Magazine article CMA - the Management Accounting Magazine

Capacity Management: Back to the Future

Magazine article CMA - the Management Accounting Magazine

Capacity Management: Back to the Future

Article excerpt

Using this capacity model can bridge the communication gap between operations and management people, while enabling all levels of your business to effectively evaluate and manage their capacity, and do things better.

"Lack of reliable cost methods has, in the past, been responsible for much of the uncertainty so prevalent in our industrial policies; but with a definite and reliable cost method, which enables us to differentiate between what is lost in manufacturing and what is lost in business, it will usually become easy to define clearly the proper business policy."(1)

H.L.Gantt (1861-1919), a well-known industrial engineer, made the foregoing statement in 1915. Has the situation he describes improved in the past 80 years? Or, has the situation deteriorated further with additional global competition, communication advances, and government regulations? Do your cost methods yield results that do not relate to what you see happening in your business?

Perhaps we should examine some of our basic assumptions to see which are inhibiting our ability to improve cost methods, especially as they relate to capacity management. Gantt also described our current cost methods for capacity management. "The view of costs so largely held, namely, that the product of a factory, however small, must bear the total expense, however large, is responsible for much of the confusion about costs and hence leads to unsound business policies."

Here, Gantt described an application of accounting principles which dictate that costs must be matched to, and be allocated fairly to, the output being produced. In general, the application of these principles associates expenses incurred in a period of time to the product produced during the same period of time. When discussed theoretically, no one can dispute this principle. However, its practical application produces the effect described by Gantt. The effect of these principles is that the cost of a product will be higher in periods when production output is lower. Conversely, the cost of a product will be lower in periods when production output is near capacity. This occurs even though nothing about the actual product has changed.

In the following example, if the product has not changed, why has
the cost changed?

Year one

Overhead                         $1,000
[divided by] Output                 200

Unit Cost                           $50

Year two

Overhead                         $1,000
[divided by] Output                 100

Unit Cost                          $100

Perhaps it is not the matching principles that have problems. Perhaps the real issue is what we are matching to the costs. Those people familiar with activity-based cost will recognize the axiom: activities consume resources and products consume activities. Turning the axiom around, one could say that the products in Gantt's statement did not consume the costs. The activities required to make the products used the resources and the products used activities. Therefore, the correct application of the matching principles would be to match the expenses of the period to the activities performed in the period.

One key attribute of any activity is its capacity to produce the output intended. On this basis we should be looking at the ability of the activity to produce its capacity. Further, the expenses should be matched to the activity's capacity. This is the approach taken by the CAM-I (Consortium for Advanced Manufacturing - International) Capacity Model. The CAM-I Capacity Model is the subject of a soon-to-be-published book, Capacity: A Manager's Primer. The primer is the output of a CAM-I cost management systems workgroup. [ILLUSTRATION FOR FIGURE 1 OMITTED]

The capacity model approaches capacity management in a manner similar to Gantt's. First, all uses and non-uses of capacity are analysed into activities. …

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