In the late 1960s and early 1970s, Japanese firms in assembly-oriented industries, such as electronics and automobile manufacturing, began producing high quality products at very competitive prices. These products had short life cycles and were produced in a wide variety of models and sizes. They were the result of a manufacturing environment that used new methods and concepts such as just-in-time (JIT), total quality management (TQM), continuous improvement (CI), and employee involvement (EI). They emphasized customer service by providing quality, timely delivery, and low-cost production.

In the U.S., there is an increasing awareness of the role played by the Japanese approaches to world class manufacturing, including JIT and CI. The number of American companies adopting these methods is growing rapidly. However, as these new techniques are implemented, it has become necessary to re-examine the management accounting systems currently in use. A way of doing this is to contrast U.S. management systems with the Japanese methods of cost accounting which include such concepts as target costing, value engineering, and functional analysis.

In Japan, the purpose of the management accounting system is to influence the behavior of a manufacturing facility's employees to achieve corporate goals. Accounting policies are subservient to corporate strategy and aid managers in answering questions such as: How do our products compare with those of our competitors? What must we do to prepare for the future? The answers to such questions determine the nature of the management accounting system.

Japanese cost-management departments take a team-oriented approach and include members from other fields (e.g., engineering, purchasing, and manufacturing) as well as accountants. These individuals are typically specialists who have rotated through several departments before taking on a cost-planning job. These people have broad perspectives that give them a unique ability to discover ways to reduce product costs.

In addition to the teamwork approach, Japanese companies use direct performance indicators extensively, including production set-up times, number of times materials are moved, or number of units scrapped. These quantitative, nonfinancial measures allow employees to monitor their performance and interpret the results of their efforts. With relevant training and frequent reports on the company's financial health, companies ensure employees understand how their work directly affects the company's performance.

The Management Accounting System

When developing a new product in the U.S., the typical approach is to design it first and then compute the cost using a standard cost approach. Direct material, direct labor, and overhead standard costs are summed, and the resulting total is the new product cost. If the cost is too high, the product goes back to design or the company accepts a smaller profit. The essentials of this approach are shown in Figure 1.

In Japan, because of the highly competitive nature of assembly-oriented manufacturing, cost reduction in the planning and design stages is an important management issue. Japanese cost accountants must compute 100% of product cost in the planning and design stages. This is how the concept of target costing evolved.

Target costing is a Japanese management accounting technique used to manage costs during a product's planning and design stages and has been used by some Japanese firms for over twenty years. It is now widely used in Japan in such industries as electronics, precision machinery, and automobiles. Its objective is to reduce current costs by using various improvement tools such as value engineering and functional analysis for each manufacturing facility.

For a Japanese firm that uses target costing, a new product project is established when a new product is proposed. Figure 2 illustrates the steps in this process. The features and functions of the product are determined, and the members of the product project team establish a target selling price based on what they believe the market will accept. They also specify a target profit margin that reflects the company's strategic plans. In many cases, return on sales is used to determine the target profit. The target cost is equal to the target selling price minus the target profit margin. This target cost is usually below what can reasonably be achieved with current manufacturing methods and materials. Achieving this cost is the goal towards which everyone works.

In the U.S., the purpose of standard costing is to practice management by exception; i.e., management's attention is directed towards situations where the actual results differ from the expected results. The expected results are based on standards set relative to the current manufacturing process. Therefore, standard costing reflects existing technology and fails to motivate improvements in the process.

In Japan, standard costs are steadily reduced by continuous improvement efforts towards the target cost. While the target cost is established during the design stage, standard costs (as well as other cost reduction techniques) are used during the production stage to attain the target cost. Thus, the standard costing system tracks progress in achieving the target cost.

After the target cost is set, each department implements value engineering (VE) activities in cooperation with each other. The target cost is broken down into cost elements (e.g., material costs, direct labor costs, and depreciation costs) and into functional components (examples for an automobile include the engine, transmission system, and chassis). VE begins with an examination of the functions of materials and purchased parts to reduce cost and/or improve performance. Typical questions asked by the VE team include: What is the function of the part or material? Can it be simplified? Is it necessary? Are all the features necessary? Can a standard part that will serve the function be found?

Important tools of VE are cost tables. Cost tables are voluminous, computerized databases of detailed cost information based on various manufacturing variables. One branch of a hypothetical cost table is illustrated in Figure 3. Cost tables illustrate a comprehensive, multi- dimensional identification of the major variables that drive costs. The cost tables are a source of information about the effect on product costs of using different productive resources, manufacturing methods, functions, and product designs.

Figure 3 shows one branch of a hypothetical cost table. Other branches would stem from each of the cost driver alternatives under tubing. In addition, other branches would be prepared for cutting and incorporating the tubing into a product or subassembly. At each manufacturing stage, the tables show unit-component cost split into material, direct labor, and production overhead.

The other major aspect of Japanese managerial accounting is functional analysis which was developed in the U.S. Under this method, cost information is available for each product function and the cost reduction implications of several alternatives can be considered. Cost tables with detailed information are critical for successful functional analysis. For example, modifications to existing functions can be investigated, or functions can be reduced, expanded, or combined. Generating higher profit margins is one of the company's goals, and cost reduction is one way to achieve this goal. Another way is to add functions to the product which may increase its cost but will increase its value to the customer even more.

Functional analysis is applied at the design stage for a new product, and a target cost for each function is set. The functional target costs are summed, and the result is a product target cost. After the first year of production for a new product, the actual cost of the previous period becomes the starting point for further cost reduction. This process of continuous improvement is known as kaizen costing and encourages continual improvements by tightening the "standards."

Cost reduction techniques include standard costing. However, standard costing has limited applicability and can lead to undesirable results. For example, to minimize the purchase price variance, a purchasing manager may purchase a cheaper, lower quality part. As a result, the quality of the product is likely to be reduced, and the company may experience higher overall costs in the form of rework or warranty problems. In contrast, value engineering is performed on a company-wide basis and can be used in planning, design, and other processes as well as production. Value engineering activities do not reduce the overall quality of the product; they do ensure that expenditures result in the receipt of appropriate value.

Japanese management accounting systems support a top-to-bottom commitment to continuous improvement in both the process and the product. Performance is judged over time, and progress towards goals is emphasized.

In the U.S., changes in the focus and methods of production need to be accompanied by changes in management accounting systems. The Japanese have demonstrated great innovation in their approaches to manufacturing and have provided insights into ways management accounting can help companies better cope with the current worldwide competitive environment.

Their methods are particularly attractive in markets where competition is intense. Price increases are more difficult to achieve in this environment. While many organizations seem to realize their management accounting systems are not responsive to today's highly competitive milieu, relatively few have moved ahead to modernize their systems. The Japanese have provided guidance on how management accounting can play a significant role in creating sustainable competitive advantages for a firm. The more organizations that rid themselves of traditional management accounting practices or of the approaches discussed above, the better is the chance that the new ideas about manufacturing can take over and really show their worth. Old ways of product costing blunt a firm's ability to compete effectively and hinder their ability to focus on world class performance.