Can depreciation be a variable cost? A comparison between the straight-line method and the units of production method in a lean company context

(1)

Can depreciation be a variable cost?

A comparison between the straight-line method

and the units of production method in a lean company

context

Tarcisio Pagnozzi

Brevini Power Transmission

[email protected]

Comitato Pianificazione & Controllo ANDAF

Milano, 16

th

_{December 2011}

Giuseppe Marzo

University of Ferrara

[email protected]

Alberto Bacco

Global Business Services - IBM Italia

[email protected]

(2)

The Premise

Assets’ depreciation method shall reflect the

pattern in which the asset’s future economic

benefits are expected to be consumed by the

entity (IAS 16)

However different depreciation methods can

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Giuseppe Marzo - Tarcisio Pagnozzi – Alberto Bacco Can depreciation be a variable cost?

Research Questions

The implementation of the Units-of-Production

Method in a lean manufacturing context: the

integration of operational management with

financial decision-making

2 How different depreciation methods affect

financial figures and both company’s and

investors’ decision-making?

1 Simulation model

Case study

analysis

(4)

The simulation model

Inputs and starting

point

Model’s kernel

Outputs

Two comparable

firms, with the

same initial

balance sheet

Growth rate for a

two-stage economy

Initial cost for a

plant with a defined

productive capacity

Book values

Financial ratios

(ROI, ROE,

Leverage, Degree

of Operating

Leverage)

Impairment test

occurrence

Rules for

Impairment test,

with the

value-in-use calculation

SLM of

depreciation rules

UPM of depreciation

rules

Income statement

and Balance sheet

for the two firms

Contribution margin

per unit of

production

Analysis

Average ratios

analysis

Standard deviation

ratios analysis

Time series

correlation analysis

Dominance analysis

Analysis of the

alternance of

dominance

First occurrence of

impairment test

analysis

(5)

Preliminary results

5

Input variables about

the economics of firm

Financial figures and

ratios

Firm behaviour when

a change in

accounting estimates

should occur

Economic conditions

about growth rate

Dynamics of financial

figures and ratios

Occurrence of

impairment test

1

2

4 Standard deviation in

financial performance

3

(6)

The case study

(1/2)

305 million €

consolidated

turnover 2011

1.200 employees

150.000 units

produced

5 Italian

Plants

1 Chinese

Plant

1 German

Plant

25 Sales

Branches

in all 5

Continents

1 Italian

Plant

1 Italian

Plant

Assembling &

Warehouse

Factories in

the

Nederlands &

USA

(7)

The case study

(2/2)

7

Design

Wide Range of product

for wide range of

application

Delivery

Enabling Technologies

Consistent Processes

CRM

High level of support

from proposal to after

(8)

Overall Equipment Efficiency

OEE

is a "best practices" way to monitor and improve the

effectiveness of the manufacturing processes (i.e. machines,

manufacturing cells, assembly lines) and supports the actions

to

improve!

OEE

takes the most common and important sources of

manufacturing productivity loss, places them into specific

categories and distills them into metrics that provide an

excellent gauge for measuring “as-is”.

OEE

is frequently used as a key metric in

Lean

Manufacturing

programs and gives a consistent way to

measure the effectiveness of production by providing an overall

framework for measuring production efficiency.

(9)

OEE to apply UPM Depreciation

9

Machine

useful life

• Technical dept. / Manufacturer

define the life for each

machine in terms of hours

OEE

Formula

• Nr. of pieces x standard

working time

Impairment

Test

• “Maintenance Test” based on

fair value of each machine

• “Commercial Test” based on

(10)

Depreciation: a Variable cost?

Purchase

orders

Pattern or Die

purchase orders

Fixed

assets

Master file

Items

Master file

(raw mat.)

Reading

Cost Item

Master

File

Writing

Raw material

Purchase order

Raw Material

Incoming

warehouse

Warehouse

Incoming

goods

1

2

3

(11)

INDIRECT COST CENTERS

S

K

U

/V

A

L

U

E

S

T

R

E

A

M

RAW MATERIALS

PACKAGING

MATERIALS

EXTERNAL

OPERATIONS

DIRECT LABOR

SPECIFIC

DEPRECIATION

FIXED PRODUCTION OVH

GENERIC DEPRECIATION

RECEIVING AND PAKAGING

OTHER VARIABLE COSTS

DIRECT COST CENTERS

(production line/Value Stream)

C

O

S

T

C

E

N

T

E

R

C

O

S

T

S

VARIABLE DIRECT

COSTS

FIXED DIRECT

COSTS

FIXED INDIRECT COST

(support and overhead)

PLANT

Cost allocation model

VARIABLE

DIRECT

ENERGY

CONSUMPTION

MATERIAL

WARRANTY REPAIR

ROYALTIES COSTS

BOM

ROUTING

OVERHEAD

END PERIOD

ALLOCATION

(12)

Lean Accounting and SAP

Performance

Measurement

Entity

Controlling Model based on Value stream

Accounting Model input for Value Stream

Profit Center Entity and Value Stream

Costing

Costing Model Actual

Specific Cost Component

Structure

Production Cost Analisys on

Make to stock and Make to order

Processes

• Actual Finance Model for Value

Stream

• Planning Processes (Budget,

Forecast) Value stream

Profitability and Cost

management Reporting

Value Stream Costing

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