a comparison of activity-based costing & japanese cost management

8/10/2019 A Comparison of Activity-Based Costing & Japanese Cost Management

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Lee, J. Y., R. Jacob and M. Ulinski. 1994. Activity-based costing and

Japanese cost management techniques: A comparison.Advances In

Management Accounting(3): 179-196.

Summary by Charles Hart

Master of Accountancy Program

University of South Florida, Summer 2003

ABC Main Page| Japanese Management Main Page| Target Costing Main Page

This article compares activity based costing (ABC) with Japanese cost management techniques, a

combination of target costing and kaizen costing.

At the heart of this article is the question, how do we deal with the problems that conventional cost

accounting systems create or cannot deal with? ABC is a cost accounting concept that views costs

through a prism of organizational activities; not organizational departments. Target costing is

market-driven system of cost reduction, focused on managing costs at the developmental and desigstages of a product. Kaizen costing relies on setting cost reduction targets and attaining the targets

through continuous improvement activities in the manufacturing phase.

Activity Based Costing

In an ABC structure, organizational departments that have served as cost centers, where costs are

accumulated for allocation to products or services, are replaced by organizational activities through

which costs are viewed. The heart of ABC is to trace and account for the pool of fixed overhead

costs and show that they are really variable. The crucial aspect of ABC is its focus on the causality

and variability with respect to operations and resource consumption in organizations.

This focus can be examined in detail using four categories of activities and consumption: unit-level

expenses, batch-level expenses, product-level expenses, and facility-level expenses. Unit-level

expenses very proportionately with the production volume in units. These costs are typically

materials and supplies. Batch-level expenses are incurred as a batch of products is manufactured.

These expenses are setups, quality inspection, and procurement. Product-level expenses are related

to the activities performed to support specific products in a companys product line. These costs ar

typically seen when a company makes engineering and product design changes. Finally, facility-

level expenses are common to various product lines, and cannot be logically attributed to specific

Management And Accounting Web

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products. Examples include the plant superintendents salary and property tax on the plant.

If properly implemented, ABC can become a powerful tool for a company in costing products and

services, evaluating performance, formulating pricing strategies, and making product and customer

mix decisions. Recent studies have found the first benefit from ABC is the realigning of the involve

organizations expenses from functional categories and departments to activities and business

processes. The information gained from ABC was to be used to make decisions on outsourcing,

eliminating nonessential activities, and improving efficiency.

The hardest part of ABC implementation was reported as identifying and measuring cost

drivers. The identified drivers were used to connect activities to products, customers, or other cost

objects. ABC reveals that low-volume, complex products tend to be more expensive than more

traditional standard cost systems have indicated.

Additionally, pertinent actions are required to turn the ABC findings into actual cost reductions to

improve the companies bottom line performance. Usually, insufficient time exists for senior

management to establish profit priorities. Simply, the radical changes brought on by ABC create a

problem in that management is not able to respond quickly enough or use the information to the

greatest advantage because it requires them to break with everything they know about their

business. Meanwhile, the radical change is hindered by most companies being unprepared to make

radical changes or being willing to make changes, but ill-equipped to make the necessary changes to

take full advantage of the information.

ABC is only effective when the possible changes are identified in advance and then planned for

before implementation. Companies need an explicit plan for line managers to execute desirable

actions based on ABC. Thereby, desirable actions could be taken in the areas of costing products

and services, evaluating performance, formulating pricing strategies, and making product and

customer mix decisions. Without such an explicit plan, ABC may never reach beyond the finance

or other group that developed the model.

Target Costing

Target costing is a market-driven system of cost reduction, focused on managing costs at the

development and design stages of a product. The Japanese believe that cost reduction activities,

especially in automated plants, carried out in the production stage of a product have a limited

effect. The effect is limited because processing methods, type of equipment, production flow, and

other aspects of the production environment related to workers and quality are determined and fixe

at the product planning stage in an automated plant.

Target costing reveals a direct link between the marketplace, corporate long-term profit goals, and

cost management practices. The process begins with finding, through rigorous market research, a

quality product that can appeal to potential customers. The expected price at which this product is

most likely to appeal to customers is also determined by the new-product team. This sales price

generally reflects not current, but future, market conditions and reflects the teams best efforts,

although the price may change over that products life cycle. Based on the companys long-term

profit plans, the new products target profit is calculated and is subtracted from the expected sales

price to arrive at the allowable cost. By design, the allowable cost is too stringent to achieve throug


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current technologies. The cost estimates are based on current engineering and production

technologies. The target cost is set somewhere between the allowable cost and the current estimated

cost.

