Manufacturers are often too familiar with the struggles between the shop floor and the back office, particularly when it comes to manufacturing costing. One of the main issues contributing to those challenges is overhead costs, including how they are calculated and the logic behind those calculations. The proliferation of advanced manufacturing strategies and technologies has made it difficult to trace manufacturing overhead directly to any particular product or product class. While there are multiple approaches manufacturers can take toward costing, all approaches may result in different data elements and calculations, thus leaving the issue unresolved.
I recently wrote an article for Manufacturing Business Technology discussing the primary methods used for costing and how the conflict can be resolved. The article highlights that the primary difference in the results obtained from these various costing methodology boils down to how overheads (direct and indirect) are absorbed into the cost calculation equation. In addition, it explores some of the unintended consequences that manifest themselves when these various costing methods become part of the performance management system for a production operation. An example of this is how performance metrics derived from a traditional approach to transactionally derived manufacturing costing can lead to incorrect decision making, especially when the operation is attempting to leverage a time-based manufacturing system such as Just-in-Time or Lean Manufacturing.
A different approach to costing methods embeds time factors into the equation. This new costing methodology allows manufacturers to resolve some of the common issues that manifest themselves in more traditional approaches. A key tenet of this alternative approach is using cycle time as a basis of overhead allocation rather than basing this on labor or material costs as is the case in traditional costing practices.
With cycle time based cost accounting, the less time consumed in a productive process the lower the overhead value applied to a calculated cost and vice versa. By focusing on the cost associated with throughput times to produce a given product, this approach adapts managerial costing to what matters most in a modern manufacturing environment―time efficiencies―as opposed to less meaningful measures such as overhead absorption rates versus direct labor.
Overall, costing continues to be a challenge for manufacturers. It’s important to take a closer look at the current method and data generated to ensure the business’s competitiveness and overall health in a global marketplace.
Read the full article on the Manufacturing Business Technology website.
This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax or other professional advice. Please refer to your advisors for specific advice.