CONTEMPORARY APPROACHES TO MANAGEMENT ACCOUNTING &
TECHNOLOGY
KWAME AIDOO, CA/MCIT/ACE/GAFM/MBA
BOAKEY EDWARD (CA)
CONTEMPORARY APPROACHES TO MANAGEMENT ACCOUNTING
The contemporary models of management accounting are based on the concept that current problems require
current solutions. It implies that the models currently adopted in dealing with management and corporate issues
are no longer relevant in modern business environments. In the contemporary business environment, customers’
needs keep changing and continue to be more sophisticated. Again, most businesses are now service oriented than
simple manufacturing of products. Many businesses now compete on the quality of products, delivery, reliability,
services, and customer satisfaction. Therefore, these contemporary approaches are designed to ensure the
achievement of customer satisfaction.
ACCOUNTING FOR OVERHEADS
Overheads expenditure are those costs that cannot be directly assigned to products or services. Overheads consist
of indirect materials, indirect labour and indirect expenses. Examples of overhead expenditure may include
supervision, lighting and heating, rent and rates, depreciation of machinery and insurance. Since such expenditure
cannot be directly traced to or identified with a particular product or service, they are said to be 'over-the-heads of'
so many products or services.
Although overheads cannot directly be traced to individual products or services, generally accepted accounting
principles require that all direct manufacturing costs and overheads must be allocated to products and nonmanufacturing costs and overheads cost treated as period costs. The justification for this is that all manufacturing
overheads are incurred in the production of the firm's output, and so each unit of the product produced receives
some benefits from those costs. It follows that each unit of output should be charged with some of the overheads.
This means that some methods must be used to trace overheads to the products that brought the overheads about.
The procedures used to trace overheads to products or services are collectively known as overhead allotment.
STAGES OF OVERHEADS ALLOTMENT
The traditional overhead absorption procedures can be grouped into three main stages though each stage may be
sub-divided into other substages. These are
•
•
•
Overhead collection and classification
Overhead analysis
Overhead absorption
OVERHEAD ANALYSIS
This is the process of tracing overheads into the various production departments or cost centres. Although
overheads cannot be traced directly to the individual products or services, it is possible to trace them to the various
departments where they are incurred.
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This stage is usually divided into three sub-stages as follows:
• Overheads allocation
• Overhead apportionment
• Redistribution of service department overheads to the production departments
ABSORPTION OF OVERHEADS
The purpose of understanding accounting for overheads is to aid in charging overheads costs into product units.
The process of charging overheads into cost units is known as overhead absorption. It is the process by which
overheads are included in the costs of a product or service produced in a particular cost centre.
The cost centre or enterprise determines an appropriate basis for charging overheads into the cost units because of
the nature of the cost centre and the sort of activities carried out in that centre.
To determine the amount of overheads to be charged to a product or service, it is imperative to determine the
charging rate. This may also be referred to as the Overhead Absorption Rate (OAR) or Recovery rate.
Methods for Accounting Overheads
There are two main methods by which overheads may be charged or absorbed into product units. These comprises:
a) Conventional Overhead Absorption
b) Activity Based Costing (ABC)
ACTIVITY BASED COSTING (ABC)
The ideas behind the ABC have been around the world. This differs from the conventional system. At its simplest
understanding ABC can be thought of as a method of charging overheads to cost units on the basis of benefits
received from the particular indirect activity, e.g. ordering, planning, and setting, among others. ABC does not
only charge overheads to cost units on a more realistic basis but also makes an attempt to show the relationship
between overhead costs and the activities that cause them.
There are some similarities between ABC and conventional system, but a key difference is the way that the costs
of support activities are collected and then charged to cost units.
Basis of Activity Based Costing
The ABC is designed based on the following:
a) In the modern business environment, a larger proportion of total costs are overheads and labor costs relatively
minimal
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b) It is necessary to ensure that costs are accurately traced to the products that create the costs
c) The traditional methods absorb overheads based on direct labour or machine hours which are not justifiable.
TRANSACTION-BASED COST DRIVERS
The key idea behind the application of ABC is what factor causes or drives costs, known as Cost Drivers.
Cost Driver
Any factor which causes a change in the cost of the activity, e.g. the quality of parts received by an activity is a
determining factor in the work required by that activity and therefore affects the resources required. An activity
may have multiple cost drivers associated with it.
The challenge with the use of ABC is selecting an appropriate cost driver. Therefore, Cooper warns:
'There are no simple rules that pertain to the selection of cost drivers. The best approach is to identify the
resources that constitute a significant proportion of the product costs and determine their cost behavior. If
several are long term variable costs, a transaction-based cost system should be considered.'
Examples of transaction-based cost drivers are as follows:
COST POOLS
COST DRIVER
Production scheduling
No. of production runs
INFORMATION NEEDED FOR ABC
Number of production run or setup for each
product
Set-up cost
No. of production runs
Number of setups for each product
Material handling
No. of material handling Number of materials handlings for each
product
Finished goods stock handling & No. of orders delivered Number of stocks handled or dispatched for
dispatch
each product
Material Purchasing
No. of purchase orders
Number of orders for materials for each
finished product
Raw materials stock handling
No. of orders received
Number of orders for raw materials for each
product
Selling
Number of sales orders Number of orders for each product
Warehousing and dispatch
Number of deliveries Number of deliveries for each product
made
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Steps to Consider when using ABC
1. Group production overheads into activities, according to how they are driven. These may include material
handling, purchasing, reception, dispatch, machining, assembly, etc.
2. Identify the factors which determine the costs of an activity
These activities are known as cost drivers. Examples of such cost drivers include the number of purchasing
orders, number of orders, number of set-up, etc.
3. Collect the costs of each activity. These are known as cost pools and are equivalent to conventional cost
centres.
A cost pool is an activity which consumes resources and for which overhead costs are identified and allocated.
4. Calculate a cost driver rate for each activity. The cost driver rate is calculated in the same way as the
absorption costing OAR. However, a separate cost driver rate will be calculated for each activity, by taking the
activity cost and dividing by the total cost driver volume.
5. Charge or absorb support overheads to products based on their usage of the activity, expressed in terms
of the chosen cost driver (s).
Suitability of using ABC
ABC method of product costing may be more useful under the following circumstances:
• When a larger proportion of total costs are overheads
• When absorption costing is required for inventory valuation in a manufacturing environment
• Where products are complex to produce
• Where products are produced to customers specification – Jobs
Merits of ABC
• It provides a more accurate cost per unit. As a result, pricing, sales strategy, performance management and
decision making should be improved.
•
ABC provides is flexible enough to trace costs to processes, customers, areas of managerial responsibility, as
well as product costs.
•
ABC provides useful financial measures (e.g. cost driver rates) and non-financial measure (e.g. transaction
volumes)
•
The principle of using activities to trace costs can be applied across a range of service industries as well as
manufacturing firms
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•
ABC recognizes that it is activities which cause cost and not products. It is products which consume activities.
It provides much better insight into what drives overhead costs.
•
ABC provides a reliable indication of long-run variable product cost which is relevant to strategic decision
making.
•
It can be applied to derive realistic costs in a complex business environment.
Demerits of ABC
a) A full ABC with numerous cost pools and cost drivers is more complex compared to the traditional system and
thus will be more expensive to adopt
b) ABC will be of limited benefit if the overhead costs are primarily volume related or if the overhead is a small
proportion of the overall cost.
c) It is impossible to allocate all overhead costs to specific activities.
d) ABC can be more complex to explain to the stakeholders of the costing exercise.
