Managing Costs & Revenues

1. Managing Costs & Revenues Professor William F. O’Brien, MBA, CPA Spring 2012

2. Session 2 • Strategic Cost Management/Measurement Tools and Systems • Activity Based Costs and Management • The Balanced Scorecard • Tiajuana Bronze Case MANAGING COSTS AND REVENUES-2012

3. Mgt. Actg.--Strategic Implications • Business partners must use KTT in their business decisions to meet “customer” needs. • Business partners must be cost efficient and cost effective. • Achieved by knowing what the customers want • Business partners must promote the economics of time and excel at their own time management. • Achieved by knowing what the customers want MANAGING COSTS AND REVENUES-2012

4. IMA’s M/A Roles • Business and strategic partner • Provider of strategic business understanding • Participant in problem solving • Team member • Provider of information • Process facilitator MANAGING COSTS AND REVENUES-2012

5. From Scorekeeper to Player • Role change driven by: • Information technology • Global competition • Two models for Management Accountants • Corporate cop--evaluator • Business partner-enabler • Dual accountability & org. structure • Solid vs dotted-line relationship MANAGING COSTS AND REVENUES-2012

6. Accounting Business Skills“The What” • Business Perspective • Organizational Focus • Bias for Action • Communication Excellence • People Proficiency MANAGING COSTS AND REVENUES-2012

7. Financial Management Guidelines“The How” • Cc • KTT • MBWA • R ƒ R3 • responsiveness • reliability • relevance MANAGING COSTS AND REVENUES-2012

8. Mgt. Actg.--Attribute Implications • Business partners must possess broad business oriented technical skills. • Business partners use these skills to develop the behavioral attributes of a team member, tolerance with ambiguity and comfort with “soft” future-oriented numbers. MANAGING COSTS AND REVENUES-2012

9. Mgt. Acctg.--Attribute Implications • Business partners must be culturally aware and adjust their mindset to that of a participant. MANAGING COSTS AND REVENUES-2012

10. Cost Measurement Systems • Focus on “…operating information for results.” MANAGING COSTS AND REVENUES-2012

11. Strategic Mgt. Actg. System • Competitor cost information • Value Chain analysis • Strategic cost analysis…ABM • And others... MANAGING COSTS AND REVENUES-2012

12. Ansari: MOA • Strategic Implications • Info @ the cost of features customers most value • Info @ the overall cost of the product • Reflects time considerations in the fulfillment process MANAGING COSTS AND REVENUES-2012

13. MOA, cont. • Attribute Implications • Technical • Provides decision relevant information • Enhances process understanding • Behavioral • Cost structure visibility • Facilitates communication • Empowers employees • Risk of “failed expectations” re: “true” cost • Cultural • Supports process focus • Encourages cross-functional participation MANAGING COSTS AND REVENUES-2012

14. Attribution vs. Allocation • “The Scarlet Letter” revisited • Attributions promote ownership and cost relationship understanding • Arbitrary allocations do not reflect direct consequences and, therefore, are often ignored. MANAGING COSTS AND REVENUES-2012

15. Arbitrary Allocations • When all else fails…at least it forces managerial discussions and negotiations. MANAGING COSTS AND REVENUES-2012

16. Activity Based Costing • Application to Final Cost Objectives (FCO’s) on the basis of actual activities employed • Estimations of actual, causal relationships are used…reasonably accurate costs of products, services and customers • Can include fixed and variable amts. MANAGING COSTS AND REVENUES-2012

17. Types of Activity Drivers • Transaction…# of events • Time or duration…time of events • Cost per event MANAGING COSTS AND REVENUES-2012

18. Hints for Implementation • K.I.S.S. • Focus on estimates • Start small • Close enough is good enough • Use Pareto’s law MANAGING COSTS AND REVENUES-2012

19. ABC Implementation • Select an area • Identify primary activities (5-10) • Cost each activity • Determine one driver for each activity • Apply the costs to the final cost objectives on the basis of the drivers. MANAGING COSTS AND REVENUES-2012

