Capacity Management.ppt 9296f

Cost ing Standards with respect to Capacity Management and determination

Prof. (Dr.) Paresh Shah FCMA.,Ph.D.,FDP (IIM,Ahmedabad)

Capacity Management Capacity has a cost, whether it is used or not

2

Capacity • Capacity is the maximum output or producing ability of a machine, person, factory, etc.

• Capacity can be measured in physical • Measure of the amount of work done • Capacity is the measure of the maximum amount of work that can be done in a given time • Capacity = R * T • R is the rate of output per unit of time • T is the maximum amount of time available

• Capacity has a cost • Cost to acquire or rent the facility, machine, operating costs, wages, utilities, insurance, etc. • The cost is incurred even if capacity is underused 3

MEASURING THE COST OF CAPACITY Traditional measures do not reflect the cost of capacity usage or over capacity Costs are part of overhead and allocated to production - Focus is on inventory valuation, not managing capacity - Allocation base is chosen from five alternatives -Theoretical Maximum output when operating continuously at maximum efficiency

4

MEASURING THE COST OF CAPACITY Practical

• Level of output under current conditions, allowing for normal downtime for setups, maintenance, vacations, etc.

• Average level of output achieved or anticipated over several years

Normal

• Level of output anticipated for the current year

Budget

• Level of output actually achieved in the current year

Actual 5

Measuring the Cost of Capacity Amount of capacity-related overhead charged to the output depends on the allocation base chosen

A stamping machine costs Rs400,000 per year to operate. The machine can produce 200 stampings per hour. The machine runs 24 hours per day. The company does not work on weekends (104 days) or holidays (10 days) Downtime for maintenance, setups, etc. averages 15 days per year. The machine is idle because of lack of materials for an average of 5 days per year. The equivalent of 8 days of production is lost each year because of defects produced by the machine. Management expects to produce an average of 1,000,000 stampings per year over the next five years. Planned output for the current year was 1,050,000 stampings. Actual output for the current year was 1,032,000 stampings, requiring 215 days. If successfully negotiated, a new contract with a customer would increase demand for the stampings by 24,000 units per year. 6

Measuring the Cost of Capacity Traditional cost allocation measures Output Theoretical capacity Units per hour Hours per day Days per year Theoretical capacity

Operating Cost (Rs)

Cost per Unit(Rs)

* * =

200 24 365 1,752,000

400,000

0.228

* * =

200 24 231 1,108,800

400,000

0.361

Normal capacity Expected 5 year average output

1,000,000

400,000

0.400

Budget capacity Planned output for the current year

1,050,000

400,000

0.381

Actual capacity Actual output for the current year

1,032,000

400,000

0.388

Practical capacity Units per hour Hours per day Operating days per year* Practical capacity * 365-104-10-15-5=231 days

7

MEASURING THE COST OF CAPACITY • CAM-I capacity model focuses on the cost of used and unused capacity – Capacity is divided into four categories

Rated capacity

Productive capacity Nonproductive capacity

• Same as theoretical capacity

• Capacity used to produce usable output

• Capacity that does not result in usable output • Downtime for maintenance, setups, lack of materials, etc. • Productive time lost due to waste, scrap, rework, etc. • Idle capacity

8

MEASURING THE COST OF CAPACITY

Idle capacity

• Capacity that is not available due to policy decisions or market reasons such as holidays, lack of orders, etc

9

Measuring the Cost of Capacity • Cost is attached to the capacity categories based on the theoretical cost per unit Capacity category Days Rated 365 Productive 215 Nonproductive Setups 15 Standby 5 Defects 8 Subtotal 28 Idle Weekends, holidays114 Marketable 5 Not marketable 3 Subtotal 122 Total 365

Output Cost per (4,800 units per day) Unit(Rs) 1,752,000 0.228 1,032,000 0.228 72,000 24,000 38,400

0.228 0.228 0.228 0.228

16,438 5,479 8,767

0.228 0.228 0.228 585,600 0.228 1,752,000 0.228

124,932 5,479 3,288

134,400 547,200 24,000 14,400

Capacity cost(Rs) 400,000 235,616

30,685

133,699 400,000 10

Managing Capacity Costs  Capacity costs may be fixed, but can still be managed

Reduction of idle capacity Reduction of nonproductive capacity Reduction of rated capacity

• Increasing sales to use unused capacity • Renting unused capacity to others • Reduction in “days off”

• Reduction of setup time, defects, etc.