In calculating the target profit, Japanese companies use the rate of return on sales (ROS) rather than

return on investment (ROI). ROS is more technically convenient to relate profit to low-volume

products. This practice reflects Japanese manufacturers tendency to focus on the profitability of

the portfolios of related products rather individual products. After the total target cost is set for a

newly approved product plan, the engineering planners and cost management personnel divide the

total target cost for the product into various product cost elements based on the engineering design

and cost requirements. The achievement of the target cost requires intense value engineering (VE)

activities and close cooperation among departments, such as engineering, production, and

marketing.

Value engineering (VE) was first developed by General Electric and is geared toward producing

innovative, yet cost effective, product features that will satisfy customers needs. The features have

already been determined based on rigorous market research. The sales price incorporates the

appealing features based on the market research. For products and services under VE, functions aredefined, and costs incurred to perform those defined functions are measured against the functions.

One of the primary reasons that Japanese managers find target costing so attractive is its

compatibility with the management strategies they use to deal with the shortening product life cycle

in todays market. They need to monitor the profit and cost performance in short intervals because

they want to recover their investment in a short period of time. Target costing allows companies to

translate the cost reduction strategy into a series of equivalent actions according to the relationships

to the defined functions. This ability to translate the target into actions is very powerful because

cost accounting is connected to products very closely, which workers find very easy to understand

The close connection is in contrast to the loose connection between cost accounting and variousfunctions and products in standard cost systems.

Kaizen Costing

While target costing is a critical means of managing the costs in a new product design and

development stage, Kaizen costing supports continuous improvement activities in the manufacturin

phase. It is an alternative to ABC and combined with target costing, Kaizen costing helps Japanese

manufacturers accomplish their objective of cost reduction in the full cycle of design-development-

production cycle.

Kaizen costing functions in the same way as a budgetary control system but is usually located

outside the regular cost accounting system. In the standard cost accounting system, the focus is on

meeting standards. Kaizen costing , in contrast, mandates the setting of a cost reduction target

amount and the attainment of the target amount through continuous improvement activities. These

improvement activities, which should lead to cost reductions, are clearly specified for each

organizational unit and for each accounting period.

The cost reduction process in each period follows the annual budgeting process that represents the

current years portion of a manufacturing long-term program. Each organizational unit prepares


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projections and plans that become an integral part of their annual profit budget. For example,

projections would cover:

production, distribution, and sales plan,

projected parts and materials costs, and

fixed expense plan.

Using the contribution approach, the budgeted contributed margin (BCM) is calculated as

follows:

BCM = budgeted sales expected variable costs

Expected changes from manufacturing variable costs are used to adjust the BCM. Expected fixed

costs from the personnel plan, facility investment plan, and fixed expense plan are deducted from

the adjusted BCM to calculate budgeted operating profit.The budgeted operating profit is assigned

to each department. Performance of each department is measured on the basis of the difference

between actual profit and budgeted profit. After the total target reduction amount has beendetermined, the cost reduction target is decomposed and assigned along the hierarchical organizatio

in each plant: from plant top management to department, to section, to subsection, and all the way

to each manufacturing process.

The decomposition of the cost reduction target, which is performed at each organizational level of

the plant before cost targets are assigned, is closely related to the objectives of each level of the

organization. The target decomposition is performed in connection with each organizational levels

established objectives on manufacturing productivity, product quality, and cost. Kaizen costing is

not affected by the financial accounting focus of the standard costing system used by Japanese

manufacturers. The close link is rather with the profit planning process of the whole organization.This link allows Kaizen costing to function effectively in cost management without being tied to the

endless ritual of analyzing and explaining standard cost variances that cannot be easily translated

into actual tasks performed by employees.

Comparison

Comparison Between ABC and Kaizen Costing

ABC Kaizen Costing

Control location Within cost system Outside of cost system

Feedback time frame Long term Short term

Connection between cost Connection is made Connection through cost


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system and strategic

decisions

through cost accounting accounting is not critical

Primary focus on costs Fixed costs Variable costs

Relate transactions to cost

accounting

Transactions are directly

related to cost accounting

Transactions are not

directly related to costaccounting

Use cost drivers and

performance measures

Use activity cost drivers

and performance measures

Use performance measures

Nature of methodology Comprehensive cost

accounting and

management methodology

Tool for motivation and

enforcement

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