Review Questions
Question 1
Bela Ltd makes and sells two brands of confections (Alewa) – Black and White. Information on the production
and sales for the current month is as follows:
Direct material costs per unit
Direct labour cost per unit
Black
8,000
GHS
40
4
White
16,000
GHS
20
8
Direct labour hours per unit (hours)
0.2
0.4
Sales (units)
Production overheads are GHS2m for the month. Analyses of the overheads show that there are four main activities
that cause the overhead expenditure. Details of the activities cost, and activities are shown below:
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Activity
Total Costs
Cost Driver
Total
number
Sweetened
Unsweetened
Batch set-up
Order handling
Machining
Quality control
Total
GHS
200,000
400,000
240,000
160,000
1,000,000
Number of setups
Number of orders
Machine hours
Number of checks
40
80
30,000
64
20
48
12,000
18
20
32
18,000
14
Required:
Calculate the full product costs for each product using:
a) Traditional absorption costing (absorbing production overhead over labour hour basis)
b) Activity-Based Costing
Question 2
The following three (3) products are produced by a company under the “1D1F” policy with additional information
provided.
Product
Units
Labour hours per unit
Number of units in a batch
Number of machine hours per unit
Cee
4,000
3
400
4
Dee
6,000
2.5
500
5
Gee
4,800
1.5
600
7
The annual overheads have been grouped under three (3) headings:
GHS
Labor related
45,000
Batch related
69,000
Machine related
120,000
Required:
i) Using the Activity Based Costing (ABC) technique, calculate the cost driver rates for each group of overheads
ii) Calculate the overhead costs per unit of product Cee under the ABC technique.
Question 3
Zanku Ltd, a manufacturing company, produces three products, A, B and C, all made from the same material.
Currently, overheads are absorbed on a labour hours basis and the company is considering an Activity-Based
Costing system. Information for the three products for the year is as follows:
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A
60,000
GHS
10.60
8.40
3.00
B
48,000
GHS
14.40
9.60
2.00
C
72,000
GHS
19.20
12.80
4.00
Information on activities for the year is given below:
Number of units per set-up
1,875
Number of purchase orders per annum
24
Number of supplies to customers per set-up
1.5
Machine hours per unit
2
2,000
28
1.25
3
4,500
42
3.875
4
Production and sales (volume)
Direct materials cost per unit
Direct labour cost per unit
Other direct costs
Labour is currently paid GHS2.50 per hour. The annual overhead costs and the cost drivers are as follows:
Machine running costs
Procurement costs
Supply costs
Set-up costs
GHS
265,600
192,000
217,280
106,200
Cost Drivers
Unknown
Unknown
Unknown
Number of set-ups
Required:
a) Calculate the full cost per unit under traditional absorption costing.
b) Using the Activity Based Costing (ABC), calculate the full cost per unit
c) Explain the implications of the company switching from the current absorption costing to the Activity
Based Costing.
d) Explain TWO (2) benefits derived from using ABC method.
Suggested Solution
a) Unit cost statement
Production and sales (volume)
Direct materials cost per unit
Direct labour cost per unit
Other direct costs
Prime Costs
Overheads (Working 1)
Total costs
A
60,000
GHS
10.60
8.40
3.00
22
3.50
25.50
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B
48,000
GHS
14.40
9.60
2.00
26
3.99
30.00
C
72,000
GHS
19.20
12.80
4.00
36
5.32
41.32
Activity Based Costing (ABC)
Production and sales (volume)
Direct materials cost per unit
Direct labour cost per unit
Other direct costs
Prime Costs
Overheads (Working 1)
Set-up
Machine Running
Procurement
Delivery
Total overheads per unit
Total cost per unit
A
60,000
GHS
10.60
8.40
3.00
22
B
48,000
GHS
14.40
9.60
2.00
26
C
72,000
GHS
19.20
12.80
4.00
36
47,200
57,600
49,021
74,496
35,400
69,120
57,191
46,560
23,600
138,240
85,787
96,224
3.81
25.81
4.33
30.33
4.78
40.78
Workings
Overheads Absorption rate (OAR) =
Budgeted Overheads
Budgeted Labor Hours
GHS
106,200
265,600
192,000
217,280
781,080
Budgeted Overheads
Set-up costs
Machine running costs
Procurement costs
Supply costs
Budgeted Hours
= (60,000 x 3.36) + (48,000 x 3.84) + (72,000 x 5.12)
= 201,600 + 184,320 + 368,640
= 754,560 hours
OAR = GHS1.04 per hour
ABC
Overhead recovery rates
Activity
Set-up
Machine Running
Procurement
= Cost Pool
Cost Driver
Cost Pool (GHS)
106,200
265,600
192,000
Number of Activities
(Cost Drivers)
72 (32+24+16)
552,000 (120+144+288)
94 (24+28+42)
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Absorption Rate
GHS
1,475 per set-up
0.48 per hour
2,042.55 per PO
Supply
217,280
140 (48+30+62)
1,552 per delivery
Question 4
Sanbra Ltd manufactures plastic components for the car industry. The management is considering adopting an
activity-based costing approach for setting its budget, in place of the current practice of absorbing overheads using
direct labour hours. The main budget categories and cost driver details for the whole company for July are set out
below:
The following budgeted information available for three of its key plastic components:
X
Y
Z
¢ per unit
¢ per unit
¢ per unit
Selling price
200
183
175
Direct material
50
40
35
Direct labour
30
35
30
Units produced and sold 10,000
15,000
18,000
The total number of activities for each of the three products for the period is as follows:
Number of purchase requisitions
Number of set –ups
1,200
240
1,800
260
2,000
300
Overhead costs have been analysed as follows:
Receiving/ inspecting quality assurance
¢1,400,000
Production scheduling / machine set up
¢1,200,000
Required:
Calculate the budgeted profit per unit for each product using Activity Based Costing.
Suggested Solution
Profit or Loss statement
Sales Price
X
10,000
¢
200
Y
15,000
¢
183
Z
18,000
¢
175
Direct cost (W1)
80
75
65
Total Direct Cost
800,000
1,125,000
1,170,000
Sales (units)
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Overheads: (W2)
Receiving Inspection
Scheduling
Total Overheads
Total Costs
Sales Revenue
Profit/(Loss)
96,000
360,000
456,000
1,256,000
2,000,000
744,000
504,000
390,000
894,000
2,019,000
2,745,000
726,000
560,000
450,000
1,010,000
2,180,000
3,150,000
970,000
Workings
Overhead Recovery Rate
Cost Pool
Cost Driver
Receiving/Inspecting
1,400,000
5000
¢280 per requisition
Set-up
1,200,000
800
¢1,500 per set-up
(W1)
Material
Labour
Direct cost/unit
50
40
30
35
80
75
35
30
65
Overheads
Receiving
X (1200 x 280)
Y (1800 x 280)
Z (2000 x 280)
96,000
504,000
560,000
Scheduling
W (240 x 1500)
X (260 x 1500)
Y (300 x 1500)
360,000
390,000
450,000
Question 5
Rabito is a private hospital carrying out two types of procedures on patients. Each type of procedure incurs the
following direct costs:
Procedures
Medical supplies
Direct labour
Stage One
¢
600
400
Stage Two
¢
880
540
Rabito currently absorbs overhead to each procedure based on the number of procedures performed. The
management accountant has suggested that this basis does not provide a fair justification of the overhead absorbed
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to each procedure, and therefore an alternative costing technique must be adopted. He has therefore obtained an
analysis of the company’s overheads for the last year and has submitted the following information:
Costs
Administration
Nursing costs
General facility costs
Cost Driver
Administration time per procedure
length of patient stay
length of patient stay
¢
935,080
776,965
534,600
The following additional information on activities are also gathered for the year:
Procedure
Stage One
No. of procedures
7300
Administration time per procedure (hours)
1.5
Length of patient stay per procedure (hours)
24
Stage Two
11,200
2.0
48
Required:
Calculate the full cost per procedure using Activity-Based Costing and the charge per procedure if Rabito expects
a minimum mark-up of 20% on full costs
Suggested Solution
Procedure
Stage One
¢
Stage Two
¢
Cost Element
Medical Supplies
Direct Labour
Prime Costs
600
400
1,000
880
540
1,420
Overheads
Administration
Nursing
General Facility
Total Overheads
42.0
26.4
18.0
86.4
56.0
52.8
36.0
144.8
Full cost per procedure
Mark-up (20%)
Charge
1,086.4
217.3
1,303.7
1,564.8
313.0
1,877.8
Workings:
OAR = Total Cost Pool
Total Costs Drivers
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Cost
Administration
935,080
33,350
OAR
¢28 per Admin Hr
Nursing
776,965
712,800
¢1.1 per patient stay
General Facility Costs
534,600
712,800
¢0.75 per patient stay
Question 6
Dior has three product lines: X1, X2 and X3. Since its inception, the company has been using a single direct labour
cost percentage to assign overhead costs to products. Despite X3 being a relatively new product line, it is attracting
additional business. However, increasing overhead costs has resulted in loss-making in recent times. X2
particularly has been a significant product line since its inception.
