CIA 3004

Seminar in Management Accounting

TOPIC 1
Evolution of Management Accounting
Outline
 Definition of Management Accounting
 Scope of Management Accounting
 Evolution of Management Accounting
 Criticisms of Traditional Management Accounting

2
What is Management Accounting?
 The process of identifying, measuring, analyzing,
interpreting, and communicating information in
pursuit organization’s goals.

 National Association of Accountants (NAA):

"Management accounting is the process of
identification, measurement, accumulation, analysis,
preparation, interpretation, and communication of
financial information used by management to plan,
evaluate, and control within an organization and to
assure appropriate use of and accountability for its
resources. 3
Definition of Management Accounting
 New definition issued by Institute of Management
Accountants (IMA: “Management accounting is a
profession that involves partnering in
management decision making, devising planning
and performance management systems, and
providing expertise in financial reporting and
control to assist management in the formulation
and implementation of an organization’s strategy.”

4
Scope of Management Accounting
The American Institute of Certified Public Accountants (AICPA)
states the 3 scope of MA:
 Strategic management - advancing the role of the management
accountant as a strategic partner in the organization.

 Performance management - developing the practice of business

decision-making and managing the performance of the
organization.

 Risk management - contributing to frameworks and practices

for identifying, measuring, managing and reporting risks to the
achievement of the objectives of the organization.

5
Evolution of Management Accounting

Kaplan, R. S. (1984). The Evolution of

Management Accounting. The Accounting
Review (July), pp. 390-418.
 Provides historical developments of cost and
management accounting since early 20th
century.
 Management accounting began under the label ‘cost
accounting’ and split from cost accounting in the 1950s.
 Describes new innovations in management
accounting.

6
Evolution of Management Accounting
International Federation of Accountants (IFAC)’s
Evolution of MA (1998):
Stage / Time period Focus Managerial Accounting Practices

Stage 1: Prior to 1950 Cost determination Budgeting and cost accounting systems.

Providing information needed for Investment appraisal, decision analysis,

Stage 2: 1950 - 1965
planning and control. responsibility accounting

Stage 3: 1965 - 1985 Reduction of waste ABC, strategic cost management etc.

Balanced scorecards of leading economic

Creating firm value
Stage 4: 1985 - 1995
(value creation)
indicators, measures that approximate
shareholder return, MAS that address
current & future strategic uncertainties. –
value-based management, value-chain
analysis
7
Evolution of Management Accounting

8
Evolution of Management Accounting
Stage 1 - Cost determination and financial control
 Prior to 1950, the focus is on cost determination and financial
control with the use of budgeting and cost accounting
techniques.

 Management accounting was seen as a technical activity to

achieve organisational objectives.

 The main source of data was from financial statements: Income

Statements, Balance Sheet and Cash Flow Statements.

 The use of predominant methods: ratio analysis, financial

statement analysis, budgeting and other cost accounting
techniques

9
Evolution of Management Accounting
Stage 2 - Information for management planning and control
 From 1950 to 1965, the focus shifted to the provision of
information for management planning and control.

 Management accounting was seen as management activity.

 Involved staff support to line management through the provision

of information for planning and control purposes. To enable the
management team to plan, control and take the best course of
action in their decision-making processes.

 Management accounting techniques: standard costing, cost-

volume-profit (CVP), break-even analysis, transfer pricing and
performance measurement, which support decision analysis and
responsibility accounting.

10
Evolution of Management Accounting
Stage 3 - Reduction of resource waste in business
processes
 From 1965 to 1985, the focus was on reducing waste in
resources used in business processes, process analysis and
cost management technologies.

 Through the elimination of ‘non value added activities’.

 MA techniques: JIT, Activity Based Costing (ABC), TQM,

Economic Order Quantity (EOQ), inventory valuation
methods such as Last In First Out (LIFO), First In First Out
(FIFO), Management Resource Planning (MRP) and multiple
regression.

11
Evolution of Management Accounting
Stage 4 - Creation of value through effective use of resources
 From 1985 to 1995, attention shifted to the generation or
creation of value through the effective use of resources and
technologies.

 Examine the drivers of customer value, shareholder value and

organisational innovation.

 Relatively modern MA methods: Target Costing, Balanced

Scorecard, Value Chain Analysis and Strategic Management
Accounting

#Note: Even though the management accounting evolution can be

distinguished into four recognisable stages, the techniques used in
previous phases continued to be used in later stages. 12
Evolution of Management Accounting

13
Criticisms of Traditional Management
Accounting
Johnson and Kaplan (1987). Relevance Lost:The Rise
and Fall of Management Accounting.
 Explored and discussed about the growth and decline
of management accounting between 1800 and the late
1980s.
 Argued that traditional management accounting
techniques that were developed during industrial
revolution are no longer relevant to the current use.
 Even though the techniques originate from the
scientific era, but their innovation has stagnated since
then.
14
Criticisms of Traditional Management
Accounting
Johnson and Kaplan (1987). Relevance Lost:The Rise
and Fall of Management Accounting.
1. Management accounting information, driven by the
financial reporting cycle is too late, too aggregated,
too distorted and too narrow to be relevant for
managements needs.
◦ Too late – do not provide timely information, not useful for
control purposes (Variance reports in standard costing)
◦ Too aggregated – by functional areas and time – eg: Indirect
costs (diff categories) are combined in plant wide or
departmental overhead accounts, mfg costs are aggregated by
months/quarters
◦ Too distorted – relate to volume-based allocation of
overhead costs
◦ Too narrow – eg. Focus on financial measures and ST focus 15
Criticisms of Traditional Management
Accounting
Johnson and Kaplan (1987). Relevance Lost:The Rise
and Fall of Management Accounting.
2. Direct labor allocation systems
◦ Inaccurate and may lead to cost distortion.

3. Provide short term financial measures that

are invalid indicators of performance.
◦ Short-term orientation
◦ Focus only on efficiency
◦ Promote data manipulation
◦ Not adequate for evaluation, controlling and decision
making processes.

16
Other Criticisms of Traditional
Management Accounting
Maskell (1991).
 Lack of relevance - many of today's manufacturing strategic
goals are non-financial such as customer satisfaction,
quality and flexibility which cannot be monitored with
traditional reports (mainly in financial based measures),
thus not relevant for operational control.
 Cost distortion - allocation of overhead costs based on
direct labor content will lead to a major cost distortion
when direct labor only represents less than 10% of total
costs.

