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IMRE Cost Accounting & Controlling 2010 M.Sc. Angela Freche

Literature II List of Abbreviations III A. Cost Accounting 1

1 Basics of Cost Accounting 1

1.1 Concept and Structure of Accounting .................................................. 1

1.2 Cost Categories ................................................................................... 2

1.3 Groups and Systems of Cost Accounting ............................................ 2

2 Cost Category Accounting 3

2.1 Tasks of Cost Category Accounting .................................................... 3

2.2 Costs of Materials ................................................................................ 5

2.3 Imputed Depreciations ....................................................................... 12 3 Cost Center Accounting 19

3.1 Tasks of Cost Center Accounting ...................................................... 19

3.2 Steps of Cost Center Accounting ...................................................... 20

3.3 Methods of internal performance allocation ....................................... 26

3.3.1 Step-ladder Method or Step Down Allocation........................... 27

3.3.2 Equation Method or Reciprocal Allocation ............................... 33

4 Cost Unit Accounting 40

4.1 Tasks and Types of Cost Unit Accounting ......................................... 40

4.2. Usual Surcharge Rate Calculation..................................................... 42

4.3 Machine Hour Rate Calculation ......................................................... 49

5 Operating Income Statement 57

5.1 Tasks of an Operating Income Statement ......................................... 57

5.2 Expenditure Style of Presentation ..................................................... 59

5.3 Cost of Sales Style of Presentation ................................................... 65

B. Controlling 72

1. Basics of Controlling 72

2. Operations Management 73

2.1. Direct Costing .................................................................................... 73

2.2. Bottleneck-Analysis ........................................................................... 76 2.3. Break-Even-Analysis ......................................................................... 89

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2.4. Cost Control 94

2.4.1. Introduction to Cost Control ...................................................... 94

2.4.2. Cumulative Method ................................................................ 100 2.4.3. Differentiated Method ............................................................. 106

3. Strategic Management 110

3.1 Target Costing ................................................................................. 110 3.2 Value Benefit Analysis ..................................................................... 120 3.3 Balanced Scorecard ........................................................................ 125

Literature

Horngren, C.; Bhimani, A.; et al.: Management and Cost Accounting; New Jersey USA 1999

Horngren, C.; Foster, G.; et al.: Cost Accounting; New Jersey USA 2000

Neuner, J.; Frumer, S.: Cost Accounting; Homewood 1967

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List of Abbreviations

al depreciation per unit used

at depreciation allowance in period t

A initial value

bi consumption of material for the production of one product unit of product i

cv variable costs

Cf fixed costs

CC Cost center

CM contribution margin vcpCM −=

d rate of degression

I / J total number counted

L total potential of usage

mij number of u that CC i provides for CC j

Mi total u provided by CC i

n asset life

p price of goods

P Profit upP ×=

p.c. primary costs

PSCi primary costs of CC i

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q price of resources

r total consumption vxr ×=

Rn remaining value

Rt value in period t

s.c. secondary costs

t considered period

TCM total contribution margin ∑CM

tpi transfer price for 1 u of CC i

tp1*m12 individual consumption (transfer price of CC 1 times the number of u provided from CC 1 to CC 2)

TU time unit

u unit

v consumption per unit

xi output per product

xb output breakeven

?p planning data

?a actual data

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A. Cost Accounting

1 Basics of Cost Accounting

1.1 Concept and Structure of Accounting

In an industrial plant, factors of production (raw materials, machines, personnel) are used to produce and sell products. This comprises a lot of activities within the organization as well as interactions with the environment. To control these activities, a lot of information has to be provided, e.g. about cash and product flows. This is the task of ac-counting.

Accounting = systematic determination, description, analysis and in-terpretation of numbers (amount and value) of single businesses and their relations with other business subjects.

Concerning the structure, the following division is common: external accounting (balance sheet, profit and loss statement) internal accounting (cost and revenue accounting)

Basically, it can be assumed that external addressees (e.g. creditors, the state) can only inform themselves through published information, while internal addressees (owners, employees, management) can use internal data as well. But this is not always true in practice. For example, a bank which actually is an extern addressee will usually be able to demand internal data while a small shareholder, who is an in-ternal addressee, cannot.

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1.2 Cost Categories

1) Variable Costs and Fixed Costs

a) variable costs = change in dependency of the changes of a cost driver

b) fixed costs = do not change despite changes of a (certain) cost driver,

2) Direct Costs and Indirect Costs

a) direct costs = can be directly assigned to a cost ob-ject

b) indirect costs (also overheads) = can not be directly accounted to a cost object

1.3 Groups and Systems of Cost Accounting

Cost accounting is usually divided into the following groups according to the information objective:

1) Cost category accounting

2) Cost center accounting

3) Cost unit accounting

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2 Cost Category Accounting

2.1 Tasks of Cost Category Accounting

The system of cost category accounting is used to an-swer the question of which costs did occur or are ex-pected to occur.

recording of all costs, that occurred or are expected during an accounting period (partly divided into quantity figures und value figures)

structuring of the recorded costs using certain crite-ria, usually factors of production, e.g. cost of materi-als, personnel costs, imputed depreciations, imputed interests; are used for this

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Definitions:

costs of materials = rated consumption quantity of ma-terial consumer goods, a company buys (especially raw materials, auxiliary supplies, operating supplies)

personnel costs = costs for personnel

imputed depreciations = the costs that occur by wear and tear at durable or immaterial goods

imputed interests = in cost accounting, interests are usually calculated for using capital provided by the company owners and by creditors

Tasks of cost category accounting:

1) Basis for following calculations (cost center account-ing and cost unit accounting)

2) Own analysis of cost structure (portions of particular costs, chronological development)

In this lecture only 2 categories are discussed more closely. Those will be costs of materials and deprecia-tions.

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2.2 Costs of Materials

Definitions:

costs of materials = rated consumption quantity of ma-terial consumer goods, a company buys (especially raw materials, auxiliary supplies, operating supplies)

raw materials = material goods, a company takes over from other companies and changes, and which be-come a main component of the product (e.g. wood in the wood-processing industry)

auxiliary supplies = material goods, a company takes over from other companies and changes, and which become unessential product components (e.g. screws, nails, glue)

operating supplies = material goods, which a company takes over from other companies, and which are used in the production process, but do not enter the product (e.g. fuel, lubricant)

quantity and value need to be determined each.

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1) Determination of the consumption of material:

a) Inventory method:

Both initial inventory and final inventory are deter-mined by an inventory (physical inventory taking)

b) Return accounting:

Consumption quantities are derived from the pro-duced units and their composition, which is recorded in bills of material or receipts, including an additional quantity for waste and (factory) rejects.

c) Clearing or perpetual inventory method:

The consumption of material is recorded using mate-rial stores accounts and receipts (material requisition slips).

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2) Valuation of material consumption quantities:

a) average valuation:

valuation with the help of a weighted arithmetic av-erage of the purchase prices (either period related or permanent)

Evaluation / criticism:

simplification, relative good results when prices fluc-tuate in both directions

b) method of process costing:

form of collective valuation

valuation with the help of assumptions concerning the sequences of consumption, either relating to the date of entry or the prices (period related or perma-nent, respectively)

• FIFO: first in-first out

• LIFO: last in-first out

• HIFO: highest in-first out

• LOFO: lowest in-first out

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• simplification; assumed sequence of consump-tion should be equal to the actual

• sequence (e.g. FIFO when silo storing, LIFO when storing on a dump)

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Example A.1

quantity price initial inventory 100 22.- increase in inventory 01/04 140 20.- quantity withdrawn 01/09 110 ? increase in inventory 01/15 120 21.- quantity withdrawn 01/20 100 ? final inventory 150

period related average valuation:

89.20360

211202014022100=

∗+∗+∗

material costs = 90.386,489.20210 =∗

FIFO-valuation:

material costs 400,42011022100 =∗+∗=

LIFO-valuation:

material costs = 320,4209021120 =∗+∗

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Exercise A.1

For a raw material the following changes in stock occurred:

Change in inventory Amount (kg) Price (€/kg) Initial inventory 1,000 15.00 Increase in inventory 10,000 12.10 Decrease in inventory 7,000 ? Increase in inventory 9,000 16.00 Decrease in inventory 5,000 ? Final inventory 8,000

Calculate the value of the final inventory as well as the value of the goods used by means of the following methods:

a) period related average valuation, b) period related FIFO-valuation, c) period related LIFO-valuation.

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Exercise A.2

For a raw material the following changes in stock occurred:

Change in Inventory Amount (kg) Price (€/kg) Price (€) Initial inventory 400 24.00 9,600 Decrease 02/03 300 Increase 03/12 250 25.00 6,250 Increase 04/15 150 28.00 4,200 Decrease 06/18 200 Increase 08/20 100 29.00 2,900 Decrease 11/03 150 Calculate the value of the final inventory as well as the value of the goods used by means of the following methods:

a) period related average valuation, b) period related FIFO-valuation, c) period related LIFO-valuation.

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2.3 Imputed Depreciations

Definition:

depreciations = the costs that occur by wear and tear at durable or immaterial goods

usually described as calculatory depreciations, since a different valuation, compared to the calculation ac-cording to legal requirements, is used.

