effective marginal costing: know your resource needs larry r. white, cgfm, cma, cfm, cpa executive...
TRANSCRIPT
Effective Marginal Costing: Know Your Resource Needs
Larry R. White, CGFM, CMA, CFM, CPAExecutive Director, Resource Consumption Accounting InstituteCAPT, USCG (Retired)
Agenda
What exactly is Marginal Costing?
• Why is Marginal Costing important?
• How is Marginal Costing done?
Quiz
• What is Marginal Costing?
• Does it have any other names?
• Where or When do you use it?
• What do you remember about it from Cost Accounting or Microeconomics?
What is Marginal Costing?
• Wikipedia: – Marginal Cost is the change in total cost that arises
when the quantity produced changes by one unit.
– Marginal Costing (under Cost Accounting): This method is used particularly for short-term decision-making. Its principal tenets are:
– Revenue (per product) - variable costs (per product) = contribution (per product)
– Total contribution - total fixed costs = total profit or total loss)
• Thus, it does not attempt to allocate fixed costs in an arbitrary manner to different products.
A Closer Look
• What resource use (and costs) will change if output changes?
• What you need to know:– Relationships within a process: What resources in the
value chain contribute to creating the output?– Characteristics of the resources used:
• Which resources will need beefed up or reduced?• What resource quantities have fixed and proportional
relationships with the change in output?
– Costs associated with the resource changes.
What we need to know:
Final Output 1
Final Output 2
Final Output 3
Final Output 4
Resource Pool A
Resource Pool E
Resource Pool H
Resource Pool F
Resource Pool G
Resource Pool B
Resource Pool C
Resource Pool D
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Product A Product B
Service 1 Service 2 Service 3
Total Volume
$’s
Change in Total $’s Due
to a Change in Total Volume
Fixed Cost
Variable Cost
Cost-Volume-Profit Analysis
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Product A Product B
Service 1 Service 2 Service 3
An Output
Inputs &their $’s Fixed
Inputs
Proportional Inputs
An Output
Inputs &their $’s Fixed
Inputs
Proportional Inputs
An Output
Inputs &their $’s
Fixed Inputs
Proportional Inputs
An Output
Inputs &their $’s Fixed
Inputs
Proportional Inputs
An Output
Inputs &their $’s Fixed
Inputs
Proportional Inputs
Responsiveness
Marginal Costing vs. Unit Costing
• More Accounting Transactions – 12,000/yr
• Finance Center:– Personnel Cost $30,000,000– Operating Cost $15,000,000– Transactions/year: 3,000,000
– Unit Full Cost Cost: $15/transaction X 12,000 = $180,000
– Judgmental Marginal Cost: 1 GS-7 = $65,000
Agenda
What exactly is Marginal Costing?Why is Marginal Costing important?
• How is Marginal Costing done?
Importance of Marginal Costing
• Budgets are incremental or decremental.
• Full Cost is nearly always a gross overstatement.
• Only way to achieve transparency and internal management alignment around financial impacts.
Full Cost
• Full Cost is the correct figure for very few actions
• Worse you can calculate full cost easily
• And……know next to nothing about your processes or resources. – Finance Center Transaction Example.
Example
• Fact set: City Council is requiring fire inspections every 18 mths rather than every 3 years.
• Current Fire Inspection Staff: 1 Supervisor, 3 Inspectors, 1 Clerk, .75 FTE Hearing Officer/Judge, 1 FTE Billing and Collection at City Treasurer
• What else do you need to know?– Space, Current Capacity (including non fire
inspection work), equipment (computers, vehicles), training, hearing workload………
Agenda
What exactly is Marginal Costing?Why is Marginal Costing important?How is Marginal Costing done?
Calculating Marginal Costs
• How are marginal costs calculated?
• Ad hoc Analysis – Advantages/Disadvantages
• Policy Based Formulas– Advantages/Disadvantages
• Directly fm Management Accounting Information– Advantages/Disadvantages
Calculating Marginal Costs
• What you need to know:– Process Flow– Resources in the process – How resources interact/support each other
Characteristics of the resource• Fixed and proportional relationship to outputs
(intermediate and/or final)
– Costs to overlay the resource flows.
