Preface and Chapters 1-3
Summary by James R. Martin, Ph.D., CMA
Professor Emeritus, University of South Florida
Links to Other Chapter Summaries or to Summaries
that include some CAM-I concepts:
4. Accounting Models
5. Life Cycle Management - See the PLC Summary.
6. CMS Performance Measurement
7. Investment Management - See the Investment Management Summary.
8. Issues of Cost Management in Relation to the Cost Accounting Standards Board
9. Cost Accounting in Japan.
Three Phases for Study:
Phase I: Conceptual Design - This Book
Phase II: Systems Design - Considered the design implications from JIT, islands of automation, CIM, target costing, cost drivers, portfolio management of investment opportunities.
Phase III: Implementation - Developed strategies, started pilot cost management systems, reports on pilots, etc.
Problem and Reason for the Conceptual Design Study:
No comprehensive knowledge base of cost management strategies for computer-integrated manufacturing (CIM).
Traditional cost systems encourage overproduction by focusing on controlling production processes and ignoring the product's life cycle.
This book presents the preliminary findings from an attempt to build a common knowledge base of cost management practices from an international forum of cost management experts.
Many companies have started pilot programs, but there are few, if any, new cost management systems in operation on a company wide scale.
Cost Management is more comprehensive than cost accounting.
Cost Management takes a proactive role in planning, managing, and reducing cost before the cost are incurred as opposed to simply reporting cost.
Advantages of the cost management approach
1. Continual improvement in eliminating non-value added costs, or costs that do not make the product more valuable to the customer, i.e., no additional performance, function, quality or perceived value.
2. Activity accounting.
3. Externally driven targets, including target cost. (Pull vs. push)
4. Improved traceability of cost to management reporting objectives. (From 2)
Example of Non-value added costs:
Lead time = Process time + Inspection time + Move time + Wait time
All are non-value added activities except process time, thus
Lead time = Process time + Non-value added time
Manufacturing Cycle Efficiency or MCE = Processing time/Lead time
The goal is for MCE to equal 1 or 100%.
Lot size = 1 and time between operations = defects = setup time = 0
Process time can be improved by:
1. Reducing downtime - caused by equipment failure, setups and adjustments.
2. Reducing speed variations - idling and minor stoppages.
3. Reducing quality problems - caused by defects in the process or materials.
4. Balancing production - by eliminating bottlenecks and failures in other processes.
5. Providing sufficient orders.
The activity accounting approach to cost management organizes work into functions, activities, tasks and sub-tasks.
Tasks and sub-tasks represent the work elements of an activity.
Functions are too global for traceability.
Tasks are too small for control.
Activities are practical for traceability and control.
Activity Accounting is the basis of the CMS Conceptual Design
Advantages of Activity Accounting:
1. Activities are easily understood because they correspond to events. Traditional overhead allocations are not understood by users.
2. It is conceptually easy to associate cost and performance data with an activity since activities often result in transactions.
|Identify requirement||Purchase requisition|
|Place order||Purchase order|
3. It provides a logical framework for integrating:
a. cost accounting, - (determining the cost of activities)
b. performance measurement - (determining efficiency and effectiveness) and
c. investment management - identifying, evaluating and implementing new activities, or alternatives for existing ones, to improve future performance.
4. Activities provide the basis for understanding cost drivers.
The emphasis in the CMS conceptual design is on tracking cost and performance for only significant activities.
The target cost concept is market based in that it represents the cost derived from a target price needed to provide a target market share and desired profit.
Target cost = Target sales price - desired profit
If target cost < standard cost, cost reductions are needed.
Cost reductions may be achieved in two ways:
1. Effects of the learning curve. (See the Learning Curve section).
2. Continual improvement in eliminating waste. Increasing Need for Traceability Automation causes higher ratios of fixed cost to variable costs. The higher the ratio the more traceability needed. In a "lights out factory" (100% robots and automation) all significant cost, except materials are fixed.
CMS Overall Goal and Objectives
1. Identify the cost of significant activities.
2. Determine the efficiency and effectiveness of activities performed.
3. Identify and evaluate new activities that can improve future performance.
4. To do all this in a changing technological environment.
The overall goal is to help companies produce products or services that are competitive in terms of cost, quality, functionality, and timing in the world market.
1. Assist management in improving the traceability of cost. We need a disinterment of costs that traditional systems bury in overhead, e.g., technology, tooling, work-in-process, maintenance, data processing and engineering.
2. Help companies optimize life-cycle performance. Using the life-cycle concept requires capitalizing many cost that traditional systems expense.
3. Enhance decision making tools by recognizing the impact of product design on all aspects of cost.
4. Expand the investment management process using a portfolio approach to evaluate interrelated projects rather than evaluating projects on a stand-alone basis.
