Section 01
🌐 The Big Picture — Executive Summary
Chapter 4 sits at the strategic heart of the SCPM syllabus. While earlier chapters deal with how costs are measured, this chapter addresses how costs are managed and controlled — proactively, before they are even incurred. This shift from reactive to proactive cost management defines modern, competitive businesses.
💡 Why This Chapter Matters
In India's intensely competitive markets — from FMCG giants like HUL and ITC, to automobile manufacturers like Maruti Suzuki and Tata Motors, to tech firms — pricing power is limited by the market, not by the manufacturer. A company cannot simply charge cost-plus prices and expect customers to pay. This is the central problem that every technique in this chapter addresses.
🎯
Target Costing
Market sets the price → Company designs to a cost. Used by Maruti for the Alto 800; by consumer electronics firms for price-sensitive Indian buyers.
🔄
Life Cycle Costing
All costs across a product's life — from R&D to disposal — viewed holistically. Critical for infrastructure projects (NHAI highways, metro rails) and pharma pipelines.
⛓
Theory of Constraints
Identify and break the bottleneck. Directly applicable to production scheduling in auto-ancillary and textile mills where one machine throttles output.
⚡
Throughput Accounting
Maximize revenue through the bottleneck. Used in batch manufacturing and IT services to prioritise the most "throughput-rich" work.
🌿
Environmental Mgmt. Accounting
Identify "hidden" environmental costs and integrate them into decisions. Mandatory for industries under MoEF reporting obligations (paper mills, chemicals, leather).
⚠️
Exam Weightage Alert: Target Costing and Throughput Accounting are consistently high-scoring topics. Life Cycle Costing problems frequently appear as 8–10 mark numerical questions. EMA is increasingly tested as a 5-mark theory question since the ESG reporting wave.
Section 02
⚖️ Cost Control vs. Cost Reduction
The 'Why' — The Logic Behind the Distinction
Cost Control asks: "Are we spending within the budget?"
Cost Reduction asks: "Should the budget itself be lower?"
Cost Control is a compliance activity; Cost Reduction is an innovation activity. Both are needed — control prevents waste today, while reduction permanently reengineers what is possible tomorrow.
📖 Key Definition
Cost Control: Regulation of the costs of operation through executive action; involves continuous comparison of actual costs with standards or budgets to regulate the former.
Cost Reduction: The real and permanent reduction in unit cost of goods manufactured or services rendered without impairing the utility for the intended use.
The Landmark Comparison Table
| Dimension | Cost Control | Cost Reduction |
|---|
| Nature | Temporary savings possible | Real & permanent savings |
| Benchmark | Compared to standards/budget | No standard ceiling — targets optimal level |
| Quality | Quality not guaranteed | Product utility & quality must be retained |
| Approach | Relatively static (compliance) | Fully dynamic (innovation) |
| Applicability | Limited to costs with standards | Universal — all areas of business |
| Time Focus | Present and past behaviour | Present and future costs |
| Examines Standards? | No — standards are the benchmark | Yes — standards themselves are challenged |
| Indian Example | Monthly variance report in a garment factory | Maruti redesigning the dashboard mould to save 60g of plastic per car |
Prerequisites of Cost Control (Crowningshield & Gorman)
🔤 Mnemonic
D A M T R A
D Delegation of authority and assignment of responsibility
A Agreed plan with clearly defined targets
M Motivation (financial and non-financial)
T Timely and efficient reporting
R Recommendations must be followed by action
A An effective system of follow-up
Scope of Cost Reduction — Key Areas
🏭 The POFP Framework
- Product Design — Over 80% of production costs are committed at this stage. Greatest opportunity.
- Organisation — Clear roles, delegation, communication channels.
- Factory Layout & Equipment — Eliminate wastage, maximise utilisation.
- Production Plan, Programme & Method — Reduce idle capacity, overhead, and defects.
Tools & Techniques for Cost Reduction
Value Analysis
Inventory Mgmt (JIT, Backflush)
Business Process Reengineering
Target Costing
Kaizen Costing
Standardisation
Section 03
🎯 Target Costing — Conceptual Deep-Dive
The 'Why' — Logic Behind Target Costing
Traditional cost-plus pricing: Cost → Add Margin → Selling Price. This ignores what the market will actually pay.
