Definitions & Standards

SOCIETY OF COST ENGINEERS – DEFINITION OF TERMS

NOTE: These DEFINITIONS are generally accepted but should be used as GUIDELINES only. The key to any good cost model is not to be rigidly held to these definitions but to understand them and to apply them correctly. To ask a supplier to define each in their terms and make sure they are accounted for correctly.

NOTE: This page is continually being updated. If you have questions, comments or suggestion as to needed definitions or disagreements with the content, please use the CONTACT US page and we will attempt to address these.

ABC model*

A representation of resource costs during a time period that are consumed through activities and traced to products, services, and customers or to any other object that creates a demand for the activity to be performed.

 ABC system*

A system that maintains financial and operating data on an organization’s resources, activities, drivers, objects and measures. ABC models are created and maintained within this system.

Activity*

Work performed by people, equipment, technologies or facilities. Activities are usually described by the “action-verb-adjective-noun” grammar convention. Activities may occur in a linked sequence and activity-to-activity assignments may exist.

Activity analysis*

The process of identifying and cataloging activities for detailed understanding and documentation of their characteristics. An activity analysis is accomplished by means of interviews, group sessions, questionnaires, observations, and reviews of physical records of work.

Activity-Based Budgeting (ABB)*

An approach to budgeting where a company uses an understanding of its activities and driver relationships to quantitatively estimate work load and resource requirements as part of an ongoing business plan.   Budgets show the types, number of and cost of resources that activities are expected to consume, based on forecasted workloads. The budget is part of an organization’s activity-based planning process and can be used in evaluating its success in setting and pursuing strategic goals. (See Activity-based planning.)

Activity-Based Costing (ABC)*

A methodology that measures the cost and performance of cost objects, activities and resources.  Cost objects consume activities and activities consume resources. Resource costs are assigned to activities based on their use of those resources, and activity costs are reassigned to cost objects (outputs) based on the cost objects’ proportional use of those activities. Activity-based costing incorporates causal relationships between cost objects and activities and between activities and resources.

 Activity-Based Management (ABM)*

A discipline focusing on the management of activities within business processes as the route to continuously improve both the value received by customers and the profit earned in providing that value.  ABM uses activity-based cost information and performance measurements to influence management action.  (See Activity-based costing.)

 Activity-Based Planning (ABP)*

Activity-based planning (ABP) is an ongoing process to determine activity and resource requirements (both financial and operational) based on the ongoing demand of products or services by specific customer needs.  Resource requirements are compared to resources available and capacity issues are identified and managed. Activity-based budgeting (ABB) is based on the outputs of activity-based planning.  (See Activity-based budgeting.)

 Activity dictionary*

A listing and description of activities that provides a common/standard definition of activities across the organization.  An activity dictionary can include information about an activity and/or its relationships, such as activity description, business process, function source, whether value-added, inputs, outputs, supplier, customer, output measures, cost drivers, attributes, tasks, and other information as desired to describe the activity.

 Activity driver*

The best single quantitative measure of the frequency and intensity of the demands placed on an activity by cost objects or other activities. It is used to assign activity costs to cost objects or to other activities.

 Activity level*

A description of how elastic or sensitive an activity is to changes in the volume, diversity, or complexity of a cost object or another activity. Product-related activity levels may include unit, batch, and product levels.  Customer-related activity levels may include customer, market, channel, and project levels.

Allocation*

A distribution of costs using calculations that may be unrelated to physical observations or direct or repeatable cause-and-effect relationships.  Because of the arbitrary nature of allocations, costs based on cost causal assignment are viewed as more relevant for management decision-making.  . (Contrast with Tracing and Assignment.)

Amortization

It is the process of allocating the cost of an asset (equipment or machine) over a period of time. For example, if we purchase a machine worth 100,000 USD, and decide we want to “amortize” it in 5 years, it means we need to recover 100,000 / 5 = 20,000 USD every year during the first 5 years. This amount (20,000 USD) needs to be included in the equipment hourly rate.

Assignment

A distribution of costs using causal relationships. Because cost causal relationships are viewed as more relevant for management decision-making, assignment of costs is generally preferable to allocation techniques. (Synonymous with Tracing.  Contrast with Allocation.)

Attributes

A label used to provide additional classification or information about a resource, activity, or cost object.  Used for focusing attention and may be subjective. Examples are a characteristic, a score or grade of product or activity, or groupings of these items, and performance measures.

Batch

This is the number of parts produced between setups. Not to be confused with LOTS or MOQ.

Best practices*

A methodology that identifies the measurement or performance by which other similar items will be judged.  This methodology is used to establish performance standards and to aid in identifying opportunities to increase effectiveness and efficiency.  Best practices methodology may be applied with respect to resources, activities, cost object, or processes.

Bill of activities*

A listing of activities required by a product, service, process output or other cost object.  Bill of activity attributes could include volume and or cost of each activity in the listing.

Bill of Materials (BOM)

Bill of Process (BOP)

Bill of resources*

A listing of resources required by an activity.  Resource attributes could include cost and volumes.

