Accounting for our planet – a global conversation on COP26

Accounting for our planet – a global conversation on COP26

Climate resilience: Emergency treatments

#climatechange #climateactionnow #climateemergency #climatesolutions #climatefinance #climatefinanceday #climatetech #climaterisks #greenfinance #greeneconomy #greenenergysolutions

Throughput accounting emphasis over cost control and to minimise inventory level.

What is Throughput Accounting (TA)?

TA is based on theory of constraints which means that throughput of the factory will be determined by the speed of bottleneck process. TA is very similar to marginal costing but here throughput is relevant rather than contribution analysis. TA assumes that only variable cost is material cost and all other factory cost is fixed in the short run along with labour cost. It is more appropriate to use Just-in-time (JIT) environment because of emphasis on minimising inventory and cost control.

Throughput = Sales - Material Costs.

In a JIT environment, production only for building inventory is a bad thing. Products should not be made unless there is a customer for them. This mean that accepting some idle time in non-bottleneck operations. Work In Progress (WIP) should be valued at material cost only so that no value is added to profit until sale in made.

Profit is determined by the rate at which throughput can be generated i.e. how quickly raw material can be turned into sales to generate cash. Producing for the sole purpose of increasing inventory creates no profit and so should not be encouraged.

Traditional costing	Throughput accounting
Labour costs and variable overheads are treated as variable costs.	All costs other than material are seen as fixed in the short run.
Inventory is valued at total production cost.	Inventory is valued at material cost only.
Value is added when an item is produced.	Value is added when an item is sold.
Product profitability can be determined by deducting a product cost from selling price.	Profitability is determined by the rate at which money is earned.

TPAR = Return per factory hour / Cost per factory hour. Return per  factory hour = (Sales revenue – material purchases) / Time on bottleneck resources. Cost per factory hour = Total factory costs / Time on bottleneck resource. Total factory costs = Fixed production costs including labour.

How to interpret TPAR?

Total throughput should exceed total factory costs otherwise organisation will make a loss. This means that TPAR should exceed 1.0

How can business improve TPAR?

• Increase throughput per bottleneck hour or decrease cost per factory hour.
• Increase selling price of the product. This will increase throughput per unit and so will increase throughput per unit of bottleneck resource.
• Reduce material cost per unit. This will increase throughput per unit and so will increase throughput per unit of bottleneck resource.
• Reduce expenditure on factory costs (operating costs). This will reduce operating cost per unit of bottleneck resource.
• Improve efficiency and increase no. of units or products that are made in each bottleneck hour. This would increase total throughput per hour. The operating costs per hour would be unaffected therefore TPAR would increase.
• Elevate bottleneck so that there are more hours available of the bottleneck resource. Throughput per unit of bottleneck resource would be unaffected but operating costs are fixed costs and there are more bottleneck hours available, the operating cost per bottleneck hour would fall and the TPAR would increase.

However there may be adverse consequences from some of these measures.

Measures	Consequences
Increase sales price per unit	Demand for the product may fall
Reduce material cost per unit, eg change materials or suppliers	Quality may fall and bulk discounts may be lost
Reduce operating expenses	Quality may fall or errors may increase

How throughput accounting can help to make effective growth in a business?

 

How effective growth in a business can be achieved by Throughput Accounting (TA)?

Throughput accounting (TA) can help to make an effective growth in a business because  it is essential to know that what you should produce for effective utilisation of your resources. TA is an approach to production management where aim is to maximise throughput contribution while also reducing inventory & operational expenses.

TA is a management accounting technique which is based on Theory of Constraint ( ToC ) and is consistent with the use of just in time production method.

What is the Basic concept of TA?

Under TA organisation should seek to maximise throughput by identifying and eliminating bottlenecks. All operational expenses except materials are assumed to be fixed costs.

How to calculate throughput?

throughput = Sales revenue - Direct material cost.

 What is Theory of Constraint ( ToC ) ?

ToC is a production system where key financial concept is to maximise throughput while keeping conversion & investment costs to a minimum. Five steps of ToC has been mentioned in the image above.

It is an approach of production management & optimising production performance that was developed by Goldratt & Cox in 1986. Its key role to turn material into sales as quickly as possible.