Target costing reverses this: Market Price → Deduct Required Margin → Maximum Allowable Cost. This forces the organisation to engineer cost out of the product before it is built, not after.
📖 The Examiner-Precise Definition
"A structured approach to determining the cost at which a proposed product with specified functionality and quality must be produced, to generate a desired level of profitability at its anticipated selling price."
Origin: Japan, 1970s. Key note: It initiates cost management at the earliest stage of product development and applies it throughout the life cycle via the entire value chain.
The Master Formula
Target Selling Price
− Required Profit Margin
─────────────────────
= TARGET COST ← Maximum allowable cost
Cost Gap = Estimated Cost − Target Cost
(This gap must be closed through Value Engineering)
Steps of Target Costing (Implementation Sequence)
1
Re-orient culture Shift from technical-led to market-led thinking. Prioritise customer needs over engineering preferences.
2
Identify market requirements Design, utility, features — be customer-oriented. If multiple products, repeat for all.
3
Establish market-driven target price Based on competition, elasticity, market share, and strategy.
3A
Determine production volume at the target price.
3B
Establish target profit margin based on long-term objectives and financing needs.
4
Determine target cost = Target Price − Required Margin. Allocate to sub-assemblies/components.
4A
Balance target cost with customer requirements — Lock the target cost.
5
Establish the target costing process — Persons, roles, tools & techniques.
6
Brainstorm alternatives using multiple design concepts and manufacturing process alternatives.
6A
Establish product cost models for each concept (analogy technique early; industrial engineering later).
7
Close the gap using Value Engineering / Value Analysis to reduce cost to target.
7A
Reduce indirect costs — Re-engineer using ABC and Activity-Based Management to eliminate non-value-added functions.
8
Measure results and maintain management focus as a continuous improvement programme.
6 Principles of Target Costing (Ansari, Bell & Swenson, 2006)
🔤 Mnemonic
L C T R D A
L Leadership of Target Selling Price
C Customer Focus
T Teamwork — Using and Developing
R Reduce cost over Product Life Cycle
D Design Stage Focus
A All stages of Value Chain — Attention
Value Analysis (VA) vs. Value Engineering (VE)
🔧 Value Analysis (VA)
Applied to existing products. A planned, scientific approach to cost reduction reviewing material composition and production design so modifications don't reduce value to the customer.
In simple terms: Cost avoidance or cost reduction of a product already in production.
🔬 Value Engineering (VE)
Applied to new products. Same approach as VA but at the design stage.
In simple terms: Cost avoidance or cost reduction before production begins.
The 8 VA/VE Review Questions
🔤 Mnemonic
E D M P S C S B
E Can we Eliminate functions from the production process?
D Can we eliminate some Durability or reliability?
M Can we Minimize the design?
P Can we design the product better for the manufacturing Process?
S Can we Substitute parts?
C Can we Combine steps?
S Can we take Supplier's assistance?
B Is there a Better way? (Start from scratch)
Pros & Cons of Target Costing
✅ Advantages
- Reinforces top-to-bottom innovation
- Proactive — plans costs before incurrence
- Enhances employee empowerment and supplier partnerships
- Encourages value-added activities, eliminates NVA
- Enhances product life by reducing time-to-market
- Market-driven → better price and cost control
❌ Disadvantages
- Can lengthen development process significantly
- Mandatory cost-cutting causes inter-departmental conflict
- Difficult to reach design consensus
- Requires detailed cost data — expensive
- May reduce quality through cheap substitutes
- Heavy reliance on forecasting and estimation
- Needs a strong team leader — dominant solution to all cons
🔑 Examiner's Key Note
The dominant solution to ALL disadvantages of Target Costing is: a strong, cross-functional team leader who has exceptional design knowledge, interpersonal skills, and strict adherence to time and cost budgets.
Also note the Kaizen Costing connection: Since VE cannot uncover ALL cost savings, Kaizen Costing is designed to repeat VE steps continuously during production, constantly stripping out extra costs with smaller incremental gains.
When Is Target Costing MOST Useful?
Target Costing is best suited to companies that are:
Assembly-oriented
Diversified product lines
Factory automation (CAD/CAM)
Short product life cycles (<8 years payback)
Implementing JIT / Value Engineering
It is less useful for fast-food restaurants (costs not locked at design) and chemical production (no design features, pure process efficiency).
