Learning Objective

Learning Objective Describe the total-life-cycle costing approach to managing product costs over the value chain.

Total-Life-Cycle-Costing • What is total-life-cycle costing? • It is the process of managing all costs along the value chain. • A TLCC system provides information for managers to understand and manage costs through a product’s design, development, manufacturing, marketing, distribution, maintenance, service, and disposal stages.

Total-Life-Cycle-Costing RD&E Cycle Manufacturing Cycle Post Service Cycle

Total-Life-Cycle-Costing • What are the three stages of the research, development, and engineering cycle? • Market research • Product design • Product development • 80% to 85% of a product’s total life costs are committed by decisions made in the RD&E cycle.

Total-Life-Cycle-Costing • What are committed costs? • These are costs that a company knows it will have to incur at a future date. • What are manufacturing cycle costs? • These are the costs incurred in the production of the product. • Usually at this stage there is not much room for engineering flexibility.

Total-Life-Cycle-Costing • When does the post-sale service and disposal cycle begin? • It begins when the first unit produced is in the hands of the customer.

Total-Life-Cycle-Costing • What are the three stages of the service cycle? • Rapid growth • Transition • Maturity

Total-Life-Cycle-Costing Traditional Stages of the Accounting Total life Cycle Focus Post-Sale $ Costs Research, Development, Manufacturing Service and and Engineering Cycle Disposal 100% 80% 60% 40% 20% 0% Cost Committed Costs Incurred

Learning Objective Explain target costing.

What is Target Costing? It is a cost planning method used during the RD&E cycle that focuses on reducing costs for products that require discrete manufacturing processes and reasonably short product life cycle.

Goal of Target Costing • To design costs of products in RD&E stage of a product’s total life cycle – rather than during the manufacturing stage • Product selling price is constrained by the market place • Target cost is determined by analysis along the entire industry value chain and across all functions

Benefits of Target Costing • Increased understanding of markets, competition, customer needs in terms of products, quality, timeliness and price • Price competitive - prices are driven by market forces in competitive markets

Target Cost • Target cost = difference between targeted selling price and targeted margin • Costs are viewed as a derivative of prices and profit margin, rather than the other way around • Costs must be lower than prices to make money

Target Cost • The target cost is a financial goal for the full cost of a product, derived from estimates of selling price and desired profit. • Customer-driven • Cost reduction Costing is both price-led costing and customer- oriented

Target Costing & Cost Reduction • A large proportion of costs can be committed or locked-in during the planning and design stage • Trying to reduce costs once a product reaches production is very difficult • Cost management can be effective during the planning and design stage

Steps in Target Costing Process (1)Determine the target price which customers are willing to pay for a product or service (2) Deduct a target profit margin from the target price to determine the target/allowable cost - the target cost is the market price less the required return

Steps in Target Costing Process (3) Determine the cost reduction target - difference between the total target cost and currently feasible cost (4) Redesign or design products and processes to achieve the cost reduction target – this can be an iterative process until both the product or service and its cost meet marketing and financial objectives.

Target Cost • Aim of actions in steps from (1) to (4) is to achieve target cost • Target costing involves searching for a target cost for a product before it is manufactured and reaches the market.

Calculating Target Cost Target selling price of product RM800 Desired profit margin (30% of sales) 240 Hence, target cost (RM800- RM240) 560 Projected cost based on existing conditions 700 • Each functional department will work towards reducing cost from RM700 to RM560

Cross-functional Teams • Teams may include representatives from design engineering, manufacturing, management accounting, marketing, as well as representatives among suppliers, customers, distributors and waste disposal • Cooperation between managers from different functions is vital to make adjustments for cost reduction

Supply Chain Management • Involves developing cooperative, mutually beneficial long-term relations between buyers and suppliers • Suppliers participate in resolving cost reduction problems

Value Engineering Value engineering is a process in which each component of a product is scrutinized to determine whether it is possible to reduce costs while maintaining functionality and performance.

Value Engineering Value engineering reduces costs by eliminating wasteful practices through: • Material substitutions • Process efficiency • Market driven product improvements • Energy efficiency

Target Costing: Some Problems • Conflicts between various parties involved in the target costing process Marketing, design and development, procurement, process engineering, manufacturing and accounting Excessive pressure on subcontractors and suppliers to conform to a schedule and reduce costs can lead to alienation and/or failure of the subcontractor

Target Costing: Some Problems • Design engineers may become upset when other parts of organizations are not cost conscious • Employees in many Japanese companies experienced burnout • Development time may increase because of repeated value engineering cycles to reduce costs • Delay introduction of product to the market