ToC also states that at all times there will be a bottleneck resource and it can be sales demand in theory but it is more likely to be a resource that an organisation uses.

Bottleneck resource / binding constraint is a process which has lower capacity than preceding or subsequent activities, thereby limiting throughput.

In the above diagram, Process 2 is bottleneck because this process is slow as only 50 units per hour can be processed as compare to the Process 1 & Process 3 as 100 units per hour can be processed. So Process 2 is bottleneck.

Note: Once the capacity of Process 2 is increased then Other Processes may become bottleneck resource.

Example 
Cat Co makes a product using three machines – X, Y and Z. The capacity of each machine is as follows:

The demand for the product is 1,000 units per week. For every additional unit sold per week, net present value increases by $50,000. Cat Co is considering the following possible purchases (they are not mutually exclusive):

Purchase 1: Replace machine X with a newer model. This will increase capacity to 1,100 units per week and costs $6m.

Purchase 2: Invest in a second machine Y, increasing capacity by 550 units per week. The cost of this machine would be $6.8m.

Purchase 3: Upgrade machine Z at a cost of $7.5m, thereby increasing capacity to 1,050 units.

Required:
Which is Cat Co’s best course of action?

Solution:
First, it is necessary to identify the system’s bottleneck resource. Clearly, this is machine Z, which only has the capacity to produce 500 units per week. Purchase 3 is therefore the starting point when considering the logical choices that face Cat Co. It would never be logical to consider either Purchase 1 or 2 in isolation because of the fact that neither machines X nor machine Y is the starting bottleneck. Let’s have a look at how the capacity of the business increases with the choices that are available to it.

From the table above, it can be seen that once a bottleneck is elevated, it is then replaced by another bottleneck until ultimately market demand constrains production. At this point, it would be necessary to look beyond production and consider how to increase market demand by, for example, increasing advertising of the product.

In order to make a decision as to which of the machines should be purchased, if any, the financial viability of the three options should be calculated.

The company should therefore invest in all three machines if it has enough cash to do so.

The example of Cat Co demonstrates the fact that, as one bottleneck is elevated, another one appears. It also shows that elevating a bottleneck is not always financially viable. If Cat Co was only able to afford machine Z, it would be better off making no investment at all because if Z alone is invested in, another bottleneck appears too quickly for the initial investment cost to be recouped.

How desirable profitability can be achieved under Product Life Cycle Costing (LCC)?

 

Query no.1: What is product Life Cycle Costing?

Solution: LCC is a whole life costing of the product from the beginning to an end. It is an accumulation of all costs over the entire life of the product.

Query no.2: What is the aim and objective of product LCC?

Solution: The aim is to maximise return over the entire life of the product and objective is to minimise costs. This means that, Products that are not expected to be profitable after allowing for design & development costs or clean up costs should not be considered for commercial development. All costs related to a product including research & development are associated with the product. This enables true assessment of a product's profitability.

Query no.3: Why LCC is modern costing technique?

Solution: LCC is a modern costing technique because in the past, costs & revenues of a product are assessed on a financial year on year basis or period basis. But life cycle costing change this phenomenon since it tracks and accumulates actual costs & revenue attributable to each product over the entire product life cycle. 

Query no.4: How many stages, sales volume & costs in product LCC?

Solution: In a table below:

Stages	Sales Volume	Costs
Development	None	Research & development
Introduction	Very low level	Very high fixed cost i.e. non-current assets & advertisement
Growth	Rapid increase	Increase in variable cost some fixed cost may increase i.e. Increased no. of factories
Maturity	Stable	Primary variable cost
Decline	Falling	Primary variable cost (Now decreasing some fixed cost) i.e. Decommissioning cost

 

Query no.5: What type of costs spent in research & development costs?

Solution: Design cost, Cost of making a prototype, Testing costs, Production process and Equipment development & investment.

Query no.6: What other costs over product life cycle?

