Analysis Paper on Komatsu, Ltd. (B) Profit Planning Product Costing - Article Example

Analysis of Profit Planning Product Costing in Komasatu, Ltd. Profit Planning and Product Costing It appears that the company has taken a new facet in 1989, changing from what it was earlier. In 1991, Komatsu has been able to be a large international firm with revenues of ~989 billion and net income of ~3 1 billion. It seems that one of the pressing issues underneath could have been the case that 80% of the corporate revenue has been generated by the three major lines of business such as construction equipment, industrial machinery, and electronic-applied products. The fact that the remaining operations (construction, real estate, unit housing, chemicals and plastics, and software development) brought forward only 20% of the corporate revenues would have been considered the need for a change in planning It seems that the 3G” strategy of growth, globalization, and group diversification adopted in 1989, was able to make a financial progress by following correct processes of Profit Planning and Product Costing. Profit Planning Process The act that Komatsu’s profit planning process consisted of three major stages: policy making, profit planning, and evaluation seems to be a good starting point towards progress. Similarly, the decision to change/revise the Profit planning to be done on yearly basis, instead of the previous semi-annual practice, is a prudent move based on the given three reasons. It is true as it takes a lot of pre-preparation time, as everyone has to devote a substantial amount of their working time in preparing reports. This has been found out as counterproductive as it happens at the expense of their working time. It is also true, that semiannual report is based on a short term perspective. Perhaps, it may not give the relevant picture as some of the processes take time to produce expected outcome. It is also correct to understand that if allocations of fixed costs have to be changed based on the figures emanating from the semi-annual, it may not be realistic as well as too arbitrary to be meaningful. Policy-Making Stage While analyzing the processes followed under Policy Making Stage, it can be clearly seen that they followed correct procedures, instead of taking arbitrary decisions by the policy makers. The fact that the development of the long-term plan began with the preparation of a preliminary long-term plan by the corporate planning and control department is an exemplary procedure to follow, which is ignored by most of the contemporary businesses. Their practice of submitting the approved preliminary long term plan to each division is very practical and commendable. This will enable the divisions who are dealing with the ground level realities to pin point their ideas to the Board and the policy makers. This means that this particular process automatically paves way to considerable discussions and amendments. This also gives ample avenues for everyone to incorporate their views into the long term plan. This process also enables the policy makers to review whether these suggestions are in line with the vision, mission and the objectives of the corporate business. One of the loop holes in contemporary businesses is that the employees do not have the feeling of ‘ownership’ of the plans and the activity schedules. They tend to feel them as tight deadlines impose on them, as they have no idea of the vision, mission, objectives and the rationale of the activity schedules. By applying the above policy strategy, management can make the employers also part and parcel of the policy decisions. Hence it could be argued that it is correct to go by a preliminary long term plan and prepare the long term plan based on the discussions with the employees. Similarly, preparation of each year’s annual schedule of action based on the strategic directions emanating from prevailing, conditions and challenges is also vital. This is of course the correct procedure, to revise the annual schedule of activities based on the identified current opportunities and threats. However, although it is not mentioned here in this report, I assume that the management follows SWOT analysis at the time of the formulation of the preliminary long term plan, as well as preparing the annual implementing activity schedule. Profit Planning Stage It is interesting to analyze the processes followed by Komastu in deciding the profits. This looks more realistic and down to earth compared to aggressive and arbitrary decisions taken by the Board of directors or the management of most of the contemporary business organizations. One interesting aspect is to use the divisional profit plans as the basis of negotiations between headquarters and the divisions regarding production and sales volume. It is normally other way round in traditional organizations, as the management at the top level develop these plans initially, and impose the same on divisions sometimes even without any discussions. What is unique in Komastu is that these negotiations facilitated to emerge the sales and production plans for each division. The beauty of the process was that using the same for developing more power and equipment investment plans. It is also reported that the plans were combined to produce the preliminary divisional cost plans. Perhaps this strategy could have emerged based on their “3G” strategy of growth, globalization, and group diversification. It is a good strategy to incorporate the views of a multi-dimension business such Komatsu. Otherwise, each division will palm of the blame to the others and try to scapegoat their responsibility. As we can see from the status of Komatsu prior to 1989, it was only the core divisions which were generating 80% of the profit. The new strategy helps every division to think in terms of growth and take relevant strategies to achieve the same. Similarly, what is more important is the transparency aspect of the lost and profit formulation process. Another crucial aspect is the focus of all the activities towards the initial long term objectives. While Komastu allows every division to prepare their plans, they also have a strategy to focus all those towards the objectives through continuous negotiations and assessing the same against the long term objectives. Thus, the final budget and cost plans become a combine effort of all those who are involved, including the board, to ensure that it may not deviate from the long term objectives. One complain that is always in the air is that the headquarters or the administration is there to consume the profit generate by the rest and their role is basically to find faults of others. However, from the 3 G strategy adopted by Komastu, there is no room for such allegations as everyone has a thorough role in this process. The final budget and cost plans were used as the basis for preparing more detailed budgets for each division. These budgets were used by the firm’s cost system to generate product costs and transfer prices. The reported product costs and transfer prices were used to check the budget and to develop the execution cost plan and the profit plan by product. When they all get involved in working out all aspects, each division will automatically understand the need of all aspects of the business and may develop a sense of respect