Section 04
🔄 Life Cycle Costing — Conceptual Deep-Dive
The 'Why'
Traditional accounting measures profit period by period. But many costs (R&D, design, decommissioning) occur in different periods than the revenues they generate. Life Cycle Costing solves this by tracking all costs and revenues from inception to abandonment as a single, complete picture.
📖 Key Definition
Life Cycle Costing is a system that identifies and accumulates the actual costs and corresponding revenues attributable to a cost object from its inception to abandonment. It aims to maximise the profit a product can generate over its life using strategies best suited to each stage.
The 4 Stages of Product Life Cycle
| Dimension | Introduction | Growth | Maturity | Decline |
|---|
| Objective | Create awareness & trial | Maximise market share | Maximise profits while defending share | Reduce expenditures & milk the brand |
| Sales | Low | Rapidly rising | Peak | Declining |
| Profits | Negative | Rising | High (peak) | Declining / negative |
| Customers | Innovators | Early Adopters | Middle Majority | Laggards |
| Competitors | Few | Growing rapidly | Steady, beginning to decline | Declining |
| Pricing | Cost-plus or penetration/skimming | Penetrate market | Match or beat competitors | Price cutting |
| BCG Matrix Link | ❓ Question Mark | ⭐ Star | 🐄 Cash Cow | 🐕 Dog |
| Indian Example (Maruti 800) | 1983–1986: First car, 3-yr waitlist | 1986–1998: 2nd gen, profits rise | 1998–2004: 2 lakh units/yr | 2004–2014: Sales crashed to 33k; discontinued Jan 2014 |
Costs at Each Stage — Lite Limited Framework
| Stage | Significant Cost Categories |
|---|
| Design / R&D | Research, Development, Design & Testing costs |
| Manufacturing | Material, Labour, Overheads, Machine Set-up, Inventory, Training, Maintenance, Depreciation |
| Operations / Distribution | Distribution, Advertising, Warranty claims |
| End of Life | Environmental clean-up, Disposal, Decommissioning |
Benefits of Life Cycle Costing
🔤 Mnemonic
E B L F L C T
E Earlier actions to generate revenue / lower costs
B Better, more realistic assessment of revenues & costs
L Long-term rewarding over short-term profitability
F Framework for total incremental costs over entire lifespan
L Long-term picture of product line profitability
C Control of manufacturing costs enhanced
T Traces R&D and design costs to individual products
Uses of Product Life Cycle (PLC) — The FCF Triangle
📐 FCF Framework
- Forecasting — Less useful; sales histories show diverse patterns
- Controlling — Measures product performance against past product launches
- Planning — Characterises marketing challenges in each stage; suggests strategies (e.g., Kaizen in maturity)
Numerical Application — Key Concept
🔢 Life Cycle Cost Comparison Logic
When comparing alternatives (e.g., System CF vs. System OF in Illustration 3), never compare only initial costs. Always calculate:
Total Life Cycle Cost = Initial Cost + PV of all future operating costs
A higher initial investment may have far lower total lifecycle cost. This is the central exam trap — students choose the cheaper-to-buy option without considering lifetime costs.
Section 05
⛓ Theory of Constraints (TOC)
The 'Why'
The TOC (Goldratt & Cox, OPT, 1986) challenges the traditional assumption that all machines must run at full capacity. It asserts that the entire system's output is limited by its weakest link — the bottleneck. Making non-bottleneck resources produce more only creates inventory pileup, not more sales.
📖 Key Concept — Bottleneck
A bottleneck resource is any resource whose capacity is less than or equal to the demand placed upon it. It restricts throughput. A non-bottleneck resource has spare capacity — making it produce more does not increase total output.
The 3 Operational Measures of TOC
Throughput (T) = (Sales Revenue − Unit Level Variable Expenses) / Time
[Note: Direct Labour is treated as FIXED — NOT deducted]
Investment (I) = Money tied up within the system (assets, WIP)
→ Minimise
Operating Expense (OE) = All other money spent (labour, overheads)
→ Decrease
Management Goal: INCREASE T, while MINIMISING I and OE
Goldratt's 5-Step Improvement Process
1
IDENTIFY the bottleneck — Which resource limits total throughput?
