K.C. COLLEGE

SESSION: 2015-2016

TYBMS SEMESTER-V

GROUP MEMBERS:

DHIRAJ BATHIJA (03)

SAGAR DURGANI (12)

MOHIT JETHANI (25)

FACULTY:

PROF. VIKRAM SHROTRI

SUBJECT:

ELEMENTS OF LOGISTICS AND SUPPLY CHAIN

MANAGEMENT.

TOPIC:

LOGISTICS COSTING

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INDEX

TOPICS PG NO.LOGISTICS COSTING 3TOTAL COST ANALYSIS APPROACH

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COSTS INVOLVED IN DEVELOPING 5-6ACTIVITY- BASED COSTING (ABC) 7COST IDENTIFICATION 8ADVANTAGES OF ACTIVITY- BASED COSTING

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ESSENTIALS FACTORS OF A GOOD ACTIVITY- BASED COSTING SYSTEM

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CLASSIFICATION OF ACTIVITIES 11DIFFERENCE 12

MISSION BASED COSTING13

CONCEPT OF MISSION BASED COSTING

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FOUR STAGES OF IMPLEMENTATION

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INPUT/COST ASSOCIATED WITH MISSION

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BENEFITS 17CONCLUSION 18BIBLIOGRAPHY 19REFERENCE BOOK 19

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LOGISTICS COSTING:

The two approaches of costing – Activity-Based Costing and Mission based Costing – both follow the logic of tracing costs according to the specific activity or mission. Such process-oriented approaches, however, have only been applied for approximately 20 years. Some theoretical work dates back further, but practical application has not been adopted earlier. There has been interest or research in logistical cost accounting prior to this, as methods based on information stemming from the volume based accounting systems were utilized prior to Mission Costing and Activity-Based Costing.

The Total Cost Concept as introduced in the 1960s aims to highlight the importance of the flow of materials in connection with the profitability of an organization. This concept builds on the notion that reducing the total costs of the system can increase profitability. This notion yielded another important aspect – trade-offs: the concept that changing one factor will affect other variables. In a total cost perspective, the cost of transportation is held against the cost of inventory management and capital of products in inventory. If these can be minimized, the total cost of a system can then be brought down. In sum, the argument is that transportation costs will decrease as inventory units rise, because the cost of transportation from inventory unit to customer is more expensive than transportation to fill the inventory unit. This argument assumes that transportation to refill inventory units is carried out less frequently and with greater volumes – which are easier to plan. With more inventory units, the distance to the customer is reduced and thus transportation distances will be shorter, whereby the overall transportation costs are reduced. Analyzing logistics costs as a function of profitability has been conceptualized in the “DuPont” model (1990). Via the DuPont model, different accounting elements are isolated from the traditional volume-based accounting information including logistics cost information to illustrate the effect on the overall cost structure. The principle behind this model is a hierarchy of indicators starting with the Rate of Return. This is then broken down into Rate of Capital Turn-over and Profit Ratio, respectively. The breakdown is continued until factors indicating the logistical costs are found. This model is primarily used in determining significant changes in the logistical system. The advantage is the visualization of the connection between revenue, costs and assets. The disadvantage of the above-mentioned is that the cost information stems from traditional volume-based accounting systems. There is, of course, some value in such an analysis and the model has established merits. However, further breakdown is needed, which ultimately led to the notion of the missions of logistics actions as introduced by Christopher.

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TOTAL COST ANALYSIS APPROACH

The two types of accounting systems used by companies are:

1. The Financial Accounting System (Traditional costing method)2. The Managerial Accounting System

Organizations following the Financial Accounting System provide reports such as balance sheet, income statements and cash flow statements to outside parties like investors and stock holders. But this system may fail to meet the needs of managers of the organization.

The second system called the Managerial Accounting System serves the internal company needs. The Logistics Accounting System is a type of Managerial Accounting System. It can help managers to plan, implement and control logistics system. Logistics accounting information is useful for budgeting which is an important part of the logistics planning process. It also helps in allocation of resources for implementing the plans.

Total Cost Approach in Logistics

Today the marketing view point of any organization is that the Customer is the King of the market. Hence at whatever cost, the customer must be satisfied. Thus the importance of customer service has grown day in and day out. Today a customer, well become the reason for a manufacturer’s downfall.

