Category: Management Accounting

Management Accounting in Public Administration

Management accounting in public administration

The costs of public institutions and administrations are constantly rising, whether due to inflation, higher staffing levels, more services, new legal requirements or political decisions. These tasks are usually financed by tax contributions, user fees of all kinds or financial contributions from other sources.
As a result, the administrative and management areas of municipalities, cities, districts or countries are increasingly occupied with the cost-effective management of their own operations and facilities. With financial accounting, only rudimentary evaluations per cost center can be delivered. To individual products and services there is no reference if there is no decision relevant management accounting.

Some examples of affected organizational units:

    • Kindergardens, elementary school, secondary schools through to universities, vocational training and further education and training for professionals
    • Leisure facilities and public swimming pools
    • Water supply and wastewater
    • Energy supply
    • Waste disposal
    • Local police and fire departments, local public transport organizations
    • Maintenance of roads, squares, parks, cemeteries
    • Retirement and nursing homes, medical services
    • Tax offices
    • Information and advisory organizations for citizens.

Managers, politicians and citizens want to know how much the products and services cost per unit, what costs are to be borne by each administrative area and how the costs per service unit change over time.
This presupposes that the products and services of public administration units are defined and that work plans and – where applicable – bilss of material are drawn up for each product. Similar to industrial companies, management accounting systems must therefore be set up which can calculate planned, target and actual costs per cost center and product or service.
The book “Kosten-Leistungsrechnung für die Verwaltung” (Management accounting for public administration) shows with various examples how management accounting can be realized in public administrations in plan and actual. Together with the Office for Municipalities of the Canton of Zurich (Switzerland), the product catalog of a smaller city was developed. This catalogue is included in the aforementioned book and serves as a template for structuring and calculating cost centers, products and services (incl. CD with integrated numerical model).

Management Accounting for Hospitals

Hospitals, nursing facilities and retirement homes

Management accounting is important for hospitals, nursing facilities and retirement homes because patients and insurance organizations require proof of the costs of treatment. The main object of analysis is the individual case of a particular patient. Invoicing is usually based on (legally) regulated tariffs.

External case-related services (e.g. X-rays) can be assigned to the “case” (person treated). Many purchases from the hospital pharmacy and aids from the hospital warehouse can also be assigned to the case. In a production company, one would speak of external service and direct material costs, which are charged directly to the product, i.e. the case, using warehouse withdrawal slips or vendor invoices.

Services from the kitchen, especially special catering or drinks, can also be recorded on a case-by-case basis.

In cost accounting, purchases of medicines or auxiliary materials for cost centers, e.g. a nursing or bed ward, which cannot be allocated directly to the individual case, are referred to as material overheads. These items are included in the proportional planned cost rate of the respective cost center, e.g. an inpatient ward.

Personnel costs are usually the most important cost type in a hospital. They are planned and reported by cost center. By recording services, it is possible to determine how many working hours are used directly for the care of individual patients (case-related proportional costs) and what proportion of hours is used for operational readiness (fixed costs of the cost centers).

The availability of a surgical suite incurs fixed costs of service readiness  such as rent, imputed depreciation and maintenance of the installed equipment and facilities as well as basic cleaning. These costs cannot be allocated to an individual operation on the basis of causation. They are incurred in order to carry out operations at all.
The surgical team must ensure that all the equipment required for a particular operation is in working order and that the cutlery and aids are ready for use. These persons must be present during the operation so that they can provide immediate support in the event of complications. The same applies, mutatis mutandis, to the anesthesia team and to cleaning and disinfection after each operation.
The costs incurred for these functions are proportional costs of the operation, they are caused by the case.

