PGPMA MANAGEMENT ACCOUNTING – TERM 2. Costing techniques.pdf · Target costing approach...
Transcript of PGPMA MANAGEMENT ACCOUNTING – TERM 2. Costing techniques.pdf · Target costing approach...
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COSTING TECHNIQUES
MANAGEMENT ACCOUNTING
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Target Costing
Traditional approach to product costing• Develop a product• Determine the expected standard production cost• Set a selling price (probably based on cost)
• Resulting profit• Costs are controlled through variance analysis at monthly
intervals
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Target Costing
Target costing approach Competitive market price • Set according to what the competition is charging Or• If the product is new set using market research or functional
analysis/pricing by functionDesired profit margin • As determined by the organisation’s strategic profit plans• Target cost = Competitive market price less desired profit
margin • This is the resulting cost that must be achieved
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Set target selling prices based on customer expectations and sales forecasts
Establish target profit, based on long-term profit objectives and projected volumes
Determine the target cost per unit
Compare with Establish cost reduction targets for each component and production activity, using value engineering and value analysis
Estimated “current cost” of the new product
Steps in target costing process
Service industries are mostly not design driven
Too much focus on cost may take attention away from quality
Little room for gradual improvement in cost
The target costing process takes a long time
Service industries are mostly not design driven
Too much focus on cost may take attention away from quality
Little room for gradual improvement in cost
Difficulties of using target costing in the service industry
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A target cost gap might be closed
Target Cost gap = Target Cost– Estimated cost (based on current material, labour, OH)
Example
A specifically designed Integrated Circuits (I.C.), the standard cost of Target Plc wasestimated at $360,000.
However, the target cost for 10,000 units of I.C. derived by deducting target profit($110,000) from target price ($440,000) was $330,000.
It clearly indicates that the target costing gap for the company was $30,000 (i.e., $360,000 –$330,000). The financial goal of the company would be to close the gap.
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Target Costing
Target cost • When a product is first manufactured, the target cost may be
well below currently achievable cost • But management will set benchmarks for improvement
towards the target cost by specified dates • These will be incorporated into the budgeting process• Value analysis can be used to reduce costs if and when
targets are missed (covered in later slides)
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Options available to reduce cost • Develop the product in an atmosphere of
continuous improvement• Apply value engineering techniques• Collaborate closely with suppliers• Change production methods• Improve technologies/processes• Cut out non-value added activities
Target costing
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Target costing v standard costing How costs are controlled • Target costing - no cost slashing but continual
pressure to ensure costs are kept to a minimumStandard costing • Costs must be kept within predetermined standard
costs• Variances are calculated to check that this has
happened
Target costing
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Target costing v standard costing continuedRelationship between product concept, cost and price• Target costing – Product design concept then selling
price - the target cost leading to profit margin • Standard costing – Predetermined product design
then cost leading to profit
Target costing
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Target costing v standard costing continuedLink with strategic plans• Target costing – The product concept and target profit
margin take into account medium-term strategic plans• Standard costing – None. The approach is short-term
cost control through variance analysisTime frame for cost control • Target costing – Continual cost reduction. Target costs
are revised monthly• Standard costing – Standards are usually revised
annually
Target costing
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• Value analysis (VA) is a planned, scientific approach to cost reduction
• It reviews the material composition of a product and the production design
• Modifications and improvements can be made which do not reduce the value of the product to the customer/user
Benefits • Lower costs • Better products • Higher profits
Value analysis 1
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The benefits of value analysis are achieved by: – Cost elimination/prevention– Cost reduction– Improving product quality and so selling more at
the same price– Improving product quality and so increasing
selling price
Value analysis 2
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Aspects of a product’s value to consider • Cost value – cost of producing / selling it• Exchange value – its market value• Use value – what it does• Esteem value – prestige customer attaches to it
Conventional cost reduction techniques v value analysis • Conventional cost reduction techniques – to achieve
the lowest production cost for a specific product design• Value analysis – tries to find the least cost method of
making a product that achieves its desired function
Value analysis 3
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Typical consideration in VA• Can a cheaper (but as good or better) substitute
material be found?• Can unnecessary weight or embellishments be
removed without reducing the product’s attractiveness/desirability?
• Is it possible to use standardised or fewer components?
Value analysis 4
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Steps in a VA study • Select a product/service for investigation• Obtain and record information about it• Analyse this information and evaluate the product,
considering each aspect of value in turn• Consider alternatives• Select the least-cost alternative for recommending to
management• Make a recommendation• If accepted, implement the recommendation• After a period, evaluate the outcome and measure the
cost savings
Value analysis 5
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Functional analysis• This is most commonly applied during the development
stage of products • It uses the functions of a product/service (such as ‘to
make a mark’ for a pen) as the basis for cost management
• The steps in functional analysis are similar to those in VAValue engineering • The application of similar techniques to those of VA to
new products • The aim is to design and develop new products of a
given value at minimum cost
Value analysis 6
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Stages in the life cycle• Introduction• Growth• Maturity• Decline
The stage a product is at in its life cycle will affect the returns expected
Life cycle costing 2
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Performance measures Introduction • Cash – net user • Return on capital employed – not important • Growth – vital • Profit – not expected Growth • Cash – net user • Return on capital employed – not important • Growth – vital• Profit – important
Life cycle costing 3
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Performance measures continued Maturity• Cash – generator • Return on capital employed – important • Growth – grow with new uses• Profit – important Decline • Cash – generator• Return on capital employed – important • Growth – negative growth• Profit – very important
Life cycle costing 4
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Life cycle costing • The profiling of cost over a product’s life, including the
pre-production stage
Life cycle costing 5
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How to maximise the return over the product life cycle
• Design costs out of products• Minimise the time to market• Minimise breakeven time• Maximise the length of the life span• Minimise product proliferation
Life cycle costing 6
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Impact on marketing strategies • As a product progresses through its life cycle, it
faces different challenges and opportunities • These will require changes in the marketing mix and
alternative marketing strategies• Example: During the maturity stage, incentives
should be given to entice competitors’ customers to switch
Life cycle costing 7
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Traditional management accounting systems v life cycle costing Traditional management accounting systems • Based on the financial year and so dissect the product life
cycle into a series of annual sections • Profitability is thus assessed on an annual basis• Such systems total all non-production costs and record them
as a period expense• They write off R&D expenditure against revenue from
existing products • Therefore existing products seem less profitable and are
scrapped too quickly
Life cycle costing 8
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Traditional management accounting systems v life cycle costing continued Life cycle costing • This approach tracks and accumulates a product’s
actual costs and revenues over the entire product life cycle
• This means that a product’s total profitability can be determined
• It traces non-production costs to individual products over complete life cycles
Life cycle costing 9
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Benefits of life cycle costing • Full understanding of individual product profitability• More accurate feedback information• Cost reduction/minimisation and revenue expansion
opportunities more apparent• Increased visibility of non-production costs
Life cycle costing 10
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Customer life cycle • Aim is to extend the life cycle of a particular
customer• Do this by encouraging loyalty (e.g. loyalty cards)• Customers become more profitable over their life
cycle (e.g. bank customers)
Life cycle costing 11
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Questions to be done from Kaplan P2 Study Text (Chapter 3)
1. Objective test question 22. Objective test question 33. Data set question4. Case Style Question
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Questions
Classwork:P2 May 2010: Section A Question 3P2 May 2012: Section A Question 4
Homework:P2 Nov 2013: Section A Question 2