Solution: In the bullets below:

• Cost of purchasing any technical data required i.e. purchasing the right from another organisation to use a patent.
• Training costs. including initial operator training & skills updating.
• Production cost when product is eventually launched int he market.
• Distribution costs including transportation & handling costs.
• Marketing & Advertising i.e. Customer service, Field maintenance & Brand promotion.
• Inventory costs including  spare parts, warehousing & so on.
• Retirement & disposal costs i.e. costs occuring at the end of the product's life which may include costs of cleaning up a contaminated site.

Some of above costs such as design cost are once-only costs. Others would be incurred throughout the product's life but vary with production & sales volume.   

Query no.7: How to maximise return over the product life cycle?

Solution: In the bullets below:

• Design out cost of product: Approximately 70% to 90% costs can be determined by decision made early in the life cycle at the design & development stage.
• Minimise time to market: A company should get a product to the marketplace very quickly since it will give the product as long a span as possible without competitors' rival product in the market.and this mean that market share is increased in the long run.
• Minimise breakeven time: Pricing strategy can affect both contribution & volume generated. A short breakeven time is very important for liquidity purposes.
• Extend the length of the life cycle itself i.e. Product development, finding other uses of products or launch in the other relevant markets.

Query no.8: What are the implications to calculate LCC?

Solution: Looking at the product life cycle, It is clear that product will make a loss initially. Viewing profitability on a period basis can put unnecessary pressure on management because of the visibility of the loss which can lead to incorrect decision making.

It would not be appropriate to set one price for the product's entire life since there will be different level of demand for a product over its expected life.

Query no.9: What can be the advantages of LCC?

Solution: In the bullets below:

• It helps management to assess profitability over the entire life of a product which in turns helps management to decide whether to develop the product or continue making the product. 
• It can be very useful for organisations that continually develop products with a relatively short life, where it may be possible to estimate sales volume & prices with reasonable accuracy.
• The life cycle concept results in earlier actions to generate more revenue or lower costs.
• Better decision making should follow from more accurate & realistic assessment of revenues & costs at least with in a particular life cycle stage.
• It encourages longer-term thinking and forward-planning and may provide more useful information than traditional reports of historical costs & profits in each accounting period. 

Why targeting costing is difficult to implement in service organisations?

Query:

Why targeting costing is difficult to implement in service organisations? 

Solution:

Because services are different in nature such as banking, transport parcel delivery, energy, supply, entertainment, education, hotels, car repair and so on.

A feature of labour content may be high in the service industry but as per material content it is often very low.

Following can be difficulties to implement target costing in the service organisations as below:

• Lack of substance due to its nature of intangibility. There is no material substance or physical aspect in the services. For example, No taste, no visible presence of the substance and so on. When services are provided by a human it is not possible to reduce cost to a targeted level by reducing material cost.
• Many services are created at the same time as they are consumed such as thinking of medical treatment as there is no service exists until it is actually being experienced.
• Services are naturally perishable. Such as The service of a hair treatment is purchased for a particular period of time.
• There is no transfer of ownership in the business services. It does not result in the transfer of property or ownership.

How to achieve your desired profit in a manufacturing industry?

Query no.1: 

What is target costing?

Solution: 

Target costing is a cost reduction technique and its real essence exists at the design stage because major cost can only be reduced at this point of time. This is not just a costing technique but also an evolution to achieve your desired profitability.

Query no.2: 

What is the aim of target costing?

Solution: 

Target costing is the cost at which product must be produced and sold in order to achieve required profit at the targeted selling price. When product is planned then its estimated cost is often higher than its targeted cost. The aim of target costing is to find ways of closing this target cost gap and producing & selling the product at targeted cost.

Query no.3: 

Why target costing is a better place as compare to the traditional costing techniques (cost plus pricing)?

Solution: 

In the past, Product cost is based on its cost which includes non-value added activities. At that time, Effective utilization of resources, Competition among manufacturers, Short life cycle products, High range of products and Use of high tech & Complex manufacturing system was not common and potential customers was not allowed to participate with manufactures regarding the specification of a new products i.e. Customer relationship management (CRM) system. In these days, trend has been changed and it might be due to the customer relationship management where manufacturers & consumers are equally important to consider the importance of values. What they should buy? And why they should buy? Target costing has become a need of modern environment due to shorting product life cycle. Organisations should redesign their products to achieve their desired profit. 

Query no.4: 

How to implement target cost?