If management accounting of a hospital is to be set up, the requirements of a manufacturing company can be assumed in many areas. However, some special features must be taken into account for the system:

    • The master data must not only be collected on a customer-specific basis, but also on a case-specific basis.
    • External services are usually ordered on a case-specific basis, not item-specific
    • Inventory levels must be continuously updated for both aids and medicines (pharmacy).
    • The time spent by staff in surgery and medicine should also be recorded per case as far as possible. In nursing, this is only possible to a limited extent, as the workload can rarely be measured per patient.
    • The amount of work required for a decision-relevant management accounting system in a hospital is greater than in other economic sectors.

This effort is worthwhile for the following reasons:

    • Better decision-making basis for the management staff, especially for the control of service readiness costs and directly case-dependent costs,
    • Meaningful, performance-related calculations for negotiations with health insurers and state funding bodies,
    • Possibility of cost control in the cost centers, taking into account the current level of activity.

 

 

Management Accounting for Banks and Insurance Companies

Banks

Many banks use the money deposited by their customers to finance loans. They charge interest on the loans granted and use them to pay interest on the depositors’ balances as well as to cover their own costs and profits. In addition to this business with interest differentials, banks have developed countless additional products designed to increase a bank’s profitability. Some examples:

    • Financial consulting for bank customers
    • Securities trading (shares, bonds and other investment products)
    • Financing export and import transactions.
    • Foreign exchange, coin and precious metal trading.

Bank managers focus on both, the profitability of the individual customer and on the profitability of the products offered. The purchase prices for shares, bonds and other traded products can usually directly be charged to the respective customer order. This also applies to the fees to be paid to suppliers on an item-related basis (direct costs of the order).

But the costs of actual banking operations can only rarely be charged to individual products or clients according to their origin. If for example the “Research” cost center recommends buying or holding certain shares, the costs of this recommendation can neither be charged directly to the individual client advisor nor to the client buying on the basis of this recommendation but only to all advisors and all customers.

The bank fees invoiced for the purchase or sale of individual securities can be charged to the client, his advisor or the security, but it is not possible to trace which portion of the fee is attributable to the advisor and which one to the executing traders.

This chain of arguments is intended to show that although the revenues generated from banking transactions can be determined per customer, the costs for the generation of these revenues arise in several cost centers. There it is seldom possible to record the time spent on individual products or customers in a way that reflects the source of the work, because in many cases there is no direct cause-and-effect relationship between the work performed and the product or customer.

Insurance Companies

By paying a premium (one-off or recurring), policyholders want to ensure that they do not have to pay themselves for financial claims arising from losses  and to prevent to go bankrupt or lose significant parts of their assets as a result. In the knowledge that not all policyholders suffer losses, the insurance company tries to persuade as many customers as possible to sign an insurance policy and thus spread the risk across all customers.

The insurance company is financially successful if the premiums from all customers cover over time the costs of all insured losses to be paid as well as the company’s entire operating costs and its profit. This means that insurance management has a lot to do with statistics and estimating the financial development of risks. This is because the proportional product costs arise on the one hand from the losses that occurred and have to be paid for, and on the other hand from building up provisions for losses that are likely to occur (example: damage to buildings that may result in coastal areas from the melting of ice at the North and South Poles or damage caused by earthquakes or forest fires). Statistical analyses can be used to forecast the development of already known types of damage, while the insurance company’s specialists must estimate types of damage that have not yet occurred but are expected.

Incurred and expected claims are the main proportional product costs of an insurance company and must therefore be taken into account in the product calculation.
The sales organization of an insurance company is responsible for the net proceeds and contribution margins of existing and newly concluded insurance contracts. It must therefore know for each contract which product was or is to be sold to which customer groups via which sales channel, via which sales organization, in which region and by which salesperson.

This requires multidimensional planning and determination of the contribution margins per

    • Claim type (product)
    • Product group
    • Customer (policyholder), possibly industry
    • Salesperson
    • Insurance broker
    • Sales region.

Like in a production or service company insurance companies must also determine the contribution margins achieved in the various product and market dimensions after deducting the proportional fixed costs and the fixed costs that can be clearly allocated to a specific dimension.