20. ABC/ABM Case-Gulfstream Recreation Gulf Stream Recreation, a major sporting goods firm in California has two major products--the Bobcat Racer and the Snidley Whiplash Cruiser. For the current year, overhead was planned at $850K. Overhead is applied on the basis of machine hours. Each racer uses 2 machine hours and each cruiser uses 1 machine hour. GSR planned to build 10K racers and 50K cruisers. The cost structure for each product is as follows: Racer Cruiser Direct Material $35 $50 Direct Labor 25 13 Machine Hours 2 1 GSR is considering some type of activity based costing system. Sandra Jones, the cost accounting manager, suggested the following drivers: Driver Relationship to FCO DriverTotal Activity CostTotalRacerCruiserActivity P.O.'s (#) $300K 2000 1250 750 Purchasing Rework Hrs. (Hrs) $200 450 200 250 Quality Control Invoices (#) $200 600 150 450 Billing Change Orders (#) $150 300 150 150 Mfg. Eng. 1. Calculate the unit costs of each product under the traditional method. 2. Calculate the unit costs of each product under activity based costing. 3. What pricing implications are inherent in this example. MANAGING COSTS AND REVENUES-2012

21. Gulfstream Recreation Solution Standard Overhead Rate: $850K/70K Mhrs. = $12.14 per machine hour Traditional Cost Structure: RacerCruiser Direct material $35 $50 Direct labor $25 $13 Overhead $24 $12 Total $84 $75 MANAGING COSTS AND REVENUES-2012

22. Gulfstream Solution, continued ABC Overhead Rate: RacerCruiser Purchasing $187.5 $112.5 Quality control $ 88.9 $111.1 Billing $ 50.0 $150.0 Mfg. Engineering $ 75.0 $ 75.0 Total $401.4 $448.6 Per unit $40.10 $ 8.97 Traditional Cost Structure: RacerCruiser Direct materials $35 $50 Direct labor $25 $13 Overhead $40 $ 9 Total $100 $72 MANAGING COSTS AND REVENUES-2012

23. Remember... • ABC does NOT yield “true” costs! MANAGING COSTS AND REVENUES-2012

24. Ansari: ABM • Strategic Implications • Visibility on the efficiency & effectiveness (the quality) of activities • Visibility of costs for process redesign • Insight into timing consideration of actions MANAGING COSTS AND REVENUES-2012

25. ABM, cont. • Attribute Implications • Technical • Greater focus on work • Provides cross-functional cost impact • Highlights operational interdependencies • Behavioral • Heightens importance of process knowledge • Reinforces continuous improvement • Empowers employees--be careful of “non-value” terminology • Cultural • Reorients focus on process not people • Challenges current thinking • May add cultural conflict MANAGING COSTS AND REVENUES-2012

26. ABM, cont. • ABM Process (one approach) • Obtain existing cost information • Determine the major processes • Identify process inputs and outputs • Determine the specific activities • Identify the resources used • Define output measures (what we measure) • Define performance measures (how we measure it) • Assess performance through benchmarking • Brainstorm improvements MANAGING COSTS AND REVENUES-2012

27. ABM-Schematic Quantity Inputs Outputs Activities Quality Resources MANAGING COSTS AND REVENUES-2012

28. Balanced Scorecard Analysis

29. Bscol.com Balanced Scorecard Model Financial Perspective Learning & Growth Perspective Customer Perspective Internal Business Process Perspective MANAGING COSTS AND REVENUES-2012

30. Balanced Scorecard Components • Financial Perspective • Customer Perspective • Internal Business Process Perspective • Learning and Growth Perspective MANAGING COSTS AND REVENUES-2012

31. The Measures • Approximately 5-7 per section • Link the measures…cause & effect • Include outcomes and drivers • Strategic measures become part of the bal. scorecard; control system measures become “critical success factors” (or everyday measures) MANAGING COSTS AND REVENUES-2012

32. Features of a Good Balanced Scorecard • It tells a story. • It helps communicate a strategy. • It preserves a financial focus. • It provides for metric focus. • It highlights sub-optimal tradeoffs. MANAGING COSTS AND REVENUES-2012

33. Balanced Scorecard Pitfalls • Failure to allow the scorecard to evolve. • Emphasizing across the board improvement. • Focus on only objective measures. • Failure to focus on both costs and benefits. • Failure to include non-financial measures in evaluating employees. MANAGING COSTS AND REVENUES-2012

34. BSC Future Options • BSC format as Management by Objective tool • Personal BSC • 4 F’s MANAGING COSTS AND REVENUES-2012