E.g.: If a customer has received goods which have been damaged in transit and which he is unable to return or if the goods are of very poor and which, too he is unable to return, or which he finds great difficulty in returning, he is likely to remain a one-time customer. He may further even publicize his adverse opinion to his colleagues, friends and others and caution them to be careful while purchasing goods from this particular manufacturer. On the other hand, a satisfied customer would recommend a particular product and a manufacturer and even give unsolicited testimonial to prospective customers.

Thus it has become important to keep the customer satisfied through good customer service, which requires an up-to-date logistics system. The logistics system may require huge investments and at times may become a large portion of the total cost incurred by the company.

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The various costs involved in developing and maintaining a successful logistics system are: 

Inventory cost

Inventory costs are directly affected by such factors as the mode of transport, the number of warehouses planned, the levels of inventory maintained to ensure a certain level of service, etc. The inventory costs are the cost of the money locked-up in the cost of goods, insurance, occupation of space, pilferages, losses, damages, etc., as well as the maintenance of inventory

Warehousing costs

Goods have to be stored for some time after production, however small that time interval may be. This is done either at the production center, or in the marketing area, or somewhere in between or at all the three locations. The warehousing of raw materials either step up the cost of their supply or of the cost of distribution of finished product. As a manufacturer wishes to approach the objective of zero loss of production, adequate warehousing capacity becomes essential; and this pushes the firm in higher fixed and operating costs of warehousing. Also, to improve customer service to certain levels, it becomes necessary to increase the number of warehouses. Accordingly, the company management has to arrive at the optimum number of warehouses which is consistent with the minimum total cost of distribution, taking into account the effect on the other elements of cost in the total logistical system.

Production or Supply costs

Production costs tend to decrease with an increase in the volume of production. Also, these costs vary between various production points. If a manufacturer has several plants producing the same product, he has to make a decision to vary the supplies or production from certain plants – a move which inevitably affects the cost of production itself as well as the cost of transportation, transit times, warehouse and inventory costs. 

Communication and Data Processing Costs

An effective distribution system requires continual of order pricing, inventory control, accounts receivable, dispatches, etc. An increased number of distribution points would certainly improve customer service, but would make processing of information more cumbersome and expensive.

The same time, if the time taken to process the information is decreased, it is likely to lead better customer service. A manufacturer has, to decide about the speed and convenience with which information may be processed. One of the ways is use of computers having advanced software.

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Transportation Costs

The cost of transport varies generally with the speed with which goods are transported. Water transport is the cheapest, while air transport is the most expensive. Rail transport is cheaper than road transport, beyond a certain distance. Both rail and road transport stand somewhere in between water and air in terms of the cost of transport.

Material Handling Costs

A suitable material handling system should be designed to reduce the cost of material handling to the minimum. This would require the consideration of several possible combinations of manual and mechanized handling of the goods and materials. But material handling operations have an impact on other distribution aspects, such as the cost of packaging as well as damages and losses that results form material handling. The design of the material handling system and the consideration of its cost also affect the selection of the mode of transport to be used and hence the cost of transport gets affected.

Packaging Costs

Decisions on packaging are affected by decisions on such factors as type of product, the mode of transport and type of material handling equipment used. A total cost approach would make it necessary for us to select packaging version, which takes into account other distribution factors as well. Thus it would not be sufficient merely to reduce the cost of packaging to the minimum.

Customer Service Costs

If the manufacturer or supplier guarantees the satisfaction with goods and agrees to give a refund on returned goods or exchange the returned goods, he must arrange for the movement of defective or returned goods from the customer (or retailer) back to the supply warehouse or manufacturing Centre. Complaints of defects or of the deficiencies pointed out by the customer in the goods that are returned may therefore be utilized as a management feedback to improve the quality of service. Incidentally, with such a guaranteed service the manufacturer on a permanent basis, would win the customer’s loyalty.

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Activity-Based Costing (ABC)

Activity Based Costing is a method of allocating total costs to products or

customers. Whereas the General Ledger of traditional accounting systems describes

‘what was spent’, ABC describes ‘what it was spent for’. Whereas the General

Ledger uses a chart of accounts, ABC has a chart of activities.