The key difference is that the proportional production costs of insurance companies also include the assumed costs of risks that have not yet materialized.

The extent to which an insurance company covers potential financial risks through reinsurance is not examined further here.

Management Accounting for Service and Transportation Companies

Service providers in general

The focus is on the individual work performed by the company’s own employees for a customer order. The main task is to charge the performance-related cost center costs to the customer orders according to cause. To do this, it is often necessary for employees to record their working hours per order on a daily basis. Based on this activity recording, these times are multiplied by the planned proportional cost rate per hour of the cost center providing the service and charged directly to the customer order. This procedure is the prerequisite for determining the contribution margin I of a customer order, as well as the absolute contribution margins achieved by a service group.

Material taken from the warehouse is charged to the customer order at standard purchase price. If material for a customer order comes directly from an outside supplier, the bill is recorded at actual price in the accounts payable department and charge directly to the customer order.

This applies above all to workshops and craft businesses of all kinds (e.g. car repair shops, heating fitters, plumbers, tailors). The costs of inventory management and procurement cannot be allocated to the individual sales order according to cause.

If other providers procure services for the execution of the customer order, these are order-specific external services (e.g. software licenses, design drafts, expert opinions, transportation services, laboratory tests). Also such positions are recorded in accounts payable and assigned directly to the customer order.

As in industrial operations, also service providers need to cover their fixed costs and to generate profit. The main focus here is on the customer order, rarely on an individual item. The sum of all contribution margins has to cover all fixed costs plus the EBIT needed.

If new products are developed in service companies that are subsequently made available to customers for use over several years, it should be considered from an operational perspective whether the project costs incurred should be capitalized, i.e. added to fixed assets and depreciated in subsequent years. These considerations are mainly necessary when developing application programs (software for sale) and consulting modules if the development costs are to be covered by the contribution margins of the subsequent years of use. In financial accounting, an attempt may be made to write off the total expenditure for such a project in the year in which it is created in order to save taxes in the short term.

Transportation companies

In airlines, railroad companies, local public transport and direct transportation from the supplier to the recipient, the following cost types are the most important:

    • Personnel costs
    • Fuel and energy consumption
    • Maintenance of the means of transportation
    • Distance or time-dependent imputed depreciation.

Only in the case of direct transportation for a single client from the point of departure to the point of arrival is it possible to determine the proportional costs and thus the contribution margin I of a transport order according to the origin. The time spent by drivers and attendants as well as the miles driven can be measured and evaluated, which makes it possible to determine the proportional costs and the contribution margin I of the transport.

In air, sea, rail or bus transport the transportation options are usually offered according to a timetable or flight plan. The proportional costs arise when the transportation offer is executed. Whether the seats on the train, flight or public transport are well or moderately utilized has little influence on the proportional costs as the personnel deployment remains largely the same and energy consumption changes only insignificantly.

However, if the proportional costs of the unit produced (a flight or a train) remain more or less the same, the net revenue can be increased without significant additional costs by increasing the utilization of the available seats or transport areas. On trains that run between 0900 and 1130 and between 1400 and 1630, a large proportion of seats are often unoccupied. In particular American airlines and railroad companies in Europe recognized this and therefore advertise time-restricted offers at lower than usual prices (see the real examples in “Customer profitability, seller productivity, p. 76”. This approach is known as Revenue Management. On one hand the lower sales prices can increase the absolute contribution margin volume and on the other hand they reduce capacity bottlenecks on flights or trains with a high “Load Factor”.

Like in production also service companies should thus know the proportional costs of their services. This is the only way to determine which services contribute how much to covering fixed costs and profit.

Management Accounting for Industry, Construction and Trade

Industrial production

The main trigger for the development of management accounting was industrial production. Their managers want to know the net revenue of a product or order and compare it with the costs directly caused by the product. The difference is the contribution margin I (CM I).