However, it has lost considerable market share due to an increase in overhead cost in recent times and consequent
increase in price per unit. Management is, therefore, convinced that the costing system needs some review. A team
led by the management accountant was put together to develop an improved system of costing based on activities.
The team spent several weeks collecting data for the different activities and products.
Below is data on Dior's three product lines and overhead costs for the current accounting period:
X1
Production volume (units)
7,500
Selling price per unit (GH¢)
47
Material cost per unit (GH¢)
18
Direct labour cost per unit (GH¢)
4
Materials movements (in total)
4
Machine hours per unit
0.5
Set-ups (in total)
1
The proportion of engineering work 30%
Orders packed (in total)
1
Activities overhead cost:
Machine maintenance and depreciation
Material receiving and handling
Engineering
Packing
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X2
12,500
80
25
8
25
0.5
5
20%
7
X3
4,000
68
16
6.4
50
0.2
10
50%
22
¢
390,000
150,000
100,000
60,000
Set-up labour
Total
18,688
718,688
Required:
Identify for each overhead activity an appropriate cost driver from the information supplied, and then calculate the
product unit costs using a system that assigns overheads based on the use of activities.
VALUE CHAIN ANALYSES (VCA)
Value chain analysis is a strategy tool used to analyze internal firm activities. VCA is model for analyzing and
understanding how an entity creates value. Value is the satisfaction a consumer derives from using a product. In a
business, a series of activities that are performed in a coordinated manner creates value for consumers. The goal of
VCA is to recognize which activities are the most valuable (i.e., are the source of cost or differentiation
advantage) to the firm and which ones could be improved to provide a competitive advantage.
Value chain analyses consider every step a business goes through, from raw materials to the eventual end-user.
The goal is to deliver maximum value at the least possible cost. VCA is an interconnected activity that creates
value.
Porter refers to Value chain analysis as “the internal processes or activities a company performs to design, produce,
and market, deliver and support its product… A firm’s value chain and the way it performs individual activities
reflect its history, its strategy, its approach of implementing its strategy, and the underlying economies of the
activities themselves.”
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Below is a chart depicting the flow of a firm’s activities.
Primary Activities
Inbound
Logistics
•
•
•
•
•
•
•
•
Operations
Outbound
Logistics
Marketing &
Sales
Services
Firms Structure
Lines of communication
Organizational structure
Chain of command
Finance
Administration
•
•
•
•
Technology
Product & Process
design
R&D
Market testing
Procurement
It concerns with the purchasing of
inputs or resources for use in the
business
Human Resource Mgt
Staff recruitment
Rewarding
Motivation
Counselling
Support/ Secondary Activities
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P
R
O
F
I
T
Details of the primary activities
Inbound logistics
Operations
Activities involving:
Activities
involving:
•
Receiving,
•
Warehousing, and
•
Inventory
management
of
sources materials
and components,
and storage till
they are needed.
•
Outbound logistics Marketing
sales
Activities related to: Involves:
•
Turning raw
materials and •
components
into finished
products.
•
Operational
activities
•
include
machining,
assembling,
packaging,
sorting,
testing, etc.
Distribution
•
Packaging
Sorting and
Shipping
•
and Service
Involves:
Activities after sale.
They include:
• Installation
Creating
awareness and
delivering
of •
products to final
consumers.
•
This includes •
activities such
as promotion,
advertising,
shipping, and
pricing
Training
Repair
Customer
service
The Value System
Value chain exists in every organization. It is also important to differentiate value chain analyses from a supply
chain. In the supply chain, there are different moving products from one entity through the end-user. For instance,
in a typical supply chain involving manufacturing and distribution, production begins with the manufacturer, to
the distributor, retailer, then eventually to the consumer. In each of the entities in the supply, they have their own
value chain activities. The sum of the respective value chain in each organization is termed as the value system.
The management accounting systems should assist management to identify areas in the business activities where
value can be created, or undue costs can be eliminated.
Objectives of Value Chain Activities
a) To build competitive advantage
In today’s era, it has become crucial to be distinguished from the competitors, value chain analysis helps a firm to
have some advantages over competitors which leads to higher prices, more customers and brand loyalty. It is
essential for a business to be successful.
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b) To increase customer satisfaction.
A firm’s efforts are directed towards the need for satisfaction of present and potential customers, which can be
done by increasing value and reducing cost.
c) To maximize profits.
The focus is on the elimination of non-value-added activities, reducing costs and increasing value which stimulates
customers to pay more for the offered value of products leads to the higher margin as well as increase the overall
profitability of the firm.
d) Reduced cost advantage.
By adopting VCA, costs can be reduced to a maximum possible extent by analyzing the value generated by the
activities and correspondence costs incurred by the same.
Limitations of Value Chain Analysis
The following are the limitations of value chin analysis:
a) Due to the breaking of operations into various segments, there is a chance of losing firm’s overall vision and
strategy.
b) Its application is limited to the manufacturing industries only as service industries found it difficult to
implement this technique.
c) It is a complex technique that requires hiring of experts.
d) The concept of value is theoretical as well as vague.
Question 1
Describe the concept of value chain analysis and its process and explain the activities involved in it.
Question 2
Every enterprise carries out several activities in their operational process to create value for their shareholders.
From time to time, these activities are reviewed for cost control, differentiation and for other competitive reasons.
You have just been appointed by a manufacturing company to assist in reviewing its business activities.
Required:
Identify and explain FIVE (5) key primary activities and TWO (2) secondary activities of manufacturing
organizations.
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BENCHMARKING
Benchmarking is the process of identifying the highest standards of excellence for products, services, or
processes, and then making the improvements necessary to reach those standards, commonly called “best
practices”. This helps companies to understand and evaluate their current position in relation to the best practice
(best in class). The concept of benchmarking is to identify an enterprise as the benchmark or the reference for
best practices.
Types Of Benchmarking
There are 4 different types of benchmarking.
a) Internal benchmarking.
b) Competitive benchmarking
c) Customer benchmarking
d) Process benchmarking
Internal Benchmarking
This is benchmarking which is focused on comparison using historical internally generated information. This has
to do with comparing your organization’s own performance against previous performances. Companies use this
to get an introverted view with regards to the growth of the company. Internal benchmarking can be used by
comparing internal performances of branches, departments, or trend analyses. The challenge with this is that it
will be difficult to compare performances when branches are at different locations. Example, a branch in the city
and that in a town will be difficult to compare.
Competitive Benchmarking
This is comparing the performance of a company with its direct competitor (s). Competitive benchmarking’ s
goal is to compare companies in the same markets which have competing products, services, or work processes.
Under this type of strategy, it is advantageous to see what a company’s related performance is. Only under certain
conditions with direct competitors, information would be easy to reach. Particularly information in the public
domain would be the most accessible. Competitors may choose to make it very difficult to obtain their priceless
information.