5. Integrate performance measurement criteria with financial performance, by converting non-financial measurements (for such things as quality, lead time and flexibility) into financial measurements and highlight non-value added costs to facilitate elimination.
6. Support various levels of automation and diverse manufacturing philosophies using a data base concept to enable a company to capture data only once to support multiple reporting purposes.
CMS Data Architecture
Cost Centers are established for homogeneous groups of cost.
Significant activities are defined for each cost center.
Some activities transcend cost centers, i.e., are common to all centers.
The cost of accounting transactions are captured only once to satisfy multiple requirements.
Life cycle management requires product cost across all activities that occur during the products life cycle using inception-to-date cost information.
1. Identify the costs of non-value added activities to improve resource use.
2. Recognize holding costs as non-value added activity traceable directly to a product. Use an imputed cost for management reporting purposes.
3. Trace significant cost to management reporting objectives such as projects, processes and products. Separating cost into fixed and variable is not meaningful for routine decisions.
4. Establish separate cost centers for homogeneous groups of activities (i.e., those with the same cause and effect relationship) consistent with organizational responsibility.
5. Activity based costing will improve cost traceability.
6. Develop separate bases for allocations based on causal relationships and management reporting objectives where direct assignment is not possible.
7. Accumulate cost by activities to provide cost over the entire product life-cycle including product development, production and logistics.
8. Treat technology costs as a separate cost element and assign directly to products. Use machine hours or through-put time rather than traditional depreciation methods.
9. Measure actual cost against target cost to support the elimination of waste.
10. Develop cost effective approaches for internal control for automated systems.
Objectives of Performance
1. To measure activities against goals and objectives developed for the firm's strategy.
2. To support the elimination of waste, non-financial measurements should be understandable in financial terms.
Performance Measurement Principles
1. Performance measurements should be congruent with objectives and link activities with strategy, within the accountability of the person performing the activity and visible to as many people as possible. "You get what you measure."
2. Performance measures should be established for significant activities.
3. Performance measures should be established to improve the visibility of cost drivers
4. Both financial and non-financial measures should be included that are quantifiable and easy to understand.
Investment Management Principles
1. Investment management is more than capital budgeting and includes identifying, evaluating and implementing new activities or alternatives.
2. Investment management decisions should be consistent with company goals and strategy.
3. Multiple criteria should be used including improvements in throughput and flexibility as well as traditional methods.
4. The investment strategy should include risks and benefits from linked activities.
5. Activity data should be traced to the specific investment opportunity.
6. The focus of investment decisions should be to improve performance.
7. Investment management decisions should support achieving target cost.
Today's cost systems are not providing the information needed to identify, prioritize and solve problems in a changing environment caused by an explosion of technology.
Background and Manufacturing Trends
1. Competition is changing because of automation. Automation provides potential for products with new capabilities, lower cost, higher quality, faster throughput time, higher reliability and maintainability with lower field support cost and faster delivery.
2. The Technology Explosion causes a dynamic competitive environment. Accounting has not kept up. Approximately 90% of engineering and physical science knowledge was developed in the last 30 years. There may be more technological change in the next 10 to 20 years than has occurred in all history.
3. Product life cycles are becoming shorter. Some are three years or less. This causes an increasing need to understand the total product cost over the products entire life cycle including design and support costs. Firms must join technical/engineering competence with financial monitoring.
4. Better production flows have allowed for a reduction in inventory buffers that obscured problems.
5. Advanced manufacturing technologies have caused a need for more timely information, but the problem (technology) provides the solution which is local area networks (LANs) to track and report for control and communication.
But this local information still needs to be integrated into the total manufacturing process.
6. Integrated manufacturing technology is available to move from islands of technology to integrated systems. Automation will not guarantee success.
7. Factors of production are shifting from variable to fixed. Higher ratios of fixed to variable cost limits a company's ability to respond to economic changes, e.g., you can't layoff robots.
Cost Accounting Issues
1. Overhead costs have risen dramatically.
2. Direct labor is becoming smaller, below 12% of total cost.
3. Equipment related costs are becoming a larger part of total costs with decreases in technological lives of products and processes.
4. There is an increasing dependence on computerized information, but there are no mechanisms for determining the value added by more accurate and timely (real-time as opposed to batch) information.
Bases For Cost Allocation
Allocations have a misleading aura of precision, but changing cost behavior patterns demand that companies re-evaluate their allocation decisions continually.
A single basis change such as changing from direct labor to machine hours will not solve the cost management problems.
The focus on direct labor is invalid.
Cost are changing. Direct costs are becoming smaller and indirect costs are becoming larger. With LANs many indirect costs can be treated as direct costs.
Inventory costing needs to be de-emphasized.
Work-in-Process carrying costs are not segregated, but should be. These costs include: finance cost, obsolescence and scrap, material storage, movement, taxes and insurance, WIP accounting and production control.