ABC can be defined as:

“A means of applying the total cost and performance of resources (such as salaries, transport costs and facilities) as used in activities (such as order administration, contract planning, stock control and debt management) to

cost objects (such as products, contracts or customers)” In other words, it is the process of costing system which focuses on activitiesPerformed to produce products. This system assumes that activities are responsible for the incurrence of costs and products create the demand for activities. Costs are charged to products based on individual product's use of each activity.ABC aims at identifying as many costs as possible to be subsequently accounted as direct cost of production. Any cost that is traced to a particular product via its consumption of activity becomes direct of the product.

Different Stages in Activity-Based Costing

There are different activities in ABC costing. The following are the important stages of Activity-Based Costing:(1) Identify the different activities within the organisation.(2) Relate the overhead cost to the activities.(3) Support activities are then spread across the primary activities. (4) Determine the activity cost drivers.(5) Calculate the activity cost drivers rate, i.e., the quantity of cost driver used by each product

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COST IDENTIFICATION :-

Direct or operational costs :-

Expenses incurred specifically by the performance of the logistics work .These are Cost of Transportation, Inventory, Warehousing, and Material Handling.

Indirect Expenses :-

Costs that are more or less fixed as a result of allocation of resources to logistical operations .For instance Cost of capital invested in real estate, etc.

Overheads:-

These resources expenditures are to be allocated to the specific functions as per their share .Any wrong allocation which distort the total cost of logistical mission, giving wrong signal to decision maker

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LOGISTICS COST

DIRECT COSTS

INDIRECT COSTS OVERHEADS

Advantages of Activity-Based Costing

ABC system is a very valuable tool of control. It offers a number of advantages to the management and the following are the main advantages :(I) It brings accuracy and reliability of the costing data in determination of the cost of the products(2) It facilitates cause and effect relationship to exercise effective cost control.(3) It provides necessary cost information to the management to take decisions on any matter, relating to the business(4) It is much helpful in fixing the cost and selling price of a product.(5) It facilitates overhead costs allocate directly to the specific product.(6) It enables to manage the activities rather than costs.(7) It helps to remove all types of wastages and inefficiencies.(8) It provides valuable information to evaluate on the relative efficiencies of various plants and machinery.(9) Cost Driver Rates will help in significant impact on the development of new products or modification of existing products.

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Essentials Factors of a Good Activity-Based Costing System

The success of the Activity-Based Costing system depends on the following factors:(1) Objectives of costing system and level of competition.(2) Number of products manufactured.(3) Product diversity and the business(4) Adaptation of cost management measures, standardization and technical aspects.(5) Degree of sophistication and suitability to the firm.(6) Determination of single or combined Cost Driver.(7) Determination number of Activity Centre, Cost Pools and Cost Drivers.(8) Determination of total overhead costs and economy.(9) Evaluation of tradeoff between measurement of costs and cost of errors.(10) Elasticity and adoptive to the changing circumstances.

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Classification of Activities In the first stage of the Activity-Based Costing activities are identified and classified into different categories or segments of the production process. The grouping of activities is preferably done using the different levels at which activities are performed. Broadly, activities are classified into:(1) Unit Level Activities(2) Batch Level Activities(3) Product Level Activities(4) Facility Level Activities

(1) Unit Level Activities: Unit Level Activities are those activities which are performed each time aSingle product or unit is produced. These activities are repetitive in nature. For example, direct labor hours, machine hours, powers etc. are the activities used for each time for producing a single unit. Direct materials and direct labor activities are also unit level activities, although they do not overhead costs. Cost of unit level activity varies with the number of units produced.

(2) Batch Level Activity: These activities which are performed each time a batch of products or group of identical products are produced. All the units of a particular batch are uniform in nature and in size. The cost of batch level activities vary with the number of batches are ascertained. Machine setups, inspections, production scheduling, materials handling are examples of batch level activities which are related to batches.

(3) Product Level Activities: These activities which are performed to support the production of each different type of product. Maintenance of equipment, engineering charges, testing routines, maintaining bills of materials etc. are the few examples of product level activities.

(4) Facility Level Activities: Facility Level Activities are those which are needed to sustain a factory's general manufacturing process. These activities are common to a variety of products and are most difficult to link to product specific activities. Factory management, maintenance, security, plant depreciation are the few examples of facility level activities.