Challenges of Competitive benchmarking
a) Accessing from the competitor will be difficult unless the information is already in the public or competitor
is willing to share the information
b) The cost of the benchmarking could be high which may erode the benefits of the process
c) Difficulty in getting the management or employees to understand the purpose of the inter-company
comparisons. That is, after comparing the performance to competitor, what is the use. This must be explained
for the management to appreciate and work with it.
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d) Information from the inter-firm comparison may become an avenue for blaming the employees for nonperformance. If that happens the employees may be resentful of the entire process and become defensive.
Process Benchmarking
This focuses on the best work processes. Instead of directing the benchmarking to the business practices of a
company, similar procedures and functions are emphasized. This type can be used across dissimilar or unrelated
organizations. Areas of process benchmarking may include purchasing, call handling, order processing, delivery
systems, etc. This is all about how to improve processes and have superior processes to compete.
Although it is thought to be extremely effective, it is difficult to implement. Process benchmarking requires a
broad conceptualization of the entire process and a careful understanding of the procedures
Customer Benchmarking
Customer benchmarking involves understanding what the customer wants against what the company can or
provides. In this way, the gaps can be identified and worked on to meet the needs of the customer. This is about
customer expectations versus reality and closing the gap.
Categorization of Benchmarking
Functional benchmarking
This is performed externally against industry leaders or the best functional operations of certain companies.
The benchmarking partners are usually those who share some common technological and market characteristics.
They also seem to concentrate on specific functions. Because there are no direct competitors involved, the
benchmarking
partner is more willing to contribute and share. Functional benchmarking is a form of competitive benchmarking.
It could be the comparison of a function such as sales and marketing between two competitors.
Strategic Benchmarking
Strategic benchmarking involves the identification and comparison of strategies of different entities. This is to
find out why a company is more successful in its strategies than others. Strategic issues that may be benchmarked
include strategic objectives, strategic alliance, core competences, etc
Product benchmarking
Strategic benchmarking involves comparing the product of a competitor to an entity’s own products. That makes
it a form of competitive benchmarking. Areas of comparison may include the product concepts, features,
functionality, costs, etc. Product benchmarking is also referred to as reverse reengineering.
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The Benchmarking Process
This step involves identifying the strategic intent of the business or process to be benchmarked. Many times, this
information can be obtained by looking at the company’s mission statement which summarizes its main purposes.
Then selection of the actual processes to be benchmarked must be chosen. This consists of identifying Key
Performance Indicators. Then the customers’ expectations must be identified. Finally, the critical success factors
must be determined to benchmark. These factors are linked to successful business results.
Below are the processes in benchmarking:
• Identify the area of performance that must be compared to the benchmark partner
• Select a suitable benchmark partner
• Compare the product, service, or work process with the benchmark (or benchmark partner)
• Identify the gaps in performance between the benchmark and the product, service, or work process
• Identify the changes that can be made to improve performance
• Implement the improvements
• Monitor the success of the changes in improving performance and measure the benefits.
Advantages of Benchmarking
Increasing productivity
By simply looking outside itself, a company can identify breakthroughs in thinking. A similar process used in a
different way can shed light on new opportunities to use the original process. This can help in the increase in
productivity without necessarily increasing the production factors.
Assessment of performance
Benchmarking is defined as “the process of identifying and learning from best practices” anywhere in the world.
By identifying the “best” practices, organizations know where they stand in relation to other companies.
The other companies can be used as evidence of problem areas and provide possible solutions for each area.
When companies benchmark, they use partners to share information with and learn from each other.
Benchmarking allows organizations to understand their own administrative operations better, and marks target
areas for improvement. It is an ideal way to learn from other companies who are more successful in certain areas.
Additionally, benchmarking can eliminate waste and help to improve a company’s market share
Encourages Continuous improvement
With comparison to direct competitors, there is no room for complacency since companies are looking for ways
to always get a competitive advantage in the market. Benchmarking hence encourages organizations to always
be on their toes in order not to fall behind.
Learning from the success of others
Since benchmarking is about learning from the best practices, mistakes already made by more successful
companies can be learned from and avoided. This gives businesses a more direct route to success by looking at
what industry leaders did right to get to where they are currently.
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Disadvantages of Benchmarking
a) Other organizations may be unwilling to share information.
b) Employees may pay too much attention to performance and hence may ignore consumer needs.
c) Identifying best practices is difficult and may tend to be costly.
d) Best practice continually changes.
e) Benchmarking can be used to defend rather than to improve poor performance.
Implications for management and employees
Implementing the benchmarking process has implications on both management and employees of the company.
Benchmarking requires feedback and participation in all levels of the organization. Management must be able to
implement the process and train employees so that they will know and understand the process. In order to
benchmark effectively, there needs to be a strong strategic focus and some flexibility in achieving the goals set
forth by management. Perhaps the most important aspects of effective implementation are adequate planning,
training, and open interdepartmental communication.
Question
There are many tools for evaluation available to a Management Accountant. Benchmark is one of such models.
Required:
Under what circumstances would benchmarking be an effective model of evaluating performance.
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QUALITY
Quality is one of the elements of customer satisfaction. It is an important aspect of product design and marketing.
It represents standards or excellence.
•
Quality is associated with distinctive features that a product may possess. It is what makes a product unique
from others.
•
Product can also be referenced in terms of product price. It is a measure of value proposition to customers.
It is what makes customers choose to buy a competitor’s product over the other.
•
Quality could also mean the product meeting its intended purpose. Being functional as designed to achieve.
Free from errors or damage needing to be returned.
QUALITY CONTROL
Quality control is the process of managing the quality of products, service, work processes, and systems. Quality
control is intended to ensure that the actual product quality conforms to the set standards. Quality control involves:
•
•
•
Comparing actual product quality against the set standards or target
Reporting quality performance to the appropriate managers for action or identifying any quality variances
Taking corrective action where the actual quality underperforms the standards
It is worth noting that quality control is a proactive approach to achieving quality rather than a reactive approach.
It is to ensure that products or services meet the quality standards.
Measuring Quality
Quality is an embodiment of several underlying metrics. Quality can be measured by using the following
performance measures:
Performance Objective
Quality
Performance Measure
• % rate of defective product
• Number of customer complaints
• The # or cost of warranty claims
Speed
•
•
Lead time for processing orders
Production cycle time
Dependability
•
•
% of items delivered late
% of customer orders met from inventory
Flexibility
•
•
Range of product or services
New product development time
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Costs
•
•
Actual vrs budgeted
Labor productivity
QUALITY COSTS
Quality costs are the costs associated with preventing, detecting, and remediating product issues related to
quality. Quality costs do not involve simply upgrading the perceived value of a product to a higher standard.
Instead, quality involves creating and delivering a product that meets the expectations of a customer.
Cost of Quality is the total expenses incurred by an organization in achieving and maintaining good quality as well
as in managing poor quality throughout its line of operations with an aim of attaining the highest level of customer
satisfaction.
Therefore, quality costing technique has become as one of the most “effective management tool” for collecting and
“measuring” the expenses in maintaining quality in a production process and also identifies the non-value-added
expenses.
Quality costing is based on the saying that; “Prevention is better than cure”.
Components of Cost of Quality Cost of Quality (COQ) can be classified into two categories:
a)
b)
Cost of Conformance (COC) or Cost of Good Quality (COGQ)
Cost of Non-Conformance (CONC) or Cost of Poor Quality (COPQ).
Cost of Conformance (COC)
COC, also referred to as Cost of Good Quality (COGQ), can be defined as Costs associated with doing quality job,
conducting quality improvements, and achieving quality goals. These are the costs that aim at assurance of quality
and prevention of bad quality.
Cost of Conformance has two sub-divisions: Cost of Assurance and Cost of Prevention.
