Cost Monitoring

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Activity Based Costing

Real Time Cost Monitoring

Activity Based Costing (ABC) is a cost accounting philosophywhich links cost elements to production activities for adetailed and consistent cost allocation. Storing detailed costinformation in the same database with quality and productiondata results in increased possibilities for tracking andanalysis, cost and value calculation for each product unit,and the ability to determine profit margins for specific orders.

Real Time Cost Monitoring (RTCM) is the integratedacquisition, processing and reporting of product and processcost data in approximate real time. RTCM makes activitybased costing possible by detecting cost variances early in amulti-step production process and facilitating solutions tocost problems in conjunction with quality and productionconstraints. The result is detailed and consistent costallocation, a thorough understanding of the cost structurethroughout the production process. Business becomes moreprofitable as quality requirements are met while costs fall andproduction increases.

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ACTIVITY BASED COSTING

There are strong demands in the process manufacturing industries for providing correct and detailedcost information from daily plant operations. The state of the art is well described by H.T. Johnson andR.S. Kaplan:

Today’s management accounting information, driven by theprocedures and cycle of the organization’s financial reporting system,is too late, too aggregated and too distorted for manager’s planningand control decisions.

The cost of operation is typically calculated once a month. While this is good for financial reportingpurposes, manufacturing wants to allocate the real cost in the production process to the end product.Rather than distribute cost top-down following certain standards, manufacturing wants to calculatecost bottom-up based on real consumption of resources in the process.

Linking cost to the activities in the production process is one of the benefits of doing Activity BasedCosting (ABC). ABC is a philosophy for cost accounting and not a detailed methodology. Hence, theprinciples of ABC can be applied several ways. ABC is per definition linking all cost elements toproduction activities. Cost of resources like materials, energy and chemicals are easily calculated butalso services like quality inspection and production setups should be handled similarly. The result isdetailed and consistent cost allocation.Cost is not considered to be only variable or fixed, but alsosemi-fixed depending on the time frame of analysis. The clue is to identify the correct cost pools andcost drives for various cost types. There are multiple solutions, and careful analysis of the productionprocess should be carried out to ensure a good implementation. For details regarding Activity BasedCosting, please refer to one of the publications listed below.

Storing detailed cost information in the same database as quality and production data has strongadvantages. Cost is calculated from the input resources in the process and stored with the same timestamps as quality and production data, and gives unique possibilities for tracking and analysis. Costcould be used as an alarm indicator analogous to process related signals, and analysis should becarried out to find real causes of cost variance. All process steps can be linked together, adding costand value to the product as it moves through the process. Finally, profit margins can be calculated forspecific orders. This will identify which products and customers contribute to the profit.

Using real time activity based cost monitoring will give reduced cost and increased production. Bygetting early warnings of cost variances, problems in the process can be solved in conjunction withquality and production aspects. This is obtained through detailed and consistent cost allocation, whichalso gives a good understanding of the cost structure in the production process. Common cost andquality objectives for all process departments can be established, creating increased understandingand motivation for the common goal: a profitable business.

Real Time Cost Monitoring (RTCM) is based on the concepts of Activity Based Costing, and may bedefined as integrated data acquisition, processing and reporting of product and process cost inapproximate real time. RTCM has a strong basis in business problems and solves them in a flexibleand thorough way. Some of these aspects are described and discussed below.

REAL TIME COST MONITORING (RTCM) CONCEPT

Real Time Cost Monitoring (RTCM) is based on the concepts of Activity Based Costing, and may bedefined as integrated data acquisition, processing and reporting of product and process cost inapproximate real time. RTCM has a strong basis in business problems and solves them in a flexibleand thorough way. Some of these aspects are described and discussed below.

Production, Quality and CostIn the production process there are strong inter-relationships between production, quality and cost.The objective is to achieve high production at low cost with quality according to the customersrequirements. Despite this objective, the three issues are often handled separately due to historicalreasons, organization, etc. There are obvious advantages by working systematically with them in onesystem.

