1. Presented to Finance Leaders Association
November 20, 2010
Buffalo Grove, Illinois
Barrett Peterson, C.P.A.
Manager, Accounting Standards, Procedures & Analysis
TTX

2. 
 Political risks – laws, regulations, changes in officials
 Global financial system
 Central bank actions and agreements; the impossible trinity
 “Hot capital “flows
 Global trade
 Wage rates and wage arbitrage – outsourcing/off-shoring
 Comparative advantage
 Emerging consumer markets’ growth rates
 Commodity distribution and economic power
 Oil
 Gas
 Coal
 Rare earths minerals
 Cadmium [think batteries]
 Fresh Water – a problem now and growing
Strategic Cost Management – Global
Drivers

3.  Quantitative Easing 2 and U.S. long-term interest rates:
advantage commodity prices
 U.S. Health care act [including 1099 political error]
 US deficit reduction committee chairmen’s “proposal”
 U.S. new consumer protection agency
 U.S. near term legislative prospects and the budget
 Basel III increased capital requirements
 Swiss capital requirement increases
 Turkey capital increases aimed to reduce “hot capital”
 Bank capital {equity and near equity} requirements
 Global Trade
 G-20 “rebalancing” and trade discussions
 South Korea trade agreement
 Commodity prices, including “rare earths”
Strategic Costs – Select Current
Considerations

4. 
Product and Service Design
Product Line Planning
Process Design and Planning
Capacity Management
Market Segment Decisions
Sales and Marketing Channel Decisions
Logistics and Distribution
Outsourcing
The Role of Strategic Cost
Management – Impacted Decisions

5. 
 Single product entities can use just about any costing
method reliably
 Entities with few products with little difference in
resource consumption patterns can use simple cost
allocation methods: Activity Based Costing will add
little or no value
Cost Management Simplification

6. 
 Price is an input unit measure
 Driven by units acquired
 Usually denominated as amount per unit acquired
 Cost is an output measure
 Usage inefficiency can drive waste, reducing output
volume, and dramatically increasing cost both directly
and by slow-down
 Quality can affect waste and customer perception of
price, perhaps lowering price realization, reducing
margin [“increased cost”]
Cost –Key Reminder: Cost is not
equal to resource price

7. 
Cost objects – key for today
 Resources
 Processes
 Products
 Cost Management Objectives
 Effectiveness – doing the right things
 Efficiency – doing things right
 Economy – maximizing margin [can include cost
reductions, or improving revenues]
Strategic Cost Management Key
Aspects

8. 
Resource Elements
 People – employees, consultants, advisors
 Facilities, owned or leased
 Equipment, owned or leased
 Materials
 Services – insurance, banking, etc.
 Capital – Equity, debt, leasing, hedging, etc.
Cost of Business – Elements &
Drivers

9. 
Cost Management Resources -
People

10. 
Cost Management Resources –
Facilities, Equipment

11. 
Cost Management Resources –
Technology Improvement

12. 
Cost Management Resources -
Capital

13.  Drivers
 Product Design, including features [market segments],
appearance, materials, packaging, and expected life
 Process Design
 Technology – Operations, Support Functions
 Logistics Requirements
 Marketing and Sales Methods
 Capital Markets
 Value Chain Position
 Cultural Expectations and customs
 Legal Compliance
 Tax
 Regulation
 Financial Reporting
 Conduct and Social Responsibility
Cost of Business – Elements &
Drivers

14. 
Cost Management - Drivers

15. 
 Products
 Product Lines
 Processes
 Customers
 Distribution Channels
 Facilities
 Departments
 Individual Machines
Cost Accounting Objects

16. 
 Strategic/Long-Term
 Target Costing
 Activity Based Management (ABM)
 Intermediate
 Activity Based Costing/Management (ABC/M)
 Marginal Analyses – direct costing
 Tactical/Short-term
 Margin Oriented – Grenzplankostenrechnung (GPK)
 Full Absorption – Traditional or ABC
Cost & Profit Management Time
Frames

17. 
 Economic Trade-off based
 Target Costing
 Life Cycle Costing
 Allocation Based Methods
 Traditional Product Based Allocation – Fixed vs. Variable
 Driver Based Allocation
 Resource Consumption Accounting
 Activity Based Costing (ABC) applied to product objects
 Theory of Constraints (TOC)
 “Costed” resource consumption analysis [“Pure RCA]
 Allocation Free or Limited – Direct/Attributable Costing
Oriented
 Marginal Analyses [Direct/Attributable Costing]
 Grenzplankostenrechnung (GPK) [marginal plus fixed]
Cost Practices & Techniques