Prevention Costs
You incur a prevention cost to keep a quality problem from occurring. It is the least expensive type of quality
cost, and so is highly recommended. Prevention costs may include Costs of Verifications – checking of incoming
material, processes, products, and services to ensure that they conform to agreed specifications; Preventive
Maintenance; Calibration of measuring and test equipment etc. These are planned and incurred before the actual
operation and money is all spent before the product is built. The focus on prevention tends to reduce preventable
costs of bad quality.
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Cost of Assurance
These costs are associated with the quality requirements, systems and procedures, control measures and audits to
ensure appropriate quality standards are used and complied such as money spent on establishing methods and
procedures; Process Capability Studies; robust Product Design; proper employee training in performing good
quality job; supplier rating / supplier certification (assessment and approval of suppliers of products and services),
Quality audits (confirmation that the quality system is functioning correctly) acquiring tools, and planning for
quality. Quality assurance provides confidence in the system that ensures quality of deliverables.
Cost of Non-Conformance (CONC)
Cost of Poor Quality (COPQ) is the cost associated with all activities and processes that do not meet agreed
performance and / or expected outcomes. These costs would disappear if every task were always performed without
deficiency. These costs have two sub-divisions: Cost of Appraisal and Cost of Failure.
Appraisal Costs
Money spent to review completed products or supplied product against requirements. Appraisal includes the cost
of inspections, testing, and reviews. This money is spent after the product is built but before it is shipped to the
user or moved into the customer’s place.
They could include inspection of finished goods, field testing, pre- dispatch inspection, checking the shipping
documents before dispatch etc.
Cost of Failure
All costs associated with defective products produced and or that have been delivered to the user. These costs are
further sub-divided into Internal Failure Costs and External Failure Costs.
a) Internal Failure Costs
An internal failure cost is incurred when a defective product is produced. This appears in the form of scrapped
or reworked goods. The cost of reworking goods is part of this cost.
These are the Costs generated before a product is shipped but after a product is made and inspected and found nonconformance to requirements, such as – Product/service design failure costs (internal – Design corrective action;
Rework due to design changes; Scrap due to design changes); Purchasing failure costs (Purchased material reject
disposition costs; Purchased material replacement costs; Supplier corrective action; Rework of supplier rejects;
Uncontrolled material losses); Operations (product or service) failure costs (Material review and corrective action
costs – Disposition costs – Troubleshooting or failure analysis costs (operations).
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b) External Failure Costs
Costs generated after a product is shipped because of non-conformance to requirements, such as Complaint
investigation/customer service; Returned goods; Retrofit costs; Recall costs; Warranty claims; Liability costs;
Penalties; Customer/user goodwill; Lost sales; Other external failure costs which is the cost of losing customers.
Question
Valtech Limited manufactures and markets office communications systems. During the year ended 31 March 2024,
VL made an operating profit of ¢7.5 million on sales of ¢90 million. However, the directors are concerned that
products do not conform to the required level of quality and VL is therefore not fulfilling its full potential in terms
of turnover and profits achieved.
The following information is available in respect of the year ended 31 March 2024:
i)
Production data:
Units manufactured and sold
Units requiring rework
Units requiring warranty repair service
Design engineering hours
Process engineering hours
Inspection hours (manufacturing)
4,500
525
675
12,000
13,500
72,000
ii)Cost data:
Design engineering per hour
Process engineering per hour
Inspection per hour (manufacturing)
Rework per communication system reworked (manufacturing)
Transportation costs per repaired unit (distribution)
Warranty repairs per repaired unit (customer service)
¢
24
18
13
1,200
70
1,150
iii) Staff training costs amounted to ¢45,000.
Required
Prepare a cost analysis which shows actual prevention costs, appraisal costs, internal failure costs, and external
failure costs for the year ended 31 March 2024. Your statement should clearly show the total cost of quality.
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TOTAL QUALITY MANAGEMENT (TQM)
Total Quality Management (TQM) is a concept that helps in dealing with and eliminating quality costs where
necessary. It is argued that an entity must only invest to prevent and detect defective products if it reduces the
internal and external failure costs by a greater amount. If this is not the case, then it is not worth the investment.
However, TQM is of the view that it is necessary to invest in prevention costs. Once that is feasible the entity can
eliminate defective products.
TQM is the continuous improvement in quality, productivity and effectiveness through a management approach
focusing on both the process and the product.
TQM is a highly significant trend in modern business thinking. Because it embraces all aspects of an organization’s
processes to ensure that no aspect of the business is ignored. TQM is employed right from when resources are
brought into the company’s premises, process, and through when supplies get to the customers so as ensure that
customers are satisfied.
TQM is an integrated and comprehensive system of planning and controlling all business functions so that
products or services are produced which meet or exceed customer expectations – CIMA.
In effect, TQM is used to assess organizational performance in the following areas:
a) Measuring quality of incoming supplies
b) Monitoring or inspection of work done as it proceeds
c) Measuring customer satisfaction
Fundamental features of TQM
• Prevention of errors before they occur
• Constancy of purpose
• A new philosophy – defects, delays, errors are not tolerated
• Improve every process
• Importance of total quality in the design of systems and products
• Real participation of all employees
• Commitment of senior management to the cause
• Recognition of the vital role of customers and suppliers
•
•
•
•
Recognition of the need for continual improvement
Institute training on the job
Permit pride of workmanship
Drive out fear.
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Benefits of TQM
•
Less product defects. The objective of TQM is to create products and services correctly the first time. This
means that products ship with fewer defects, reducing product recalls, future customer support overhead and
product fixes.
•
Satisfied customers. High-quality products that meet customers' needs result in higher customer satisfaction.
High customer satisfaction, in turn, can lead to increased market share, revenue growth via upselling and
word-of-mouth marketing initiated by customers.
•
Lower costs. As a result of less product defects, companies save money on customer support, product
replacements, field service and creating product fixes. The cost savings flow to the bottom line, creating
higher profit margins.
•
Well-defined cultural values. Organizations that practice TQM develop and nurture core values around
quality management and continuous improvement. The TQM mindset pervades across all aspects of an
organization, from hiring to internal processes to product development.
Disadvantages of TQM
•
Planning and resources. TQM needs a significant amount of planning and resources over time to be properly
allocated to the change.
•
Companywide commitment. Continuous improvement in TQM means the organizational culture must
focus on improving processes. All management levels must be supportive.
•
Added costs. TQM might add training, infrastructure and team development costs.
•
Time. It might take years for an organization to fully show intended results.
•
Partial efforts. Because of the effort involved in implementing TQM, a partial move toward it can result in
failure.
CONTINOUS IMPROVEMENT
Continuous improvement is part of the TQM as the TQM ensures the prevention and detection of defective products
right from the beginning of the work processes. Continuous improvement about achieving minor improvements on
a continuous basis. Continuous improvement must not just be an event but an on-going activity. It is about
continuing to find ways to improve regardless of how much improvement is made. There must be consistency and
not a one-off improvement.
Below expands on the meaning of continuous improvement in accordance with ISO 9004:
• Involves the entire organization
• Initiates quality improvement activities
• Investigate possible causes of quality problems
• Establish cause-and-effect relationships
• Take preventive or corrective action to improve quality
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•
•
•
Confirm improvement
Sustain the gains
Continue the improvement
Quality Circle
Quality circle is like the value system and the quality chains (the interrelationship of various activities within the
work process). It is worth noting per the concept of TQM, quality is a process (chain of activities) and not an event.
So, the quality must be encompassing all the activities in the work process.
However, quality circle involves some individuals identifying quality issues and finding ways to improve them.
Quality circle is a way of achieving continuous improvement. In this circle, everyone, whether a senior manager
or employee contributes to finding solutions to work problems.
TARGET COSTING
Target costing is a system of costing where the cost of a product or services is predetermined by reference to the
product’s estimated selling price and the organization's expected profit margin. It is ‘a product cost estimate
derived by subtracting a desired profit margin from a competitive market price. This may be less than the
planned initial product cost but will be expected to be achieved by the time the product reaches the mature
production stage'. In the real world, companies that apply target costing include Toyota Corp, Swatch, etc.