Reasons for depreciation:

a) deterioration of time, e.g. at a machine, which stands outside (even, when it is not used in the process of production)

b) deterioration of use, e.g. by employment in the proc-ess of production

c) technical progress, e.g. development of more effi-cient machines

d) depletion of real estates / property, e.g. at gravel pit

e) expiration of patents

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For the determination of the depreciation allowances, the following questions have to be answered:

1) depreciation base

2) useful life or potential of usage

3) depreciation method

1) Depreciation base:

• historical costs (purchasing price + purchasing costs)

• replacement / market prices (value at the time of machine replacement)

2) Useful life:

• technically possible useful life:

• economic asset life: reasonable asset life under an economic point of view

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3) Method of depreciation:

a) time-depending methods

depreciation depending on the time of the calendar

• straight-line depreciation

• declining-balance depreciation

• sum-of-the-years digit depreciation

b) usage-depending method

depreciation depending on the usage of the machine

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Example A.2

purchasing price 280,000 € purchasing costs 20,000 € useful life 6 years remaining value 60,000 € total potential of usage 24,000 h effective usage t1 4,200 h effective usage t2 4,400 h effective usage t3 3,800 h

a) straight-line depreciation:

nRAa n

t−

=

depreciation ( ) year€/000,40

6000,60000,20000,280

=−+

=

b) declining – balance depreciation:

⎟⎟⎠

⎞⎜⎜⎝

⎛−∗= n n

ARp 1100

pAat ∗= (p = percentage rate)

%p 5275508.23000,300000,601100 6 =⎟⎟

⎠

⎞⎜⎜⎝

⎛−∗=

a1 65.582,70235275508.0000,300 =∗=

a2 ( ) 28.976,53235275508.065.582,70000,300 =∗−=

a3 ( ) 99.276,41235275508.028.976,5365.582,70000,300 =∗−−=

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c) sum-of-the-years digit depreciation:

( )( )1

2+−∗

=nn

RAd n

( ) dtnat ∗+−= 1

( )( ) 57.428,11

166000,60000,3002

=+∗−∗

=d

a1 ( ) 42.571,6857.428,11116 =∗+−=

a2 ( ) 85.142,5757.428,11126 =∗+−=

a3 ( ) 28.714,4557.428,11136 =∗+−=

d) usage-depending method:

al LRA n−

=

at lt al ∗=

houral /€10000,24

000,60000,300=

−=

a1 000,4210200,4 =∗=

a2 000,4410400,4 =∗=

a3 000,3810800,3 =∗=

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Evaluation depends on reason of depreciation, for the us-age (wear and tear) the depreciation should be shown as exactly as possible

a) time related methods are good for deterioration of time

b) depreciations depending on usage are good for dete-rioration of usage

since usually both reasons are relevant, a combination of both methods seems reasonable

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Exercise A.3

The following information regarding a machine is available:

Purchasing price 1,000,000 €

Purchasing costs 100,000 €

Useful life 4 years

Remaining value 20,000 €

Total potential of usage 16,000 h

effective usage t1 3,800 h




a) Calculate imputed depreciation and book values for the periods t1 to t4 if straight-line depreciation is to be used.

b) Calculate imputed depreciation and book values for the periods t1 to t4 if declining balance depreciation is to be used.

c) Calculate imputed depreciation and book values for the periods t1 to t4 if sum-of-the-years digit depreciation is to be used.

d) Calculate imputed depreciation and book values for the periods t1 to t4 if usage depending depreciation is to be used.

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3 Cost Center Accounting

3.1 Tasks of Cost Center Accounting

The system of cost center accounting is supposed to give an answer to the question in which business areas costs originated or will origi-nate. In this system the separation into direct and indirect costs is im-portant.

Direct assignment of indirect costs to cost units is not possible; with-out the use of cost center accounting, they could only be assigned to a cost unit by using a total surcharge

Tasks of cost center accounting:

1) Basis for cost unit accounting as down-stream calculation. The system of cost center accounting is supposed to allow an ex-act assignment of indirect costs to cost units; it is considered to which extent a cost unit has used the capacity of a cost center

2) Supervision of operating activities within the single cost centers regarding their cost-effectiveness and compliance of cost budg-ets.

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3.2 Steps of Cost Center Accounting

1st Step: assignment of indirect costs which have been recorded by the cost category accounting to cost centers

2nd Step: allocation of internal performance 3rd Step: formation of surcharge rates for the cost unit accounting 4th Step: control of cost-efficiency 1st Step: Assignment of Indirect Costs to Cost Centers The assignment should – if rationally supportable – correspond to the costs a cost center has caused, i.e. indirect costs should be assigned to those cost centers that are responsible for their origin.

First of all the question of which of the costs are indirect costs needs to be solved. For this purpose, we will look at the types of costs again:

1) Material Costs:

are partly direct costs and partly indirect costs

• raw materials: often direct costs; usually they are recorded as such

• auxiliary supplies: strictly taken, they are direct costs as well, but for the reason of cost-efficiency they usually are not re-corded as such (so called fictive indirect costs)

• operating supplies: are mostly real indirect costs

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2) Personnel Costs: are partly direct costs and partly indirect costs

• direct labor (wages for work directly performed to produce the products): usually handled as direct costs, although the as-signment can be difficult (meaning, that often, those wages are not depending on activity, e.g. time or minimum wages)

• auxiliary labor (wages, that are not directly used for produc-tion, e.g. wages for maintenance): indirect costs; and as far as they are not provided for single cost units, they are usually handled as such.

• salaries: indirect costs

• imputed entrepreneur income: indirect costs

• legally required social costs: can be accounted together with wages and salaries, i.e. they are partly direct costs and partly indirect costs

• voluntary social costs: indirect costs

• other personnel costs: indirect costs

3) Imputed depreciations: usually accounted as indirect costs, but can also be direct costs

(e.g. when depreciations, depending on usage, are used)

4) Imputed interests: normally indirect costs, since there is no information which kind of

capital is used in the cost center

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Primary costs are those costs which are directly taken over from cost category accounting.

2 types can be distinguished:

a) Cost center direct costs:

can be directly assigned to the cost center which caused them, e.g. costs for wages and salaries of personnel that is only employed at a particular cost center

b) Cost center overheads:

allocation only possible with the help of units of billing, e.g. salary of a foreman who is leading more than one cost center (e.g. allocation in proportion to employees employed in a cost center or to number of machines)

Please note: I have mentioned the concept of direct and indirect costs before. Those are strictly taken direct cost unit costs and indirect cost unit costs.

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2nd Step: allocation of internal performances This allocation is necessary, because some cost centers only produce what is used within the business unit itself and therefore show no di-rect relation to the cost units.

2 types can be distinguished: 1) Services, products, performances that are usable for several

years:

e.g. a self-generated machine can be capitalized, and there-fore, they can be handled as a cost unit

they enter the cost center accounting for several periods as depreciations and interests

2) Services, products, performances that are used within the same period:

e.g. energy, maintenance

those performances have to be charged between the receiving and delivering cost center

• indirect cost center: deliver performances, services to differ-ent cost centers

• final cost center: performances, services can be directly as-signed to cost units

Normally the following final cost centers are used: material (supply and storage of material), manufacturing, administration and selling / distribution

Therefore, the task of internal performance allocation is to allocate the primary costs, which are assigned to the indirect cost centers, to final

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cost centers according to provided and received performance. The allocated costs are called secondary costs.

The assignment should follow the principle that costs are allocated to that cost center which causes them. Usually, a proportional relation is assumed between the reference figure and performance delivery, as well as between the reference figure and performance utilization. (e.g. number of hours of repair for the cost center repair)

Methods will be introduced and explained further on.

3rd Step: formation of surcharge rates

After finishing the 2nd step, all costs are assigned to final cost centers. Now, they have to be allocated to cost units. Therefore, the indirect costs are set into relation with a reference figure (e.g. direct labor costs, produced output, provided machine hours). This results in a surcharge rate. With the help of this surcharge rate, the indirect costs can be allocated to the cost units.

Step 3 is the connection between cost center accounting and cost unit accounting (Chapter 4). It is necessary when cost unit account-ing uses a surcharge calculation. Therefore it is only necessary for specified forms of cost unit accounting.

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4th Step: Control of cost-efficiency

simple form:

comparison of actual total costs and allocated total costs of final cost centers

• positive difference (underapplied costs): less than actual re corded indirect costs are allocated to the cost units

• negative difference (overapplied costs)

But: no meaningful cost efficiency control, since the allocated total costs are only an average of historical costs 3.Internal Cost Allocation

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3.3 Methods of internal performance allocation

This is the 2nd step of the cost center accounting.

Problems:

• large number of cost centers

• mutual performance interweaving

Different methods have been developed for the internal performance allocation

1) no consideration of performance interweaving: ex-pense distribution method

2) consideration of one-sided performance interweav-ing: stepladder method

3) consideration of mutual performance interweaving: equation method, iterative methods

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3.3.1 Step-ladder Method or Step Down Allo-cation

a) assignment of costs (indirect cost center) to final cost centers using other indirect cost centers, i.e.:

• consideration of performance relations of down-stream cost centers

• no consideration of performance relations of pre-liminary cost centers

Please note: sequence of cost centers should be se-lected in a way, that, if possible, minor performance relations are neglected

b) assignment of primary costs in proportion to the per-formance utilization

Definition

transfer price = a cost centers primary costs: total of provided performance units

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Please note: only performances provided to down-stream cost centers count

Indirect cost center

Indirect cost center

Final cost center 1

Final cost center 2

Final cost center 5

Final cost center 4

Primary costs p.c. p.c. p.c. p.c. p.c. p.c.

Allocation indirect CC 1

Primary and secondary costs

p.c. + s.c.