2
EXPLOIT the bottleneck — Ensure it is 100% utilised. Optimise the product mix at the bottleneck (use Throughput/bottleneck hour ranking).
3
SUBORDINATE everything else — Non-bottleneck production is paced by the bottleneck. Don't let non-bottleneck machines create WIP build-up.
4
ELEVATE the bottleneck — Take action to remove the constraint: new machine, additional shifts, redesign product, outsource, train workers.
5
REPEAT — Once the constraint is broken, a new bottleneck will emerge. Return to Step 1.
🔤 Mnemonic — Goldratt's 5 Steps
I E S E R
I Identify the bottleneck
E Exploit the bottleneck (maximise use)
S Subordinate everything else
E Elevate the bottleneck (remove constraint)
R Repeat when new constraint emerges
Section 06
⚡ Throughput Accounting (TA)
The 'Why'
Created by Galloway & Waldron (1988–89) from TOC. The key insight: accounting should monitor the rate at which a business makes money. Only direct material is treated as variable; all labour and overhead costs are treated as fixed (factory costs). This simplifies decision-making around the bottleneck.
📖 Key Definitions
Throughput Contribution = Selling Price − Direct Material Cost (per unit)
Throughput Accounting (TA) Ratio = Throughput per bottleneck minute ÷ Factory cost per bottleneck minute
If TA Ratio > 1 → Product is "profitable" (covers its share of factory costs). If < 1 → Not covering costs; action needed.
The 3-Step TA Numerical Process
1
Calculate Throughput per unit = Selling Price − Direct Material Cost
2
Calculate Throughput per bottleneck minute/hour = Throughput per unit ÷ Bottleneck minutes per unit → This gives the ranking
3
Calculate TA Ratio = (Throughput per bottleneck minute) ÷ (Total Factory Cost ÷ Total bottleneck minutes available)
Factory Cost per Minute = Total Factory Costs ÷ Total Bottleneck Minutes Available
TA Ratio = Throughput Return per Bottleneck Minute
─────────────────────────────────────
Factory Cost per Bottleneck Minute
TA vs. Marginal Costing — The Critical Distinction
🔵 Throughput Accounting
- Only Direct Material is variable
- Labour = Fixed
- Overhead = Fixed
- Focus: Maximise throughput through the bottleneck
- Short-run orientation
🟣 Marginal Costing
- Variable material + labour + overhead all variable
- Labour = Variable
- Focus: Maximise contribution per unit of limiting factor
- More nuanced cost classification
Advantages & Disadvantages of TOC / TA
✅ Advantages
- Reduction in inventory
- More productive machines
- Shorter lead times
- Better product mix decisions
- Better customer service
❌ Disadvantages
- Short-term focus vs. ABC's long-term view
- Emphasis on volume, not quality (unlike TQM)
- Treating labour as fixed is simplistic
- Only valid if applied to the total supply chain
- May lose the "overall picture" for specific constraints
Section 07
🌿 Environmental Management Accounting (EMA)
The 'Why'
Poor environmental behaviour causes fines, lawsuits, brand destruction, loss of sales and inability to secure financing. The Exxon Valdez (1989) and Deepwater Horizon (2010) disasters triggered global recognition. India's MoEF and Companies Act CSR provisions are direct responses. EMA moves environmental considerations from external reporting into internal management decisions.
📖 Key Definition
EMA is the process of collection and analysis of information relating to environmental cost for internal decision-making. It identifies and estimates the costs of environment-related activities, seeks to control these costs, and integrates best management accounting thinking with best environmental management practice.
Environmental Information — 2 Types
📊 Physical Information
Physical flows of energy, water, material, waste, and emissions. Used to create environmental performance indicators and set targets.
💰 Monetary Information
Environmental costs (including savings and earnings) driven by efforts to control waste and emissions. Used in management decisions.
4 Classifications of Environmental Costs
Classification 1 — Generic (Internal vs. External)
🏭 Internal Environmental Costs
Borne by the organisation. Includes waste disposal, regulatory compliance (duties, taxes, cess), up-front and back-end costs, system improvement costs.
🌍 External Environmental Costs
Borne by society. Includes carbon emissions, climate change, healthcare costs from pollution, soil erosion, forest degradation.