of the contribution done by others to make it a profitable venture. They may not complain as they have a place to air their voices and suggest their views at the outset. Since the budget plans and profit plans by product were used to develop the all-Komatsu profit plan, and were subjected to approval by the Board after negotiations, ensure another assurance for further negotiations, should there be a need. The fact that divisional execution plans were prepared after the above process, will assure that the monthly profit and loss plans are achievable and realistic. This process is also important in terms of using them as a benchmark against which to evaluate in divisional performance. Evaluation Stage Komatsu seems to have a very well planned strategy as each stage is directly connected to the next stage in a meaningful manner. For example, the divisional execution plans had not only the activities needed to be done to achieve the expected profits, but also the benchmarks to ensure that each activity has brought about the expected output. At the evaluation stage the above benchmark seems to be the target, and actual sales and revenue will be measured based against the target. One other aspect which is more commendable is the planned process that is linked to the valuation stage. That is not the normal report to say whether the targets have been achieved or not and the percentages. For Komatsu evaluation stage gives the company another opportunity to move towards the expected goals and objectives. The strategy adopted by Komastu to include two reports, is very meaningful. While the first report evaluates the actual outputs (actual sales revenue, sales quantities, and costs) against the estimated figures, the second report analyze in detail the reasons for the difference between actual and expected performance. What are very productive are the counter measures suggested in the second report to ensure that profit and sales shortfalls were as small as possible? This shows that this second reports give them another chance to come out with alternative measures to rectify the gaps between profits and loss. Hence instead of waiting for the next annual plan, they get an opportunity to take actions without further delay. However, constant haphazard changes are also counterproductive to any long term plan as there is a tendency to lose focus. However, these revised plans are subjected to the approval of the board after several rounds of negotiations. Hence, it will give a chance to the Board to ensure that suggested alternative measures will not drag them away from the long term goals and objectives of the business. Product Costing The way that Komatsu calculated product costing at the outset of the change is somewhat questionable. Although like any other business, they also use standard prices to calculate the product costing, it has not given a realistic pictured due to the reasons given if the following paragraph. . However, when it comes to plan execution, they apply a very careful method of finding out the variances and thereby tracing the actual costs. This will help a company to find out hidden costs and also unproductive cost items. Also Komatsu uses five difference variances to identify the fine points rather putting everything under one basket. In this manner, they were in a position to identify the difference between expected and actual prices. It is interesting to understand that the strategy they used to identify the purchased parts price variance. They determined this after placing them into work-in-process at actual and relieved at standard. In most cases, people use standard prices on hypothetical grounds and ends up in unforeseen loses. For such businesses, the strategy used by Komastu, could be an eye-opener. In the same manner, at the outset, labor costs and overhead expenses were debited to the production overhead account as they were incurred the monthly difference between the labor and overhead expenses was charged to the production overhead account and divided into two variances: the budget and operation volume variances. By adopting this method, Komastu could easily identify the actual standard volume and standard price. Most companies either bankrupt or get caught to financial downturns due to these fine points, which could make a huge difference in terms of loss and profit. Treatment of Manufacturing Overhead Cost One other factor which makes Profit and Loss accounts inaccurate in any business is due to wrong estimation of Overhead Costs. This is being handled in a more traditional manner thinking that all the costs involved in direct and indirect costs have to be included to the cost price. Therefore it appears that even under the new system, Komastu was following more or less the same old system of calculating the overheads. Therefore, compared to the direct costs, overhead costs grow faster due to the fact that more resources are being used. In addition, the increasing labor charges, using new high tech equipments and sophisticated communication systems etc have to be added and those things also have to be covered from the price of the r the product. However, if all the overheads are equally distributed among all the products, it is unfair by individual divisions. Hence, they have been in the practice of allocating overheads under three major categories such as direct manufacturing overhead, indirect manufacturing overhead and production overhead. However, there was no proper estimation of the actual consumption of these overheads by each product. Even under the new cost system, it appears that management has changed only by placing all three overhead categories under one umbrella term called plant control overhead. When allocating these costs to the product categories, it did not make sense, if we analyze the amount of service that each item has received. This is because basically due to the mindset of the management all over in any business. They are of the view that the staff, buildings, maintenance, management and equipments have to be used and upgraded at any cost, irrespective of the costs that have to incur. The only way they balance the overheads is by adding those to the product costs. That is why even under the new policy and the Business Plan, Komastu could not deviate from the real figures based on contribution of each overhead to each product category. However, with the pressure coming from the costing team, Komastu agreed to follow the production yen model. Accordingly, it was possible to explain that products and models differed in how they consumed overhead. However, these differences were not reflected in both old and the new system. After introducing this facet, Komastu seemed to have planned to implement a new cost system that could better assign all manufacturing costs to products, thereby increasing management’s ability to control overheads. Therefore it could be argued that although other direct cost factors are controlled, it may not serve the purpose until the overheads are subjected to check and balances. For that to happen, the people and the divisions/products should identify their actual share in this cost factor. Then only they will know and feel that they have to keep things under control. If this factor is under control, naturally the costs will go down and the profit margin may increase. Read More