Allocation indirect CC 2

Primary and secondary costs

p.c. + s.c.

p.c. + s.c.

p.c. + s.c.

p.c. + s.c.

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Example A.3

Example: (CC = Cost Center) Primary costs CC 1 (cost center) (repair shop) 134,000

Primary costs CC 2 (production planning) 64,500 Primary costs CC 3 (final cost center) 112,000 Primary costs CC 4 (final cost center) 97,500 Total 408,000

Reference figure CC 1: provided hours of repair Total hours of repair provided 3,000

Hours of repair for CC 2 150 Hours of repair for CC 3 1,300 Hours of repair for CC 4 1,550

Reference figure CC 2: number of prepared jobs Total of prepared jobs 900

Prepared jobs CC 1 200 Prepared jobs CC 3 300 Prepared jobs CC 4 400

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1st Step: Determination of cost center sequence

a) in any case, indirect cost centers prior to final cost centers

b) sequences within indirect cost centers:

approximate determination of value of comparative performances (1 to 2 as well as 2 to 1)

scenter cost intitial for dedprovi eperformancesperformanc provided

costsprimary ∗

∑

c) The sequence of final cost centers is optional, since there are no performance relations between them.

Continuing Example A.3: performance of CC 1 for CC 2:

700,6150*000,3000,134

=

performance of CC 2 for CC 1:

33.333,14200*900

500,64=

Since the performance of cost center 2 for cost center 1 shows a higher value than the return service, CC 2 is placed prior to CC 1

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2nd Step: Allocation

allocation occurs gradually, e.g.:

a) the primary costs of CC 2 are allocated to down-stream cost centers 1, 3 and 4 according to the per-formance provided for those cost centers

b) the primary and the secondary costs of CC 1 are al-located to the downstream cost centers 3 and 4

Please note: only performances for downstream cost centers will be considered

Continuing Example A.3:

Indirect CC 2 Indirect CC 1 Final CC 3 Final CC 4 64,500.-- 134,000.-- 112,000.-- 97,500.--

14,333.33 21,500.-- 28,666.67 148,333.33 133,500.-- 126,166.67 67,660.82 80,672.51 201,160.82 206,839.18

q2 67.71900

500,64==

q1 05.52150000,333.333,148

=−

=

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• relatively simple calculation

• performances of downstream cost centers for pre-liminary cost centers are neglected

• at least one-way consideration of performance rela-tions

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3.3.2 Equation Method or Reciprocal Alloca-tion

Simultaneous allocation of all cost centers costs with the help of a system of equations, i.e. consideration of all mutual performance interweaving

one equation for each cost center:

• known figures: primary costs, provided and received performance units

• unknown figures: transfer costs for a cost centers performance

Please note: number of transfer prices equal number of equations, i.e. clear solution

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Basic structure of equations:

Total value of provided performance = cost center pri-mary costs + total value of performance received

Whereas:

Value of received performance = Σ values of indi-vidually received performances

Value of provided performance = Σ values of indi-vidually provided performances

Value of individual performance relation = number of performance units * transfer price

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CC 1: 134,000 + 200 q2 = 3,000 q1

CC 2: 64,500 + 150 q1 = 900 q2

430 + q1 = 6 q2

q1 = 6 q2 - 430

CC 3: 112,000 + 1,300 q1 + 300 q2 = q3

CC 4: 97,500 + 1,550 q1 + 400 q2 = q4

For CC 3 and CC 4 the provided performance is declared to be 1, be-cause for this is example, no information, concerning the type as well as the height of performances of those cost centers, is given, i.e. q3 and q4 equal the total costs for CC 3 and 4.

First of all, the solution for the first 2 equations (2 equations with two unknown variables):

134,000 + 200 q2 = 3,000 * (6 q2 – 430)

134,000 + 200 q2 = 18,000 q2 – 1,290,000

1,424,000 = 17,800 q2

q2 = 80 €/unit

q1 = 50 €/unit

In the next step, the determined transfer prices will be used in the other equations:

CC 3: 112,000 + 1,300 * 50 + 300 * 80 = 201,000

CC 4: 97,500 + 1,550 * 50 + 400 * 80 = 207,000

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• in this case, variations are minimal; but this state-ment cannot be generalized

• determination of exact total costs of final cost cen-ters as all performance relations are considered

• high compute time, especially with complex cost center systems (direct solution often difficult)

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Exercise A.4

The following information is given:

to from

CC1 CC 2 CC 3 CC 4 Sum

CC 1 30 50 80 70 230 CC 2 200 0 120 180 500 CC 3 0 0 0 0 800 CC 4 0 0 0 0 500

CC 1 CC 2 CC 3 CC 4 primary costs 66,000 51,000 120,000 200,000

a) Conduct an internal cost allocation by means of the step-ladder method and calculate the cost of services for the final cost cen-ters.

b) Set up the complete system of equations in order to simultane-

ously allocate internal costs. Calculate the cost of services for the final cost centers.

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Exercise A.5

The following data is given:

primary costs

overall performance

From CC 1 received

performance [kWh]

From CC 2 received

performance [km]

From CC 3 received

performance [h]

CC1 50,000 € 30,000 kWh -- -- -- CC2 100,000 € 500,000 km 6,000 -- 24,000 CC3 72,000 € 80,000 h -- 150,000 -- CC4 140,000 € 8,000 units (X) 24,000 300,000 40,000 CC5 200,000 € 10,000 units (Y) -- 50,000 16,000

a) Conduct an internal cost allocation by means of the step-ladder method and calculate the cost of services for the final cost cen-ters.

b) Set up the complete system of equations in order to simultane-

ously allocate internal costs. Calculate the cost of services for the final cost centers.

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Exercise A.6

A company consists of three indirect cost centers (CC1, CC2, CC3) and two final cost center (CC4, CC5). The relations between those cost centers are shown in the following table:

The following primary costs are given:

a) Determine the cost center sequence which leads to the best re-

sults when using the step-ladder method.

b) Set up the complete system of equations in order to simultane-ously allocate internal costs.

to from

CC1 CC2 CC3 CC4 CC5 Sum

CC1 10 20 25 35 20 110 CC2 20 15 0 70 60 165 CC3 30 20 0 80 70 200

CC1 CC2 CC3 CC4 CC5 Primary costs 100,000 200,000 250,000 400,000 600,000

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4 Cost Unit Accounting

4.1 Tasks and Types of Cost Unit Accounting

The system of cost unit accounting is supposed to answer the ques-tion for which purpose costs did occur or will occur.

Definition:

Cost units = produced goods or other operational services, which ac-tivated or will activate wear and tear, e.g.:

• Jobs of single unit production

• Product units or lots of batch, serial or mass production

• Consulting, research, transport or other services for company ex-ternals

• Internal performance (e.g. self provided facilities)

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Tasks of cost unit accounting: (calculation)

Generally: Cost determination for individual units, e.g. unit related manufacturing costs and unit related prime costs

1) Evaluation whether the profit target for individual products was achieved or not as well as regulation of production and sales with regard to a better target achievement

2) Basis for the selection of prices as well as of production and sale units

Please note: This is just the view of cost accounting. For reaching a decision you need to consider other aspects as well.

3) Basis for decisions making concerning the question of producing or not producing, when prices are given / known.

4) Basis for the selection of lot sizes while producing more than one product

5) Valuation of finished and unfinished products as well as self pro-vided facilities

Types of cost unit accounting:

1) output costing: for one product 2) weighting figure calculation: for different versions of one particular

product 3) surcharge calculation: for different products

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4.2. Usual Surcharge Rate Calculation

System of surcharge rate calculation:

Direct material costs + material overheads = Material costs Direct labor costs + Special direct costs of manufacturing + Manufacturing overheads = + Manufacturing costs = Costs of production + Administrative overheads + Selling overheads = Prime costs

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Determination of surcharge rates:

Surcharge rate for material overheads [%] = 100

costs material directoverheads material

∗

Surcharge rate for manufacturing overheads [%] = 100

costs labor directoverheads ingmanufactur

∗

Surcharge rate for administrative overheads [%] = 100

sold units of costs productionoverheads tiveadministra

∗

Surcharge rate for selling overheads [%] = 100

sold units of costs productionoverheads selling

∗

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Example A.4

Information about all products:

Direct material costs 120,000 €

Material overheads 36,000 €

Direct labor costs cost center 1 200,000 €

Manufacturing overheads cost center 1 160,000 €

Direct labor costs cost center 2 84,000 €

Manufacturing overheads cost center 2 134,400 €

Administrative overheads 55,080 €

Sales overheads 58,752 €

Information about product X:

Direct material costs 160 €/unit

Direct labor costs cost center 1 180 €/unit

Direct labor costs cost center 2 135 €/unit

- 45 -


Calculation:

Direct material costs 160 €/unit Material overheads 48 €/unit Material costs 208 €/unit Direct labor costs cost center 1 180 €/unit Manufacturing overheads cost center 1 144 €/unit Direct labor costs cost center 2 135 €/unit Manufacturing overheads cost center 2 216 €/unit Manufacturing costs 675 €/unit Costs of production 883 €/unit Administrative overheads 66.23 €/unit Selling overheads 70.64 €/unit Prime costs 1,019.87 €/unit

- 46 -


Determination of surcharge rates:

for material overheads: %30000,120000,36

=

for manufacturing overheads cost center 1: %80000,200000,160

=

for manufacturing overheads cost center 2: %160000,84400,134

=

for administration overheads: %5.7400,734

080,55=

for selling overheads: %8400,734

752,58=

Determination of indirect costs for product X:

Material overheads unit/€483.0160 =∗

Manufacturing overheads cost center 1 unit/€1448.0180 =∗

Manufacturing overheads cost center 2 unit/€2166.1135 =∗

Admin. overheads ( ) unit/€23.66075.021614448135180160 =∗+++++

Selling overheads ( ) unit/€64.7008.021614448135180160 =∗+++++

- 47 -



• Using differentiated surcharge rates leads to result, which are more meaningful than the results arising from only a single surcharge rate

• Precision of results depends on the accurate re-cording of direct costs:

small rate of direct costs compared to indirect costs leads to high surcharge rates, which can result in the fact that mistakes from recording direct costs have a strong influence on indirect costs

• Precision of results depends on the fact, whether the assumed proportional relation between indirect costs and the basis for the surcharge rate (direct costs or manufacturing costs) really exists or not:

often a proportional relation does not exist; it may exist between material overheads and direct mate-rial costs, but not with e.g. manufacturing overheads and direct labor costs (especially as part of an in-creasing automation)

- 48 -


Exercise A.7

Calculate the prime costs per unit of products X and Y by using the following (simplified) data, following the approach of surcharge rate calculation (all data refers to one period).