17
Other Criticisms of Traditional
Management Accounting
Maskell (1991).
 Inflexibility - accounting reports (based on financial
measures) are inflexible for manufacturing management –
managers are not able to modify the measures as the
needs of performance measures vary among plants,
products, processes and departments.
 Impediment to progress in manufacturing excellence. High
emphasis on machine and labor efficiency results in
production in large batch size with the focus on
production quantities. This is actually the opposite of the
modern manufacturing, such as JIT, that focuses on small
lot size, zero inventory and high quality.
18
Other Criticisms of Traditional
Management Accounting
 Cost control rather than cost reduction (Shillinglaw,1989).
 Only providing cost data, thus does not seem to support
strategies and actions (Nanni and Dixon,1992).

Criticisms of Standard Costing

 Overemphasises the importance of direct labour
 Delay in feedback reporting – out of date information
 Standards are a static base against which actual events are
measured (standards can quickly become out of date)
 Their main objective is control, with conformance to standards
and the elimination of any variances – this is seen as restrictive
and inhibiting
 Areas of responsibility may not have clear lines of demarcation
19
The End

End of Lecture

20
 CTEA 3227
Management Accounting III

TOPIC 1
Evolution of Management Accounting
Outline
 Definition of Management Accounting
 Scope of Management Accounting
 Evolution of Management Accounting
 Criticisms of Traditional Management Accounting

2
Definition of Management Accounting
 Managerial accounting is an integral part of the
management process. It is the process of identifying,
measuring, analyzing, interpreting, and communicating
information in pursuit an organization’s goals.

 National Association of Accountants (NAA) (1981):

"Management accounting is the process of
identification, measurement, accumulation, analysis,
preparation, interpretation, and communication of
financial information used by management to plan,
evaluate, and control within an organization and to
assure appropriate use of and accountability for its
resources.
3
 New definition issued by Institute of Management
Accountants (IMA) in 2008: “Management
accounting is a profession that involves partnering
in management decision making, devising planning
and performance management systems, and
providing expertise in financial reporting and
control to assist management in the formulation
and implementation of an organization’s strategy.”

4
Scope of Management Accounting
The American Institute of Certified Public
Accountants (AICPA) states the 3 scope of
management accounting:
 Strategic management - advancing the role of the
management accountant as a strategic partner in
the organization.
 Performance management - developing the practice
of business decision-making and managing the
performance of the organization.
 Risk management - contributing to frameworks and
practices for identifying, measuring, managing and
reporting risks to the achievement of the objectives
of the organization.
5
Evolution of Management Accounting

Kaplan, R. S. (1984).The Evolution of

Management Accounting. The Accounting
Review (July), pp. 390-418.
 This article and a book (relevance lost) made a
wakeup call for academicians, researchers,
accountants and many others as well.
 Provides historical developments of cost and
management accounting since early 20th century.
 Management accounting began under the label ‘cost accounting’
and split from cost accounting in the 1950s.
 Describes new innovations in management
accounting.

6
International Federation of Accountants
(IFAC)’s Evolution of MA (1998):
Stage / Time period Focus Managerial Accounting Practices

Stage 1: Prior to 1950 Cost determination Budgeting and cost accounting systems.

Providing information needed for Investment appraisal, decision analysis,

Stage 2: 1950 - 1965
planning and control. responsibility accounting

Stage 3: 1965 - 1985 Reduction of waste ABC, strategic cost management etc.

Balanced scorecards of leading economic

Creating firm value
Stage 4: 1985 - 1995
(value creation)
indicators, measures that approximate
shareholder return, MAS that address
current & future strategic uncertainties. –
value-based management, value-chain
analysis
7
Evolution of Management Accounting
IFAC’s Evolution of MA (cont’d):

8
IFAC’s Evolution of MA (cont’d):
Stage 1 - Cost determination and financial control

 Prior to 1950, the focus of management accounting is on cost

determination and financial control with the use of budgeting
and cost accounting techniques.

 Management accounting was seen as a technical activity to

achieve organisational objectives.

 The main source of data was from financial statements which

include Income Statements, Balance Sheet and Cash Flow
Statements.

 The use of methods such as ratio analysis, financial statement

analysis, budgeting and other cost accounting techniques was
predominant in this period. 9
IFAC’s Evolution of MA (cont’d):
Stage 2 - Information for management planning and control

 From 1950 to 1965, the focus shifted to the provision of

information for management planning and control.

 Management accounting was seen as management activity.

 It involved staff support to line management through the provision

of information for planning and control purposes.

 The aim is to enable the management team to plan, control and

take the best course of action in their decision-making processes.

 The use of management accounting techniques which could

support decision analysis and responsibility accounting was
introduced. Hence, the introduction of traditional methods such as
standard costing, cost-volume-profit (CVP), break-even analysis, 10
transfer pricing and performance measurement was increased
during the period.
IFAC’s Evolution of MA (cont’d):
Stage 3 - Reduction of resource waste in business
processes

 From 1965 to 1985, the focus was on reducing waste in

resources used in business processes, process analysis and cost
management technologies.

 Waste in resources was made possible through the elimination

of ‘non value added activities’.

 During this period, management accounting techniques included

JIT, Activity Based Costing (ABC), TQM, Economic Order
Quantity (EOQ), inventory valuation methods such as Last In
First Out (LIFO), First In First Out (FIFO), Management
Resource Planning (MRP) and multiple regression.
11
IFAC’s Evolution of MA (cont’d):
Stage 4 - Creation of value through effective use of
resources

 From 1985 to 1995, attention shifted to the generation or

creation of value through the effective use of resources and
technologies which examine the drivers of customer value,
shareholder value and organisational innovation.

 Relatively modern management accounting methods such as

Target Costing, Balanced Scorecard, Value Chain Analysis and
Strategic Management Accounting were prevalent during this
period.

 Even though the management accounting evolution can be

distinguished into four recognisable stages, the techniques used
in previous phases continued to be used in later stages.

12
13
Criticisms of
Traditional Management Accounting
Johnson and Kaplan (1987). Relevance Lost:The
Rise and Fall of Management Accounting.

 Explored and discussed about the growth and decline of

management accounting between 1800 and the late 1980s.

 Argued that traditional management accounting techniques

that were developed during industrial revolution are no
longer relevant to the current use.

 Even though the techniques originate from the scientific

era, but their innovation has stagnated since then.
14
Johnson and Kaplan (1987).
Relevance Lost:
The Rise and Fall of Management Accounting.
1. Management accounting information, driven by the
financial reporting cycle is too late, too aggregated,
too distorted and too narrow to be relevant for
managements needs.
◦ Too late – do not provide timely information, not useful for
control purposes (Variance reports in standard costing)
◦ Too aggregated – by functional areas and time – eg: Indirect
costs (diff categories) are combined in plant wide or
departmental overhead accounts, mfg costs are aggregated by
months/quarters
◦ Too distorted – relate to volume-based allocation of
overhead costs
◦ Too narrow – eg. Focus on financial measures and ST focus

15
2. Direct labor allocation systems
◦ Inaccurate and may lead to cost distortion.

