MTSU Alumni Day 2007

MTSU Alumni Day 2007 Hot Topics in Cost and Managerial Accounting By Jeannie J. Harrington Cost/Managerial Professor

Hot Topics in Cost and Managerial Accounting • GPK • Beyond Budgeting • Lean Accounting • Six Sigma

GPK • Grenzplankostenrechnung (Flexible cost planning and control system) • Pronounced GPK in the U.S. • Time-tested German cost accounting system • Sort of like variable costing used here in the U.S. • Very complex system with lots of detail • German cost accountants are very happy with the system, unlike U.S. counterparts with over 80% saying they are not pleased with their accounting system.

GPK – What’s Different? • German accounting systems focus on providing information to managers • U.S. accounting systems focus on providing information for external financial reports • Management reports are often abstracted from financial data • Since the primary emphasis is on managerial reporting, systems are often tailored to meeting managers needs better.

GPK – What’s Different? • Many more cost or resource centers used • German companies use between 8 - 20,000 cost centers with the average around 400-600 • U.S. companies use about 1 to a few per department • Detail, forecasting and variance analysis • Extended by cost center in German companies • Not usually extended in U.S. companies • Idle capacity • Allocated to all products in U.S. companies • Not assigned to manufactured products in German companies

History of GPK • In 1950s and 1960s, Hans-Georg Plaut (automotive engineer) and Wolfgang Kilger (researcher) developed GPK • Purpose was to develop an accounting method which would support decision making.

GPK Implementation • Separate costs • Costs must be separated into fixed and variable (referred to as proportional) costs • Assign variable and direct fixed costs only • Assigned to cost centers at the lowest level • Indirect fixed costs should not be charged to products. • Cost centers • Very small • Must have a robust relationship between its variable costs and their cost driver. • Only one person is responsible for each cost center. • A cost center will have 10 or less workers.

GPK Implementation • Types of cost centers • Final cost centers (manufacturing process) • Primary cost centers (deal with management,etc.) • Allocation • Costs of primary cost centers are then assigned to final cost centers • Reciprocal method often used instead of the step method of allocation. • All costs, even selling and administrative costs, are allocated to cost centers.

GPK Implementation • Cost centers are created in the General Ledger • General Ledger is used for management and control as well as financial reporting • A single manager may have multiple cost centers • Each cost center has well defined and differentiated activities

GPK Implementation • Contribution margin accounting is used: Sales - Variable costs = Contribution margin I - Fixed costs (product) = Contribution margin II - Fixed costs (company) = Net income

GPK Implementation • More cost classifications used, including • Fixed vs. proportional • Direct vs. indirect • Relevant vs. irrelevant for decision making • Primary vs. secondary costs • Type – production, R&D, G&A, Marketing/Dist. • Nonabsorbable vs. Absorbable • Production cost type • Production cost category • Cash-flow relevance • With all this detail, ERP is a definite help. • SAP (German IT system) has modules for GPK.

Benefits of GPK • Cost control • Capacity decisions • Transparency for cost information • Make vs. buy decisions made easier • Sales and planning decisions are enhanced with focus on the contribution margin • Focus on contribution margin helps in managing bottlenecks • CM per bottleneck calculations

Comparison between ABC and GPK • Variable/fixed cost breakdown • GPK breaks down costs and allocates only proportional costs to resource cost centers • ABC does not – it allocates all costs to activities • Long run/short run • GPK is more short-term oriented since a lot of fixed overhead costs are expensed currently • ABC focuses more on long-run • Cost drivers • GPK uses mainly cost drivers tied to output related resources (machine hours, labor hours, direct materials pounds) • ABC can use any cost drivers (engineering hours, number of purchase orders, number of setups)

Companies Using GPK • Mostly German speaking companies • Lots of manufacturing companies but service companies use it as well, including: • Daimler Chrysler AG (2,500 cost centers) • (but not Chrysler in U.S.) • Porsche AG (450 cost centers) • Schering AG (3,500 cost centers) • Deutsche Telekom (20,000 cost centers) • Stihl AG & Co. (650 cost centers) • North America • Toronto’s Hospital for Sick Children (previously used ABC) • Stihl Inc. – North American subsidiary

Why little GPK in the U.S. • Our systems are financial oriented • Costs are high to implement and maintain (may outweigh benefits) • Easier to downsize here • Not many English version manuals • Not many other companies in U.S. to model • Not many consultants are aware of it

Trends of GPK • IMA has adopted GPK as its new cost accounting method • They are working on developing a method based on GPK principles that is not as complex • The IMA hopes to train academics, consultants and workers in the GPK methodology.