Information Elements for Marginal Costing
• Organizational components
• Resource Pools in the Process
• RP output & ouput consumers
• Output Capacity
• Resource Relationships to Output– Fixed & Proportional
• Cost of Resource Pools– Primary (inherent) & Secondary (support)
Based on Cause and Effect Relationships
Creating Accurate Marginal Costs
• Requirement 1: Accurately render the enterprise’s flow of economic goods and services with causal relationships
Fire InspectionResource Pool
Inspections - Clean
Inspections – Fines & Penalty
Re-Inspections - Clean
Output:Inspector Labor Hrs
Bldg Space
IT Support
Motor Pool
HR & Pay
Procurement
SQFT
# WS
# Cars# Miles
HR Events
# PO’s
Hearings/Court Appearances
Re-Inspections – Fines & Penalty
FD Internal Affairs
Bldg Space
IT Support
Motor Pool
HR & Pay# Man hrs
Causal Relationships
• Strong Form - Consumption relationship can be quantified
• Weak Form – Consumption relationship exists, but cannot be quantified– Examples: Excess Capacity, Fire Chief & personal
staff
• Attributable Cost – Costs of an output that could be eliminated if that output were discontinued and resources were reduced accordingly.
Attributable Cost Example
Fire Inspectors
Fire Investigators
Fire Stations
Training Center
Internal Affairs
Fire Chief/Staff
Bldg Space
IT Support
Motor Pool
HR & Pay
Procurement
Inspections
Investigations
Readiness
Fire SafetyMission Man-Hrs
Product/Services
ResultsSegment
Weak CausalRelation
Creating Accurate Marginal Costs
• Requirement 2: Link the quantitative flow of goods and services to their monetary implications.
Example
Primary Costs: Fixed $ Prop $
Supervisor 2,000 hrs 75,000
Inspectors 6,000hrs 180,000
Clerk 2,000 hrs 30,000
Operating Budget 100,000 25,000
Secondary Costs: Output Fixed Qty
Prop Qty
Fixed $ Prop $
Bldg Space SQFT 1,200 120,000
IT Support Wk St 8 0 24,000
Motor Pool F:Cars P:Miles
3 30,000 9,000 18,000
HR& Pay HR Events 130 15 2,050
Procurement PO’s 60 24 3,000 2,400
FD Internal Aff Man Hrs 120 6,000
Example (Continued)
• Output Capacity: 6,000 Inspection Hours
• Planned Output: 4,500 Inspection Hours
• Restricted/Idle Capacity: 1,500 Hours
• Fixed Cost: $339,050 Rate: $56.50
• Proportional Cost: $255,400
• Rate: $42.60 – 6,000 hrs
• Rate: $56.80 – 4,500 hrs
Creating Accurate Marginal Costs
• Requirement 3: Provide Insight into input-output behaviors and their respective costs– Changing Nature of Costs – Become more
Fixed
Electricity
Janitorial
HVAC Maint
Bldg Security
Building 6 SpaceResource Pool
ProportionalFixed
Creating Accurate Marginal Costs
• Requirement 4: Segment the cost model for only that portion of economic goods and services relevant to the decision at hand.– Ex: Levels of decisions
• Resource Level: Fire Inspection Dept Costs & Resources
• Value Chain/Process Level: Improve Fire Inspection Violation Enforcement. Inspection to Hearing to Collection.
• Product/Service Line Level: Fire Prevention Activities
• Organizational Profitability/Performance: Reduce Number of Fires in City – Incidents, Property/Lives Lost
Creating Accurate Marginal Costs
• Requirement 5: Reflect all causal relationships and their characteristics relevant to the decision at hand– What costs are relevent?
• Hire 3 new inspectors• Contract for 4500 hrs of Inspector Expertise.• Buy new Inspection Documentation software and
equipment.• Revise inspection schedule to permit geographic
sequencing.• Increase fines for Fire Inspection violations.
Creating Accurate Marginal Costs
• Requirement 6: Provide accurate monetary information for all relevant cost categories appropriate to the decision.