3. The traditional accounting systems provide

short term financial measures that are invalid
indicators of performance.
◦ Short-term orientation and ex post evaluation in nature
◦ Focus only on efficiency
◦ Promote data manipulation
◦ Not adequate for ex ante evaluation, controlling and
decision making processes.

16
Other Criticisms of
Traditional Management Accounting
Maskell (1991).
 Lack of relevance - many of today's manufacturing strategic
goals are non-financial such as customer satisfaction,
quality and flexibility which cannot be monitored with
traditional reports (mainly in financial based measures),
thus not relevant for operational control.
 Cost distortion - allocation of overhead costs based on
direct labor content will lead to a major cost distortion
when direct labor only represents less than 10% of total
costs.

17
Maskell (1991).
 Inflexibility - accounting reports (based on financial
measures) are inflexible for manufacturing management –
managers are not able to modify the measures as the
needs of performance measures vary among plants,
products, processes and departments.

 Impediment to progress in manufacturing excellence. High

emphasis on machine and labor efficiency results in
production in large batch size with the focus on
production quantities. This is actually the opposite of the
modern manufacturing, such as JIT, that focuses on small
lot size, zero inventory and high quality.

18
 Cost control rather than cost reduction (Shillinglaw,1989).
 Only providing cost data, thus does not seem to support
strategies and actions (Nanni and Dixon,1992).

Criticisms of Standard Costing

 Overemphasises the importance of direct labour
 Delay in feedback reporting – out of date information
 Standards are a static base against which actual events are
measured (standards can quickly become out of date)
 Their main objective is control, with conformance to
standards and the elimination of any variances – this is
seen as restrictive and inhibiting
 Areas of responsibility may not have clear lines of
demarcation

19
Project Paper

1. Did management accounting regain its

relevance? The case of manufacturing firms in
Malaysia.

2. Discuss the current issues in management

accounting in manufacturing environment in
Malaysia.

 Group project (5 in a group)

 Group presentation in week 10
 Submit a report in week 10
20
The End

End of Lecture

21
 CTEA 3227
Management Accounting III

TOPIC 2
Strategic Management Accounting
Outline
 What is Strategic Management Accounting (SMA)?
 Contemporary SMA Techniques:
➢ Value Chain Analysis
➢Activity Based Management
➢Business Process Re-engineering

2
What is SMA?
 Still no comprehensive framework of what SMA is and no standard
definition.
 From a review of literature:
◦ Defined as the provision and analysis of management accounting data
about a business and its competitors for use in developing and
monitoring the business strategy (Simmonds, 1981, 1982) – (Simmonds
is the first person who introduced a strategic dimension into discipline
of management accounting).
◦ It is “the provision and analysis of financial information on the firm’s
product markets and competitors’ costs and cost structures and the
monitoring of the enterprise’s strategies and those of its competitors in
these markets over a number of periods” (Broomwich, 1990:28).
◦ SMA as the provision of information to support the strategic decisions
in organisations (Innes, 1998).
3
 Strategic management accounting is defined as ‘a form of
management accounting in which emphasis is placed on information
which relates to factors external to the entity, as well as non-
financial information and internally generated information’ (CIMA,
2005, pp. 54).
 SMA is a new approach/domain of management accounting that
focuses on strategic issues (relating to several disciplines).
 Provide information for the formulation of organization's strategy
and managing strategic implementation.
 Strategic decisions usually involve the longer term, have a significant
effect on organization, and they may have both internal and external
elements.

4
What is SMA?

 Lord (1996) identified 3 main characteristics for SMA:

1. External information about competitors
2. Relates to strategic positioning of firms
3. Gaining competitive advantage through exploiting linkages in
the value chain

5
1. External information about competitors
◦ SMA should help firms to evaluate its competitive position
in relation to the rest of the industry.

◦ More outward looking

– analyze competitors’ position, obtain information from
many sources (external information).

◦ Seek strategic advantage

– e g. pricing, quality, costs, market share.

◦ Provides advance warning of the need for a change in

competitive strategy.
6
2. Relates to strategic positioning of firms
◦ Strategy as patterns of actions intended for the attainment
of goals (Mintzberg,1978).

◦ Strategy as “the determination of the basic long-term goals

and objectives of an enterprise, and the adoption of courses
of action and the allocation of resources necessary for
carrying out these goals” (Chandler,1962, p. 13).

◦ Strategy as a comprehensive plan of action that matched

environmental opportunities and threats, internal strengths
and weaknesses, and managerial values (Chandler, 1962).

7
◦ Strategy is essential for firms to attain a position of
competitive advantage.

◦ SMA, therefore, should be concerned with the relationship

between the strategic position chosen by a firm and the use
of management accounting information or techniques.

◦ The use of particular accounting techniques depends on

which strategic position that the firms adopt.

◦ Different strategies demand different accounting

techniques.

8
◦ Types of strategies:
- Cost leadership, differentiation, and focus (Porter, 1980)
- Defender, prospector, and analyzer (Miles & Snow, 1978).

◦ Cost leadership – aims to be the lowest cost producer

within the industry
◦ Differentiation – offers some unique dimension in its
products/service which can command a premium price.
◦ Focus – seeks advantage in a narrow segment of market
either by way of cost leadership or by product
differentiation.
◦ Prospector – focus on new product innovations and market
development
◦ Defender – focus on efficiency through cost, quality and
service, engage in little R&D.
◦ Analyzer – a combination of prospector and defender
strategy – Hybrid strategy.
9
3. Gaining competitive advantage through exploiting
linkages in the value chain

◦ By analyzing ways to decrease costs and enhance the

differentiation of a firm/s products through exploiting
linkages in the value chain and optimizing cost drivers.

◦ Value-chain activities – a linked set of value-creating

activities all the way from basic raw material sources
(suppliers) to the ultimate end-use products/service
(customers).

◦ A firm which performs the value chain activities more

efficiently and at a lower cost than its competitors will gain
a competitive advantage.
10
Value Chain Analysis
 The term ‘Value Chain’ was used by Michael Porter in his
book "Competitive Advantage: Creating and Sustaining
superior Performance" (1985).

 The value chain consists of all major business functions that

add value to a company’s products and services.

Business Functions Making Up The

Value Chain
Product Customer
R&D Design Manufacturing Marketing Distribution Service

 The value-chain analysis focuses on the product’s total value

chain, from its design to its manufacture to its service after
the sale.
11
 The underlying concept of the analysis is that each individual
firm occupies a selected part of parts of this entire value chain.