Beyond Budgeting • Formal budgeting, developed in the 1920s, has gotten out of hand • The budgeting process takes on average 4 ½ months and 30% of senior management’s time • The budget is often out-of-date early in the year and only 20% of companies change it • The budget is used as a performance evaluation tool • Majority of workers are dissatisfied with the budgeting model • Jack Welch, former CEO of GE, “the budget is the bane of corporate America. It never should have existed.” • In 1997, some professionals frustrated with the corporate budgeting process established the BBRT (Beyond Budgeting Round Table). • Main goal is to abolish budgeting totally!!!!!

Beyond Budgeting • Today’s business environment demands adaptability. • Budget limits change, has too many controls, stifles creative thinking and innovative actions. • Budget is NOT CUSTOMER ORIENTED. • Businesses need to focus on strategy more, not past results from budgets • 85% of managers spent less than one hour a month discussing corporate strategy. • 60% of managers did not link strategy to the budget.

Beyond Budgeting Principles Can use all of these principles or only a few: • Create relative targets • Beating benchmarks or the competition • Continuous strategy-setting • Bottom-up, continuous process • Anticipatory Systems • No tie between forecasts and reward system. • Forecasts set at least six quarters in the future. • Resources on Demand • Resources are allocated to business units that need them the most. • Alleviates spend equal amount as last year’s budget

Beyond Budgeting Principles • Fast, Distributed Information • Available quickly • Relevant and reliable • Both lagging and leading indicators • Comparisons with competition • Relative Team Rewards • Individuals and groups are rewarded • Self-governance Framework • Decentralized into many smaller, self-managing units • Empowered Managers • Managers set both short and medium term goals • Managers decide how to achieve their set goals

Beyond Budgeting Principles • Accountability for Dynamic Outcomes • Management is evaluated on what they could have achieved, given the circumstances. • Network Organization • Self-managing units form independent, customer-focused entities • Market is the determining factor, not the planning, budgets, and controls • Market Coordination • Self-managing units can either purchase support services from external support or from the organization’s central support. • Supportive Leadership • Managers of self-managing units are allowed to take risks and make mistakes without fear of punishment.

Benefits of Beyond Budgeting • Faster response time • New, innovative strategies • Lower costs • Customer loyalty

Comments on Beyond Budgeting • “Beyond Budgeting is an idea that promotes an agile and innovative, forward looking, customer and people oriented enterprise, that empowers its entrepreneur-managers to continuously develop new and original solutions to unexpected and non-programmable opportunities and problems.” – Michel J. Lebas, Professor of Management Accounting, H.E.C. School of Management, France.[1] • [1] Beyond Budgeting, 2007.

Comments on Beyond Budgeting • “Recent events have shown that there has never been a better time for a radical reassessment of how we manage organizations. We face rapid change despite having more limited sight than at any time since the 1940s. A climate of international terrorism and volatile stock markets does not encourage planning beyond weeks and months, never mind months and years. We need more adaptive processes and a culture that supports them. Instead, too often we have fixed targets and fixed plans. They no longer make sense. Beyond budgeting is a provoking alternative we should take seriously.” – Charles T. Horngren, Littlefield Professor of Accounting, Emeritus, Stanford University.[1] • [1] Beyond Budgeting, 2007.

Comments on Beyond Budgeting • “Stretching allows people to constantly reach for the goal. And people are getting more and more comfortable with the idea that you can get the best out of people not by fighting budgets, which are all about minimal numbers, but by getting people to do the best they can, and measuring their progress toward it – against last year, against what competitors are doing. We’re in the process of enriching our organization through the stretch concept. Operating margins are 50 percent higher than they were for the first one hundred and eight years of our company, and in a tougher global environment.”- Jack Welch, CEO, General Electric.[1] • [1] Beyond Budgeting, 2007.

Lean Manufacturing and Lean Accounting • Lean Manufacturing • A management strategy that requires everyone in the value stream to have one common vision for the company of reducing waste resulting in improvements in quality and production time as well as reduction in costs. • Continuous improvement is emphasized • Customers are the main focus • Pioneered by Toyota in the 1950s • Lean Accounting – reduce waste in the accounting process and give managers the information they need to run a lean company.