Inverse relationship: Higher internal costs → Lower external costs.
Classification 2 — US EPA Framework (4 Categories)
🔤 Mnemonic
C P C R
C Conventional Costs — raw materials, utilities (not usually considered "environmental" but usage matters)
P Potentially Hidden Costs — buried in overheads (upfront, regulatory, back-end costs)
C Contingent Costs — future possibilities: fines, penalties, legal costs, clean-up costs
R Relationship & Corporate Image Costs — intangible costs (cost of preparing environmental reports)
Classification 3 — Hansen & Mendoza (Quality Cost Analogy)
| Category | Nature | Indian Examples |
|---|
| Environmental Prevention Costs | Before harm occurs; associated with preventing adverse environmental impact | Buying pollution control equipment; NGT-compliant furnaces; EIA studies |
| Environmental Appraisal Costs | Checking compliance with standards, policies, laws | CPCB effluent monitoring; ISO 14001 audits; contamination tests |
| Environmental Internal Failure Costs | Produced but not yet discharged into environment | Recycling chemical scrap; disposing hazardous waste; decommissioning cost at plant closure |
| Environmental External Failure Costs | After discharge into environment; harms reputation and natural resources | Cleaning contaminated Ganga riverbed; restoring mining land in Jharkhand |
Classification 4 — UNDSD (2001)
Environmental costs = (1) Costs incurred to protect the environment (prevent pollution) + (2) Costs of wasted material, capital, and labour (production inefficiencies).
3-Phase EMA Management Methodology
PHASE I — IDENTIFY Environmental CostsReview general ledger for hidden environmental costs
PHASE II — ALLOCATE to Cost Centres & Cost UnitsUse one of 4 techniques (see below)
PHASE III — CONTROL Environmental CostsTQM / individual element focus (Waste, Water, Energy, Transport)
4 Techniques for Identification & Allocation of Environmental Costs (UNDSD)
🔤 Mnemonic
I F L A
I Input-Output Analysis — "What goes in must come out" — balances material inflows with outflows (product + waste)
F Flow Cost Accounting — Tracks material flows through organisational structure; records losses at each stage. (Canon saved €30M using MFCA)
L Life Cycle Costing — Full cost accounting over entire product life; captures all environmental costs regardless of who bears them
A Activity Based Costing — Distinguishes environment-related costs (traceable to joint cost centre) from environment-driven costs (hidden in overheads)
🔑 Key Distinction — ABC in EMA Context
- Environment-related costs → Can be directly attributed to a joint environmental cost centre (e.g., sewage plant, waste filtration unit)
- Environment-driven costs → Hidden in general overheads; don't relate directly to an environmental cost centre (e.g., increased depreciation, higher labour due to environmental precautions)
ABC removes environment-driven costs from general overheads and traces them to products/services via environmental cost drivers.
Controlling Individual Environmental Elements
| Element | Control Approach |
|---|
| Waste | 'Mass balance' approach — compare material weight purchased vs. product yield; identify savings |
| Water | Identify where water is used; find consumption reduction opportunities (businesses pay twice — to buy and to dispose) |
| Energy | EMA identifies inefficiencies; often significant cost reduction at very little cost |
| Transport & Travel | More fuel-efficient vehicles; route optimisation; reduce material transport |
| Consumables | Direct discussions with management; e.g., refilling toner cartridges vs. replacing |
Pros & Cons of EMA
✅ Advantages
- Improved Revenue — environmentally responsible brand commands premium
- Cost Reductions — resource efficiency translates to savings
- Better Corporate Image among stakeholders
❌ Disadvantages
- Increase in Costs — compliance with regulations is expensive
- Additional burden on top management — diverts from core activities
- Costs of Failure — clean-up, fines can be enormous
Section 08
🔍 The Examiner's Lens
Trigger Words in Case Studies
| Trigger Phrase / Scenario | Concept Signalled |
|---|
| "Competitive market … competitors offering at ₹X … profit of Y%" | Target Costing — calculate target cost |
| "…product cannot be sold above ₹X in the market…" | Target Costing — market-led pricing |
| "…cost gap must be closed through design changes…" | Value Engineering / Value Analysis |
| "…one machine / department limits output…" | Theory of Constraints / Throughput Accounting |
| "…direct material is the only variable cost…" | Throughput Accounting (not marginal costing) |
| "…rank products given limited bottleneck hours…" | Throughput per bottleneck hour ranking |
| "…R&D costs ₹X … product will be sold for 5 years…" | Life Cycle Costing |
| "…environmental costs hidden in overheads…" | EMA / ABC for environmental costs |
| "…wastewater / emissions generated by process…" | EMA — cost allocation using environmental drivers |
| "…product in maturity/decline stage…" | Product Life Cycle + Pricing strategy |
Common Mistakes — Where Students Lose Marks
⚠️ Top 8 Examiner Traps
- Target Costing: Forgetting to deduct royalties or commissions from the selling price before computing the target cost. (See KTC Illustration — royalty was 15%.)