 The determination of which part or parts of the value chain to

occupy is a strategic analysis based on the consideration of
comparative advantage for the individual firm.

 Value chain analysis is a strategic analysis tool used to:

1. better understand the firm’s competitive advantage
2. identify where value to customers can be increased or
costs reduced
3. better understand the firm’s linkages with suppliers,
customers, and other firms in the industry

12
Activity Based Management

Using activity-based
costing (ABC)
information to support
The use of organizational strategy,
ABC costing information improve operations,
and manage costs is
to help called activity-based
management management or
ABM.
make decisions

13
Activity-based costing establishes relationships
between overhead costs and activities so that
we can better allocate overhead costs.
Activity-based management focuses
on managing activities to reduce costs.

1-14
Two-Dimensional ABC and Activity-Based Management

Activities

One way to describe the relationship between ABC and ABM is in terms of a
two-dimensional activity-based costing model. The activities, which are the
center of the model, are the focal point of ABC and ABM. (LO8)

1-15
 Cost Assignment View

Resource costs

Activities

Cost Objects

The vertical element of the model is the cost assignment view of an ABC
system. Cost assignment in an ABC system uses a two-stage cost allocation to
assign the costs of resources to the firm’s cost objects. (LO8)

1-16
 Cost Assignment View
Resource costs
Process View
Activity Analysis Activity Evaluation
Root Activity Performance
Causes Triggers Activities Measures

Cost Objects

The horizontal element of the model is the process view of an ABC system. The emphasis now
is on the activities themselves, the various processes by which work is accomplished in the
organization. The left-hand side is the activity analysis. This is the identification and
description of the activities conducted in the enterprise. Activity analysis also identifies the
root causes of activities, the events that trigger activities, and the linkages among activities. The
right-hand side is the evaluation of activities through performance measures. It is these
processes of activity analysis and evaluation that comprise activity-based management. (LO8)
 Activities

Non value-
added
activities
Unnecessary Necessary

Reduce or Continually
Eliminate Evaluate
and Improve

An important goal of activity-based management is to identify and eliminate nonvalue-added

activities and costs.
Non-value-added activities are operations that are either (1) unnecessary and dispensable
or (2) necessary, but inefficient and improvable.
Non-value-added costs, which result from such activities, are the costs of activities that can
be eliminated without deterioration of product quality, performance, or perceived value.
(LO8)
 Activity Based Management (cont’d)
1. Identify Activities.
2. Identify Non-Value-Added Activities.
3. Understand Activity Linkages, Root
Causes, and Triggers.
Inspect Rework
Specify Select Receive Produce
finished defective
parts vendor parts goods
goods products

4. Establish Performance Measures.

5. Report Non-Value-Added Costs.

1-19
There are five steps that provide a strategy for eliminating nonvalue-added costs in both
manufacturing and service industry firms.
Step one identifies all of the organization’s significant activities. The resulting activity list
should be broken down to the most fundamental level practical. (LO8)
In step two, the nonvalue-added activities are identified. Three criteria for determining
whether an activity adds value are as follows:
• Is the activity necessary?
• Is the activity efficiently performed?
• Is an activity sometimes value-added and sometimes non-value-added?
(LO8)
In identifying nonvalue-added activities, it is critical to understand the ways in which activities
are linked together. The following chain of activities provides an example:
The rework of defective units is a non-value-added activity. The rework is triggered by the
identification of defective products during inspection. The root cause of the rework, however,
could lie in any one of a number of preceding activities. Perhaps the part specifications were in
error. Or an unreliable vendor was selected. Maybe the wrong parts were received. Or the
production activity is to blame. A set of linked activities (such as that depicted above) is called
a process. Sometimes activity analysis is referred to as process value analysis (PVA).
(LO8)
By continually measuring the performance of all activities, and comparing performance with
benchmarks, management’s attention may be directed to unnecessary or inefficient activities.
(LO8)
Non-value-added costs should be highlighted in activity center cost reports. By identifying
non-value-added activities, and reporting their costs, management can strive toward the
ongoing goals of process improvement and elimination of non-value-added costs. (LO8) 20
Activity Based Management (cont’d)

Process time

Inspection time Storage time

Move time Waiting time

1-21
One approach that cost-management analysts find
helpful in identifying nonvalue-added activities is to
categorize the ways in which time is spent in a
production process. In most manufacturing operations,
time is spent in the five ways (LO8)

22
Business Process Re-engineering
 The fundamental rethinking and radical redesign of business
processes to achieve dramatic improvements in critical areas
of performance such as cost, quality and delivery.

 Focus is on strategic processes:

◦ Processes that focus on achieving a company’s business
objectives and strategies.
◦ Common processes: developing new products,
manufacturing products, acquiring customer orders, fulfilling
orders and developing human resources.

 Aim: to totally reorganise the way in which work is done by

identifying and eliminating non-value-added activities.
23
Four major steps of BPR:
1. Prepare a business process map
– A flowchart of activities that make up the business process.
2. Establish goals
– Based on customer value
– May include quality, cost, delivery performance
3. Reorganise work flow
– To enable goals to be achieved
4. Implement the program
– Involves substantial change so careful implementation is
required to minimise resistance to change and business
disruption.

24
Is BPR the same as ABM?
 ABM focuses on incremental, continuous improvement of
processes and the use of cost driver analysis to manage costs.
 BPR focuses on major business processes and implement
fundamental changes to the way processes are structured.
 Both use activity analysis to identify processes and activities.

25
End of Lecture 2

26
 CIA 3004
Seminar in Management Accounting

Life Cycle Costing,

Target Costing and Kaizen Costing
 Harrmaneesha Kaur
17183224/1

Life Cycle Costing

Alternative approach to cost management which

accumulates and manages costs over a product’s life
cycle

Objectives:

● Helps management to understand the cost consequence of

developing and making a product
● To identify cost impact of various design options for decision
making purpose

2
 STAGES OF LIFE CYCLE COSTING
-from start to end
treated as product
cost

SULOSHNA 17100372/1 SOURCE : ADAPTED FROM BURSTEIN (1988, P.261)

Committed/Locked-in Costs

● Those cost that have not been incurred but that will
be incurred in the future (during the manufacturing
and post sale service and abandonment stages) on
the basis of decisions that have already been made
during the product planning and design phase.

● difficult to alter

4
Committed/Locked-in Costs

● About 80% of a product’s costs are committed costs.

● Thus, cost management (cost reduction) can be most
effectively exercised during the planning and design stage – A dollar
spent on design and R&D can reduce costs in the stages of the
product’s life cycle by $8 - $10 (Shields &Young, 1991).
● Cost containment/control – manufacturing stage
● The pattern of cost commitment and cost incurrence differs based on
industry and type of products.

