actual costs involved
2 Second, having defined them, some of the costs are difficult to separate out and identify
3 Third, the costs can need to be controlled but this can only be done if they have been correctly identified in the first place
The majority of environmental costs are already captured within accounting systems It is often difficult to pinpoint and allocate them to a particular service
Methods of Environmental accounting in different organizations
This method operates on the principal that what comes in must go out Output is split across sold and stored goods and waste
Measuring these categories in physical quantities and monetary terms, forces a business to focus on environmental costs
Flow diagrams are often used to illustrate how the input is split across different output such as stored goods and waste
Environment -related costs such as costs relating to a sewage plant or an incinerator are attributed to joint environmental cost centers
Environmental -driven costs such as increased depreciation or higher staff wages are allocated to general overheads
Examples of environmental cost drivers include volume of emissions and the cost of complying with environmental
Material flows through an organization are divided into three categories
The values and costs of each flow are calculated This method focuses on reducing costs by questioning them and having a positive effect on the environment
Environmental costs are considered from the design stage right up to the last stage costs such as decommissioning and waste removal etc
This may influence the design of the product itself, saving on future costs
Which of the following statements regarding environmental cost accounting are true?
1 The majority of environmental costs are already captured within a typical organisation’s accounting system The difficulty lies in identifying them
2 Input/output analysis divides material flows within an organisation into three categories: material flows; system flows; and delivery and disposal flows
3 One of the cost categories used in environmental activity-based costing is environment-driven costs which is used for costs which can be directly traced to a cost centre
Environmental life-cycle costing allows for the assessment of environmental costs associated with a product from its design phase through to its decommissioning This comprehensive approach ensures that all stages of a product's life cycle are considered, facilitating more sustainable decision-making.
Most organizations do collect data about environmental costs but find it difficult to split them out and categories them effectively
Life-cycle costing does allow the organisation to collect information about a product’s environmental costs throughout its life cycle
The technique which divides material flows into three categories is material flow cost accounting, not input/output analysis
ABC identifies certain costs as environment-driven, which are typically concealed within total overheads in traditional costing systems These environment-related costs can be directly allocated to specific cost centers.