- Material cost: Failing to gross up for substandard / wastage (e.g., 0.6 kg / 96% — not simply 0.6 kg × rate).
- Life Cycle Costing: Comparing only initial cost; missing the PV of total operating costs over the full life.
- Throughput Accounting: Treating direct labour as a variable cost. In TA, only direct material is variable.
- TOC: Assuming that improving a non-bottleneck resource will increase total output. It will not — it only creates WIP.
- VA vs. VE: Confusing the two. VE = new products (before production). VA = existing products (already in production).
- EMA: Confusing environment-related costs (traceable to a cost centre) with environment-driven costs (hidden in overheads).
- Life Cycle Stages: Forgetting the BCG Matrix equivalents or mixing up customer types (Innovators → Early Adopters → Middle Majority → Laggards).
Inter-Topic Connectivity
| This Chapter's Topic | Links To | How |
|---|
| Target Costing | Kaizen Costing (Ch. 3), ABC, Value Chain Analysis | VE finds initial savings; Kaizen continues the search during production; ABC allocates costs to support the costing model |
| Life Cycle Costing | Investment Appraisal (DCF), Pricing Strategy, Budgeting | LCC uses PV of future costs; pricing must reflect stage; budgets must cover all lifecycle phases |
| Theory of Constraints | Throughput Accounting, Limiting Factor Analysis (Ch. 2) | TOC identifies the constraint; TA measures performance at it; LFA maximises contribution per constraint unit |
| Throughput Accounting | Marginal Costing, Performance Measurement | TA Ratio is a performance metric analogous to contribution per limiting factor |
| EMA | Strategic Management Accounting, Balanced Scorecard, CSR Reporting | Environmental KPIs appear in BSC's learning & growth and internal process perspectives; CSR disclosures use EMA data |
Section 09
📊 Visual Synthesis — Summary Tables & Flowcharts
Master Comparison Table — All 5 Techniques
| Dimension |
Target Costing |
Life Cycle Costing |
Theory of Constraints |
Throughput Accounting |
EMA |
| Core Question | What cost must we achieve to earn our target profit? | What is the total cost/profit over the product's entire life? | What is limiting our output? | What is the return per bottleneck minute? | What are our true environmental costs and how do we manage them? |
| Time Horizon | Pre-production (design phase) | Entire product life | Short-run | Short-run | Short to long-run |
| Primary Tool | Value Engineering / Kaizen | NPV / PV of costs | Goldratt's 5 Steps | TA Ratio | ABC / Input-Output / Flow Cost |
| Variable Cost View | All costs managed to target | All costs over life | All non-material costs = fixed | Only material = variable | Environmental costs identified from overheads |
| Key Output | Target Cost = Price − Margin | Total Life Cycle Cost / Profit | Identifies & removes bottleneck | Ranks products by T/bottleneck minute | Environmental cost per unit; product-wise profitability |
| Indian Context | Maruti Alto pricing; Jio's ₹0 data launch model | NHAI highway projects; pharma drug pipelines | Auto-ancillary bottleneck machines; port container handling | Steel plant blast furnace as bottleneck | Leather industry, paper mills, chemical companies under MoEF |
Target Costing Process — Logic Flowchart
MARKET RESEARCHDetermine what the market will pay → Target Selling Price
DEDUCT REQUIRED PROFIT MARGINTarget Cost = Target Price − Required Margin
ESTIMATE CURRENT COSTUsing cost models / industrial engineering
CALCULATE COST GAPGap = Estimated Cost − Target Cost
APPLY VALUE ENGINEERING8 VA/VE Questions — Eliminate / Substitute / Combine / Better Way?