To achieve this, management accounting is to be set up that it can calculate the proportional production costs in planned and actual values, based on the quantity and activity structure of the manufactured product. The bills of materials and routings with consumption quantities and working times are used for this purpose (see the post “Pizza Dough and Management Accounting“).

Net revenue less proportional production costs results in the CM I per product unit, as described several times in this blog. Based on this, the contributions to the coverage of fixed costs and profit for product groups, customers, customer groups, regions or sales channels can be determined in planned and actual in various levels and dimensions (see the post “Multidimensional CM-Calculation“). After deducting all fixed costs, the top level of summarization is the EBIT achieved by the company as a whole.

Construction Companies

In construction companies the focus is on the contribution margin of a specific customer order. The person responsible for implementing the order (construction manager) is assessed according to how well he succeeded in realizing the planned contribution margin for the order. As in industrial operations it is important to adhere to the planned costs of the bills of materials and subcontracting, as well as to avoid higher actual time consumption by employees compared to the projected target times.

In both industrial and construction operations, the splitting of cost center costs into their proportional and fixed costs is necessary for cost planning and control (see the post “Cost splitting”). Even the best financial accounting software cannot fulfill this requirement because it can only record values, but not quantities and times per order.

Pure Trading Companies

A pure trading company sells its products as they are purchased. Customers usually receive the products directly from the warehouse or from the rack in the store. Packaging for shipping is determined by the size of the order, rarely by the individual item. This usually also applies to online retailers.

Because in trading companies the purchased product is not changed,  no routings are required and bills of materials are only needed if the items to be sold consist of product bundles. Therefore, in the cost centers of a pure trading company, all cost center costs, from purchasing to warehousing, sales and administration, are fixed costs. There is no need to split costs into proportional and fixed costs in the cost centers because the proportional production costs correspond to the stock withdrawals for the sales executed.

Management Accounting for Different Types of Companies

Management Accounting for Different Types of Companies

Private companies, many foundations and associations as well as public organizations and their administrative units manufacture products and services. All these organizations must be able to cover at least the costs of a period under review with the revenue of this period (year) and, where appropriate, to achieve a profit in line with the market. (See the post “Profit in Line with the Market“).

Consumption-related disbursements usually happen before customers pay. Therefore, it must be ensured that sufficient cash and cash equivalents or open credit lines are available at all times to pay the amounts due. For this, financial accounting is the appropriate instrument in all organizations. However, financial accounting is not suitable for planning and controlling an organization as it cannot process neither quantities nor services and relate their costs to the revenues according to cause.

Management accounting is the only way to charge costs and services to individual service and product units in line with causation. It calculates the planned and actual costs directly caused by the manufacturing of a product or service unit and deducts them from the net revenue generated. The result is the contribution margin I. This is used to cover all costs of the organization that are not directly product-related (fixed costs) and to achieve a profit in line with the market.

For decision-relevant management accounting this results in the requirement to split costs into proportional and fixed when planning cost centers and to charge only the proportional costs of the manufactured units to products or other cost centers. This is because there is only a direct cause/effect relationship for the proportional cost center costs. The fixed costs remaining in the cost centers are period costs. They are the responsibility of the cost center managers. They are transferred as cost blocks to the stepwise contribution accounting.

According to current knowledge, only Resource Consumption Accounting (RCA, see L. White, Resource Consumption Accounting) fulfills this requirement. In German-speaking countries, Grenzplankostenrechnung GPK combined with contribution accounting correspond to RCA. RCA shows which costs are caused directly by the manufacture of the individual product unit produced. These costs are to be recorded per unit as inventory receipts and can be charged to the units sold according to their origin. The costs not incurred directly per unit remain in the cost centers. They are to be understood as fixed costs for the period under review. They are fixed costs because they are incurred for the cost center’s readiness to perform.