Changing Basis for Depreciation
Charging depreciation to overhead and then charging to products using typical direct labor basis causes significant distortions.
Depreciation based on machine hours or inventory velocity and technological life would be more accurate. Using tax allowable life may be unrealistic.
Current methods of accounting for technology prevent needed investments.
Inadequacy of Period Reporting
Life-cycle reporting is needed, not period reporting. The primary determinates of life cycle costs occur during the design phase.
Design and process decisions have a long term effect on a product's cost structure.
The product specifications lock in most of the costs.
Development cost need to be identified with the product, but traditional cost systems focus on production cost.
Thus, process and equipment planning are also important.
Functional organization (e.g., finance, design, engineering, marketing, processing, etc.) causes sub-optimal management behavior since there is no incentive to reduce costs that are outside the manager's area of responsibility.
Need to Provide Financial Data to Design and Process Engineers
The majority of product costs are locked in early in the design and development stages.
Need to Expand the Emphasis on Process Engineering
Spending more on design and planning activities reduces cost in the later stages of the PLC.
Need to Revise Cost Center Structure
The entire shop floor cannot be treated as a cost center.
For example, there is a need to create new cost centers for new machinery, not just include new cost by revising the old overhead rate.
However, managers must remember that accounting does not add value, just costs.
Automation will have an impact on internal control systems because of the paperless environment.
Standard Information Systems
It would help if software was compatible.
Investment Justification Issues
1. Cost behavior patterns for radically new manufacturing methods are poorly understood. Focusing only on quantifiable cost and excluding potential improvements in quality, flexibility, throughput time, and responsiveness to customers penalizes investments in advanced manufacturing technologies.
2. Discounting future benefits at excessively high hurdle rates penalizes investments in the future.
3. The lack of a portfolio approach that links benefits from many advanced manufacturing projects causes problems. In other words, evaluating each project individually causes double counting of some benefits and overlooking other synergistic benefits.
4. There is a conflict between the absorption costing approach used to evaluate investments since much of the information needed is un-quantifiable.
Performance Measurement Issues
1. Need reporting for the strategic benefits from automation such as improved quality, shorter production cycles, and greater responsiveness to changing requirements.
2. New cost management systems must be able to monitor strategic projects such as multi-year programs to improve quality or to train workers.
3. The best way to control cost is to control the cost drivers.
Why the Slow Pace?
1. Insufficient knowledge base. For example, there is no standard definition for cost management.
2. Most companies have a mix of manual and automated systems.
3. External organizations such as the SEC, IRS, DOD, and AICPA make the reform process beyond the capabilities of any individual firm.
4. The traditional conservative bias that requires objective, consistent information has an influence. But financial information is getting softer, i.e., less direct cost, because of automation.
5. Increasing complexity of manufacturing processes makes it more difficult to understand the cost drivers.
Conceptual Model of a Generic Discrete Parts Manufacturer
Objectives are stated in absolute terms to change the mind-set from one of acceptable balanced levels of performance to one of continual pursuit of improvement. For example, adopt the objective of zero defects, as opposed to minimum defects.
Thus, the cost/benefit (optimizing) mentality is inconsistent with the CAM-I conceptual design.
key Idea - We need to stop doing with great efficiency that which should not be done.
Ten Generic Engineering/Manufacturing Objectives:
|Drivers that affect the company's ability to achieve the objective.|
|1. Produce for demand to avoid inventory buildup.||Accurate forecasts of customer demand. Manufacturing capability. Capacity constraints. Production cycle time. Manufacturing policies. System responsiveness.|
|2. Detect the best product design.|
|3. Minimize production cycle time and minimize customer delivery time.|
|4. Strive for zero defects.|
|5. Use optimal means of production.|
|6. Strive for zero time between operations.|
|7. Strive for zero setup time.|
|8. Maintain zero raw materials and finished goods inventories.|
|9. Minimize management and support structures.|
|10. Minimize total life cycle costs.|
The CMS Engineering/Manufacturing Functional Model
The model defines fifteen functions and the activities needed to perform each function, thus it provides a basis for developing and activity accounting system.
|1. Strategic planning|
|2. Basic Research and Development|
|4. Product/process development and maintenance|
|5. Tools and production programming|
|6. Production management|
|7. In process material movement|
|8. Production operations|
|9. Incoming material control|
|10. Outgoing material control|
|11. Production quality control|
|12. Human resources|
|13. Information systems|
|14. Facilities management|
|15. Product services|
The CMS Manufacturing Practices Profile
This section shows how the emphasis of the fifteen engineering/manufacturing functions change as the company moves through five levels of automation. This is presented in five tables, 3-1 through 3-5. The levels of automation include:
1. Traditional manufacturing
2. Process simplification
3. Islands of automation
4. Computer integrated manufacturing (CIM)
5. Optimized manufacturing
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