Target Costing RD&E Cycle Manufacturing Cycle Post Service Cycle Target Costing

Comparing Traditional Cost Reduction to Target Costing Traditional Cost Target Reduction Costing Market Research to Determine Customer Requirements Customer Needs and Price Points Product Specifications

Comparing Traditional Cost Reduction to Target Costing Traditional Cost Target Reduction Costing Design Target Selling Price Target Product Volume Engineering Target Profit Supplier Pricing

Comparing Traditional Cost Reduction to Target Costing Traditional Cost Target Reduction Costing Estimated Cost Target Cost Desired Profit Margin Value Engineering Supplier Pricing Pressure

Comparing Traditional Cost Reduction to Target Costing Traditional Cost Target Reduction Costing Manufacturing Periodic Cost Reduction Continuous Cost Reduction

Comparing Traditional Cost Reduction to Target Costing • Under traditional costing, the profit margin is the result of the difference between the expected selling price and the estimated production cost. • Pt = St –Ct • The cost-plus method is another traditional approach.

Comparing Traditional Cost Reduction to Target Costing • Under the cost-plus method the selling price is the sum of the expected product cost and the expected profit margin. • Scp =Ccp + Pcp

Comparing Traditional Cost Reduction to Target Costing • Under target costing, the target profit margin results from a long-run profit analysis often based on return on sales. • The target cost is the difference between the target selling price and the target profit margin. • Ctc = Stc – Ptc

Concerns About Target Costing • What are some potential problems in implementing target costing? • Conflict can arise between parties involved in the process. • Employees may experience burnout due to pressure. • Development time may increase.

Learning Objective Explain Kaizen costing.

Kaizen • What is Kaizen? • It is a Japanese term for making improvements to a process through small, incremental amounts rather than through large innovations.

Kaizen Costing • Kaizen means "improvements in small steps" (i.e., continuous improvement) • Kaizen is a Japanese term for making improvements to a process through small, incremental amounts rather than through large innovations. • A costing system developed in Japan by Yashuhiro Monden. • Widely used in Japan in such industries as electronics, precision machinery, and automobiles.

Kaizen Costing • What is Kaizen Costing? • It is a planning method used during the manufacturing cycle with an emphasis on reducing variable costs in one period below the costs in a base period. • The target-reduction rate is the ratio of the target reduction amount to the cost base.

Kaizen Costing Manufacturing Cycle RD&E Cycle Post Service Cycle Kaizen Costing

Comparing Traditional Cost Reduction to Kaizen Costing Standard Costing 1. Cost-control system concept 2. Assumes stability in current manufacturing process 3. Goal is to meet cost performance standards Kaizen Costing 1. Cost-reduction system concept 2. Assumes continuous improvements in manufacturing 3. Goal is to achieve cost reduction standards

Comparing Traditional Cost Reduction to Kaizen Costing Standard Costing Techniques 1. Standards are set annually or semi- annually 2. Variance analysis involves comparing actual to standard costs 3. Investigation occurs when standards are not met Kaizen Costing Techniques 1. Cost reduction targets are set and applied monthly 2. Variance analysis involves target Kaizen costs versus actual cost reduction amounts 3. Investigation occurs when target reductions are not attained

Comparing Traditional Cost Reduction to Kaizen Costing Who has the best knowledge to reduce costs? Standard Costing Managers and engineers develop standards Kaizen Costing Workers are closest to the process and thus know best

Concerns About Kaizen Costing • What is a concern about Kaizen Costing? • The system places enormous pressure on employees to reduce every conceivable cost. • What is a cost-sustaining period? • It is a period that allows employees to learn new procedures before Kaizen targets are imposed.

Objective of Kaizen Costing • Objective is to reduce current costs by using various improvement tools such as value engineering and functional analysis for each manufacturing facility • The goal of Kaizen costing is to ensure that actual production costs are less than the prior year’s cost

Kaizen Costing • Kaizen costing focuses on reducing costs during the manufacturing phase of products • Aim of kaizen costing is to reduce cost during the manufacturing phase of an existing product • Kaizen focuses on production processes after manufacturing activities have begun

Kaizen Costing • Since the product is already in the manufacturing process, it is difficult and costly to make large changes to reduce costs • Assume continuous improvement in manufacturing • Reduce cost but not to the extent of disrupting production

Achieving Cost Reduction Targets · Cost reduction targets are set and applied monthly. · Continuous improvement (Kaizen) is implemented during the year to attain target profit or to reduce the gap between target profit and estimated profit. · Cost variance analysis involving target Kaizen costs and actual costs reduction amounts. · Investigate and respond when target Kaizen amounts are not attained

Concerns about Kaizen Costing • The system places enormous pressures on employees to reduce every conceivable cost • Kaizen costing leads to incremental rather than radical process improvements This can cause myopia as management tends to focus on details rather than the overall system

Learning Objective