How to plan cost center costs and to calculate proportional cost rates for product costing is a main topic of this blog. The application of the methodology in different kinds of companies as well as in corporations with many daughter companies or in public administration are discussed in more detail in the following posts. The focus is on:

    • Production and sale of physical products, e.g. industrial and construction companies
    • Pure trading companies
    • Service companies, e.g. consulting companies, auditors, law firms, software developers
    • Transportation companies
    • Banks and insurance companies
    • Healthcare facilities such as hospitals, retirement homes, laboratories
    • Public administrations and educational institutions.

What these types of companies have in common is that they

    • work for several customers,
    • can process several orders for a particular customer, each with several order items,
    • offer different products or services,
    • can divide their organization into cost centers, each of which is the responsibility of one manager,
    •  should charge activities between cost centers according to their origin (Charging Internal Services, no allocation of fixed costs),
    • want to know which customers, products and services generate how much contribution margin.

For the planning and analysis of results by the managers concerned, the contribution margin I per product and per customer is always relevant for decision-making in the various types of companies. Because the fixed costs cannot be allocated to an individual order item according to their origin, the evaluations must always be based on CM I per order item.

The following data model shows that for aggregated reports always 1:n relationships (1 < —>> n) are needed:

Management accounting for different kinds of companie
Management accounting for different kinds of companies

Reading method: On a specific date, a customer can purchase one or more products or services. The proportional product costs are defined per unit, customer and date, the CM I is the difference between the net revenue agreed with the customer and the proportional cost. Based on the customer, the product and the date, net revenue, proportional product costs and CM I can be summarized according to all higher-level dimensions.

Imputed Depreciation

Imputed Depreciation

“Imputed depreciation is a cost equivalent for the devaluation of long-term usable operating resources (see Wolfgang Kilger, Flexible Plan Cost Accounting and Contribution Margin Accounting, 9th Improved Edition, Wiesbaden, 1988, p. 398).”
Imputed depreciation amounts are intended to lead to corresponding amounts of money being “reserved” in the financial assets for replacement investments, in order to procure replacement assets if necessary and thus be able to continue to meet the operational purpose. The devaluation equivalents mentioned by W. Kilger are to be calculated on the basis of the replacement values of the investments from the point of view of value retention.

It follows that imputed depreciation should not be calculated on the basis of the historical acquisition value of long-term working assets, but on the amount to be paid at the end of the year for equally efficient assets. From our point of view, a company’s profit potential is only preserved when the equally efficient operating resources can be procured again. As a consequence, there is no distributable profit for the owners/shareholders until the imputed depreciation calculated  from the replacement value has been deducted. Only the residual amount can be distributed with a clear conscience if the company is not to suffer a loss of substance.

In order to determine replacement values and imputed depreciation, it must be clarified annually what changes in the purchase prices are to be expected for the various fixed assets. There are many reasons for imminent purchase price increases or expenses for updates:

    • Inflation in procurement markets
    • New technical or legal regulations to be complied with
    • Changed safety regulations for the operation of the facilities (and buildings)
    • Adaptation of computer programs, program extensions and release changes
    • Switching to another machine supplier because the previous one no longer exists.

It also happens that equipment to be replaced becomes cheaper to purchase because physical plant components are replaced by electronics or metal by plastic.
In the event of expected increases as well as reductions in the purchase prices of fixed and intangible assets, imputed depreciation for the plan year must be recalculated and taken into account in management accounting. Like all other costs they determine the annual internal profit.

Imputed depreciation should not only be calculated for long-term assets such as buildings, facilities, machinery and vehicles. Increasingly, the resources also include rights and potential benefits of a non-physical nature such as ERP- and CRM-systems, rights of use and sales, purchased customer addresses, time-limited licenses of use. If such potential benefits lose their value over time and require new investments to preserve their benefits, the corresponding estimated amounts have to be taken into account in the replacement value, which in turn leads to higher imputed depreciation.
Sustainably successful corporate management requires the inclusion of imputed depreciation and amortization in the income statement. This prevents funds from being distributed to the owners, which will be necessary to maintain the company’s potentials for success and thus its continued existence.