Lean Accounting Systems • Management wanted “one source of the truth” that was consistent, accurate, timely, and insightful. • Management wanted greater involvement in the planning processes so they could have a better understanding of what can be influenced and what can’t. • Management wanted proactive decision support from “man markers” who make an effort to understand how they operate and give them greater guidance on how to use financial information effectively.

Lean Accounting Systems • Do not reward managers for overproducing • Do not reward managers for favorable labor efficiency variances due to • Manufacturing large batches for which there is not demand • Building high inventories • Hiding waste • Use nonfinancial measures as well as financial measures in performance evaluation • Provide timely, understandable financial and nonfinancial information to those on the shop floor

Lean Accounting Systems • Lean manufacturing systems have little inventory • Standard costs are replaced by target costs based on market pricing • Target costs include only variable expenses; all fixed costs expensed • Financial accounting and management accounting are treated separately.

Lean Implementation • Include as many people as possible involved in the task under observation • Examine product flow • Standardize the work • All workers contribute and the “best” process is adopted. • Determine if there is enough resources, personnel, and equipment to meet demand • Change process.

Value Stream Mapping (VSM) • Develop process flow diagrams • Have a team of about 7-10 members • Go through steps and determine if essential or nonessential. • Eliminate nonessential activities.

Six Sigma • A Four Sigma process results in 6,000 defects per million • A Five Sigma process will result in 233 defects per million activities • A Six Sigma process will have no more than 3.4 defects per million activities • Most companies believe their current quality resides between a Three or Four Sigma

Characteristics • Focus on getting bottom-line results • Aims at improving human elements • Teamwork • Customer Service • Company Culture • Aims at improving actual processes • Statistical process control • Work process improvement

Characteristics • Six Sigma projects have three characteristics: • A problem to be solved • A process in which the problem exists • One or more measures that quantify the gap to be closed and can be used to measure progress • The focus is on robust/drastic change

Example • The process is delivering documents • The defect is any delivery that happens after the customer-defined time • For instance, the customer requirement could be that the delivery needs to happen within 24 hours • This means that if the delivery process was Six Sigma, then only four out of a million will be delivered beyond 24 hours

Example

Methodology • DMAIC • Define • Measure • Analyze • Improve • Control

Training • Three training levels • Green belt • Black belt • Master black belt • Definitions of the belt levels varies between organizations • Motorola • GE • Training time for the different levels usually takes a number of weeks (e.g. 16-20 weeks for a black belt)

Industries • Manufacturing • Pharmaceutical • Financial Services • Government • Healthcare

Motorola • Invented Six Sigma • As early as the 1960’s, Motorola realized that quality had to be improved if the company was going to effectively compete with Japanese manufacturers • Bill Smith, a senior engineer and scientist, introduced the Six Sigma concept in 1986 • Today, Motorola uses Six Sigma in the following areas: • Sales and marketing, product design, manufacturing, customer service, transactional processes, and supply chain management • Since implementation, Motorola has documented over $17 billion in savings

General Electric • Jack Welch, CEO of GE, implemented Six Sigma in 1995 • First to formalize Six Sigma for departments other than manufacturing • Focus on customer service

General Electric • Company culture • A shift from the command-and-control structure to employee empowerment • All employees from clerical staff up are required to reach green belt proficiency • New employees are expected to obtain green belt certification within their first year of employment • Recognized $10 billion in savings during the first five years of implementation

Bank of America • Implemented Six Sigma in 2001 • Integration into company culture, similar to GE • Focused on operational areas first • Reducing missing items from customer statements • Lowering the number of late posted customer transactions • Reducing encoding errors and improving the efficiency of large scale printing operations

Bank of America • Next, the company focused on customer issues and performance gaps • Increased reliability of ATMs, telephone banking, and online banking • Developed new sales processes that increased IRA accounts • Now, the company employs more than 5,000 “Green Belts” and “Black Belts” • Savings of $2 billion since implementation

Other Companies

Sarbanes-Oxley Compliance • Companies are using Six Sigma to improve the efficiency and effectiveness of business processes and the related controls • Gives management more peace of mind when certifying the financial reports

Sarbanes-Oxley Compliance • Seven step process • Top management commitment • Identify appropriate processes • Establish teams • Provide appropriate training • Develop an action plan • Measure and communicate results • Implement change and continuously monitor the process

Conclusion • GPK - more detail • Beyond Budgeting – less detail, more customer-focus • Lean Accounting – quicker response time • Six Sigma – significant improvements • ALL CAN HELP IMPROVE THE MANAGEMENT OF YOUR COMPANY!!!!

MTSU Alumni Day 2007