The cost and revenue of a product is related to the complexity of matching the customersrequirements of the production process to trade offs among production speed, quality properties andcost of resources. It is always possible to meet the requirements by adding enough resources in theproduction process. A systematic approach will have a long term goal of getting detailed knowledgeabout all process variables and cost elements related to the customers’ orders. The best way toachieve this is by storing cost, quality and production data in one system. These requirements aresupported by the RTCM concept.

Production and Servicing DepartmentsToday’s production plants are integrated production processes with several departments, and theproduct follows certain routes through the production process. In addition there exist several servicingdepartments like quality inspection, maintenance, sales and accounting. A profitable businessrequires that these functions are well integrated and that quality, cost and productivity are correctlyperceived in all departments. The organization network is complex, and open for suboptimization.

The RTCM concept has the objective to present detailed and correct information based on wellaccepted rules for cost calculation and presentation. Based on detailed cost information, thedepartments may have different requirements for reporting the data. In the long run a homogeneousview will develop of what constitutes profitable production. Presenting information relevant for decisionmakers in each department is important, and the operators and managers must observe cost effectsof their process actions. RTCM has the capabilities to support this process.

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Integrated ConceptCost information is typically calculated at the monthly level with few or no possibilities to study theunderlaying details. The traceabilty from end products to raw materials is also very restricted. Thegoal should be a model where detailed and aggregated cost is consistently calculated andaccumulated through production departments. A paper manufacturing example is shown in the figurebelow.

Cost ModelThe RTCM concept is implemented in a cost model by calculating on line the necessary cost data andmapping the cost elements to the activities and entities in the production process. This can beexplained by looking at the paper manufacturing example presented in the figure below.

By entering the order’s sales price, the net profit margin can be calculated. So far only the costcalculation has been outlined. Along the process line usage, price and capacity variances have beencalculated for all resources, and this information also ends up on the order level. This opens for thepossibility to zoom down into the process details from aggregated order data. In the example aboveRTCM is configured into a mill specific system. However, the concept is generic in its form, and mayfit any production process in multiple steps following the guidelines above.

The example shows a mechanicalpulp mill integrated with a paper millproducing paper reels. These reelsare cut into rol ls, and rol ls arerelated to specific orders. The pulpmill is an independent productiondepartment, and an unit cost formechanical pulp is calculated. Thiscost is input to the paper mill whereit is handled as a price ofmechanical pulp. The cost of apaper reel is then calculated at reelturnup time. A link from the reelCost model

turnup time to the production time in the pulp mill is established for traceability reasons. Later the rollsare linked to specific reels, and the related cost is calculated. An order is then entered for a group ofrolls, and the total order cost is calculated.

The figure can best be explained byan example. An alarming costsituation for the end product paperis observed on day aggregates, andneeds further investigations.Zooming down on the details(batches) in the day aggregates,gives access to detailed productionand quality information. A thoroughanalysis of the underlaying detailsin the aggregated alarm situationcan be carried out. The reason

could be caused by the cost in the previous production department, and the cost variances can betraced back and further analyzed. This flexibility in analysis is indicated by the arrows in the figure,where forward-backward analysis is taken care of by traceability and up-down analysis is a change inaggregation levels. This functionality is one one of the key aspects in the RTCM concept.

RTCM: An integrated concept

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Operation, Reporting and AnalysisRTCM is a tool for several levels in the organization, each with different requirements. The operatorsmay use it for taking cost effective decisions in the process. This strongly depends on high dataquality and user friendly presentations through forms and graphs. Production and accountingmanagement wants to look at the same basis data at an aggregated level using reports. Graphics ofkey process variables should be included in the reports. In specific problem situations the processengineers and accountants need to perform detailed analysis and tracking. They want to look atactions taken in the process by the operators which can be logged in the database and form a solidbasis for knowledge acquisitions.

A consistent mapping and integration of several functions like data input and presentation, reporting,analysis and tracking and knowledge acquisition is implemented in the RTCM concept. Thesefunctions form a learning cycle for continuous improvement in the production process.