• Replace the asset with one having less capacity • Lower capacity asset can be more fully utilized 11

IMPLICATIONS OF THE CAM-I MODEL Illustrates the reasons for idle and nonproductive capacity

Illustrates the cost of idle and nonproductive capacity

Helps management prioritize capacity utilization efforts

12

PRACTICAL CONSIDERATIONS IN MEASURING CAPACITY How is capacity defined? • Worker, machine, factory, etc. • Higher-level capacity (process, factory, etc.) is determined by the lowest capacity component

Capacity may change over time • Assets slowing with age • Technological improvements to assets

13

Cost ing Standard On Capacity Determination • Cost ing Standard 2 (cas 2) issued by the Council of the Institute of Cost and Works ants of India on “CAPACITY DETERMINATION”.

• The standard deals with determination of Capacity of a unit.

• Better utilization of capacity means better utilization of resources. It is an important consideration for cost determination and cost reduction. It is an important consideration for cost determination and cost reduction. • Thus, it is essential to establish the capacity of the plant. Cost ing Records Rules under section 209(1)(d) of Companies Act, 1956 and Cost Audit Report Rules, 2001 under section 233B of the said Act specify that comparative statement of installed capacity and actual capacity utilization is to be recorded and furnished in order to assess the operating level.

Objective • The objective of the standard is to prescribe the method of determination of capacity to be applied uniformly and consistently.

• The standard is to help the management to identify the bottlenecks, imbalances and idle capacity for effective use of various resources.

• The standard is to help in proper allocation, apportionment and absorption of cost.

Scope • The standard should be followed for capacity determination required to be carried out for any purpose or under provisions of any Act, Rules or Regulations except where capacity determination has been prescribed otherwise.

• The standard shall also be followed for maintaining cost records under the Cost ing Records Rules or for furnishing information on Capacity Utilization under the Cost Audit Report Rules issued pursuant to Section 209(1)(d) and section 233B of Companies Act,1956 respectively

• The standard is applicable for an undertaking, whether existing or new, where there is expansion of more than 5% of the existing capacity due to introduction of new machines or productive resources. Similarly, the standard is also applicable where there is more than 5% reduction of the existing capacity due to disposal or withdrawal or impairment of old machines or productive resources.

Definitions Licensed Capacity

Installed Capacity

• is the production capacity of the plant for which license has been issued by an appropriate authority.

• is the maximum productive capacity according to the manufacturers’ specification of machines / equipment. Installed capacity of the unit/plant is determined after taking into imbalances in different machines/ equipment in the various departments / production cost centers in the unit / plant and number of working shifts.

• is the maximum productive capacity of a plant reduced by the predictable and unavoidable factors of interruption pertaining to Practical or internal causes. Achievable Capacity

Definitions (contd.) Normal Capacity

Actual Capacity Utilization

Idle Capacity

• is the production achieved or achievable on an average over a period or season under normal circumstances taking into the loss of capacity resulting from planned maintenance.

• is the volume of production achieved in relation to installed capacity.

• is the difference between installed capacity and the actual capacity utilization when actual capacity utilization is less than installed capacity.

Definitions (contd.) • is the difference between installed capacity and the actual capacity utilization when actual capacity utilization is more Excess Capacity than installed capacity.

Utilization

Abnormal idle capacity

• is the difference between practical capacity and normal capacity or actual capacity utilization whichever is higher.

Determination of Installed Capacity Installed capacity is determined based on :

Manufacturers’ Technical specifications

Capacities of individual or interrelated production centres.

Operational constraints / capacity of critical machines

Number of shifts

Any other factor

Determination of Installed Capacity (contd.) • In case of manufacturers’ technical specifications are not available, the estimates by technical experts on capacity under ideal conditions may be considered for determination of installed capacity.

• In case a product es through different production processes and each process is having different capacity then the process which brings effective or ultimate production shall be considered for deciding installed capacity

Determination of Practical/Achievable Capacity Practical capacity or achievable capacity should be determined after adjustment of the following with the installed capacity. Available production hours taking Normal time Loss in into loss in batch efficiency due consideration change over, to ageing of break downs of holidays, the machines/ machines, normal shut equipment down days and repairs etc normal idle time.

Number of shifts

Any other factor

Determination of Normal Capacity • Normal capacity is determined based on the productive capacity achieved over a period of time, say average of three normal years out of preceding five years or expected to be achieved over a period of time, say next three to five years . • This capacity is determined after adjustment of external factors with practical capacity. • Normal capacity of production process involved in the production of a product or the productive capacity of the plant as a whole should be taken into to arrive at normal capacity for a product or plant, as the case may be • The periods influenced by abnormalities should be excluded for this purpose.

Explanation • In case the same products with different specifications and of different ranges in of size, type, variety etc are manufactured, then there is a need to determine equivalence among them in order to determine the capacity.

• In case some intermediate products / components etc are also produced, they should be taken into consideration for determining equivalent capacity.

• In case some machines are leased out/let out or some machines are taken on lease, resulting decrease / increase in capacity should also be considered.

Example

Calculation