Tag: ERP

Contribution Margin Accounting supports BSC

It is only in the overall view and in comparison with the plan that the extent to which the BSC proposals have been successfully implemented becomes apparent. To be able to put the overall picture together, quantities, services, times, inventories must be made equal. This can be done in the profitability analysis and in the internal balance sheet.

Contribution Margin Accounting supports BSC

If the profitability analysis is structured as a step-by-step and multidimensional contribution margin accounting, intermediate results can be presented for which the responsible managers can take direct responsibility. In addition, developments over time (from comparisons with the previous month to changes over several years) as well as planned to actual comparisons can be presented. Variances from the plan are shown to the accountable manager. There is no need to allocate variances to product units.

Contribution Margin Accounting as an Integration Tool
Contribution Margin Accounting as an Integration Tool

Find an example of stepwise contribution accounting here

Responsibilities and variance analysis

Salespeople can be responsible for net revenue first because they plan and control all the determining variables. If the planned proportional standard production costs are deducted from the realized net revenue of a sale, all variances arising in the downstream functional areas are left out. This allows the selling persons to also take responsibility for the CM I achieved in their area.

In line with the company’s own business model and market development, Contribution Accounting must be structured on a multi-dimensional basis:

    • In the product group view, the fixed costs of sales promotion can clearly be assigned to the contribution margins of the product groups or assortments. Product group managers can thus take responsibility for the CM I of their product group as well as for their own fixed costs that can be directly influenced. They are thus responsible for the contribution margin of their product group after deduction of their direct fixed costs and their spending variances.
    • Analogously, the contribution of a sales territory can also be planned and measured. The CM I achieved in a sales territory (after deduction of the proportional standard manufacturing costs) minus the directly controllable costs of the sales territory (cost center) result in the sales territory contribution.
    • If the sales channel is stored in the customer master data for each customer (e.g. direct sales, online, dealer), the contribution margin can also be calculated for this dimension. In this case, the fixed costs of channel support that can be influenced must be deducted from the CM I of the sales channel.

With the outlined multi-level and multi-dimensional CM-calculation, it is possible to clearly assign the achieved CM I as well as the fixed costs and the variances. Those responsible for sales can assess in each case how BSC activities did affect the results of their area.

Variances between the flexible budget and actual costs can occur in all cost centers. The difference between target and actual costs is called spending variance. The respective cost center manager is responsible for them (for the distinction between planned to actual and target to actual see “Flexible budget” in the glossary). The spending variances cannot be allocated to the product units according to their cause. In the stepwise contribution accounting-system they are presented at the lowest summarization level to which there is a clear reference.

Since production needs to adapt to customer demand and at the same time to take into account inventory targets in the warehouse, various types of variances arise for which the production manager is responsible, as he, together with his staff, is to achieve the planned values in the processed production orders. If the lot sizes in production increase due to larger sales quantities, this leads to positive lot size variances, because the setup costs only occur once per production order. If less material is consumed per piece than planned, positive material quantity variances occur. If more good pieces can be produced from the material input than planned, positive yield variances occur. If production orders are processed in cost centers other than those planned (due to bottlenecks), process or routing variances occur. Finally, working time variances occur when more or less time than calculated is used to process a production order in the production cost centers.

All these types of variances must be reported to the production managers, as they are the only ones who can directly ensure that such variances do not occur. Therefore, these variances are not allocated to the units produced and are not reported in the product contribution margins. The variance analysis for the production orders shows by how much the actual costs of the orders produced deviate from the planned costs per unit. Added to this are the spending variances of the production cost centers. Avoiding such variances is the responsibility of the production manager and of his cost center managers.

If differences arise between planned and paid prices in purchasing, purchase price variances occur. For these the purchaser is responsible, not the consuming cost center. Only if the material is purchased directly for a specific production order can a purchase price variance be charged to the order according to its cause. This type of variance arises at the moment of purchase, not at the moment of consumption, see also the post “Standard Cost Calculation of Products“.

These in-depth target to actual comparisons are used for control during the year, so that the responsible persons can quickly determine corrective measures. For the provision of data for the balanced scorecard, the condensed information on services rendered and the recalculated actual costs are usually sufficient.