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DIFFERENCE

(I) It begins with identifying activities andthen to producing the products(2) It mainly focuses on activities performedto produce products(3) Cost Drivers used for identifying thefactors that influence the cost ofparticular activity(4) Overhead costs are assigned to CostCentre or Cost Pools(5) Overhead costs are assigned to productsusing Cost Drivers Rates(6) Variable overhead is appropriatelyidentified to individual products(7) In ABC many activity based on CostPools or Cost Centres are created(8) There is no need to allocate and redistributionof overhead of servicedepartments to production departments(9) It assumes that fixed overhead costsvary in proportion to changes in thevolume of output.

1) It begins with identifying cost and then toproducing the products(2) It emphasises mainly on ascertainment ofcosts after they have been incurred(3) Cost unit is used for allocation andaccumulation of costs(4) Overhead costs are assigned to productiondepartments or service departments(5) Overheads allocated on the basis ofdepartmental overhead allocation rate(6) Costs may be allocated or assigned eitheron actual cost incurred or on standard costbasis(7) Overheads are pooled and collecteddepartment wise(8) The process of allocation and re-distributionof the costs of the service departments toproduction department is essential to findout total cost of production(9) It assumes that fixed overheads do not varywith changes in the volume of output.

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MISSION BASED COSTING

Mission Costing Martin Christopher first introduced the building blocks to the concept that would later be known as Mission Costing in 1971. This first attempt to develop a total cost approach to physical distribution via “The Mission Approach to Physical Distribution” came as a response to the introduction of Planning, Programming, and Budgeting System (PPBS) which ultimately allowed for the examination of the horizontal cost and revenue structures as opposed to the vertical, functional structures (Christopher 1971).

According to Barrett (1982), however, the practical application of this concept held many problems. Many authors both helped develop the theoretical foundation as well as test the practical applicability in the following years of the concept’s introduction. Contributions were made by Walters (1972) and Ray et al. (1980) among others. Almost a decade passed before the issue of practical applicability progressed. This came with the work of Christopher, Schary and Skjott-Larsen in 1979. These authors pointed out that:

“The output of the physical distribution system is not only a flow of product which has been transported through both time and space, but also the terms under which the product flow is provided, whereby these terms are the conditions of response to orders and are generally known as “service”.

“The concept of service is capable of enlarging the concept of physical distribution from the total cost orientation to a total system orientation.” Barrett (1982)

The initial concept as introduced by Christopher was refined with contributions by different authors in the following decade. The most recognized problem of practical applicability appeared to be resolved, and in 1982, Barrett was able to conclude on the findings of the previous decade.

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CONCEPT OF MISSION BASED ACCOUNTING:

In account of the concept of “Mission Costing,” built on Christopher’s “The Mission Approach to Physical Distribution,” Barrett (1982) seeks to provide a framework that will allow practical applicability and utilization of the conceptual benefits by providing information not only on the costs, but also on the revenue aspects of providing varying levels of customer service. Barrett describes the aim of this work as:

“The Mission Approach, therefore, provides us with an analytical framework with which we can analyze the physical distribution process. The view is that the physical distribution process comprises sub-systems, which form symbiotic relationships for the purpose of providing multitudinous service level outputs, which yield revenue. The approach provides us with both a total cost concept, which emphasizes the interrelationship between subsystems, and with a total systems concept, which matches these inputs with the revenues resulting from the service levels, which they provide. Any one mission can only be appreciated by adopting such a holistic approach.” (1982).

Several elements of importance can be derived from the above statement. The physical distribution system is comprised of numerous sub-systems, e.g. transportation, warehousing etc. All of the sub-systems work together to provide time and space utilities for the products of a company. The interaction between sub-systems is crucial in this account.

If sub-systems are observed isolated, then sub-optimum decisions are likely to be considered. Sub-systems should be viewed as providing input to the total distribution system, hereby performing symbiotic relationships – in other words, they are mutually supportive. Adopting such a holistic view of the sub-systems and their interaction will allow for a broader understanding of the physical distribution system (Barrett, 1982). It explicitly accounts for the cost vs. revenue issue as well as the role of service.

The idea behind the Mission Costing approach is the ability to trace costs back to “missions” instead of observing the costs of sub-systems. In other words, it concerns the ability to focus on the output of distribution systems and the identification of the associated costs of those outputs. Christopher (1998) defines “mission” in the context of logistics as a set of service goals that the system aims to achieve within the framework of a specific product/market context. 5 Elaborating on this notion, an effective logistics system is said to seek the determination of the total systems cost in meeting the sought logistical objective as well as the costs of the different components required in meeting these outputs.