Amount of production and of units sold for product X 1,000 u Amount of production and of units sold for product y 2,000 u Cost of raw materials product X 1,000,000 € Cost of raw materials product Y 600,000 € Direct labor costs for product X 1,400,000 € Direct labor costs for product Y 1,600,000 € Straight-line depreciations for machines in production 600,000 € Wages for workers of the raw materials warehouse 200,000 € Wages for workers in administrative department 400,000 € Wages for workers in selling department 200,000 €

- 49 -


4.3 Machine Hour Rate Calculation

Advancement of usual surcharge rate calculation, for the reason, that the proportional relation between direct labor costs and manufacturing overheads, which was assumed above, hardly ever exists in reality (increasing automation).

The aim is an exact allocation of manufacturing overheads, by distinction between machine-depending and machine-indepen-dent manufacturing overheads

The system of machine hour rate calculation is often described as an individual method. Strictly taken it is version of surcharge rate calcula-tion since the basic approach is identical. The only difference lies in the more exact allocation of some manufacturing overheads.

- 50 -


Steps of Machine hour rate calculation:

1) Separation of manufacturing overheads into ma-chine-depending and machine-independent costs:

• machine-depending: e.g. imputed depreciations, imputed interests, energy costs, operation supply costs, maintenance costs

• machine-independent: e.g. salaries, auxiliary supply costs, rent

Example A.5

(For the basic data see Example A.4)

Additional information about CC1:

imputed depreciations 36,000 € imputed interests 10,400 € energy costs 10,700 € operation supply costs 9,600 € maintenance costs 7,400 € costs of tools 30,400 € other costs 31,000 € TOTAL 135,500 €

- 51 -


2) Allocation of machine depending costs on the basis of machine hours:

a) determination of costs per machine hour

hourmachinepercostscapacity

overheadsingmanufactur depending-machine=

whereas the capacity equals the total machine hours

b) determination of machine-depending indirect costs:

costs per machine hour ∗ machine hours for the product = machine-depending indirect costs for the product


Assumption:

total of 3,440 hours per period; 4 hours for product X

machine hour rate = hour/€39.39440,3500,135

=

machine-depending costs of product X = 39.39 ∗ 4 = 157.56 € / unit

- 52 -


3) Allocation of machine-independent costs on the ba-sis of direct

labor costs:

rateehargsurc100costs labor direct

costs indirect gindependinmachine=∗

−


remaining manufacturing overheads = 160,000 – 135,500 = 24,500 €

surcharge rate = %25.12000,200

500,24=

machine-independent costs of product X = 0.1225 * 180 = 22.05 € / unit

4) Allocation of remaining overheads (material, admin-istrative and sales overheads):

as in usual surcharge rate calculation

- 53 -


5) System of machine hour rate calculation:

Direct material costs + material overheads = Material costs Direct labor costs center + special direct costs of manufacturing + machine-depending manufacturing overheads + machine-independent manufacturing overheads = + Manufacturing costs = costs of production + Administrative overheads + Sales overheads = Prime costs

- 54 -



Direct material costs 160 €/unit Material overheads 48 €/unit Material costs 208 €/unit

Direct labor costs center 1 180 €/unit machine-depending manufacturing overheads CC 1 157.56 €/unit remaining manufacturing overheads cost center 1 22.05 €/unit

Direct labor costs center 2 135 €/unit Manufacturing overheads cost center 2 216 €/unit Manufacturing costs 710.61 €/unit

Costs of production 918.61 €/unit

Administrative overheads 68.90 €/unit Sales overheads 73.49 €/unit

Prime costs 1.061 €/unit

- 55 -


Evaluation / criticism of the machine hour rate calcula-tion:

• Using differentiated surcharge rates for manufac-turing overheads leads to results, which are more meaningful than the results arising from only a single surcharge rate

• Separation into machine-depending and inde-pendent costs is often difficult and only possible with primary costs

• More complex system than surcharge rate calcu-lation

- 56 -


Exercise A.8

A company has obtained the following information about two prod-ucts:

Product A Product B Amount of production and of units sold in u/period 1,000 1,500 Costs of raw materials in €/period 80,000 30,000 Costs of production wages in €/period 120,000 200,000 Sales price in €/u 1,000 350 Overhead costs of cost centers in €/period: Purchasing Production Administration Sales

220,000 600,000 125,000 62,500

The company also calculates that 80 % of overhead costs of produc-tion are dependent on the usage of machines. The potential of usage of the machines during a period is 1,600 h. For product A 1,200 h is used, for product B 400 h.

Calculate the prime cost per unit of products A and B using the nor-mal surcharge calculation and the method of machine hour rate calcu-lation.

- 57 -


5 Operating Income Statement

5.1 Tasks of an Operating Income Statement

Shall answer the question, which operating revenue a company reached within a period

comparison of revenues and costs of a period to de-termine the operation income

also called cost unit period accounting or short term in-come statement (the term cost unit period accounting is ambiguous since you consider not only costs but also revenues)

Tasks of a operating income statement:

1) Evaluation whether the profit target of the company has been reached or not

2) Analysis of reasons for success or failure for short term regulation

- 58 -


Period of time:

Normally relatively short (1 month), else regulation would be impossible

problems to assign costs, which occurred for a longer period to a shorter period (e.g. Christmas gratification, usually constant assignment)

Classification:

To increase the informative value, a differentiated clas-sification of costs and revenues seems reasonable, e.g. by factors of production, operating units or products

Methods:

• expenditure style of presentation (ESP)

• cost of sales style of presentation (CSSP)

- 59 -


5.2 Expenditure Style of Presentation

Characteristics: assignment of costs and revenues within the period, the products are produced

Profits:

• sales proceeds, i.e. profits for sold products (sales prices as valuation basis)

• inventory increase of finished and unfinished goods (costs of production as valuation basis or market price if it is lower)

determination can be problematic if sold products come from different periods, i.e. an inventory existed at the beginning of the period

use of average costs of production

application of collective valuation methods, e.g. FIFO

• self generated assets (analog inventory increase, shall be neglected in this lecture)

- 60 -


Costs:

• operating expenses for all units produced within the period (finished and unfinished goods, self gener-ated assets)

• inventory decrease, surely a negative figure, but no costs; only a correcting entry to sales proceeds, be-cause costs for incoming inventory and a revenue (inventory increase) in equal amount have already been assessed within the period

Structure:

• revenues are usually structured as seen above; as well as a division of sales proceeds by types of products

• costs are usually structured by types of production factors, i.e. material costs, personnel costs, depre-ciations

• in cost accounting, an account structure is normal:

- left side (debit): costs

- 61 -


- right side (credit) : revenues

- operating income to balance both sides (need to be identical), i.e.

- profit on the left side (revenues > costs)

- loss on the right side (costs > revenues)

operating income account according (ESP)

• period costs, differentiated by types of costs

• inventory decrease of finished and unfinished goods valuated with costs of production

• operating profit

• sales proceeds, differentiated by types of products

• inventory increase of finished and unfinished goods valuated with costs of production

• operating loss

- 62 -



• costs and revenues are related to the units produced within the actual period, i.e. all costs and revenues of the period are assigned

• evaluation of expenses:

a) ESP can be easily integrated into the system of financial accounting (there, usually applica-tion of total cost method)

b) changes in inventory need to be determined

• using a structure according to types of production factors, as it is usually done, operating income reve-nue for individual products can not be determined

But: basically, using the expenditure style of presenta-tion, costs can be structured differently as well (typi-cal for the method is only the relation to produced units)

- 63 -


Example A.6

For the X-corporation, the following facts are known about product A for the year 2002:

raw material costs 600 €/unit direct labor costs 700 €/unit depreciations for machines 500,000 €/period administration salaries 400,000 €/period distribution salaries 250,000 €/period

Initial inventory of product A 0 units produced units of product A 1,000 units sold units of product A 500 units selling price 2,800 €/unit

- 64 -


To set up an operating income statement according to the ESP, first of all, it is necessary to valuate the inventory.

In this case, all units are produced in 2002 (leaving an initial inventory of 0). Therefore it is not necessary to take into account whether there are still products left in inventory of the former period(s).

Here, a valuation based on cost of production is used. Generally, oth-er valuation bases are imaginable.