5
WONG YONG SHENG - 17162914/1
 Stages of Life Cycle Costing
Analysis of the costs of a system or a component
over its entire life span (Total cost of
Ownership)

Planning and Service and

Designing Abandonment

1 2 3
Manufacturing
and Sales

77
Raihana Mohamad 17172687/1
 Stages of Life Cycle Costing

Example of cost incurred:

PLANNING & DESIGNING
❖ Include the stages of market
Research & Development
and Designing in product
life cycle.
❖ High level of setup costs will
be incurred
★ Research and Development
Cost
★ Product Designing Cost
★ Purchasing Cost (for
machinery)

8
Raihana Mohamad 17172687/1
 Stages of Life Cycle Costing

Example of cost incurred:

MANUFACTURING AND SALES
❖ The stage where products are
manufactured to be introduced
in the market
❖ Covered the cost for Production,
Marketing and Distribution
★ Administration Cost
★ Advertising Cost
★ Labor Cost
★ Raw Material Cost
★ Delivery Cost
★ Packaging Cost

9
Raihana Mohamad 17172687/1
 Stages of Life Cycle Costing

Example of cost incurred:

SERVICE AND ABANDONMENT

❖ This stage signified by a decline in ★ Provision of spares or

a sales volume expert services

❖ The producers may be required to ★ Disposal Cost

provide after sales service for
already sold products

❖ The machinery that is no longer

useful or fully depreciated also
need to be dispose
10
Raihana Mohamad 17172687/1
 Why Product Life Cycle Costing is different from the Tradisional Management
Accounting Costing ?

Traditional method LCC

Focuses mainly on the manufacturing Focuses on the entire stage of
(production) stage of product’s life product’s life cycle
cycle. - including before and after
- only 1 part
Pre-manufacturing costs are treated Pre-manufacturing costs are treated
as period cost as product cost
-Design costs -Design costs
-Research and development costs -R&D costs

Focuses on cost control Focuses on cost reduction

Short-term perspective Long term perspective
SULOSHNA 17100372/1
 An illustration
A company is deciding to purchase a pump and they have 2
alternatives

12
Raihana Mohamad 17172687/1
 INSTALL POWER REMOVE
$1,000 $4,000/yr $200

If the pump last for 20 years, the total cost of this

pump would be MAINTAIN REPAIR
= $10,000+$1,000+($500x20)+($4,000x20)+
$500/yr $300/yr
($300x20)+$200

= $107,200

13
Raihana Mohamad 17172687/1
 INSTALL POWER REMOVE
$1,000 $5,000/yr $200

If the pump last for 20 years, the total cost of this

pump would be
= $10,000+$1,000+($600x20)+($5,000x20)+ MAINTAIN REPAIR
($300x20)+$200 $600/yr $300/yr

= $124,200

14
Raihana Mohamad 17172687/1
 Harrmaneesha Kaur
17183224/1

Life Cycle Budgeting

● A budget that compares planned costs and predicted revenue over each year
of the product’s life
● Enables comprehensive assessment of the profitability of a product over its
entire life
● Includes all upstream and downstream costs

15
 Harrmaneesha Kaur
17183224/1
Illustration
ABC Co specializes in the manufacture of solar panels. It is planning to introduce a new slimline
solar panel specially designed for small houses. Development of the new panel is to begin
shortly and ABC Co is in the process of determining the price of the panel. The Marketing
Director expects that the customer will be prepared to pay $500 for a solar panel.
It expects the new product to have the following costs:

16
 Harrmaneesha Kaur
17183224/1
Solution

17
 Harrmaneesha Kaur
17183224/1
Solution

The total lifecycle costs are $529.40 per solar panel which is
Costs per Unit: higher than the price proposed by the marketing director
($500). ABC Co will either have to charge a higher price or
look at ways to reduce costs.
=
It may be difficult to increase the price if customers are price
sensitive and are not prepared to pay more.
=
Costs could also be reduced by analysing each part of the
costs throughout the life cycle and actively seeking cost
savings.
= $529.40 per unit
For example:
● using different materials
● using cheaper labour
● acquiring more efficient technology.

18
 Advantages
of
Life Cycle Costing

Shantosh Balachandar
17178420/1
 Shantosh Balachandar
17178420/1

Advantages

● Encourages Long-Term Strategic Planning LCC

● Supports downstream strategic budgeting
● Influences the overall cost viability of the project
● Influences early stage decision making
● Maximize revenue and minimize cost

20

Advantages
Encourages Long-Term
Strategic Planning LCC
Encourages forward planning and
consideration of future costs. This
will assist in forming a fully accurate
cost for the entire project, instead of
one particular aspect of it.
Shantosh Balachandar
17178420/1
Supports downstream
strategic budgeting
LCC will produce high quality early
estimate that can be used to prepare
budget. This is known as strategic
budgeting. This is difficult to implement
but very useful if it is done properly.
21

Advantages
Influences the overall
cost viability of the
project
Construction no longer becomes a
cost window. It is part of the many
windows. Hence, decision on high
cost can be made taking into
account the subsequent low
running cost. LCC allows various
phases to be put into perspective,
and highlight area where input is
required
Influences early
stage decision
making
LCC will affect early stage
decision. For 2 identical
investments of similar costs,
its running cost may be totally
different. It is wrong to
consider just their capital cost
alone. By using LCC, early
stage decision will also take
into consideration subsequent
running cost
Shantosh Balachandar
17178420/1
Maximize revenue
and minimize cost
It results in earlier action to
generate revenue or lower
costs than otherwise might
be considered. There are a
number of factors that need
to be managed in order to
maximise return in a
product
22
 Target
Costing

Focus on the
customer
Price led ( it begin
with expected market
price and work Is cross functional
backward to set the Based on the principle of life cycle ( involving managers
target cost management, placing primary from right across the
emphasis on managing production value change)
and downstream costs by focus on
the design and development phase

PUGANESWARAN 17122236/1
 T A MMI LY L A I 17178722/1

Target Costing Process

1. Conduct Research &

2. Establish margin
Identify the Market

● Review marketplace in which the ● Decide target

company wants to sell theproducts margin/profit that
● Determine the set of product needs to be met
features that customers are most
likely to buy, and the amount they
will pay for those features.
● Determine the target price which
customers will be prepare to pay for
the product.
 T A MMI LY L A I 17178722/1
Target Costing Process
3. Establish a target cost for the product
● The target cost, usually determined byusing

TC = Selling Price - ProfitMargin

4. Deterrmine estimated cost of the product – obtained

from product and process design phase.
5. Compare target cost with the estimated cost - if estimated cost
exceeds the target cost, investigate ways of driving down the
estimated cost to the target cost.