It follows that the management accounting system, which has been consistently set up in line with decision-making and responsibility, also provides the data required for the implementation of the BSC. Full cost accounting, in which fixed costs are allocated to inventories and from there to the units sold, is not suitable for supplying a BSC. This is because the allocations mean that the people responsible only see to a very limited extent, or not at all, which of their measures had a direct impact on improving process costs.

The combination of stepwise and multidimensional CM- accounting with standard cost accounting with proportional costs leads to clear interfaces between the individual management areas.

Lean Production and Management Accounting

A standard costing system that only charges proportional costs to the single unit creates a symbiosis between lean management and value-based considerations.

Link lean production and management accounting

Lean Production aims to reduce consumption of product-related working hours, input materials and externally sourced services, as well as the assets required for these, to the minimum necessary for the successful running of the business. The extent to which this can be achieved must be judged from a value-based perspective. This is why lean production and management accounting belong together.

This requires a management accounting that shows cost, activities, revenue and results. The system must be able to depict planned and actual values, variances, and forecasts for the individual item through all cost centers to the overall result in an activity-based manner.  Management accounting is the collective term for this system. In management accounting, the success of lean management projects can be planned and tracked in terms of actual value.

Financial accounting only contains values but no activities that can be planned or tracked, cost allocation to products and services can only be done with the help of (arbitrary) allocation keys. Such a full cost allocation system is not qualified to support decision-making in lean management projects.

Management accounting must be structured as a standard cost system. This creates a symbiosis between lean management and value-based considerations because quantities and services are evaluated with monetary units and thus made synonymous.

The new specifications resulting from lean production considerations (standard quantities, standard times, setup and setup times, scrap rates) are the quantitative basis for calculating the proportional standard costs of an item (target to be achieved). The planned material consumption and times resulting from the lean project are to be stored in various files:

Lean production and management accounting
Lean production and management accounting

Lean targets and cost accounting

In the managerial cost accounting system described in our book on Management Control, the planned times and quantities resulting from the lean project and directly related to the product are entered in the fields highlighted in yellow:

Represent lean targets in cost accounting
Represent lean targets in cost accounting

Transfer Lean target values to ERP

In the next plan year these activity-related objectives form the basis for the standard cost calculation of the planned  proportional cost of goods manufactured. The resulting values then have a direct impact on the contribution margin calculation and on the planned profit and loss calculation, as well as on the value development of inventories.

If fixed cost center costs are reduced through the lean project, this does not change the proportional product costs (bill of materials and work plan remain the same). The adjustment of planned fixed values must therefore be made in cost center planning.

The different procedure for proportional and fixed costs is necessary because the fixed costs are never incurred for a product unit, but always in the cost centers. This is because fixed cost center costs are the result of the operational readiness of a cost center, not the activity performed. The cause of the operational readiness costs are always management decisions. If, for example, rooms are freed up for other areas as a result of a lean project, or if fewer personnel hours are required for cost center management, this is indeed a success, but whether this also results in a reduction in total costs only becomes clear when management decides to rent the room to someone else and to reduce the freed-up work capacity (lower headcount).

Charge only proportional costs to products

Therefore, it is important that in the cost accounting system only the planned proportional cost rates of the cost centers be attributed to products or other cost centers (cost splitting), both for the correct tracking of the progress of a lean project in terms of value and for the development of results in line with the period. The cost rates of the cost centers must not contain any fixed costs or allocations (see the post “Proportional and Fixed Costs”).

This also applies to internal activity allocation if service areas (research + development, laboratories, workshops, internal transportation, or IT) provide services for other cost centers or projects. Only if the recipient (receiving cost center) can either decide for itself whether it wants to obtain an internal service from another cost center or if there is an automatic link between the activity of the recipient and that of the service area, is it a case of genuine internal service charging. The proportional cost is  charged to the recipient. In all other allocation cases, the term “fixed cost allocation” is appropriate.

For management purposes, it is advisable to always valuate in- and outflows in warehouses of products at planned proportional production costs only. This is because proportional costs are defined by the products manufactured, while fixed costs are period costs (e.g., month, year). They are charged to the period result regardless of the manufacturing and sales quantities. Successful lean projects usually result in a reduction of both proportional unit costs and fixed period costs. The reduction in unit costs also reduces the value of inventories, which in turn increases ROI.

Since the implementation of a lean project rarely coincides with a fiscal year change, the progress in the project’s start year must still be evaluated on the basis of existing planned costs. In management accounting, these improvements initially lead to positive cost variances that improve earnings.