This results in the following:

raw material costs (direct costs) 600 * 1,000 = 600,000 direct labor costs (direct costs) 700 * 1,000 = 700,000 depreciations (indirect costs) 500,000 costs of production (PC) of produced units per period 1,800,000 PC of produced units per unit 1,800 PC of sold units per period 900,000 PC of inventory 900,000

operating income account according (ESP) material costs 600,000 personnel costs 1,350,000 depreciations 500,000

revenues 1,400,000 inventory increase 900,000 operating loss 150,000

2,450,000 2,450,000

- 65 -


5.3 Cost of Sales Style of Presentation

Characteristics: assignment of costs and revenues within the period, the products are sold

revenues:

• sales proceeds, i.e. revenues for sold products (sales prices as valuation basis)

• no assessment of value of inventory increase of fin-ished and unfinished goods as well as self gener-ated assets

Costs:

• operating expenses for all units sold within the pe-riod

• inventory decrease, is contained in the costs for units sold

- 66 -


Structure:

• sales proceeds are usually structured by types of products

• costs are usually structured by areas of activity (pro-duction, administration, selling / distribution) and types of products or only by types of products (i.e. prime costs)

• in cost accounting, an account structure is normal:

operating income account according to CSSP

• costs of products sold, differentiated by types of products (if necessary, split into area of activity) • operating profit

• sales proceeds, differentiated by types of products • operation loss

- 67 -



• costs and revenues are related to the units sold within this period, i.e. not all costs and revenues are assigned

• evaluation of expenses:

a) CSSP can hardly be integrated into the system of financial accounting (there, usually application of expenditure style of presentation)

b) Cost unit accounting for sold products necessary

c) Following the information in the literature, changes in inventory need no determination

but this is only valid, if manufacturing costs are assessed with average values; else, inventory needs determination as well to determine the manufacturing costs for sold products

• using a structure according to areas of activity and products, as it is usually done, operating income re-sults for individual products can be determined

- 68 -


But: characteristically for the costs of sales style of presentation is the relation to units sold, i.e. the ad-vantage counts only for a certain design of presenta-tion


operating income account according to CSSP PC (of units sold) 900,000 Administrative costs 400,000 Distribution costs 250,000

sales proceeds 1,400,000 operating loss 150,000

1,550,000 1,550,000

- 69 -


Comparison of ESP and CSSP:

1) Results are always equal

• having an increase in inventory in the ESP, costs and revenues are higher by this amount

• having a decrease in inventory in the ESP, costs and revenues are lower by this amount (if de-crease in inventory is seen as a correcting entry)

2) Differing assignment of costs and revenues

to the periods for the reason of different interpreta-tions

3) Usually different structure of costs and revenues

- 70 -


Exercise A.9

The following data of an industrial enterprise is established for the year 2003:

Product A Product B Initial inventory [u] 0 0 Amount of production [u/period] 15,000 5,000 Sales [u/period] 15,000 4,500 Sales price [€/u] 25.- 20.- Material costs [€/u] 10.- 4.- Manufacturing costs [€/u] 6.- 8.- Costs of distribution €/u] 4.- 1.-

Assume the costs of production per unit of the initial inventory to be the same as the costs of production of 2003. The valuation is to be carried out at production costs.

a) Draw up the operating income statement using ESP style. b) Draw up the operating income statement using CSSP style.

- 71 -


Exercise A.10

The following data of an industrial enterprise is established for the year 2003:

Product A Product B Initial inventory [u] 1,000 500 Amount of production [u/period] 10,000 4,000 Sales [u/period] 9,200 4,500 Sales price [€/u] 36.- 16.- Material costs [€/u] 8.- 5.- Manufacturing costs [€/u] 12.- 7.- Costs of distribution €/u] 4.- 2.-

Assume the costs of production per unit of the initial inventory to be the same as the costs of production of 2003. The valuation is to be carried out at production costs.

a) Draw up the operating income statement using ESP style. If nec-essary, use FIFO and LIFO valuation.

b) Draw up the operating income statement using CSSP style. If necessary, use FIFO and LIFO valuation.

- 72 -


B. Controlling

1. Basics of Controlling

Controlling consists of 3 parts:

1) Industrial information system

2) Industrial budgeting and management system

3) Industrial control system

typically divided into

- operations management ⇒ short run

- strategic management ⇒ long run

- 73 -


2. Operations Management

2.1. Direct Costing

Definitions:

Full costing = all costs are assigned to the product or to a product unit

Direct costing = just a part of the costs are assigned to the product or a product unit

Implementation of Direct Costing

Feature: cost division into variable and fixed compo-nents

variable costs: change when a cost driver changes

fixed costs: do not change when a cost driver changes

- 74 -


Example B.1

A company uses the surcharge calculation. For products A and B, the following information is given:

Product A Product B Output (units/TU) 100 200 Operating expenses for raw materials 1,000 3,000 Wages for production workers 800 2,200 Imputed interest for capital bound for inventory 4,000 Operating expenses for auxiliary supplies 1,500 Depreciations on machines 4,500 Salaries for administrative employees 1,700 Salaries for selling / distribution employees 3,400 a) Determine the relevant prime costs for product A and B according

to the system of full costing. b) Determine the relevant prime costs for product A and B according

to the system of direct costing.

- 75 -


Full Costing:

Product A Product B Direct material costs 1,000 3,000 Material overheads [4,000/4,000=100%] 1,000 3,000 Direct labor costs 800 2,200 Manufacturing overheads [(1,500+4,500)/3,000=200%] 1,600 4,400

Costs of production 4,400 12,600 Administrative overheads [1,700/17,000=10%] 440 1,260 Selling overheads [3,400/17,000=20%] 880 2,520 Prime costs 5,720 16,380 Prime costs per unit 57.20 81.90

Direct Costing:

It is probable that only auxiliary supplies are variable costs (possibly imputed interest).

Product A Product B Direct material costs 1,000 3,000 Variable material overheads 0 0 Direct labor costs 800 2,200 Variable manufacturing overheads [1,500/3,000=50%] 400 1,100

Variable costs of production 2,200 6,300 Administrative overheads 0 0 Selling overheads 0 0 Prime costs 2,200 6,300 Prime costs per unit 22.-- 31.50

- 76 -


2.2. Bottleneck-Analysis

Bottleneck-analysis is part of a planning of production in a multi-product operation and is used to resolve the problem of one or more bottlenecks when producing more than one product.

Steps for a bottleneck-analysis:

1) Determination of unit contribution margins per unit

2) Determination of available capacity

3) Determination of unit contribution margins per bottleneck unit

4) Determination of an order of priority

5) Determination of (temporary) output

6) Considering different facts

7) If needed, additional actions

- 77 -


To determine a bottom price for an additional prod-uct, the following steps are necessary:

1) Determination of variable costs for the new product

2) Determination of contribution margins for the replaced products

3) Determination of the lower limit on returns

4) Comparison of lower limit on returns with possible returns

- 78 -


Example B.2

A company has to plan their production program for the next period. It is possible to produce 4 different products, which require a certain packing machine, respectively. For the coming period, the following information exists:

Products A B C D

Possible sales [unit/TU] 1,000 900 1,500 700 Sales price [€/unit] 20 100 70 145 Variable costs [€/unit] 11 60 50 95 Duration in the packing machine [min/unit] 1 5 20 2

Within the next period, the packing machine has a running time of 100 h maximum. Fixed costs of the coming period will be 45,000 €.

a) Determine the optimal production program and calculate the net proceeds of the coming period.

b) Specify possible changes of the optimal production program and net proceeds, if, with other parameter staying constant, the com-pany receives an additional inquiry for delivering 150 units of product E for the price of 90 €/unit.

Product E can be produced with the existing machines. It has variable costs of 45 € per unit and uses the packing machine 4.5 min per unit.

- 79 -


1) Optimal production program and net proceeds:

a) Determination of the priority order:

Product A

Product B

Product C

Product D

Price 20 100 70 145 Variable costs 11 60 50 95 Unit contribution margin per unit 9 40 20 50 Order of priority 4 2 3 1 Bottleneck utilization 1 5 20 2 Specified unit contribution margin per time unit 9 8 1 25

Order of priority 2 3 4 1

Order of priority using specified unit contribution margins: D – A – B – C

b) Determination of the optimal production program:

Product Possible sales

Bottleneck utilization Output Used

capacity Remaining

capacity 6,000

D 700 2 700 1,400 4,600 A 1,000 1 1,000 1,000 3,600 B 900 5 720 3,600 0 C 1,500 20 0

The inquiry for D and A can be satisfied completely, the inquiry for B only partly and for C not at all.

- 80 -


2) Decision about the inquiry for product E: a) decision using a new bottleneck analysis: specified unit contribution margin of E: 10 €, i.e. rank 2 b) decision based on the determination of a bottom price:

variable costs of product E 750,615045 =∗ + replaced contribution margin of product B

( )[ ] 400,5867585.4150 =∗=∗∗

= lower limit on returns 150,12

return of order 500,1315090 =∗

return of order > lower limit on return accept order c) Determination of net proceeds: Old net proceeds + difference between return of order and lower

limit on return: 27,800 + (13,500 – 12,150) = 29,150

- 81 -


Exercise B.1

The fun company has to plan their production program for next pe-riod. It is possible to produce 2 different engines, one for a snowmo-bile and one for a boat. Both engines must be tested on a very ex-pensive machine before they shipped to the costumers. Production data are as follows:

Available Capacity in hours: Testing Department 120 testing-hours Production Department 600 machine hours Use of capacity in hours per unit of product

Snowmobile Boat Production Department 2 5 Testing Department 1 0.5

Operating Data for fun company:

Selling Price Variable costs Contribution margin Snowmobile 800 € 560 € 240 € Boat 1,000 € 625 € 375 €

Material shortages for boat engines will limit production to 110 boat engines per period.