• Relevance = – For Strong Causal Relationship
• A clear Cause and Effect Relationship • Proportional or Fixed
– For Weak Causal Relationship• Cost Assignment to the responsibility level that can
eliminate the resource and its cost.
Cost of Fire Code Enforcement
Marginal Attributable
FID Primary Proportional Cost xxx xxx
FID Secondary Proportional Cost xxx xxx
FID Primary Fixed Cost xxx
FID Secondary Fixed Cost xxx
FID Excess Capacity xxx
Hearing Officer Primary Proportional Cost xxx xxx
Hearing Officer Secondary Proportional Cost xxx xxx
Hearing Officer Primary Fixed Cost xxx
Hearing Officer Secondary Fixed Cost xxx
Billing/Collection Primary Proportional Cost xxx xxx
Billing/Collection Secondary Proportional Cost xxx xxx
Billing/Collection Primary Fixed Cost xxx
Billing/Collection Secondary Fixed Cost xxx
Marginal Costing Requirements
• Incorporate Foundational Economic Principles
1. Provide an accurate rendering of an enterprise’s flow of economic goods and services. • Accommodate the strong
form of causality. • Accommodate the weak
form of causality
2. Link the quantitative flow of goods and services to their monetary implications.
3. Provide insight into input-output behaviors - and their respective costs
• Segment Information to Enhance Its Relevance to Decision Makers
4. Segment the cost model for only that portion of economic goods and services relevant to the decision at hand.
5. Reflect all causal relationships and their characteristics relevant to the decision
6. Provide accurate monetary information for all relevant cost categories appropriate to the decision.
RCA Structure for Marginal CostingRCA Structure
Quantitative
Definition of Material Causal Relationships
Support/Secondary Resource Pools
Support/Secondary Activities
Primary Resource Pools
Primary Activities
Product/Service Objects
Result Segments
Common Fixed Costs
RCA Recognition
Costing Continuum/Levels of Maturity
No Marginal Insight
Marginal Insight Awareness DetailedMarginal Insights
Descriptive: Expense Tracking, Cost Reporting and Consumption RatesPredictive: Demand Planning Driven with
Capacity Sensitivity
1Blind
Book-keeping
Nomarginal insights
Process/ lean accounting
2ProcessVisibility
Direct cost to outputs
Limitedprocessmarginal insights
Add indirect costs
4Output
Visibility
Direct costmarginal insights
All outputcostmarginal insights
5Explicit Outputs
Output specific marginal insights
Individual std costs, project & job costing
Push activity-based costing (ABC), Product costs
Explicit output marginal insights
6Explicit IndirectCosts
7Customer Demand Sensitive
Level 6 with customer & channel profitability reporting; Cost-to-serve
8Unused Capacity
Aware
Add customer & channel marginal insights
Unused capacity costs (estimated)
Common fixed costs begin to be isolated
9Pull ABC Resource Planning
10Time-
driven ABC
11RCA
Explicit resource cost object, supply-based denomina-tor, strong & weak forms of causality catered for
12Simulation
No change
(ABRP); forecast driver quantities X std unit rates, driver-based budgeting
Increased ability to isolate common fixed costs
Increased ability to isolate common fixed costs
(TDABC); forecast driver quantities X std unit rates; direct cost focus; repetitive work conditions
Finite systems modeling
Attributable costs on all objects, blends activity and direct resource charges, consumes activities back to resources
3Output
Visibility
RCA Institute Objectives
• Improve Management Accounting Knowledge and Practice– Focus on Decision Support for Enterprise Optimization
• Build A Highly Structured and Disciplined RCA Community– Create Standard Body of Knowledge and Standards of Practice– Initial Objective is 150-200 Highly Skilled Practitioners (The
Tipping Point)– Provide A Professional Structure that Minimizes Risk to RCA
Adopters
RCA Support & Quality Assurance
• Institute Membership
– Corporate & Individual
• Certification
– Specialist, Practitioner, Master
– Software Products
• Adopter Exploratory Workshops
– Customized Workshops applying RCA to an organization
• Implementation Review/Assurance
– Support Adopting Organizations & Practitioner Expertise
• Adopter Internal Use Reviews
– Evaluations of An Organization’s Effectiveness Using and Maintaining RCA