It is worth noting that the need to meet an expected product cost does not mean compromising on product quality.
The whole idea is to determine how much a product or service should cost to meet consumers value proposition –
Economic Value Pricing.
The aim of target costing will be to meet customer requirements such as quality and reliability at the minimum
possible cost. This will be based upon the most cost-effective design, materials and production process, irrespective
of whether the company currently the capacity to realize the plan on which the cost is based.
In effect, target costing is the reverse of traditional cost-plus pricing. Thus, in a traditional cost-plus pricing, the
price of a product is determined by adding a profit margin to the product’s actual cost incurred – pricing is the
bottom line; however, with target costing, product cost is the bottom line.
Target costing has a positive impact on pricing and cost control and performance management. For instance,
whereas traditional costing may ignore the value consumers are willing to place on the product, and how much
competitors are offering the same product on the market; target costing is engineered to address all these lapses in
the former.
Deriving Target Cost
a) Estimate a selling price for a new product that considers how much consumers are willing to pay and how
much competitors are charging. This selling price will help the firm capture the appropriate share of the
market.
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b) Reduce this figure by the firm's required level of profit. This could take into account the return required on
any new investment and on working capital requirements or could involve a target margin on sales.
c) Produce a target cost for the product designers to meet.
d) Reduce costs to provide a product that meets that target costs through value engineering.
Value Analyses
Value analyses are also referred to as 'cost engineering' or 'value engineering’. This is a technique in which a
firm's products, and maybe those of competitors, are subjected to a critical and systematic examination by a small
group of specialists. In this critical examination, several questions including the following are dealt with:
a) Does the use of the product contribute value?
b) Are its costs proportionate to its usefulness?
c) Does it need all its usefulness?
d) Is there anything better for the intended use?
e) Can a usable part be made better?
f) Is it made on appropriate tooling, considering the quantities used?
The implication of using target costing on pricing
•
Target costing considers competitor's pricing and how much consumers are willing to pay
•
Target costing is usually considered superior to cost-plus pricing as it considers the demand for a product or
service. This is done with reference to the fact that costs are controlled to set prices that are more competitive
to capture the required market share.
Implication on cost control and performance
•
Target costing has a potentially major positive impact on cost control since it seeks to change the accounting
from one of recording costs to one of reducing costs in order that the cost target can be met.
•
The requirement to meet target costs can generate new ideas and new ways of working which in turn can
generate substantial cost savings and facilitate a more proactive to cost control.
•
Performance management is also potentially enhanced since the setting of target costs requires a business to
identify how costs can be managed down to the target cost level. This may involve service or product
redesign.
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Question 1
Asafo Coy Ltd is about to launch a new type of digital radio on which it requires profit per unit of ¢80. The expected
sales level is 80,000 units and at a selling price per unit of ¢250. Total costs per unit of a radio are currently
estimated at ¢185 per radio.
Required:
a) Calculate the target cost per unit of radio
b) Explain the possible ways the company could eliminate the target cost gap (if any).
PRODUCT LIFE CYCLE
A product’s life cycle is the amount of time a product goes from being introduced into the market until it's taken
off the shelves. The term product life cycle refers to the length of time from when a product is introduced to
consumers into the market until it's removed from the shelves.
There are four stages in a product's life cycle—introduction, growth, maturity, and decline.
A life cycle of a product is shown and analysed below:
KAIZEN COSTING
Kaizen is a Japanese term that means ‘change for the better or ‘Continuous Improvement.’ It is a business
philosophy dating back to World War II. Makai Imai was a Japanese researcher and management consultant who
coined Kaizen. Kaizen was first applied by Toyota in the 1950’s after World War II had ended. It is underlined by
continuous improvement and TQM.
Kaizen costing is a system of cost reduction via continuous improvement. It tries to maintain present cost levels
for products currently being manufactured via systematic efforts to achieve the desired cost level.
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Kaizen Costing is a costing technique to reflect continuous efforts to reduce product costs, improve product
quality, and/or improve the production process after manufacturing activities have begun. Kaizen costing involves
making continual, incremental improvements to the production process during the manufacturing phase of the
product/service lifecycle, typically involving setting targets for cost reduction.
Kaizen cost-targets or Implementation of Kaizen Costing
In order to achieve cost reduction, variable as well as fixed costs are considered. However, since fixed costs are
needed to maintain continuous growth, Kaizen cost is achieved mainly by reduction in the variable costs, direct
material and direct labor costs. In non-manufacturing departments, reduction is achieved through fixed cost items.
Targets for kaizen costs are set monthly based on the following procedure:
➢ Per product actual cost in the previous year = Total actual cost of last year ÷ Actual production in last year
➢ Estimated amount of total current year’s actual cost = Per product actual cost in the previous year x Estimated
production for the current year
➢ Kaizen cost target for the current year = Estimated amount of total current year actual cost x Ratio of cost
reduction target
➢ Assignment cost to each plant (assignment ratio) = Cost directly controlled in single plant ÷ cost directly
controlled in all plants
➢ Kaizen cost target for each plant = Kaizen cost target for the current year x Assignment ratio
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Kaizen Costing and the Seven Waste Management
Kaizen costing has been developed to support the continued cost reduction of existing components and products.
One of the main ways to reduce costs is through the elimination of the seven main types of waste:
a) Over-production - produce more than customers have ordered.
b) Inventory - holding or purchasing unnecessary inventory.
c) Waiting - production delays/idle time when value is not added to the product.
d) Defective units - production of a part that is scrapped or requires rework.
e) Motion - actions of people/equipment that do not add value.
f) Transportation - poor planning or factory layout results in unnecessary transportation of materials/work-inprogress.
g) Over-processing - unnecessary steps that do not add value
Types of Kaizen Costing
There are two main types of Kaizen costing namely:
1. Asset Based: Under this part enterprises endeavour to reduce the cost of the asset and the cost of
manufacturing
2. Product Based: This is product specific, that is, reducing the cost of producing a product.
5S’ in Kaizen Costing
The S
Performance
• Categorizing the items based on their necessity
Sort
• Unnecessary items should be labelled red and needs to be moved out of the
organization. These items can be sold to the staff or as scrap else can be dumped
by the organization.
•
•
•
Straighten
Now, the organization is left with essential items.
These must be arranged in an orderly manner to simplify the operations.
This step improves the visibility, availability, and accessibility of all the tools
and items.
Shine
•
•
Shine refers to maintaining cleanliness at the workplace
It creates a positive work environment for the employees
Standardize
•
To establish standards for cleanliness, usability and maintaining the placement
of items in day-to-day business operations
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Sustain
•
•
The final step is to communicate and educate the employees about the changes
made.
Thus, developing a sense of self-control and discipline among them to maintain
and follow the set standards
ADVANTAGES OF KAIZEN COSTING
▪
▪
▪
▪
▪
▪
▪
▪
Customer Satisfaction
Forming Work Teams
Continuous Improvement
Creates a Better Work Environment
Problem Solving
Promotes Cross-Functional Teams
Widely Applicable
Reduces Wastage
DISADVANTAGES OF KAIZEN COSTING
▪
▪
▪
The burden on Lower-Level Management
Lack of Training
Permanent Change System
Question 1
Bossu Ltd manufactures webcams, devices for live streaming videos and audio. It has recently been suffering from
low demand for this product and hopes that this low demand can be resolved by launching a new webcam. The
webcam is expected to have a product life cycle of two years. Market research has been carried out to establish a
target selling price and projected lifetime sales volumes for the product. Cost estimates have also been prepared
based on the current proposed product specification.
