Slides 14 1 determine purpose and characteristics of output

• Standard: with at least 80% accuracy • Identify suitable organizations for output based control • Discuss the four dimensions of cost in relation to output based control • Apply basic

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Determine Purpose and Characteristics of Output Based

Cost Management and Control

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All Ins and Outs Can be Thought of as $:

The Language of Management

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Terminal Learning Objective

• Task: Determine Purpose and Characteristics of Output

Based Cost Management and Control

• Condition: You are training to become an ACE with

access to ICAM course handouts, readings, and

spreadsheet tools and awareness of Operational

Environment (OE)/Contemporary Operational

Environment (COE) variables and actors.

• Standard: with at least 80% accuracy

• Identify suitable organizations for output based control

• Discuss the four dimensions of cost in relation to output based control

• Apply basic cost measurement and management principles

to an output based control scenario

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Different Types of CMOs

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Output Based vs Org Based Control

• Organization based control exploits the reporting

relationship of the org chart

• Sometimes we wish to add an additional additional level of control that focuses on outputs for:

• Organizations seeking to reduce the cost of their outputs

• Organizations that are funded on the basis of their outputs

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What Kinds of Organizations are

Funded on the Basis of Outputs?

• All for profit organizations must sell their products or

services

• Revenue represents the funding or cash inflow and is

entirely based on priced outputs

• If the cost of producing outputs exceeds revenue the

company eventually goes out of business

• This issue’s importance is why most texts and writing on cost control has an output focus

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What Kinds of Organizations are

Funded on the Basis of Outputs?

• Most government organizations are not are not funded on the basis of what they output

• They are funded via appropriation

• Some government organizations are are funded on the basis

of their outputs

• These are typically called revolving funded organizations revolving funded organizations

• They may also be called

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The Army Materiel Command

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www.amc.army.mil

• The U.S Army Materiel Command is the Army’s premier

provider of materiel readiness – technology, acquisition

support, materiel development, logistics power projection, and sustainment – to the total force, across the spectrum of joint military operations

• If a Soldier shoots it, drives it, flies it,

wears it, eats it or communicates with it,

AMC provides it

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www.amc.army.mil

• AMC is headquartered at Redstone Arsenal, AL., and

impacts or has a presence in all 50 states and 155 countries

• Manning these organizations is a work force of more than 70,000 dedicated military and civilian employees, many

with highly developed specialties in weapons development, manufacturing and logistics

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Output Based Control

• Builds the after action cost review and accountabilities around outputs

• Fits many government organizations where outputs are clearly defined

• Particularly useful in non appropriation funded

organizations

• Especially where user fees are cost based

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Common Elements:

All Cost Management and Control

• All cost management and control efforts have the same

four requirements for success:

• Leadership

• Costing staff

• Process

• Cost measurement

• The increased scope and complexity of output based

control does influence each element

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Differences to Organization Based

and Role Based Control

• Leadership:

• Often many more subordinates involved

• Usually greater variation in contributions of subordinates

• Needs to be broader based and more experienced

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Differences to Organization Based

and Role Based Control

• Costing staf staf:

• Many more causes of variation are possible

• Volume and mix dynamics complicate understanding

• Greater skills and experience needed to explain and reconcile

• Cost measurement

• Allocation is usually required, with its potential pitfalls

• Fixed, variable, unit, equivalent unit issues may apply

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Learning Check

• How can funding be tied to outputs?

• What are the four requirements for all cost managed

organizations?

• How does an output based control focus impact the AAR process?

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What Costs Should be Considered? Defining

the Cost Measurement Process

• General guidance:

• It doesn’t make sense to spend a lot on costing process when the goal is to be more cost effective

• Costing can always be done more frequently

• Costing can always be done in greater detail

• Some cost views are more useful than others

• Costing can always include more components

Frequency

Scope

Flavor

Fullness

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Frequency Issues in Output Based Costing

• Output based control probably requires more frequent interaction because the processes can be much more

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Scope and Flavor Issues in

Output Based Costing

• The use of cost information to support user fee pricing

functions influences scope issues

• As a general rule we are still primarily interested in cause and effect relationships that inform us of real resource

consumption

• Of all cost

• By the cost objects: products or services

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Fullness Issues in Output Based Costing

• Revenue is derived from the sales of goods or services

• This transaction requires the setting of a price

or user fee, usually based on cost history

• It must cover all costs of the organization

• This means that cost measurement used for setting the price must include all costs within the boundaries of the organization

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Variance Analysis: Differences

• In organization based and role based costing we primarily looked at simple variances to expectation: plan, model, or prior period

• Output based costing may generate interest in the more

complex variances: volume, performance, spending,

efficiency, and others

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Learning Check

• How might an output based control process influence the frequency of cost measurement?