Depreciation of Fixed and Intangible Assets

Depreciation of Fixed and Intangible Assets

Buying a car privately

If private individuals want to buy a new car, they first determine how much they will have to pay for the desired vehicle including all equipment features. This results in the gross purchase price of the vehicle, which is then also shown in the purchase contract. If her used car is traded in, the trade-in price is deducted. She may prefer a leasing contract with monthly payments. When making the decision, the private individual mainly considers the cash outflows at the time of purchase and the ongoing annual expenses. Such an investment calculation only takes cash flows into account.

Why write off?

A company, on the other hand, must present a financial statement with a profit and loss account every year. To determine the annual profit for the period, it must deduct the annual loss in value of the car, i.e. depreciation, from the revenue generated and show it in the income statement and in the balance sheet.

Depreciation is the value-based expression of the annual loss in value of physical and intangible assets. External reporting and the calculation of taxes payable are governed by legal regulations. These regulations are intended to ensure that all taxable companies report according to the same rules and are therefore treated equally by the state. The management approach, on the other hand, focuses on the loss in  value of an asset or right due to its use and the expected remaining useful life of it. These different purposes can lead to different depreciation amounts being included from an operational perspective than those permitted under tax law.

External or internal valuation

In order to treat all their taxable companies equally, many countries issue commercial and tax regulations on the valuation of assets, the depreciation methods to be applied and the useful lives permitted for the calculation. In Germany, for example, these are the depreciation rules (depreciation for wear and tear), cf. the depreciation table of the German Federal Ministry of Finance (Bundesfinanzministerium – AfA-Tabelle für die allgemein verwendbaren Anlagegüter (AfA-Tabelle “AV”)). For internationally operating and reporting companies, the rules of international reporting standards such as IFRS or US GAAP are applied.

For the managers controlling a company or a group these external valuation and depreciation rules are of secondary importance. They want to be able to assess whether the depreciation and amortization charged to the internal financial statements will be sufficient to maintain the company’s performance potential in the future so that it can continue to generate profits in line with the market. Distributions  (dividends) to owners and shareholders should therefore only be decided once it has been ensured by means of imputed depreciation and amortization that funds that will be required to maintain the profit potential will not be distributed.

“Management control plans, controls and measures the implementation of guidelines, strategies and operational objectives, see the management control definition.

From this understanding of management control it can be deduced that management accounting must take  into account imputed depreciation, not financial depreciation. This is because it is about shaping the future of the company and only to a limited extent about external profit reporting.

Depreciation of fixed and intangible assets
Depreciation of fixed and intangible assets

Cost price is irrelevant for decision-making

Cost price is irrelevant for decision-making

Cost price is the total cost of a company in a period, adjusted for changes in inventory. According to Wikipedia.org, this includes material costs, manufacturing costs, research and development costs, administrative costs and distribution costs. as well as imputed interest for assets required for operations (see German Guidelines for Price Determination on the Basis of Cost of Goods Sold (Annex to Regulation PR No. 30/53 of November 21, 1953, Notes 43 – 45)). If the net revenues exceed the cost price, the company starts to make a profit.

This statement is true for the company as a whole but it misleads when it comes to management control. Who wants to calculate the cost price of an article, a customer or a subdivision of the company, has to break down the fixed costs to product units. But as there is no direct cause-and-effect relationship between the company’s fixed costs and the individual product unit sold, this can never be done properly

To calculate the profit contribution of an item, the cost price per unit of a product or service unit sold must be calculated. All fixed period costs must therefore be allocated to the product units sold. For this purpose, an overhead rate is determined for the calculation of the unit cost of goods sold. If the sales quantities or the fixed cost blocks change, the cost price per unit unit also changes. This affects inventory valuation and, even more important, the management of sales and production.

