CIMA-P2-Costing Techniques

1. PERFORMANCE
MANAGEMENT
Costing Techniques

2. Topics Covered
Throughput Accounting
Theory of constraints-TOC
Target Costing

3. Throughput
Throughput: The rate at which the system generates money through sales.
Throughput
=Sales revenue- Direct material cost
Objective of this accounting is to increase the throughput and reduce the
inventory and operational expenses.

4. Theory of constraints-TOC
Bottleneck-the factors which prevents the throughput being higher. For
example-inadequately trained staff, unreliable supply of material etc.
Goldratt and Cox describe the process of identifying and taking steps to
remove constraints as TOC.

5. Steps of TOC
• The Five Focusing Steps of On going
Improvement
 Identify the system’s constraint
 Decide how to exploit the system’s constraint
 Subordinate everything else to the prior decisions
 Elevate the system’s constraint
 If, in the prior steps, the constraint has been broken, go back to step one.

6. Measures of Throughput
1. Return per Factory Hour
= Throughput per unit
Product time on bottleneck resources
2. Cost per factory Hour
= Total Factory Cost
Product time on bottleneck resources
3. Throughput accounting ratio
=Return per factory Hour
cost per factory hour

7. Target Costing
 Target costing is the process of determining the maximum allowable cost
for a new product and then developing a prototype that can be profitably
made for that maximum target cost figure.
 Target Cost = Anticipated selling price – Desired profit

8. Steps of Target Costing
 Planning
 Concept design
 Basic design
 Detailed design
 Manufacturing Preparation

9. How it Works – Overview
Perform Market Research & Identify Customer Needs
Determine Target Price & Desired Profit Margin
Develop Cost Projections for Each Component
Explore Different Product Design Alternatives
Perform Value Engineering / Value Analysis
Approved final
product design
Production
Continuous Cost Reduction

10. Target costing and Standard Costing
Standard Costing Target Costing
 It is Push System.  It is Pull System.
Standard cost is the Requires market
basis of price research and market
Determination. understanding.
 It an internal tool.  Driven by external
market prices.
 Cost control technique.  Cost reduction activity.
 Reactive Technique.  Proactive technique. It
Margin is added in the starts from the design of
standard cost. the product.

11. Life –Cycle Costing
It is accumulation of costs for activities that occur over the entire life cycle
of the product.
Factors:
 Design costs out of the product.
 Minimize the time to market.
 Maximize the length of the life cycle itself.

12. Back flush Accounting
 Suitable for JIT environment.
 The product cost is calculated retrospectively- at the end of the accounting
period.
 This eliminates the detailed tracking of costs throughout the production
process, which is a feature of traditional costing systems.
Example
Accounting procedure when raw materials & components are purchased on
credit:
Dr RIP account
Cr Payable account
(Purchase of raw materials & component on credit)
 Labor and production overheads are directly charged to the cost of goods
sold.

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14. Life Cycle Costs
Development cost
Design cost
Manufacturing cost
Marketing cost
Distribution cost

15. Backflush Costing
 Method of costing a product that works backwards.
 Backflush costing is the reversal of traditional costing, where traditional
costing flow from accounting of inputs to outputs but backflush starts
accounting only from outputs and then works back to apply manufacturing
costs to units sold and to inventories.
 In this, cost of inventories are at the time of sale only. Costs are then flushed
back through the accounting system. It is attractive for low inventory
companies which results from JIT.
 It eliminates WIP account. There are reason for justification, they are as
follows.
i)To remove incentive for managers to produce for inventory.
ii)To increase the focus of the managers on plant-wide goal rather than
on individual sub-unit goals.

16. Thanks

17. Difficulties of Backflush costing:
i)It does not strictly adhere to generally accepted accounting principles of
external reporting.
ii)Absence of audit trails leads to critics.
iii)It does not pinpoint the use of resources at each step of the production
process.
iv)It is suitable only for JIT production system with virtually no direct material
inventory and minimum WIP inventories. It is less feasible otherwise.