• When using the output based control process in setting

user fees, how is the fullness dimension defined?

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Costing Refresher:

The Basic Template

Cost Objects: Direct Costs

Cost Objects: Indirect Costs

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Organization Based Costing:

Direct Costs

• Organization based cost management and control works primarily with subordinate organizations having direct reporting relationships

• The cost objects are simply higher organization

levels

Cost Objects: Direct Costs

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Role Based Costing:

Indirect Costs

• Role based cost management and control work primarily with allocating the indirect support and overhead costs

• Cost objects are core function organizations

Cost Objects: Indirect Costs

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Output Based Costing:

Includes All Costs

• Direct costs now include costs that are not part of an organization, like material

Cost Objects: Direct Costs Cost Objects: Indirect Costs

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Let’s Build an Output Based

Costing System

• Assume:

• We only produce stamps

• Raw materials are required

• Production has two stages

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Individual Exercise

• Given an assumption of 20 billion stamp sales

• Determine total cost given the following slide’s data

• Determine unit cost per thousand

• Set a price per thousand stamp price by rounding unit cost

to the next highest nickel

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Costing Exercise Generic Stamp Production

Quality Control 2500

Admin 7780

Product Control 2000

Stamps: Direct Costs Stamps: Indirect Costs

7180 Material

15000 Printing

8000 Engraving

All costs are $K

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• No allocation is

required when there is

only one cost object

• Total cost divided by

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Group Exercise

• Use the randbetween formula in excel to

generate six random numbers between 80 and

130: =RANDBETWEEN(80,130)

• Divide each random number by 100 (to make a percentage) and apply to six cost elements

• Use a random number between 95 and 105 to

create a percentage to adjust units sold

• Determine volume and performance variances

compared to the previous numbers

• Prepare a reconciliation to present to class

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Group Exercise Hint

• Assume that all direct costs are variable and all indirect

costs are fixed

• This is never the case in reality since:

• Printing and engraving undoubtedly have fixed costs for equipment depreciation etc

• Support functions like quality control vary the number of inspectors based on volume

• But it is often used because it is reasonable

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Example Solution

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Example Solution

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Example Reconciliation

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Let’s Build a More Complex

Costing System

• Assume:

• We produce two types of stamps:

• Fancy commemoratives and bulk flag stamps

• Direct costs are known for

• Raw materials

• Engraving

• Printing

• Simple direct allocations needed for support

• Quality control is allocated on the basis of printing cost

• Production control is allocated on the basis of printing cost

• Administration is allocated on the basis of all other cost

It is very common to have multiple outputs

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Costing Exercise Two Output Stamp Production

Quality Control 2500

Admin 7780

Product Control 2000

Direct Costs Direct Costs Commemorative Flag

Indirect Costs Indirect Costs Commemorative Flag

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Solution: Two Product Cost

Note: total cost didn’t change

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Group Exercise

• The costs in the last exercise were based on last period

where we had 20000 billion stamp sales

• Assume that no changes in variable costs per unit for

commemoratives, variable costs per unit for flag stamps, or fixed costs occurred

• Determine the P&L for this period

• Hint: remember that variable costs (the direct costs in this case) vary with the number of units

• Prepare a reconciliation to present to class that explains

results

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Solution: Variable Costs (Direct)

• More commemorative units add cost at a high rate

• Fewer flag units reduce cost at a low rate

changes weighted average

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Solution: Fixed Costs (Indirect)

• Fixed costs do not change in total

• However, the allocations do change

changes distribution

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Solution: Variance Analysis Stamps

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Solution: Stamp Analysis

• A variance analysis of stamps makes it look like variable

cost performance degraded

• Yet, we know that variable cost didn’t change for

commemoratives or flag stamps

• What happened??

• See next two slides for variance analysis of each output

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Solution: Flag Analysis

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Solution: Commemorative Analysis

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Car Analogy

• Imagine if General Motors sold all cars at the

same price based on the average cost of all its

models

• Wouldn’t this be a great opportunity to buy that

Corvette??

• What would happen to GM’s profitability if their mix

of sales shifted to Corvettes?

• Take note: average cost can be a very dangerous

concept

• This is why GM uses an output based cost

management and control process

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had drastic effects

• Flag stamps were actually making an enormous

profit, inviting

competition

negative contribution margin

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• The output based cost management and control process follows the same template as role based and org based

• The issues are more complex because the scope

is much broader

• The cost measurement is much more complicated because of the existence of:

• Multiple outputs and potential mix shifts

• Allocation of support costs to the outputs that

consume them

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