6. Reduce estimated costd and enhance customer value to achieve

target cost:
• Implement Value engineering to eliminate non-value adding
elements in product design
• Value analysis of manufacturing processes
• Work with suppliers to reduce component/material costs
 ACHIEVING TARGET
COSTING
VAlue ENgineering
technique
An approach to provide the necessary function in a product with the lowest cost.
❖ Analysing the product design and the production process.
❖ Eliminate non value added elements.
❖ Maintaining or increasing customer value or increase while achieving the target cost.

What can be done?

➢ Modify the design of some components
➢ Substitute more cost effective material.
➢ Working with supplier to reduce component or material cost.
➢ Improve the efficiency of the production process.

ENG XIAO YUAN 17187536/1

Key characteristics of successful target
costing
Focus on the customer Emphasis on cost reduction at early
stages in product development
● Target costing focuses on the
customer.
● Customer requirements for
quality, cost and time are
incorporated into the product
decisions and guide the analysis
of costs.
● Indeed target costing forces
companies to be specific about
what customers want and the
prices they are prepared to pay
● Target costing starts at the earliest
stage in new product
development, indeed is embedded
in the development process, such
that detailed financial analysis
takes place from the outset and
engineering changes are made
before production begins.
● This often means initial designs are
simplified before manufacture,
resulting in lower costs and time-
to-market once the design is
finalised.
DARSHINI 17075930/1
 N i k S h a h i r a h 17070121/1

KEYFEATURESOFTC
 N i k S h a h i r a h 17070121/1

KEYFEATURESOFTC
 L I M E E Y O N G 17168077/1

ILLUSTRATION 1 C O R P O R A T E FI NA NCE INSTITUTE

ABC Inc. is a big FMCG player that operates in a very competitive

market. It sells packaged food to end customers. ABC can only
charge $20 per unit. If the company’s intended profit margin is
10% on the selling price, calculate the target cost per unit.

Solution
Target Profit Margin = 10% x $20 = $2 per unit
Target Cost = Selling Price - Profit Margin
= $20 - $2
= $18 per unit

https://corporatefinanceinstitute.com/resources/knowledge/accounting/target-costing/
 L I M E E Y O N G 17168077/1

ILLUSTRATION 2 ACCAGLOBAL

If a company normally expects a mark-up on

cost of 50% and estimates that a new product
will sell successfully at a price of $12, what is
the maximum cost of production?
Cost + Mark-up = Selling Price

100% 50% 150%

Solution
Target cost = 100/150 ($12)
= $8

https://www.accaglobal.com/sg/en/student/exam-support-resources/fundamentals-exams-study-resources/f5/technical-articles/target-lifestyle.html
Kaizen Costing (KC)

Kaizen=continuous incremental improvement (Japanese)

▪ Create a culture of continuous improvement
▫ Employees are actively engaged
Change for the good
▫ Maintenance of present cost
-for products that is currently manufactured to achieve
desired cost level

32

Tan Si Ying 17082036

Kaizen Costing (KC)

Kaizen=continuous incremental improvement (Japanese)

▪ Create a culture of continuous improvement
▫ Employees are actively engaged
Change for the good
▫ Maintenance of present cost
-for products that is currently manufactured to achieve
desired cost level

33

Tan Si Ying 17082036

Kaizen Costing (KC)

TC-before product is in production (Planning and designing

stage)
KC-during production process (manufacturing stage)

▪ Potential cost reduction is relatively smaller

-Significant proportion of the costs will have become locked
in

34

Tan Si Ying 17082036

 Continuous Focus on production
improvement process

What is
Kaizen
Costing?

Employee
Empowerment
35

Tan Si Ying 17082036

1. Continuous Improvement

▪ Arises from small improvements rather than

quantum leaps (no major innovations)
▪ If the target improvement is not met,
▫ Explore reasons
▫ Adjust target
▫ Implement process changes
▪ Kaizen means to improve
Processes, Products, Workplaces and People

Tan Si Ying 17082036 36

2. Focus on production process

▪ Aim to increase efficiency of the production stage of

product-life cycle
▪ Reduce the cost of components and products by a pre-
specified amount
▪ Causes of wastes, excess and variations can be
continuously reduced
Eg:
Each period kaizen standard will be set based on prior period’s
improvements and push for greater future improvement.

Tan Si Ying 17082036 37

2. Focus on production process

Examples:
▪ Improve set up process
▪ Reduce by-product waste by upgrading machine
▪ Motivate employee
▪ Provide employee training

Tan Si Ying 17082036 38

3. Employee Empowerment
Employees
▪ Free to give suggestion
▪ Engaged in constantly watching for and identifying
opportunities for change and improvement.
▪ Valued, recognised, rewarded and motivated.
Company
▪ Believe that employees have the best information and
knowledge on how to improve.
▪ Combine collective talents within a company to create a
powerful engine for improvement.

Tan Si Ying 17082036 39

 CTEA 3227
Management Accounting III

TOPIC 3
Strategic Management Accounting
Outline

 Contemporary SMA techniques:

➢Life cycle costing
➢Target costing
➢Kaizen costing
➢Theory of constraints
➢Throughput accounting

2
Life Cycle Costing
 A cost management approach where costs are
accumulated and managed over the life cycle of the
product.
 Includes upstream and downstream costs.
 ‘Cradle to grave’.
 Four stages of the product life cycle:
◦ Product planning and initial concept design
◦ Product design and development
◦ Production
◦ Distribution and customer (logistic) support

3
4
5
Life Cycle Budgeting
 Involves estimating the expected costs and revenues
for each year of the expected life of a product.

 Allows for comprehensive assessment of the

profitability of a product over its entire life.

 Comparison between budgeted cost and revenue

with actual costs and revenues each year.

 Considers all relevant costs over the value chain.

 Useful in product mix or pricing decisions.

6
 Concepts of life cycle costing not widely used
because:
◦ There is a lack of awareness, or uncertainty about how to
calculate life cycle costs.

◦ Short-term orientation of budgeting systems may discourage a

life-cycle approach.

◦ Life time costs for products with longer lives are difficult to
estimate:
 Changes in consumer tastes
 Impact of competitors’ actions
 Effects of inflation

7
How is it different from the traditional management
accounting system (MAS)?
Traditional MAS
Focuses on cost
containment/cost control
Focuses primarily on the
manufacturing
stage of a product’s life cycle
Pre-manufacturing costs (R&D
and design costs) are treated as
period cost.
Report on a period-by-period
basis – short term perspective
LCC
Focuses on cost reduction – a cost
management technique
Focuses on the entire stages of
product’s life cycle
Pre-manufacturing costs (R&D and
design costs) are
treated as product cost.
Report on a product-by-product
basis over entire life-cycle – long
term perspective
8
Target Costing
 A system of profit planning and cost management that
determines the life cycle cost at which a proposed
product must be produced to generate the desired level
of profit, given the product’s anticipated selling price.