Solution: 

In a bullets below:

•  Define product specification and estimated sales volume.
• Set target selling price at which company will be able to achieve desired market share.
• Estimate required profit based on profit margin or Return on Investment (ROI).
• Calculate target cost.

Query no.5: How to calculate target cost?

Solution in the table below:

Details	$
Targeted selling price	X
Less: Desired profit	X
Targeted cost	X

 

Query no.6: How to calculate cost gap?

Solution in the table below:

Details	$
Targeted cost	X
Less: Projected cost	X
Cost gap	X

 

Query no.7: How to implement Reengineering Business Process in order to remove cost gap?

Solution: 

This is the time to take benefits from target costing since Re-engineering process (Value engineering or value analysis) can help to remove cost gap. After redesigning the product structure, if cost gap still exists then renegotiation will be explored with the customer. And if re-negotiations are successful and cost gap has been removed then product will be started to produce otherwise product would not be able to launch in the market.

Query no.8: 

What are other techniques to remove cost gap?

Solution: 

The following below bullets can be used to remove cost gap:

• Remove non-value added activities.
• Reducing unnecessary no. of components.
• Using cheaper staff but it should not affect quality.

• Using standard components wherever possible.
• Acquire new or more efficient technology.

• Training of the staff with more efficient techniques.
• Use different material but no compromise over quality.
• Remove unnecessary costs. 

Why organisations' production overheads costs differ under Activity Based Costing (ABC)?

Query no.1: 

Why Traditional Absorption Costing (TAC) has been replaced by Activity Based Costing (ABC)? 

Solution:

ABC is an extension of TAC since it consider the reasons of changes in Production Overheads (POH) related to each product when organisations produce a large range of products with similar costs.

Query no.2:

What opportunities can be created by the use of ABC?

Solution in the bullets below:

• To control cost as well as reduce cost by efficient management of cost drivers. 
• To better understand costing information for reasonable pricing decisions.
• To re-analyse product mix decisions in relation to production.
• To create realistic estimate of costs & profits related to products.

Query no.3:

Why ABC has become a need of current economic environment?

Solution:

ABC has become a need of current economic system due to large range of products produced along with dissimilar costs. In the past, only single product produced along with similar costs but now situation has been changed. For example, In the earlier age, Businesses were labour or machine intensive so POH are likely to be absorbed on the bases of direct labour hours or direct machine hours because at that time POH were small portion of product unit cost. 

In the same way, Modern business environment facing many challenges in relation to POH because now we have multiple options in every product. Now we have variety of products means one product produce in different colours, tastes, sizes, along with different techniques according to the customer specifications. And this situation create complexity in the current production process in relation to POH. So these factors become a need to implement ABC.

Query no.4:

What is the important role of ABC in this current economic system?

Solution:

ABC play a vital role to simplify the complexity of POH considerably since it is based on cause & effect relationship. ABC identify cost of main supporting activities & factors that drive the cost of each activity.

Query no.5:

What are the main ideas behind ABC?

Solution in the bullets below:

• Activities cause costs i.e. ordering, material handling, machining, assembling, production scheduling & dispatching.
• Manufacturing products creates demand for support activities.
• Costs are assigned to the product on the basis of product's consumption of these activities.

 

 

Overheads	Cost drivers
Production setup costs	No. of production set us
Machine oil & repairs costs	No. of machine hours
Supervisory salary costs	No. of labour hours
ordering cost handling customer orders	No. of customer orders
Material handling costs	No. of production runs

 

Query no.6:

What are the steps to implement ABC?

 

Solution in the steps below:

• Identify organisation major activities.
• Cost pool (Group overheads into activities according to how they are driven).
• identify cost drivers for each activity.
• calculate cost per unit of cost driver
• Absorb activity costs into production based on usage of cost drivers.

Query no.7:

What are the problems to implement ABC?

 

Solution:

Although ABC is very helpful to control POH costs but some responders has addresses their concerns in relation to ABC:

• It is time consuming & expensive.
• It will be limited helpful if POH are mainly related to volume.
• The benefits of ABC is limited if company produce single product or a range of products with similar costs.
• some arbitrary apportionment still exist i.e. General overheads.