As long as neither the bill of materials nor the routing and neither the material purchase prices nor the proportional planned cost rates of the cost centers involved in production change, the proportional costs incurred per unit produced remain the same. However, distributing the fixed costs to a different production or sales quantity, results in different cost prices per unit. Neither production nor sales are responsible for this, only the capacity utilization.

Cost price is irrelevant for descision-making
Cost price is irrelevant for descision-making

In the example, the monthly cost price per unit of goods sold changes because the fixed costs are divided by the production quantity of the period under review. If inventory receipts and issues are valued monthly at full productions costs, they include a portion of the period’s fixed costs. The value per unit thus changes every month. The fixed costs of other functional areas of a company are usually added as percentages to the full production costs. Although cost of goods sold is necessary in external reporting, it is not useful for corporate management purposes:

    • If the really paid purchase prices deviate from the planned ones, first the purchasing department is responsible for the variances.
    • If in the production processes more direct material is consumed per unit produced than planned (or more semi-finished products), the production management is responsible.
    • If the standard times for the manufactured product units are not adhered to in the production cost centers, it is up to the respective cost center managers to take corrective action.

The data required for this can only be obtained if the splitting into proportional and fixed costs has been set up in the management accounting system. This can be achieved with marginal costing (flexible standard costing), see the posts “Full product costs  are always wrong” and “Complete variance analysis“).

Since the demand, respectively the customers and the ability of one’s own sales organization determine the net revenues, it is necessary to compare the latter with the proportional product costs of the services and products sold. Our experience shows that most companies sell their items at different contribution margins per unit. The sum of all contribution margins achieved must be sufficient to cover all fixed costs and the targeted profit. An item that does not cover its calculated cost price can still make a considerable contribution to covering fixed costs.

The aim is always to cover all fixed costs and all variances with the contribution margins from the units sold, while at the same time achieving a profit in line with the market.

Job Order Costing

Job Order Costing

Initial situation: In the annual plan derived from strategy and medium-term plans, it is determined which items (services or physical products) are to be manufactured at what cost. For this purpose, the planned proportional production costs per unit are to be calculated in the costing system. In the sense of Management by Objectives the responsible persons have the task of adhering to these planned proportional product costs in each production order. This requires that each responsible person (e.g., production managers and project managers) must be able to track which costs were directly caused by an order. This is because they can only take responsibility for the cost elements that they can directly influence.

Three types of costing are distinguished because they serve different purposes:

    • Standard costing: Determination of the planned costs of a unit of an item (physical product or service) as part of annual planning. This costing results in the (annual) planned costs per unit produced.
    • Precalculation: On the basis of the planned costs and the actual quantities ordered, the planned costs of an order to be actually executed are calculated. This is because the actual incoming orders rarely match the planned quantities. Precalculation forms the basis for the target to actual comparison of a production order that has been placed.
    • Post-calculation: Comparison of the costs incurred in the actual order compared to the precalculation.

With this target to actual comparison managers are enabled to identify the order items that have deviated from the plan. With this information they can intervene in the next periods and find measures that will lead to achieving the target costs again in the following periods. In addition, it must be ensured that cost variances are not passed on to subsequent levels. This is because these are only responsible for their own variances.

Cost center-managers as well as production- and project-managers are responsible for variances in the production area. In decision-relevant management accounting the variances of production and all cost centers should not be charged on, neither to the warehouse nor to the sales organization, since the latter  cannot be responsible for such variances. For management-relevant Profitability Analysis (step-by-step contribution accounting), it follows that during the year all warehouse receipts should be valuated at proportional planned production costs and the variances should be shown in the (monthly) Profitability Analysis. This is because the variance types mentioned can neither be allocated to the products nor to the sales organization nor to the individual customers according to their cause.

Cf. the posts “Multdimensional Contribution Accounting” and “Complete Variance Analysis“.

The next two posts show how the various types of variances are shown in Profitability Analysis in a way that is appropriate to the levels and responsibilities, where they are to be shown, and how inventories are to be valued.