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“Mission” is a set of customer service goals to be achieved by the system within the specific market/product context. A successful achievement of defined mission involves a large input from various activity centers of the firm. Hence the logistics costing should be able to identify the total costs of meeting a desired mission. This is referred as Mission Based Costing.

Essentially Mission Based Costing seeks to identity unique costs that are generated as a result of specific logistics activities aimed to achieve certain objectives in a specific customer/market. There is no point in incurring additional costs if the additional benefits do not justify the same.

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FOUR STAGES IN IMPLEMENTING AN EFFECTIVE MISSION BASED COSTING:

Define the customer service segment. This is required as all customers do not have the same service requirements.

Identify factors that produce variations in the cost of service: for example – reducing the frequency of delivery will reduce the costs.

Identify the specific resources used to support customer segments. Attribute activity cost by customer type or segment.

INPUT/COST ASSOCIATED WITH MISSION:

1 2 3 4

MISSION A 290

MISSION B 340

MISSION C 220

250 130 170 300 850

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BENEFITS OF MISSION BASED COSTING

The ability to determine the ratio of inputs used to outputs generated, It effectively matches the resources applied to the process with the resulting revenues created by this very same process.

It provides a measure of the physical process itself. The inputs in terms of costs and the outputs in revenue yield the

possibility of looking and evaluating the efficiency of the process in terms of a profit concept vs. the traditional cost per unit of output.

This approach allows for the possibility of quantifying service level elasticity (effect on demand by service level) and in doing so, the 6 possibility of adopting the service level that will optimize the net benefit of the company – the profit of the company.

From a static analysis view, this approach allows managers to see through the cost structure of different missions in physical distribution – thereby allowing them to reengineer, optimize or shut down missions.

Mission Based Costing can be used not only to analyze the current situation (static), but also in decision-making (dynamic).

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CONCLUSION:

Although developed in different decades and by researchers rooted in different disciplines, the concepts of Mission Costing and Activity-Based Costing have many similarities. Both approaches adopt a process view compared to the traditional functional view of cost systems. Both, though with different semantics, trace costs back to activities/missions, and finally, both meet the same challenges when applied to organizations – selecting the correct level of disaggregation of activities. Christopher (1998) recognizes these similarities between the 2 concepts. ABC was not developed for the specific field of logistics, but all areas of an organization can seek to adopt the principles to their area. As stated, manufacturing was quick to adopt this means of accounting. The applicability for logistics has been highlighted and with the ever-growing advances in information systems (hardware as well as software) and continued learning of the practical application of the principles, ABC surely has a role in logistics cost accounting. Below, Table 1 summarizes the advantages and disadvantages of each approach for logistical cost accounting. The list of disadvantages for Mission Costing could presumably be as long, if not identical to that of Activity-Based Costing. The lack of empirical application yields a proportionally lesser account of potential shortcomings. The similarities – both when observing the benefits and the shortcomings – are notable. The framework for both approaches is indeed very similar. For the purpose of logistical cost accounting, ABC could be favored over Mission Costing – not necessarily because it is a better method, but because it is promoted by the Accounting discipline. Whatever problems both approaches may have, the learning curve will simply be overcome faster with ABC because of the number of people working with it. This includes both 15 accountants and logistical people, whereas only few, if any, accountants could be expected to take up Mission Costing. In reality, it could prove fruitful for advocates of ABC within logistical cost accounting to observe the framework and details of Mission Costing. Any difficulties in applying ABC to the field of logistics could be overcome given the origin of the Mission Costing concept.

BIBLIOGRAPHY:18

http://www.bms.co.in/what-is-mission-based-costing/

http://openarchive.cbs.dk/bitstream/handle/10398/6654/logistics%20cost%20accountingmads%20vangkilde.pdf?sequence=1

http://www.bms.co.in/explain-the-total-cost-approach-in-logistics/

http://dosen.narotama.ac.id/wp-content/uploads/2013/02/Chapter-24-Activity-Based-Costing-ABC.pdf

http://www.htmlpublish.com/newTestDocStorage/DocStorage/554d69c18a8740e6a3b19373a185bff8/abc.rtf

REFERENCE BOOK:

ELEMENTS OF LOGISTICS AND SUPPLY CHAIN MANAGEMENT.

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