Bossu Ltd uses Life Cycle Costing to work out the target costs for its products. The following information is
relevant on the webcam:
Projected lifetime
Sales volume
100,000 units
Target selling price per unit ¢400
Target profit margin
35%
Estimated lifetime costs per unit:
Manufacturing costs
Direct materials (bought in parts)
Direct labor
Machine costs
¢
80
52
48
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¢
Quality control
Non-manufacturing costs
Cost per unit
20
200
120
320
Additional information:
Direct material costs: All the parts currently offered for the webcam are bespoke parts. However, most of these
can be replaced with standard parts costing 55% less. However, three of the bespoke parts, which currently
account for 20% of the estimated direct material cost, cannot be replaced, although an alternative supplier
charging 10% less has been sourced for these parts.
Required:
a) Compute the target cost of the new webcam and the target cost gap, if any.
b) Suggest three (3) possible ways for closing the target cost gap
c) Explain the concept of Kaizen Costing and how Mano Ltd may adopt it in the manufacture of the new webcam.
Suggested Solution
a) Target Cost
Target/Market selling price
Profit margin (35% x 400)
Target costs
¢
400
(140)
260
Target costs Gap = 283.2 – 260
23.2
Actual Cost (320 – 80 + 43.2**)
283.2
b) Closing the Target cost gap
• Replace the bespoke parts with standard parts
• Value Analysis of the webcam to consider whether all its functionality is required by consumers
• Reconsider how the costing method for charging the quality control costs
• Evaluate the non-manufacturing processes to eliminate any non-value addition processes.
• Product redesign
c) 'Kaizen' translates as continuous improvement. Functional analysis is applied at the design stage of the new
product, and a target cost for each function is set.
The functional target costs are added together, and the total becomes the product target cost. Once the product
has been in production for a year, the actual cost of the first year becomes the starting point for further cost
reduction. It is this process of continuous improvement, encouraging constant reductions by tightening the
'standards', that is known as kaizen costing.
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Application of Kaizen costing as follows
The previous year's actual production cost serves as the cost base for the current year's production cost. A reduction
rate and a reduction amount are set. Actual performance is compared to the Kaizen goals throughout the year and
variances are monitored. At the end of the current year, the current actual cost becomes the cost base for the next
year. New (lower) Kaizen goals are set and the whole process starts again.
BUSINESS PROCESS REENGINEERING (BPR)
Business process re-engineering (BPR) is the radical redesign of business processes to achieve dramatic improvements
in critical aspects like quality, output, cost, service, and speed. Business process reengineering (BPR) aims at cutting
down enterprise costs and process redundancies on a very huge scale.
Hammer and Champy defines BPR as “the fundamental rethinking and rational re-design of the business processes to
achieve a dramatic improvement in critical contemporary measures of performance such as costs, quality, speed, and
service”.
The aim of BPR is to make changes to the operation or process and radically re-design what is carried out. It is worth
noting that BPR and Business Process Improvement (BPI) may appear to be the same; but that is not the case. The
latter involves making some minor or major changes to some aspects of the business to ensure continuous
improvement. However, BPR involves a total radical overhaul of the entire business processes to be add value and be
competitive. BPR does not matter if employees may have to lose their jobs, heavy cost cutting, product redesign,
accounting systems, etc.
Principles of BPR
• There must be a total rethink of business processes. Work must be looked at a cross-function of the enterprise
• Work must be organized around the natural flow of information
• Work should be organized around what the process produces and not around the task that goes into it
NB:
The principle underlying the BPR is that rethinking or the radical changes to be made to the process must be guided
by the intended goals or the end-results. So, under the BPR, it is not about the functions or the current processes, but
how the new expected goal results in entirely new processes.
Again, it is about shortening the processes or doing away with intermediary departments. That is the customer of a
process must be his own supplier. For instance, when sales places customers through procurement, in BPR, the
procurement may be scrapped for the sales dept to handle their own transactions from point to point.
This helps to improve performance, cost effectiveness, ownership of space and time, and economical.
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Five steps of Business Process Reengineering (BPR)
To keep business process reengineering fair, transparent, and efficient, stakeholders need to get a better
understanding of the key steps involved in it. Although the process can differ from one organization to another, these
steps listed below succinctly summarize the process:
Below are the 5 Business Process Re-engineering Steps:
1. Map the current state of your business processes
Gather data from all resources–both software tools and stakeholders. Understand how the process is performing
currently.
2. Analyze them and find any process gaps or disconnects
Identify all the errors and delays that hold up a free flow of the process. Make sure all details are available in the
respective steps for the stakeholders to make quick decisions.
3. Look for improvement opportunities and validate them
Check if all the steps are necessary. If a step is there to solely inform the person, remove the step, and add an
automated email trigger.
4. Design a cutting-edge future-state process map
Create a new process that solves all the problems you have identified. Don’t be afraid to design a totally new
process that is sure to work well. Designate KPIs for every step of the process.
5. Implement future state changes and be mindful of dependencies
Inform every stakeholder of the new process. Only proceed after everyone is on board and educated about how the
new process works. Constantly monitor the KPIs.
ENVIRONMENTAL MANAGERIAL ACCOUNTING (EMA)
Environmental Management accounting is designed by entities to understand the effect of their operations on the
environment and how best they can mitigate the costs impact on the business such as fines for environmental
pollution and image risks. Entities must operate and understand that their corporate citizens and therefore they
must respect their environments to avoid any pressure from the other citizens.
Environmental accounting aims at achieving sustainable development, maintaining a favorable relationship with
the community, and pursuing effective and efficient environmental conservation activities. These accounting
procedures allow a company to identify the cost of environmental conservation during the normal course of
business, identify benefit gained from such activities, provide the best possible means of quantitative measurement
(in monetary value or physical units) and support the communication of its results.
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It is worth noting that if environments are ignored it comes at a cost to the business, and equally, when the business
decides to adopt best environmental practices, that also affects the business’ costs. Either way there are cost
implications.
EMA provides management with relevant information (financial and non-financial) on how to make environmental
decisions.
Applications of EMA
EMA is applicable in the following circumstances:
a) To estimate annual environmental costs
b) Budgeting
c) Product pricing
d) Investment appraisal
e) Estimating savings from environmental projects
Types of Environmental Costs
This technique, as suggested by the US Environmental Protection Agency, identifies alternative terminology for
environmental costs. These include:
Terminology
Conventional costs
Meaning
These are environmental costs of materials and energy that have
environmental relevance and can be captured in costing systems.
Potentially hidden costs
These are costs that may get hidden or lost within the general heading
of “overheads”.
Contingent costs
These are environmental costs that may arise in future. Examples are
rehabilitation costs, clean-up costs, etc.
These are costs incurred in promoting an environmental image.
Image and relationship costs
Techniques for Accounting for Environmental Costs
Accounting for environmental costs may involve the use of the following techniques:
• Redefining costs
• Environmental ABC
• Environmental life-cycle costing
• Input/Output analyses
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Environmental Activity based costing (ABC)
ABC applied to environmental costs distinguishes between environment-related costs (Cost Pool) and
environment-driven (Cost drivers) costs. The former is attributed to joint environmental cost centres, for
example incinerators or sewage plants.
The four main allocation keys are:
• Volume of emissions or waste
• Toxicity of emission and waste treated
• Environmental impact added (volume x input per unit of volume) volume of the emissions treated, and
The relative costs of treating different kinds of emissions.
Life-cycle costing
Within the context of environmental accounting, life-cycle costing is a technique which requires the full
environmental consequences, and, therefore, costs, arising from production of a product to be taken account across
its whole lifecycle, literally ‘from cradle to grave’. It summarizes all the costs associated with the lifecycle of a
product regardless of who bears those costs. This method connects the conventional approach to life cycle costing
to also including environmental and social costs.
Input/output analyses
This technique involves considering the relationship between the quantum of inputs taken from the environments
and how much output is produced from these inputs.