18. 
 Full absorption focused
 Traditional – organization structure centered,
organized around organizational, often “siloed”,
departments
 Process /Activity focused – relies on assigning costs
directly when possible, and using process drivers to
allocate indirect cots
 Production Management focused
 Marginal costing and process focused – GPK, although
GPK also contains a strong cost center focus
Cost Practices & Techniques

19. 
The Importance of Strategic Cost
Management

20. 
 External Financial Reporting – GAAP: focused on
aggregate inventory levels and consistency to inform
investment decisions by investors
 Income Tax Compliance – generally similar focus as
external financial reporting plus “full absorption” to
establish tax liability
 Profitability Management – Product, Channel, Customer
or Customer Class Focused
 Performance Management – Operating Function,
Department, Process, Channel, Customer or Customer
Class Focused
Costing Method Objectives

21. 
 External parties
 Capital provision determinations – costing at entity
level aggregation is all that is needed
 Tax compliance – aggregate compliance at the tax
paying entity/group level to establish tax liability
 Entity management
 Allocations of resources among entities, products,
geographic operating areas
 Planning and controlling performance management
 Profit maximization/optimization
Costing Method Customers

22. 
 Assignment to accounting/management periods – some
large costs are inherently imprecise as to period;
depreciation; loss contingencies; pensions; facility
variable rentals and escalation provisions; hedging costs.
 Assignment within accounting periods become
increasingly difficult as the level of the costing object
becomes smaller in size or time duration, as with
products.
 Allocation techniques sufficient for entity level results are
not reliable for more detailed levels at which management
must plan and operate – the driver of “drivers”.
The Cost Management Challenge –
Assigning/Allocating Costs

23. 
 Direct costing always works, but many large dollar
costs are often not direct, particularly at the product
or product line level , introducing a level of
uncertainty to detail level decisions.
 Time horizon improves the relative amount of costs
that are direct, but longer horizons provide reduced
tactical flexibility.
 Direct margin analyses, at multiple levels, enables
comparison of long horizon planning and tactical
decision making.
The Cost Management Solution to
Assigning/Allocating Costs

24. 
 GAAP – ASC 330 [formerly FAS 151 & ARB 43]
 Production [manufacturing]or acquisition [retail] costs
 Full absorption
 Consistency
 IRS – Full Absorption [of production costs] focused
 Code section 471 – Inventory
 Code section 472 – LIFO [elimination considered]
 Code section 263 – UNICAP [some costs in addition to
production costs]
Inventory Costs – GAAP & IRS

25. 
 Product [Inventory] and Product Line
 Direct Costs
 Identification of and allocation of indirect costs
 Determine need, if any, to “tie” to financial reporting
 Profitability Management
 Operations Performance Management
 Product design
 Production Operations
 Logistics, including Warehouse and Material
Handling
Product Costing – Today’s Focus

26. 
What do these have in common?
Close is sufficient
Product
Costing
Method

27. 
 Product Design – Coordination with Manufacturing and
Marketing/Sales
 Product Mix/Product Line Variations
 Process Design
 Complexity
 Product Design
 Manufacturing Techniques
 Logistics and Material Handling Choices
 Regulation and Compliance
 Manufacturing Technology and Performance
 Distribution and Logistics
Product Cost Drivers

28. 
 Utilization Factors
 Number of shifts – hours/day of use
 Time paid not worked – holidays, vacations
 Operations Performance Factors
 Set-Up vs. Run Time
 Speed/Quality Control of Set-Up and Run - Throughput
 Maintenance – time used vs. production failure costs
 Waste Driven Slowing of Production Process
 Loss of time [slowdown, rework]
 Waste
 Defective Material
 Production Losses
Costs Drivers to Analyze/Reflect

29. 
 Assign costs directly as much as possible
 Determine costs pools for variable type indirect costs for
cost management and control
 Define around key drivers for allocation based on resource
consumption
 Include costs which reasonably attach to the pool category
 Consider two [or three] allocation layers,” indirect” indirect
functions like tools, patterns, printing plates
 Determine if “reciprocal” relationships will be used
 Consider collecting assigning fixed type indirect costs
separately using best available allocation basis
 Establish Operating Departments for management
responsibility evaluation – variable and fixed indirect
costs
Effective Cost Accounting

30. 
Effective Cost Accounting - Drivers
 Machine hours
 Direct labor hours
 Material costs
 Pallets handled
 Printing plates used
 Tool forms used
 Patterns used
 QC tests performed
 Cubic feet of compressed
air
 Mixing tank hours
 Mixing tank hours
 Labels issued
 KWH used
 Orders processed
 Space used
 Miles traveled
 Warehouse
insertions/extractions
 Maintenance labor hours
 Chiller hours