 It is a cost management technique, not a product

costing technique.

 The cost target for a product is driven by the need to

sell the product at a certain market price and to achieve
a target profit margin.
9
 Estimate the target selling price based on market
considerations, customer needs and expectations,
and competitor behaviour.

 Determine target profit margin and the target cost.

 Identify the cost reduction objective – difference

between the current product cost and target cost.

 Reduce cost and enhance customer value across the

value chain
◦ Value engineering to eliminate non-value-added aspects of the
product design
◦ Value analysis of manufacturing processes to eliminate non-
value-added activities in manufacturing
◦ Work with suppliers to reduce component/material costs
10
11
 It is price led.

 Focuses on customer expectations for product

features and quality.

 Based on principles of life cycle management, placing

primary emphasis on managing downstream and
manufacturing costs.

 Cross-functional – involving managers from across

the value chain.

12
Target Costing and Value Engineering

 It is a systematic interdisciplinary examination of factors

affecting the cost of a product or service in order to devise
means of achieving the specified purpose at the required
standard of quality and reliability at the target cost.

 Encompasses improvements in product designs, changes in

materials specifications, and modifications in process
methods.

 The aim of value engineering:

◦ to improve product design that reduce the product’s cost without
sacrificing functionality.
◦ to eliminate unnecessary functions that increase the product’s
cost and for which customers are not prepared to pay extra cost
(non value-added cost).
13
Major Strength of Target Costing

 Team work
– members from all divisions and various functions
(designers, engineers, purchasing, manufacturing, marketing,
personnel)
– reduce product development time & costs.

 Target costing is carried out before actual production

(during planning & design stage), therefore help to reduce
future manufacturing costs that are locked in/committed.

14
Kaizen Costing
 Kaizen = Japanese term for continuous and incremental
improvements to the current production process.
 Kaizen costing (KC) – like target costing (TC), widely used
by Japanese firms.
 TC – used before product is in production (in planning &
design stage).
 KC - used when product is in production (manufacturing
stage).

15
 KC relies heavily on employee empowerment.

 Workers are given the responsibility to improve processes

and reduce costs because they are closest to the
manufacturing processes and customers.

 KC assumes dynamic conditions where constraints such as

causes of waste, excess, and variations can be continuously
reduced.

 KC focuses on cost reduction efforts in the production

stage of the product life-cycle.

e.g. improve set up process, improve machine performance

to reduce waste, increase employee training & motivation
in order to encourage them to suggest ways to reduce
costs & improve quality.
16
 KC focuses on the process, not the product through
increased efficiency of the production process.

 Continuously reduce costs based on cost reduction targets

– assume dynamic condition.

 Each period kaizen standard is set based on prior period’s

improvements – locking in these improvements to push for
greater improvements in future.

17
Managing Throughput

1. The Theory of Constraints

2. Throughput Accounting

18
The Theory of Constraints
 An approach to managing costs and improving quality and delivery
performance by focusing on identifying and removing constraints
(bottlenecks) in the manufacturing process to speed up the flow of
product through the plant (to improve the rate of throughput).

 Recognises the rate of production is limited to the capacity of the

constraints (or bottlenecks) that exist.

 Aims to maximize operating income when faced with some

bottleneck and some non-bottleneck operations.

 It helps managers reduce cycle times and operating costs.

 TOC focuses on a short-run time horizon and assumes that operating

costs are fixed costs. 19
 Throughput Accounting
 Measures the effect of bottlenecks and other operational
decisions using 3 financial measures:
◦ Throughput – profit rate based on sales: Sales revenue – variable costs
◦ Investment – resources tied up in inventory, buildings, machinery, other
assets/liabilities
◦ Operating expenses – the cost of converting inventory into output such as
labour cost, machine maintenance and utilities.

 When throughput is increased with no change in investment or

operating expenses, then profit, ROI and CF will increase.

 When operating expenses decrease with no change in throughput

or investment, then profit, ROI and CF will increase.

 Decreases in investment will also increase profit, ROI and CF. 20

 Managing Throughput (cont’d)
Methods to Relieve Bottlenecks:
 Eliminate idle time at the bottleneck operation

 Reduce setup time and processing time at bottleneck operations

 Improve the quality of parts or products manufactured at the bottleneck operation

 Reduce other delays due to unscheduled and non-value-added activities, such as

inspections, machine break-downs, etc.

 Look for quality defects in raw materials that might be slowing things down.

 Simplify the operation:

a. simplify the product design
b. simplify the manufacturing process 21
22
23
24
 http://www.youtube.com/watch?feature=play
er_detailpage&v=mWh0cSsNmGY
 http://www.youtube.com/watch?feature=play
er_detailpage&v=6_N_uvq41Pg

25
End of Lecture 3

26
 CIA 3004
Seminar In Management Accounting

Activity-based Management, Business Process

Reengineering, Theory of Constraint and
Throughput Accounting
Activity Based Management (ABM)

● Process of using information from activity-

based costing to analyze activities, cost
drivers and performance so that customer
value and profitability are improved.
● Customer value - The value a customer
places on particular features of a product
● Addresses the ‘process view’ of the ABC
model
Two-Dimensional ABC Model

● One approach is to analyse activity based costing

with the use of a two-dimensional model. The model
is used to explain the components involved and
depicts the flow of information in the activity based
costing system. The information in the activity based
costing system can be viewed from two
perspectives.