The purchased input is regarded as 100% and is balanced against the outputs – which are the produced, sold and
stored goods and the residual (regarded as waste). Materials are measured in physical units and include energy and
water. At the end of the process, the material flows can be expressed in monetary units. So, if 100kg of materials
have been bought and only 80kg of materials have been produced, then the 20kg difference must be accounted for
in some way. It may be, for example, that 10% of it has been sold as scrap and 90% of it is waste. By accounting
for output in this way, both in terms of physical quantities and, at the end of the process, in monetary terms too,
businesses are forced to focus on environmental costs.
Functions of Environmental Accounting
The functions of environmental accounting are divided into internal and external functions.
Internal Functions
As one step of a company’s environmental information system, internal function makes it possible to manage
environmental conservation cost and analyze the cost of environmental conservation activities versus the benefit
obtained and promotes effective and efficient environmental conservation activities through suitable decisionmaking.
Internal functions are carried out within a company. They assess the cost incurred by environmental conservation
activities and the related benefits and are beneficial in improving the efficiency and effectiveness of environmental
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conservation activities and help in gaining an understanding of what impacts such activities might have on business
operations. By using environmental accounting as an environmental information system, it plays the role of a tool
to be employed by management and related business segments.
External Functions
By disclosing the quantitatively measured results of its environmental conservation activities, external functions
allow a company to influence the decision-making of stakeholders, such as consumers, investors, and local
residents.
External functions are effective in conveying information about a company’s environmental activities to
stakeholders. Environmental accounting data is made public through environmental reports and covers a
company’s stance on environmental conservation activities and concrete measures being taken by the company.
By disclosing such information, society’s trust and confidence in the company improves and aids in achieving a
better public assessment. Therefore, environmental accounting not only fulfils a company’s accountability to
people outside the company, such as consumers, investors and local residents, but also facilitates attaining a fairer
corporate assessment, not just from the standpoint of environmental conservation.
Elements of Environmental Accounting
Environmental accounting as defined under these guidelines consists of the following structural elements with the
purpose of attaining two types of benefits derived from costs incurred from environmental conservation activities
during the regular course of business.
Environmental Conservation Cost Associated with Conservation Activities
Investments and expenses related to the prevention, reduction, and/or avoidance of environmental impact, removal
of such impact, restoration following the occurrence of a disaster, and other activities are measured in monetary
value.
Economic Benefit Associated with Environmental Conservation Activities
Benefits to a company’s profit as a result of carrying forward with environmental conservation activities are
measured in monetary value.
ACTUAL BENEFIT
Revenue
The results from environmental conservation activities are shown on the company’s financial statements as revenue
for the current period. These revenues include the income derived from the recycling of used products or waste
generated by key business operations.
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Expense Saving
These are avoidance of expenses by conducting environmental conservation activities in comparison with the
previous year based on solid confirmation.
Expense Saving through Lower Resource Input into Business Activities
Expense savings of resources input can be achieved through the reduction of raw material costs by recycling
resources or more effective usage or reduction of energy costs by energy conservation, and reduction of water bills
by using recycled water.
Expense Savings Resulting from a Decrease in Environmental Impact and Lower Waste Emissions
Of the expenses incurred due to environmental impact and waste emissions, expense savings can be achieved by
lowering statutory expenses through a reduction in the emission of regulated environmental pollutants, trimming
wastewater treatment expenses by recycling water, and decreasing waste disposal expenses through resource
conservation and recycling.
Expense Saving for Environmental Remediation
These are the amount which a company can reduce its conventional expenses for environmental remediation, such
as funds to build-up provisions and insurance premium payments in the current period.
Question
IFAC describes Environmental Management Accounting as “The management of environmental and economic
performance via management accounting systems and practices that focus on physical information on the flow of
energy, water, materials, as well as monetary information on related costs, earnings and savings”. The above
quotation shows the increasing relevance of Environmental Management Accounting.
Required:
Discuss with examples FOUR (4) categories of environmental costs.
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THE IMPACT OF TECHNOLOGY DEVELOPMENT ON MANAGEMENT ACCOUNTING
Almost all management decisions have been replaced with artificial intelligence. It is no different that the work of
a management accountant has been impacted by technological developments. There are areas of the management
accounting functions that have been influenced by technology.
Application of technology in forecasting and analytics
Technology has facilitated management accounting in collecting, analyzing, processing, interpreting and the
storage of large amounts of data. All business sizes employ technology to facilitate their operations such product
design, processes, decision-making, communication and other areas to improve performance and compete well.
Data Analytics
This is a form of technology that helps in data analyses. It is used in data collection, processing, analyses and the
storage of data in large quantities. This technology helps management at all levels to access relevant information
for real-time decision making. In effect, this Artificial Intelligence helps reduce the incidence of human bottlenecks
in data processing.
Forecasting
decision making involves planning or forecasting. Management must be able to use available information to plan
the future. Budgeting is one of the methods of forecasting. Technology can assist in these areas to perform a more
sophisticated forecast as quickly as possible. This can also be used for complex forecasting.
Real-time
It is worth noting that there are continuous changes in the environment and information. Changes in information
will likely impact on your decisions; and decisions need to be updated in real time with the help of Artificial
Intelligence (AI) or technology.
The finance function and Information Technology
Information Technology impacts every part of the world of business. Therefore, its influence on the finance
function cannot be over emphasized. Areas in finance influenced by IT include:
Analyses of data
The finance function deals with a great volume of financial data, and it is more complex when done manually. IT
helps in collecting and analyzing voluminous and complex data in real-time.
Forecasting analyses
With the help of IT, the management accountant can be able to make forecasting with ease using various forecasting
techniques. This helps the management accountant to contribute to business strategies or the entity’s long-term
plans.
It is worth noting that that management accountant must work with IT personnel. The argument is whether the
Management Accountant must be necessarily IT inclined or whether there is the need to have IT personnel in place
to assist.
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CLOUD ACCOUNTING
Cloud accounting is the use of cloud computing services for accounting functions. It is a system of accounting
where the storage and processing of accounting data is hosted by an external party. In effect, cloud accounting is
an outsourcing of storage, processing and the hardware required for data analysis or forecasting to an outside
enterprise such as google or amazon.
Cloud accounting is a system that allows multi-user access and safe online or remote server storage. Your users
send all your data to cloud providers where the same data is processed and safely stored and returned. Cloud
technology allows business processes to be streamlined and tailored to company growth.
Difference between cloud accounting and traditional accounting
The difference between cloud accounting and traditional accounting software is that since cloud accounting is
remotely hosted, you and your team can access your files from anywhere rather than being obligated to work in
the office. Cloud accounting collaboration is easier because of convenient multi-user access, and you’ll have less
of the paper clutter that comes with traditional accounting software use.
Cloud Accounting software or packages include FreshBooks, NetSuite ERP, Microsoft Azure, QuickBooks online,
Amazon Web Services (AWS), etc.
Benefits of cloud accounting
a) It allows access to a range of IT services or skills
b) Improvement in data quality relative to in-house IT services
c) Limited or little investment in IT equipment since services are outsourced
d) Readily available support from IT specialists
e) Access to information at any location and anytime
f) Up to date view of the business so relevant decisions can be made in real-time
g) It makes collaboration easier. Since data inputs can be done at different locations and from any person. The
management accountant can access information from another person when given access.
h) Accuracy of information or report
i) Reduce the amount of paperwork and declutter the office – paperless
Risks associated with cloud accounting
a) Less control or security over data
b) Legal implications for data protection
c) Changing service providers can be challenging as it involves the transfer of files to the new provider.
d) Technical issues that cause system downtime
e) Privacy breaches
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Question
In their efforts to build equitable, resilient and sustainable systems for health, both the Global Fund and Gavi have
approached you on the implementation of ABC systems to improve on their customer profitability analyses.
Required:
Assess the applicability of ABC in the service sector (In explaining your answer, identify four units in the health
sector that ABC systems are applicable and an appropriate cost driver).
ICAG NOV 2024, Q3b
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