This is the first of a two part sequence of papers by Bernd Gaiser related to German cost management. The purpose of this article is to discuss the German cost management approach to activity-based costing. The second article describes the German version of target costing¹.

During the 1960’s and 1970’s there were two major accounting developments in Germany. The first concept called Einzelkostenrechnung, was highly influential in the academic field and involved assigning all expenses directly to cost objects. The second concept called Grenzplankostenrechnung (GPK) is still in use today. The main idea behind GPK is the responsibility center. Responsibility centers² play a key role in manufacturing firms when it comes to managing cost. GPK helps keep the cost centers in check in areas such as cost planning and cost control, while measuring efficiency. Gaiser notes that German companies generally have a lot more cost centers in place than U.S. companies.

Cost centers, direct and indirect alike, are comprised of variable as well as fixed costs. The author explains, that when creating a budget for planning purposes, the expenses for each cost center are estimated and then allocated throughout the year. These amounts budgeted for costs become the responsibility center’s standards for “efficient resource consumption”. Each month cost centers produce reports that include planned demand and actual demand for resources and the expenses associated with it. The use of standard costs helps management determine what is an allowable cost in meeting actual demand for resources.

In order to evaluate a cost center’s efficiency GPK takes into consideration the usage variance. This variance is defined as the difference between actual costs and standard costs for the center. The use of this variance, as well as others pertaining to volume and price, generates reports that management relies on in order to assess productivity and ways of improving it.

As for product costing, GPK can provide information regarding variable costs and full costs. In a first stage of product costing, manufacturing support departments are assigned to their own cost center. In the second stage of product costing, budgeted costs are allocated to products. There are certain costs that cannot be assigned to direct manufacturing centers, such as the costs of the marketing department, that are later added to a product group.

GPK makes use of a large number of cost centers, chargeback systems and measures for determining the demand for resources. GPK is mainly beneficial to use within organizations that have tasks that have been well defined and organizations that have products with long life cycles because it is able to develop better standards over a long period of time.

The author discusses some disadvantages associated with GPK as follows:  

1. It fails to provide management with information needed concerning indirect cost centers.

2. The constant updating and reviewing of GPK can become a costly process requiring
    more personnel.

3. Reports generated under GPK evaluate productivity through standards that are revised
   on a yearly basis, making it difficult to evaluate some valuable short term information
   about productivity improvement.

The pros and cons of GPK can change depending on each company’s circumstances.

In the past two decades, German managers realized that GPK’s focus on direct costs would no longer provide them with the best information for control. This resulted in two important changes:

            1. A focus on indirect processes.
           2. A focus on product development as a means of controlling product cost.

These changes emerged as a means of understanding what costs are for today and how to influence product costs for the future. Gaiser points out that Germany did not invent the basic ideas behind these two concepts. They took the idea of managing indirect costs from ABC costing and the idea of influencing costs in early stages of developing a product from Japan’s target costing.

Another important development in German cost management is Prozesskostenrechnung (process costing or German version of ABC). Created in 1987, it integrates concepts of ABC into German control systems. Process costing, as defined by Gaiser, makes a distinction between processes and sub processes. Cost management usually pays more attention to main processes in order to plan and monitor improvement in productivity. Indirect costs from main processes are assigned to the outcome using a single cost driver. According to Gaiser, the German concept of process costing mainly emphasizes indirect activities, whereas GPK is still used to provide cost data for control in production activities and departments.

Gaiser is not judgmental about the cost management systems discussed in this article. He explains the main ideas behind each concept and mentions the advantages as well as the disadvantages from a management point of view. There is no perfect way or magical formula to calculate cost. It all depends among other things, on the type of company, the product or service, the ratio of direct costs to indirect costs and the information needed by management.

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¹ See the Gaiser Part 2 summary for a discussion of the German concept of target costing.

2 See the Responsibility Accounting topic for more on responsibility centers.

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