31. 
 “Methods” – Resource Consumption Accounting
(RCA), Grenzplankostenrechnung (GPK)
 Based on consumption of resources (drivers)
 Applied to indirect costs
 The big differences in “pure” application – will not
“tie” to conventional financial reporting
 Replacement cost depreciation , w/o added output
 Capital charge based largely on the depreciation
[capital] consumed or similar measures
Cost Accounting Methods –
Resource Consumption Methods

32. 
 GPK in its fundamental form is a marginal costing system
 Use “margin” level definitions, with differing levels of
allocation of indirect and fixed costs
 Product margins
 Contribution to production costs, including production
functions’ depreciation
 Most useful for production scheduling
 Use for channel scheduling
 Calculate direct costs for both production or
manufacturing and for warehousing, distribution, and
logistics
Cost Related Decisions and Marginal
Costing

33. 
 Use, carefully, throughput measures – profitability,
not optimization, is the business objective
 Minimize down time – set-up, maintenance, materials
not ready
 Speed and efficacy of machine operation
 Optimize margin dollars per month
 Be very aware of system constraints [bottlenecks] &
consider Theory of Constraints – margin dollar
optimization will usually require optimizing the
constraint process, not all processes
Cost Measurement & Performance
Management

34. 
 Direct [final] departments – product volume variable
costs only
 Separate each process containing different
cost/operations/unit output characteristics
 Identify relevant output units
 Fixed costs are separately collected and not assigned to
products
 Indirect [primary] departments – variable costs only
 Separate departments with different cost incurrence or
output patterns
 Identify application basis or bases
 To extent possible organize indirect cost pools with the
department structure
Product Cost System Design
Considerations – RCA/GPK

35. 
 General design aspects –
 Consider replacement cost depreciation as more realistic
despite not readily reflecting potential process
improvements such as faster set-ups, or increased
throughput speed and accuracy/quality
 Minimize design complexity by not allocating costs from
one indirect department to another indirect department,
unless significant to the product
 Consider a cost of capital charge, as a function of
replacement cost depreciation
 Derive a “full absorption” estimate by using percentage
reduction for capital charge and replacement cost
depreciation ratio to recorded depreciation [by included
processes]
Product Cost System Design
Considerations – RCA/GPK

36. 
Best used for –
Product pricing decisions
Outsourcing evaluations
Product design evaluation
Manufacturing process improvements
Cost Design System – RCA/GPK

37. 
 Similar to GPK, except that the system is “full
absorption” focused and thus assigns depreciation –
usually actual book depreciation – to direct and
indirect departments
 Costs are the sum of:
 Direct costs
 Direct operating departments costs – including fixed
costs - assigned by a relevant driver
 Indirect departments costs – including fixed costs -
assigned by one or more drivers consumed by the
product or the direct process
Cost System Design – Activity Based
Costing (ABC)

38. 
 Target Costing – cost management and planning,
follows six principles:
 Price-led costing
 Customer focus
 Focus on design of products and processes [point at
which most life cycle costs are effectively committed]
 Cross-functional teams [for comprehensive
perspective]
 Life cycle cost reduction
 Value chain involvement
Costing – Other Important
Applications

39. 
 Attempts to address:
 What are the sources of idle capacity?
 How much unused capacity is assigned to product
cost?
 How large of a threat is the hidden unused capacity?
 Who is responsible for capacity management?
 How are manufacturing activities communicated in a
common language?
 How can we obtain more capacity without buying it?
Costing – Capacity Management

40. 
 Productive
 Good production
 New product
 Process development
 Non-productive
 Standby, waste, maintenance, and setup
 Process balance & variability; scrap; rework and yield
 Scheduled & unscheduled maintenance: time, volume,
changeover
 Idle
 Marketable (idle) and non-marketable (excess)
 Off limits; legal, contractual, management policy
Costing – Capacity Management –
Categories of Capacity Utilization

41. 
 Hydrox Laboratories: production and purchasing
 Production planning and scheduling
 Waste reduction through process improvement
 Capital to improve quality – capping equipment
 Bulk purchasing of hydrogen peroxide
 Components purchasing
 Hydrox Laboratories: logistics – per pallet shipping cost
reduction by altering truck load factor [per pallet, LTL,
truckload]
 Graphic Direct
 Printing press speed
 Scheduling by cut-off and color similarity
 Personalization sizing test [MWWWWM]
 Sorting and envelop filling speed improvements with more
experienced personnel
Cost and Margin Management
Examples

42. 
 www.goldratt.com
 www.tocc.com
 www.cam-i.org
 www.bpminstitute.org
 www.supplychainmetric.com
 www.rcainstitute.org
 http://www.focusedmanagement.com/knowledge_base
/articles/fmi_articles/middle/German_Cost_Accounting
_pt2.pdf
 Google text string: GPK accounting
 Google text string: Resource consumption accounting
Cost Management Resources