GAP CLOSED? → LAUNCH PRODUCTContinue with Kaizen Costing during production
If gap cannot be closed → Consider shelving the project or redesigning from scratch
Throughput Accounting Decision Flowchart
IDENTIFY BOTTLENECK RESOURCEResource where Capacity ≤ Demand
CALCULATE THROUGHPUT CONTRIBUTIONT = Selling Price − Direct Material Cost (per unit)
CALCULATE THROUGHPUT PER BOTTLENECK MINUTET per unit ÷ Bottleneck minutes per unit → Ranking
CALCULATE FACTORY COST PER MINUTETotal Factory Costs ÷ Total Bottleneck Minutes
CALCULATE TA RATIOT per bottleneck min ÷ Factory cost per min
TA RATIO > 1 → PROFITABLE → PRIORITISETA Ratio < 1 → Action needed: raise price / cut material / improve speed
Section 10
🧠 Retain & Recall
Complete Mnemonic Index
| Concept / List | Mnemonic | Stands For |
|---|
| Prerequisites of Cost Control | D A M T R A | Delegation, Agreed plan, Motivation, Timely reporting, Recommendations→Action, Follow-up |
| Scope of Cost Reduction | POFP | Product design, Organisation, Factory layout, Production plan |
| 6 Principles of Target Costing | L C T R D A | Leadership of price, Customer, Teamwork, Reduce life cycle cost, Design focus, All value chain |
| 8 VA/VE Review Questions | E D M P S C S B | Eliminate functions, Durability, Minimise design, Process design, Substitute, Combine, Supplier, Better way |
| Benefits of Life Cycle Costing | E B L F L C T | Earlier actions, Better assessment, Long-term, Framework, Long-term profitability, Control costs, Trace R&D |
| Goldratt's 5 Steps (TOC) | I E S E R | Identify, Exploit, Subordinate, Elevate, Repeat |
| US EPA Environmental Costs | C P C R | Conventional, Potentially hidden, Contingent, Relationship/Image |
| EMA Allocation Techniques (UNDSD) | I F L A | Input-Output, Flow Cost, Life Cycle Costing, Activity Based Costing |
| Hansen & Mendoza Cost Categories | P A I E | Prevention, Appraisal, Internal failure, External failure |
High-Yield One-Liners for Quick Revision
- "Cost Control regulates; Cost Reduction reinvents."
- "In Target Costing, the market sets the price, the engineer sets the cost."
- "VE = before production (new product). VA = during production (existing product)."
- "In TA, only direct material is variable. Everything else is a fixed factory cost."
- "TA Ratio > 1 = profitable; < 1 = not covering its share of fixed factory costs."
- "Improving a non-bottleneck resource does NOT increase throughput — it creates WIP."
- "Life Cycle Costing: never compare only initial costs — always compute total lifecycle cost."
- "Over 80% of a product's cost is committed at the design phase — this is why VE matters most early."
- "EMA: environment-driven costs are hidden in overheads; ABC extracts and traces them."
- "Wasted materials account for 40% to 90% of environmental costs (UNDSD, 2003)."
✅ 3-Point Mastery Revision Checklist
-
①
Can you derive and reconcile the Target Cost?
Given any price and margin, compute target cost. Then given estimated cost, calculate the cost gap. Finally, apply the 8 VA/VE questions to justify how the gap can be closed. If you can do Illustration 1 (KTC), Illustration 2 (GEAL), and the Art Décor caselet MCQs — you have mastered this.
-
②
Can you calculate the TA Ratio and derive the optimum product mix?
Rank products by throughput per bottleneck minute. Compute the factory cost per minute. Calculate TA Ratio. Interpret whether it is >1 or <1. Solve for optimum production plan considering constraints (including pre-accepted online orders). If you can solve Questions 5 and 6 in Test Your Knowledge — you are ready.
-
③
Can you classify, allocate and interpret environmental costs using ABC?
Given process-wise emission / wastewater data, allocate environmental overhead to products using relevant cost drivers. Recompute product profitability and analyse why it changes from the blanket absorption result. If you can replicate Illustration 6 and Question 8 (QR Ltd.) — you have mastered EMA.