MIKON/RTCM APPLICATIONS

The mission for MIKON/RTCM is:

presenting, detecting tracking and analyzing cost variances by linkingproduct cost to production and quality

This functionality is implemented in a set of applications concentrating on calculation, monitoring,reporting and analysis of net profit margin, production cost, cost variance, capacity utilization andprocess performance. These issues are presented below by showing examples from MIKON/RTCM.The presentation intends to give an overview of some of the functionality, and is not a completedocumentation of MIKON/RTCM.

Order and Product Cost and RevenueTo allow profit monitoring for separate orders, all cost added to the product through the process mustbe aggregated consistently to the units in the order. In the figure shown below, the cost is calculatedfrom the paper mill for separate rolls of paper before selected rolls are entered into an order. Costcalculations are based on a detailed consumption of resources (bottom-up), and the order’s salesprice can be entered to calculate net profit margin.

Order, cost and revenue. (currency = NOK)

The figure to the left is an on linespreadsheet where one columnrepresents one order and the rowsare cost signals related to theorders. The top lines indicate dateand time for finishing the order, andproduct, customer and ordernumber. The form is a sales priceinput form to enable calculation ofnet profit margin. The form is live,and any changes in theunderlaying data will cause updateof the data in the form. Severalsubmenus can be selected for adetailed study of the data displayedin the on line spreadsheet.

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Detailed Cost for Single Units (Batches) in the Production ProcessThe cost of units (batches) in the various process steps can be viewed using on line spreadsheetsand graphics similar to the ones shown above. This is used for paper rolls and reels and 8 hourproduction batches of mechanical pulp. The model is generic in form and any production process canbe modeled in a similar way, but the examples focus on an example cost model.

Cost usage variance for rolls

The detailed cost usage variancesof single rolls can be presented as inthe figure to the left. A negativevariance indicates that the usage ofresources has been greater than thestandard (budget) recommendedvalue. For roll number 22000065 allthe detailed variances can beobserved adding up to the totalpresented in the previous figure.

The figure to the left is anexample of a graphic zoom. Agraphic zoom from the order levelwill include roll details of selectedsignals from the on l inespreadsheet. This is shown in thefigure, where the total cost forsingle rolls is displayed togetherwith the cost usage variance.Several information details can beread from the graph by using agraphic crosshair. An example forreading sum cost variances forroll number 22000065 isdisplayed to the left.Detailed cost of rolls in order

The usage variances can be furtherstudied and analyzed through trendgraphs which furnish cost per ton asshown to the left. By zooming downon the details in the graph, singlevalues and related information canbe read out. The figure to the left is aproduct traceability zoom, showingbatches from the pulp mill and rollscut from the specific reel. The reelnumber 21000054 has providedpaper for roll number 22000065analyzed earlier.

Furnish cost for reels

Cost AnalysisCost analysis has been shown in the previous figure by zooming down on detailed information and bytracking certain variances. MIKON/RTCM also includes more dedicated analysis tools like costvariance analysis and Advanced QUery Analysis.

Cost variance analysis

Production cost in pulp mill

The cost of mechanical pulppresented on the graph above canbe investigated further. The cost atreel level is a function of usage andthe unit cost of mechanical pulp.The figure to the left shows how tomonitor the production cost in thepulp department. In the pulpdepartment the cost of production iscalculated at shift level since thereis no defined production units. Thetotal cost and the cost per ton iscalculated as well as the variances.The production batch number11000025 has provided pulp for thereel analyzed in the earlier figure.Quality and production data can beincluded and traced forward toseparate orders

The figure to the left shows agraphical analysis of costvariances. Top left is shown thecost variance of paper cost perton which is a master signal.The other five graphs show thecontribution from variances indifferent input resources. Allgraphs are displayed with thesame scales giving a conciseview of the various components’contribution. There is an ovalcircle in the right corner of eachgraph giving the degree ofcorrelation between the masterand one of the input resources.The diagram may therefore beused as a cause and effect chart.