Try to find the optimal solution by using graphic approach and linear programming.

- 82 -


Exercise B.2

Combustion Ltd supplies components to a major aircraft manufactur-er. A new aircraft is now being produced and Combustion Ltd can supply either component Alpha or component Beta. However, it does not have the production capacity to supply both.

Both components are made from the same metal, of which there is only 10,000 kg available at € 10 per kg. Both components must pass through two high-technology machine lines - Line P and Line R - each of which has capacity limitations.

Sales prices have been set and the following data are available for Budget Period 1 of 1995:

ALPHA BETA Maximum number of components required by aircraft manufacturer

4,250 6,100

Sales price per component Metal use per component

€ 195 2 kg

€ 160 2 kg

Machine line times per component Line P Line R

0.75 hours 0.50 hours

0.40 hours 0.60 hours

Machine line details

LINE P LINE R Total hours available 3,000 hours 3,600 hours Variable overheads per machine hour € 90 € 110

- 83 -


Required: (a) Calculate which component should be manufactured by Combustion Ltd. to maximize contribution. (b) Calculate the contribution which Combustion Ltd will earn and,

based on (a) above, whether the company will be capable of meeting the maximum capacity required for either of the two components.

(c) The aircraft manufacturer has offered an alternative pricing struc-ture per component as follows: Sales price less 10% per compo-nent plus € 60 per hour for each hour any of the production lines are unused.

Indicate how this alternative pricing arrangement might affect your choice, in (a) above, of component to be manufactured and, if it does affect your choice, calculate the new contribution.

- 84 -


Exercise B.3


Product A Product B Product CMaximum Sales [u/period] 3,000 4,800 1,600 Sales Price [€/u] 100 40 160 Variable Costs [€/u] 40 10 80 Fixed Costs [€/period] 140,000 Total Capacity of Bottleneck [min/period] 35,600 Usage of Bottleneck [min/u] 6 2 16

a) Compute the optimal production program and the earnings of the period. Explain your calculations.

b) Discuss other aspects that have to be taken into account when computing a production program.

- 85 -


Exercise B.4

Products A and B have to be processed on the same machine. On average the machine can be used 7 hours a day, 20 days a month. Monthly fixed costs are 600 €.

The following data is given about products A and B:

Product Usage of Bottleneck [min/u]

Variable Costs [€/u]

Sales Price [€/u]

Sales Forecast [u/month]

A 20 8.00 10.00 300 B 30 5.00 8.00 150

a) Discuss how the production program can be determined. b) Product A now needs to be processed on the machine 25 min/u

because of a product change. The other data is still the same. b1) Compute the new production program.

b2) Compute the bottom price of product C. It is planned to sell 80 units per month. Variable costs per month are 5.00 €/u, the usage of the bottleneck is 40 min/u.

b3) Discuss measures that could be taken by the organization in order to prevent the existence of a bottleneck.

- 86 -


Exercise B.5

A manufacturer of sports supplies produces jerseys for the sale of merchandise of BSC Freiberg and Erzgebirge Aue.

The jerseys of the Aue team are made with long sleeves. 3 m of cloth is necessary to produce them. To produce a short-sleeved jersey of Freiberg 2 m of cloth is needed. In a period, 1,800 m of cloth is avail-able.

Producing an Aue jersey takes 2 time units. The jersey of the BSC Freiberg takes 4 time units due to the complicated design. Working time of 1,600 time units is available during a period.

According to market analysis a maximum of 300 jerseys of BSC Freiberg can be sold, while there are no restrictions for the sale of jer-seys of Erzgebirge Aue. The variable costs from producing a jersey of Aue is 80 €, producing one of Freiberg costs 70 €. A sales price of 100 € is projected for both types of jerseys.

Compute the optimal production program using a graphical solution method.

- 87 -


Exercise B.6

A manufacturer of trouser produces jerseys for the sale of Esprit and SÓliver.

The jerseys of Esprit are made with shorter legs. 5 m of cloth is ne-cessary to produce them. To produce a trouser of SÓliver 8 m are needed. In a period 4,000 m of cloth is available.

Producing an Esprit trouser takes 2.5 time units. The trouser of SÓliver takes 2 time units. Working time of 1,500 time units is availa-ble during a period.

According to market analysis a maximum of 400 Esprit trousers can be sold, while there are no restrictions for the sale of SÓliver trous-ers. The variable costs from producing a jersey of Esprit is 60 €, pro-ducing one of SÓliver costs 50 €. A sales price of 120 € is projected for both types of jerseys.

a) Compute the optimal production program using a graphical solu-tion method.

b) Discuss other aspects that have to be taken into account when computing a production program.

- 88 -


Exercise B.7


Product A Product B Product C Product DMaximum sales (u/period) 1,000 600 1,500 300

Sales price (€/u) 30 40 15 75 Variable costs (€/u) 18 25 9 45

Fixed costs of the coming period will be 25,000 €. All of these prod-ucts have to be produced on the same machine. Within the next pe-riod the machine can be used 20 days. The maximum running time per day is 7.5 hours. Following data about machine usage is given:

Product A Product B Product C Product D Usage (min./u.) 3 5 4 12

a) Compute the optimal production program and the earnings of this

period. Explain your calculations. b) The company receives an inquiry for delivering 900 units of prod-

uct E for the price of 50 €/unit. Product E has to be processed on the same machine as all other products and requires 5 min./unit on this machine. Variable costs are 25 €/unit. Discuss, if, with all other parameters staying constant, the company should accept this inquiry. Determine possible changes of the production pro-gram and the earnings of this period.

- 89 -


2.3. Break-Even-Analysis

also called cost-volume profit analysis

Break even point = point from which a profit is gained, i.e. the point at which the turnover covers the full costs or the unit contribution margin covers the fixed costs

Break-Even-Analysis in a Single-Product-Operation

Break-even point means P = 0, whereas P = sales proceeds – costs

straight-line sales and cost functions

p ∗ xb – cv ∗ xb – Cf = 0

(p – cv) ∗ xb – Cf = 0

unitperCMCf = xb

- 90 -


Additional information:

Coefficient of safety = (total sales – break-even sales) / total sales

Indicates, by which percentage the planned sales can drop, before the company reaches the break-even point and therefore the loss wedge

Safety distance = given quantity of sales – critical quantity sold

Please note: term is also partly used for the coeffi-cient of safety

- 91 -


Exercise B.8

Knitwear, Inc., is considering three countries for the sole manufactur-ing site of its new sweater - Singapore, Thailand, and the United States. All sweaters are to be sold to retail outlets in the United States at € 32 per unit. These retail outlets add their own markup when sell-ing to final customers. The three countries differ in their fixed costs and variable costs per sweater.

Annual Fixed Costs

Variable Manufacturing Costs

Per Sweater

Variable Marketing & Distribution Costs Per

Sweater Singapore € 6.5 million € 8.00 € 11.00 Thailand € 4.5 million € 5.50 €11.50 United States € 12.0 million €13.00 € 9.00 1. Compute the breakeven point of Knitwear, Inc., in both (a) units

sold, and (b) revenues for each of the three countries considered for manufacturing the sweaters.

2. If Knitwear Inc. sells 800,000 sweaters in 1999, what is the budg-eted operating income for each of the three countries considered for manufacturing the sweaters? Comment on the results.

- 92 -


Break-Even-Analysis in a Multi-Product Operation

In a multi-product operation it is not easy to determine the break-even-point, since all unit contribution margins help to cover the fixed costs.

Solutions

1) Fixed ratio between the products:

- Critical sales quantity

- Critical turnover

2) No fixed ratio between the products:

Determination of product sequence, e.g.

- by unit contribution margins (CM per unit)

- by product contribution margins (CM)

- by the ratio of unit contribution margin vs. price (CM per unit/p)

- by production or selling duration (CM per unit/TU or CM/TU in total)

- 93 -


Exercise B.9

a) Using the given data compute the break-even point and break-even sales of product X explaining your calculations:

- production and sales 1,000 u/period - sales price 500 €/u - variable costs 300 €/u - fixed costs 120,000 €/period b) Discuss the computed break-even point using also the coefficient

of safety. c) Explain the assumptions that have to be considered in break-

even analysis. d) Show the problems that occur in a company with more than one

product and describe how they can be solved.

Exercise B.10

The following information is given:

Product A Product B Product C Product DProduction and Sales [units/time unit] 45,000 25,000 9,000 27,000

Price [€/unit] 2.00 3.50 4.50 3.00 Turnover [€/unit] 90,000 87,500 40,500 81,000 Variable costs [€/unit] 1.00 1.50 2.00 1.50 Fixed costs [€/time unit] 71,100

Compute the break even point for this multi-product company.