Cost view Process view

 COST VIEW

RESOURCES

Two-Dimensional ABC
Model
PROCESS VIEW COST DRIVERS ACTIVITIES PERFORMANCE

COST
OBJECTS
 Cost Assignment View
RESOURCES
- Underlying presumption:
cost objects cause the need
RESOURCE DRIVERS ASSIGNMENT for activities, and activities
cause the need for
A measure of the frequency and
intensity of the demands placed resources
on RESOURCES by ACTIVITIES ACTIVITIES

ASSIGNMENT ACTIVITY DRIVERS

A measure of the frequency and

intensity of the demands placed
COST OBJECTS on ACTIVITIES by COST OBJECTS
ABC recognises the causal
relationships of cost driver to
activities
ABM includes cost driver
analysis, activity analysis, and
performance measurement,
drawing on ABC as its major
source of data.
In simple terms, ABC is used to answer
the question “what do things cost?”
While ABM, using a process view, is
concerned with what factors cause costs
to occur?
Using ABC data, ABM focuses on how to
redirect and improve the use of resources
to increase the value created for
customers and other stakeholders.
 Process View

COST DRIVERS/
ACTIVITY ANALYSIS

Activity Performance
Root Causes Activities
Triggers Measures
any factor(s) that
change the cost of an
activity
- Includes information about cost drivers and performance measures for each activity or process in the
value chain which are essentially non-financial.
- The data provides useful information necessary for the performance evaluation which describes the
work done and the results achieved in an activity/ how well an activity is performed in meeting the
needs of the company and the customers.
- Includes measurements of efficiency, time taken and output quality of the activity
 Operational ABM case: Using ABM to
reduce costs 04
01 04
Identify the major Introduce some new
opportunities for performance
cost reduction measures to monitor
01 STEP 03 the effectiveness of
S cost reduction efforts
03
02
Develop a
Determine the real 02 program to
causes of these eliminate the
costs causes and,
therefore, the
costs
1. Identify the major opportunities for cost reduction

 Value analysis helps manager to identify

the opportunities to reduce costs.

 Eliminate the Non-value-added activities

such as waiting, inspection, rework and
the unnecessary movement.
2. Determine the real causes of these costs
I. Building activities into processes
II. Cost driver analysis
 3.Develop a program to eliminate the causes and, therefore, the costs

 ‘Grind castings’ and ‘Weld defects’

 The primary cause of defects is metal impurities
 Solution: communicate with the purchasing manager

4. Measuring performance

 Monitor the effectiveness of cost reduction

 Business Process Re-engineering
What it is about?
Rethinking and radical redesign of business
process to to achieve improvement in
performances, productivity and quality.
Focus is on strategic process
Process that focus on achieving
company’s business objectives and
strategies

Aim
Reorganise the way in which work is done
by identifying and eliminating non-value-
added activities.
 Business Process Re-engineering

STEPS

1. Prepare a
3. Reorganise 4. Implement the
business process 2. Establish goals
work flow program
map
Example - Ford Accounts Payable Process
Ford needed to review its account payable
process to:
Do it cheaper (cut costs)
- Ford employed about 500 people to
handle the entire process
- Mazda, Ford’s competitors managed
the same process with only 100 people

Do it faster (reduce turnaround times)

- It takes a lot of time for processing POs
and invoice.

Do it better (reduce error rates)

- All the work done manually.
Before Business Process Reengineering
 An invoice-less process implemented which
bring benefits of :
❖ Shared database
- POs raised by purchasing departments will
be updated in the database.
- Warehouse man would update the materials
received and confirm delivery.
- Payment would be automatically be made
without waiting for an invoice from the
vendor.
❖ Every function participates directly
❖ 75% reduction in workforce
After Business Process Reengineering - 500 employees to 125 employees
Bottleneck is a point in a process
that blocks or slows progress

17
Noor Syatirah

Rate of production limited to
capacity of
constraint/bottleneck that
exist in the organisation
An approach to managing and
improving quality and delivering
1 performances- focus on
identifying or removing
bottleneck
2

Any attempt to improve efficiency

3 in non-bottleneck area-not
improve the production flow
Applying the theory of
constraints enables a business
to increase revenue, reduce
costs and
improve customer response
4
time
18
John Blackstone (2010) Theory of Constraints. Scholarpedia, Noor Syatirah
5(5):10451.
 5 steps to manage constraints

2 4
OPTIMIZE ELEVATE
THE THE
CONSTRAIN CONSTRAIN
TS TS

1 3
IDENTIFY
THE
SUBORDINA
TE THE NON 5
CONSTRAIN REPEAT
CONSTRAIN
TS STEP 1
TS

https://www.leanproduction.com/theory-of-constraints.html 19
Noor Syatirah
 Methods to relieve bottleneck
● Eliminate idle time at the bottleneck operation
● Process only those parts or products that increase throughput contribution,
not parts or products that will remain in finished goods or spare parts
inventories
● Shift products that do not have to be made on the bottleneck operation to
nonbottleneck processes, or to outside processing facilities
● Reduce setup time and processing time at bottleneck operations
● Improve the quality of parts or products manufactured at the bottleneck
operation
● Reduce other delays due to unscheduled and non-value added activities, such
as inspections, machine breakdowns, etc.
● Look for quality defects in raw materials that might be slowing things down.
● Simplify the operation: a. simplify the product design b. simplify the
manufacturing process
WHAT IS THROUGHPUT ACCOUNTING?
▪ Throughput Accounting is the Theory of Constraints method of accounting which does not
allocate costs but instead places emphasis on increasing Throughput.
▪ Throughput = sales revenue - direct raw material cost
▪ Throughput increases when the sales revenue increase and direct raw material cost decrease
▪ TA is designed to support management decision making

21
Nur Azyyati Asmadi
 Basics of Throughput Accounting

● Throughput Accounting operationalises the key facets of TOC management and

focuses management’s attention on three basic objectives:

1. increasing throughput

2. reducing inventory

3. reducing operating expenses.

● All other aspects of basic financial accounting concepts remain the same.

22
 Throughput
● Growth in throughput, i.e. the ability to increase the profitability.

● Protecting and increasing Throughput Value Added (TVA), which is calculated

as the difference between sales revenue and variable cost, is to be treated with
higher priority than reducing inventory or reducing operating expense

● Throughput can be mathematically defined as:

Revenue-Direct material = Throughput

23
 Inventory
● The money the system invests in purchasing things the system intends to
convert into throughput (Northrup, 2004: 76)

● Throughput Accounting defines inventory in the same basic categories of Raw

Materials, Work‐in‐ Process, and Finished Goods.

● Inventory does not have value until the product is sold because it does not
generate throughput (ACCA, 2016: 50)

● In Throughput Accounting, inventories are carried at their TVC value typically

just material cost and freight in.

24
 Operating Expenses

● All the money the system spends in turning inventory into Throughput.

● Operating Expenses are the total expenses other than TVCs a company has in
any period.

● This includes, wages, salaries, depreciation, interest, overheads, etc. – Labor is

included here unless it is paid on a piece‐rate basis.

● Essentially, Throughput Accounting treats all costs other than TVCs as a period
cost.

25
 Traditional Costing vs Throughput Accounting

Traditional Costing Throughput Accounting

Inventory is an asset. Inventory is not an asset. It is a result of

unsynchronised manufacturing and is a
barrier to making profit.

Labour costs and variable overheads are All costs other than materials are seen as
treated as variable costs. fixed in the short term.

Value is added when an item is produced. Value is added when an item is sold.

Product profitability can be determined by Profitability is determined by the rate at

deducting a product cost from selling price. which money is earned through throughput.

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