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Cost, Production and Quality

The strong benefits of having cost, quality and production data in the same database have beenpointed out earlier. Some of the following figures indicate how these data can be integrated andpresented.

The graphs to the left are trends ofusage and cost of chemical pulpand the quality property tensilestrength. All these data are storedin the database with the sametimestamps. The graphs give aunique possibil i ty for studyinginterrelated cost and qualityeffects. The white bands indicatethe recommended value. Thefigure shows paper reels with lowqual i ty and high cost and theopposite. Comparing other processvariables the same way wil lprovide knowledge about cost-equality interrelationships in theprocess. To the left is presented acustomer order display showingwhich customers and orders thatgot paper from the highlighted reel.

Effects of chemical pulp

spreadsheets can be displayed using the defined filter. The figure shows the two non-consecutivepaper reels qualifying the query. MIKON/AQUA is a strong tool for process analysis involvingintegrated cost, quality and production aspects.

MIKON/AQUA is a form basedquery module which is used tofind units of production (batches)qualifying certain restrictions.Batches with cost or processalarms can be selected bydefining l imits for cost andprocess variables. In theexample shown to the left, wehave selected paper reels withquality properties (tensilestrength) below a recommendedvalue and a negative cost usagevariance for chemical pulp.Hence, these paper reels arelow quality and high cost. The query is carried out as afi l ter to f ind the batchesqualifying the query. Laterreports, graphs and on l ine

Advanced QUery Analysis

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ReportsProduction, cost and quality information customarily appears on printed reports for the various levelsin the organization. In MIKON, reports are configured by the user and may be run cyclically (e.g. everymorning). In MIKON/RTCM an enhancement has been developed allowing graphic displays onreports.

SUMMARY

The figure to the left shows a graphicreport where a standard report iscombined with a trend chart of thecost of chemical pulp. Also displayedare the standard (budget) values forchemical pulp. Any standard textreport may be configured as agraphic report.

Order, cost, production and quality data

The on line spreadsheet for orderrelated information can be used toview cost, production and qualityproperties at the order level. Thecost is aggregated through theproduct ion process, whi le thequality properties are mean valuesfor the various process steps.Only values for batches linked tothe order through the productionprocess are calculated using theproduct tracking model.Brightness is such an examplewhich is measured on paper reelsand pulp production batches. Tothe left is a product trackingdisplay showing all paper rolls andreels and pulp production batchesrelated to the currently highlightedorder.

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In this document MIKON Real Time Cost Monitoring (RTCM) is presented based on a cost model foran integrated pulp and paper mill.

RTCM has a basis in Activity Based Costing and allows integrated monitoring of cost, production andquality data. This will give strong benefits such as increased production and reduced cost, stillmeeting the quality requirements.

Calculation of product cost and analysis of cost variances have been shown for separate ordersbased on details from all the production departments. The presentation is done using graphics,forms and reports showing how product cost can be traced back using the product tracking module.

RTCM is an integrated concept with a flexible model. This provides decision support for all levels inthe organization through daily operations, analysis and reporting. The RTCM concept is generic in itsform, and may be configured into any specific production system.

LITERATURE

R.S. Kaplan and H.T. Johnson. Lost Relevance. Harvard Business School Press (1987).

R.S. Kaplan. “One Cost System Isn’t Enough.” Harvard Business Review :January - February 1988.

R. Cooper and R.S. Kaplan. “Measure Costs Right: Make the Right Decision.” Harvard Business Review: September-October 1988.

R. Cooper and R.S. Kaplan. “Profit Priorities from Activity Based Costing.” Harvard Business Review: May-June 1991.

R. Cooper. “Does Your Company Need A New Cost System?” Journal of Cost Management: Spring 1987.

R. Cooper. “The Two Stage Procedure in Cost Accounting: Part One.” Journal of Cost Management: Summer 1987.

R. Cooper. “The Two Stage Procedure in Cost Accounting: Part Two.” Journal of CostManagement: Fall 1987.

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Cost Monitoring

Documents

Transcript of Cost Monitoring