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2.4. Cost Control

2.4.1. Introduction to Cost Control

Steps of Cost Control

1) Planning of costs at the beginning of a period Planned Costs

2) Documentation of costs at the end of the period Actual Costs

3) Control of the costs at the end of the period

a) Computation of the total variance

b) Division of the total variance into partial vari-ances (decomposition)

1st Step: Setting of Planned Costs (Standard Costs)

standard costs ( Cp ) = specific standard quantity per unit (vp ) * planned quantity of units (xp ) * standard price (qp )

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2nd Step: Recording Actual Costs

actual costs (Ca) = specific actual quantity per unit ( va) * actual quantity of units produced ( xa) * actual price ( qa)

3rd Step: Computing the Total Variance

total variance = ΔC = actual costs – planned costs

4th Step: Computation of Partial Variances

V = Ca – Cp

= qa * ra - qp * rp

= ( qa - qp ) * rp price variance

+ ( ra – rp ) * qp materials quantity variance

+ ( qa – qp )* ( ra – rp )mixed variance (price/materials quantity)

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1) Alternative Method:

The mixed variance is assigned to the person in charge of purchasing as well as the person in charge of pro-duction quantities. The variances correspond to the ac-tual cost differences.

The sum of the partial variances > total variance

The method is arbitrary, as all the persons in charge are assigned some variances for which they are not responsible.

The method is not significant.

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2) Cumulative Method:

The variance is assigned to one person in charge.

a) Oriented towards production:

The mixed variance is assigned to the person in charge of purchasing. Therefore the person in charge of the production quantities is only assigned variances that he is responsible for.

b) Oriented towards price:

The mixed variance is assigned to the person in charge of the production quantities. Therefore the person in charge of purchasing is only assigned variances that he is responsible for.

The sum of the partial variances = total variance

The method is arbitrary, as some of the persons in charge are assigned variances for which they are not responsible.

The method is better than method 1.

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3) Symmetrical Method:

The mixed variance is assigned to the persons in charge in equal shares, that is half the variance for each in case of two persons in charge, and so forth.

The sum of the partial variances = total variance

The method is arbitrary, as all of the persons in charge are assigned variances for which they may not be solely responsible.

The method is better than method 1). From a theo-retical point of view this method is only in parts suit-able, even more if there are more variables the method becomes increasingly complex.

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4) Differentiated Method:

The variance is not assigned to any person in charge.

The sum of the partial variances = total variance, but some variances are not assigned to any persons in charge.

The method is not arbitrary, as all of the persons in charge are assigned only those variances for which they are solely responsible.

The method is best from a theoretical point of view. But in companies it is seldom used, as some vari-ances are not assigned to any persons in charge.

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2.4.2. Cumulative Method

Commonly the mixed variance is assigned to the person in charge of purchasing.

ΔC = Δr * qp person in charge of production

+ Δq * rp + Δq * Δr person in charge of price

or, as (rp + Δr = ra )

ΔC = Δr * qp person in charge of production

+ Δq * ra person in charge of price

quantity variance ΔCr = ( ra - rp ) * qp = Δr * qp

price variance ΔCq = ( qa - qp ) * ra = Δq * ra

This result is somewhat simplifying, as it only takes into account a general demand for a production factor. But as long as these costs are variable costs, the demand for a production factor varies depend-ing on the quantity of production. That has to be taken into account in the standard cost system.

The demand for a production factor depends on the specific standard quantity per unit (v) and the quantity of production (x). For example the materials quantity variance can be broken down into the following:

ΔCr = ( va * xa - vp * xp ) * qp

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The materials quantity variance can result in two different variances:

1) Difference of specific standard quantity per unit and actual quantity per unit

2) Difference of actual and standard production quantity

ΔCr = ( va * xa - vp * xp ) * qp

= ( va - vp ) * xp * qpperson in charge of factor consumption

+ ( xa - xp ) * vp * qpperson in charge of production quantity

+ ( va - vp ) * ( xa - xp ) * qp consumption / production quantity

Again it is difficult to decide whom to assign the mixed variance. Usually it is assigned to the person in charge of factor consumption, but it is rather hard to reason this.

ΔCr = ( va - vp ) * xp * qpperson in charge of factor consumption

+ ( va - vp ) * ( xa - xp ) * qp person in charge of factor consumption


or, as (xp + Δx = xa )

ΔCr = ( va - vp ) * xa * qpperson in charge of factor consumption


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As a result we arrive at:

factor consumption variance = ΔCv = Δr * qp = (ra – rp ) * qp =

Δv * xa * qp

production quantity variance = ΔCx = Δx * vp * qp

price variance = ΔCq = Δq * ra = Δq * va * xa

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Price Variance

possible causes:

- the purchase department chose suppliers who charge rather expensive prices

- the skills of negotiation of the purchase department

- the powerful position of the supplier(s) or of our company

- short term orders at higher prices, e.g. because the production department did not plan the material needs early enough

Depending on the cause different departments are re-sponsible for the price variance. In most cases the re-sponsible department is the purchasing department. In the last case, the production department should be held responsible for the price variance.

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Production Quantity Variance

possible causes:

- unrealistic forecast

- declining demand

- increasing competition in the market

- too much downtime in production

Only in case of the last item the production department would be held responsible for the production quantity variance.

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Factor Consumption Variance

possible causes:

- causes related to production and efficiency, e.g. too much material wasted by the production department

- causes related to contracts, e.g. alterations of the products due to special orders of buyers

- causes related to raw material, e.g. bad quality of raw materials or changes in the materials to be used in production

- causes related to composition, e.g. changes in the production process

Generally the production department is responsible for the factor consumption variance. This is not the case if the variance has occurred for special reasons, as would be the case with the last item.

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2.4.3. Differentiated Method

When using the differentiated method the mixed vari-ances are not assigned to other persons in charge. The variances can either be pure or mixed, or they can be of first, second, or third order.

first order variances

1) pure price variance

2) pure production quantity variance

3) pure factor consumption variance

second order variances

4) mixed price and production quantity variance

5) mixed price and factor consumption variance

6) mixed production quantity and factor consumption variance

third order variances

7) mixed price, production quantity, and factor con-sumption variance

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1) pure price variance ( qa - qp ) * vp * xp

2) pure production quantity variance ( xa - xp ) * vp * qp

3) pure factor consumption variance ( va - vp ) * qp * xp

4) mixed price and production quantity variance ( qa - qp ) * ( xa - xp ) * vp

5) mixed price and factor consumption variance ( qa - qp ) * ( va - vp ) * xp

6) mixed production quantity and factor consumption variance

( va – vp ) * ( xa - xp ) * qp

7) mixed price, production quantity, factor consumption variance

( qa - qp ) * ( xa - xp ) * ( va - vp )

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Exercise B.11

The following costs of the manufacture of product A were planned / detected:

• standard quantity per unit of A [kg/u] 20

• standard price per kg [€/kg] 8.50

• planned production of A [u/period] 12,000

• actual price per kg [€/kg] 7.00

• actual production of A [u/period] 15,000

• total quantity of raw material used [kg/period] 345,000

Compute the total variance. Calculate partial variances using the dif-ferentiated method.

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Exercise B.12

In order to manufacture the product X in the production department the overhead cost D is needed. The following data is given:

• standard price of D per m³ [€/m³] 20

• standard quantity of D per unit of X [m³/u] 40

• planned production of X [m³/period] 10,000

• actual price of D per m³ [€/m³] 25

• actual quantity of D per unit of X [m³/u] 50

• actual production of X [u/period] 8,000

Compute the total variance. Calculate partial variances using the cu-mulative method.

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3. Strategic Management

3.1 Target Costing

Objective: costs should be stronger based on prices, reachable on the market (to increase the company’s competitiveness).

Characteristics:

a) market orientated cost management

b) strategic cost management

Areas of application: especially on markets with

a) intense competition

b) short product life cycles

c) high pressure on prices

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Steps of Target Costing:

1) Preparation of a product design: Example B.3:

product features for a disc man

Sound

Stability

Reliability

Power consumption

2) Determination of target costs for the product:

a) Market into company

b) Out of company

c) Into and out of company

d) Out of standard costs

e) Out of competitor

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Determination of target costs by form of market into company:

a) Determination of allowable costs: Continuing Example B.3:

Determination of the price-demand-function for the product life cycle:

x1,500

1 - 400 p(x)=

b) Determination of the drifting costs: Continuing Example B.3:

Assumption: 204.- €

c) Determination of the target costs: Continuing Example B.3:

Average would be (164 + 204) / 2 = 184.- €

Here, the target costs are set equal with the allowable costs, i.e. the strict specification is selected (164.- €)

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d) Determination of costs for the target costs di-vision:

Continuing Example B.3: Assumption: indirect costs for development, administration and

distribution without relation to the components of 16,200,000 € total target costs 49,200,000 € - indirect costs for development, … 16,200,000 € = target costs for the target cost division 33,000,000 € per unit 110 € total standard costs 204 x 300,000 61,200,000 € - indirect costs for development, … 16,200,000 € = standard costs for the target cost division 45,000,000 € per unit 150 €

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3) Determination of target costs for product com-ponents (target cost division): typically the method of features is used

Continuing Example B.3: Sound 40% Stability 10% Reliability 30% Power consumption 20%

FeaturesComponents

Sound Stability Reliability Power Consumption

Encasement 0% 60% 25% 0% Scan system 30% 20% 45% 10% Board and intensifier 50% 5% 15% 40%

Driver 20% 15% 15% 50% Σ 100% 100% 100% 100%

Determination of utility proportions Utility proportion = importance according to customer view ∗ con-

tribution to feature fulfillment e.g. encasement / stability: 60 % * 10 % = 6 %

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Features Components

Sound (40%)

Stability (10%)

Reliability (30%)

Power Consumption

(20%)

Utility proportion

Encasement 0% 6% 7.5% 0% 13.5% Scan system 12% 2% 13.5% 2% 29.5%

Board and intensifier 20% 0.5% 4.5% 8% 33%

Driver 8% 1.5% 4.5% 10% 24% Determination of target costs: Encasement 0.135 x 110 = 14.85 Scan system 0.294 x 110 = 32.45 Board and intensifier 0.330 x 110 = 36.30 Driver 0.240 x 110 = 26.40

4) Determination of standard costs per product component:

Continuing Example B.3: Encasement 30 € Scan system 35 € Board and intensifier 30 € Driver 55 € Total 150 €

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5) Comparison of target costs and standard costs per product component

a) Determination of need for cost reduction Continuing Example B.3:

Result figure Components

Target costs (1)

Standard costs (2)

Need for cost reduction (1 – 2)

Encasement 14.85 30 - 15.15 Scan system 32.45 35 - 2.55 Board and intensifier 36.30 30 + 6.30 Driver 26.40 55 - 29.60

b) Determination of target cost indexes Continuing Example B.3:

Result figure Components

Utility proportion in % (1)

Cost element in % (2)

Target cost index accord. to Tanaka

(1 : 2) Encasement 13.5 20 0.675 Scan system 29.5 23.33 1.26 Board and intensifier 33 20 1.65 Driver 24 36.67 0.65

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Target cost index according to Tanaka

= ratio of utility proportion and portion of current stan-dard costs (cost element)

Thesis: costs should equal the achievable customer utility

target cost index < 1 component is too expensive, compared to others

target cost index > 1 component is too plain, since costs do not equal the importance of the component according to the customer

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Exercise B.13

The corporation RC-AG produces a car that is divided into the com-ponents “engine”, “interior”, “chassis” and “brakes“. The marketing department has determined allowable costs of 20,000 €. The RC-AG has calculated the following standard costs:

Engine Interior Chassis Brakes 6,692 5,497 10,038 1,673

The product functions were weighted as follows:

Product Function Safety Comfort Design Value Importance in % 30 20 40 10 How each component contributes towards the fulfillment of the above functions can be seen in the following table:

in % Safety Comfort Design Value Engine 25 50 - 55 Interior 31 10 30 15 Chassis 33 30 60 20 Brakes 11 10 10 10 a) Determinate the need for cost reduction. b) Calculate the target cost index according to Tanaka.

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Exercise B.14

A company produces a MP3-player, which consists of the following components: “Case”, “Hard Drive”, “Battery” and “Board and Intensifi-er”. The marketing department has determined an optimal sales price of 300 €. The company aims at an operating margin of 10%.

Product function Component

Sound Design Weight Usability

Case 10% 85% 15% 10 % Hard Drive 0% 5% 30% 40%

Battery 0% 5% 35% 40 % Board 90% 5% 20 % 10 %

The product functions were weighted as follows:

Product function Sound Design Weight Usability

Importance in % 25% 20% 20% 35%

The company calculated the following standard costs:

Component Case Hard Drive Battery Board Standard costs 50 € 120 € 106,30 € 83,70 €

a) Determine the need for cost reduction. Assume that the target costs are equal to the allowable costs.

b) Calculate the target cost index according to Tanaka. Discuss the results.

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3.2 Value Benefit Analysis

Objective: selection between different alternatives with the use of a “dimensionless” figure (utility value)

Steps of a value benefit analysis:

1) Selection of evaluation criteria:

a) Determination of possible criteria

b) Checking the criteria for multiple entries

c) Checking the criteria for benefit dependence

d) Combination of the remaining criteria

Example B.4:

Site selection for foundation of an industrial site

Locations: Freiberg, Dresden, and Hamburg Criteria: (here, given)

land price (quantitive criterion)

purchase power within the region (qualitative criterion)

labor cost level (qualitative criterion)

price for raw material X (quantitive criterion)

infrastructure (qualitative criterion)

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2) Selection of the weighting coefficients: e.g. by

a) direct weighting

b) indirect weighting

Continuing Example B.4:

Determination of a criteria ranking:

Results from the importance of the criteria for the judging person

land price > labor cost level > purchase power = price for raw ma-terial > infrastructure

No. Evaluation criteria

Comparison of evaluation criteria

Preference frequency

Weighting coefficient

1 Land price 1 1 1 1 1 1 2 3 4 5

5 0.333

2 Purchase power 2 2 2 2 2 3 4 5

2.5 0.167

3 Labor cost level 3 3 3 3 4 5

4 0.267

4 Price for raw material X

4 4 4 5

2.5 0.167

5 Infrastructure 5 5

1 0.067

Total: 15 1.0

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3) Determination of feature characteristics: Continuing Example B.4:

Dresden Freiberg Hamburg Land price 1,000,000 € 500,000 € 1,200,000 € Purchase power Good Poor Better then for 1 Labor cost level Low Higher than for 1 Lower than for 1 Price for raw material X 600 € / unit 350 € / unit 500 € / unit

Infrastructure Very good Poor Moderate

4) Object comparison per criterion: Continuing Example B.4:

Dresden Freiberg Hamburg Land price 2 3 1 Purchase power 2 1 3 Labor cost level 2 1 3 Price for raw material X 1 3 2 Infrastructure 3 1 2

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5) Calculation of sub-benefit values and total bene-fit values for the individual objects:

sub-benefit value = rank or distance figure ∗ weight-ing coefficient

total benefit value =Total of all sub-benefit values for an object

Continuing Example B.4:

Criteria WC Dresden Freiberg Hamburg

Rank SBV Rank SBV Rank SBV Land price 0.333 2 0.666 3 0.999 1 0.333

Purchase power 0.167 2 0.334 1 0.167 3 0.501

Labor cost level 0.267 2 0.534 1 0.267 3 0.801Price for raw material 0.167 1 0.167 3 0.501 3 0.334Infrastructure 0.067 3 0.201 1 0.067 2 0.134Total benefit value 1.902 2.001 2.103Position 3 2 1

6) Decision

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Exercise B.15

An organization wants to open a new market. To help in the decision making process it wants to conduct a value benefit analysis. The fol-lowing data is known about the criteria:

price > brand name recognition > number of potential customers > distance to the production plant = intensity of competence

meaning:

“=” is as important as ..............,

“>” is more important than ...........

No. Criteria Market I Market II Market III1 Price 20 30 10 2 Number of Potential Customers 150,000 100,000 300,000

3 Distance to the Production Plant 50 km 500 km 150 km

4 Number of Competitors in the Market 8 5 2

5 Brand Name Recognition high average weak Which market is preferable?

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3.3 Balanced Scorecard

Objective: The balanced scorecard translates an or-ganization’s mission and strategy into a comprehen-sive set of performance measures that provides the framework for implementing its strategy.

Key Perspectives of a Balanced Scorecard

1) Financial

Operating income; revenue growth; revenues from new products, gross margin percentage; cost reduc-tion in key areas; EVA; return on investment

2) Customer

Market share; costumer satisfaction; customer reten-tion percentage; time taken to fulfill customers re-quest

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3) Internal business process

- Innovation process

Manufacturing capabilities; number of new products or services; new product development times and number of new patents

- Operations process

Yield, defect rates; time to deliver products to cos-tumers; percentage of on-time deliveries; average time taken to manufacture orders; setup time; manu-facturing downtime

- Post sales service

Time taken to replace or repair defect products; hours of customer training for using the product

4) Learning and growth

Employee education and skill levels; employee satis-faction scores; employee turnover rates; information system availability; percentage of employee sugges-tions implemented

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Concepts in Action:

The Balanced Scorecard for Chipset, Inc., for the Year 2000 Objectives Measures Initiatives Target Per-

formance Actual Per-formance

Financial Perspective Operating income from

productivity gain Manage costs & unused capacity

$ 2,000,000 $ 2,100,000

Increase sharehold-er value

Operating income from growth

Build strong customer relationships

$ 3,000,000 $ 3,420,000

Revenue growth Build strong customer relationships

6% 6.48%

Customer Perspective Increase market share

Market share in commu-nication networks seg-ment

Identify future needs of customers

6% 7%

New customers Identify new target cus-tomer segments

5 6

Increase customer satisfaction

Customer satisfaction survey

Increase customer focus of sales organization

90% of cus-tomers give top two ratings

87% of cus-tomers give top two ratings

Internal Business Process Perspective Improve manufac-turing capability

Percentage of processes with advanced controls

Organize R&D/ manufac-turing teams to imple-ment advanced controls

75% 75%

Improve manufac-turing quality and productivity

Yield Identify root causes of problems and improve quality

78% 79.3%

Reduce delivery time to customers

Order delivery time Reengineer order deli-very process

30 days 30 days

Meet specified deli-very dates

On-time delivery Reengineer order deli-very process

92% 90%

Learning and Growth Perspective

Develop process skill

Percentage of employees trained in process and quality management

Employee training pro-grams

90% 92%

Empower workforce Percentage of front-line workers empowered to manage processes

Have supervisors act as coaches rather than deci-sion makers

85% 90%

Align employee and organization goals

Employee satisfaction survey

Employee participation and suggestions program to build teamwork

80% of em-ployees give top two ratings

88% of em-ployees give top two ratings

Enhance informa-tion system capabili-ties

Percentage of manufac-turing processes with real-time feedback

Improve off-line data gathering

80% 80%

Improve manufac-turing processes

• Number of major im-provements in process controls

Organize R&D/ manufac-turing teams to modify processes

5 5

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