Capacity*

The physical facilities, personnel and process available to meet the product or service needs of customers. Capacity generally refers to the maximum output or producing ability of a machine, a person, a process, a factory, a product, or a service. (See Capacity management)

Capacity management*

The domain of cost management that is grounded in the concept that capacity should be understood, defined, and measured for each level in the organization to include market segments, products, processes, activities, and resources.  In each of these applications, Capacity is defined in a hierarchy of idle, non-productive, and productive views.  (For further information see the CAM-I capacity model in Capacity Measurement & Improvement in the References to this Glossary.)

Constraint*

A bottleneck, obstacle or planned control that limits throughput or the utilization of capacity.

Cost center*

A sub-unit in an organization that is responsible for costs.

Cost driver*

Any situation or event that causes a change in the consumption of a resource, or influences quality or cycle time.  An activity may have multiple cost drivers. Cost drivers do not necessarily need to be quantified; however, they strongly influence the selection and magnitude of resource drivers and activity drivers.

Cost driver analysis*

The examination, quantification, and explanation of the effects of cost drivers. The results are often used for continuous improvement programs to reduce throughput times, improve quality, and reduce cost.

Cost element*

The lowest level component of a resource, activity, or cost object.

Cost management*

The management and control of activities and drivers to calculate accurate product and service costs, improve business processes, eliminate waste, influence cost drivers, and plan operations. The resulting information will have utility in setting and evaluating an organization’s strategies.

Cost object*

Any product, service, customer, contract, project, process or other work unit for which a separate cost measurement is desired.

Cost object driver*

The best single quantitative measure of the frequency and intensity of demands placed on a cost object by other cost objects.

Cost pool*

A logical grouping of Resources or Activities aggregated to simplify the assignment of resources to activities or activities to cost objects   Elements within a group may be aggregated or dis-aggregated depending on the informational and accuracy requirements of the use of the data.  A modifier may be appended to further describe the group of costs, i.e. Activity Cost Pool.

Cross-subsidy*

The inequitable assignment of costs to cost objects, which leads to over costing or under costing them relative to the amount of activities and resources actually consumed. This may result in poor management decisions that are inconsistent with the economic goals of the organization.

Cycletime

Sometimes called “Engineered Cycle Time”, is the time it takes the machine or equipment to complete its process, measured “floor to floor” (referred to the part being produced, as if it fell to the floor when the process is completed) also Drop Time. The cycle time is therefore composed of:

  • Load and Unload of the part into the machine or equipment
  • Processing time of the part insider the machine or equipment. This processing time is composed of:
    • Value added time: when there is any transformation performed at the part
    • Non-Value added time: movements and waits that add cycle time but do not add value to the part

Dedicated Equipment

When the equipment will be subject to no change over at all, and will be producing the same part (or family of parts) during the lifetime of a project.

The investment incurred to procure these machines or equipment should be spread over the number of parts produced, in replacement of the equipment depreciation calculated based on a number of years. Used in the calculation of a machine rate. If a machine is fully dedicated then the total cost of the machine should be spread over the number of parts produced.

Example: You have a machine that costs $100,000. You have a 10-year program to produce 10,000 parts per year, or 100,000 parts over the life of the program. This would mean you need to spread the $100,000 over the 100,000 parts for $1.00 per part.

For this reason we have a 3 step test to verify the equipment is truly dedicated:

TEST 1: CAN this machine EVER be reconfigured or retooled to produce any other Parts? Yes = not dedicated.

TEST 2: At the end of the program, will the machine be useless? No = not dedicated

TEST 3: Is there a contractual agreement that NOTHING ELSE CAN NOW OR NEVER be run on this equipment? No = not dedicated

After the agreed depreciation is over (total number of parts produced as agreed), this amortization should be removed from the part price, or recalculated if the equipment needs to go through any refurbishment.

Keep in mind that if it is dedicted, at the end of the life, your company owns this equipment and has the right to pick it up and move to any location if the contract is written properly.

Depreciation

The accounting method of allocating the cost of a tangible or physical asset over its useful life or life expectancy. Typically, 7 to 10 but could be al short as 1 to as long as over 30 years.

Short run assembly equipment (mostly manual) 1 to 2 years

Injection Molding press / CNC Machine 7 to 10 years

Heavy Duty Stamping Press up to 30 or more years

Direct Labor

Any worker that runs a machine or operation to the part being produced

Direct cost*

A cost that can be directly traced to a cost object since a direct or repeatable cause-and-effect relationship exists.  A direct cost uses a direct assignment or cost causal relationship to transfer costs. (See also Indirect Cost, Tracing)

Electricity Consumption (for hourly rate calculation)

Average electricity consumption of the equipment in kWh/h. Note that the equipment maximum consumption noted in the equipment specifications is NOT the average consumption. In fact, the average consumption could be well below 50% of the equipment peak consumption.

Enterprise-wide ABM*

A management information system that uses activity-based information to facilitate decision making across an organization.

Equipment or Machine

Device used at any operation to add value to the component being worked.

NOTE: Inspection operations are NON-VALUE operations that add cost to the component

Gas consumption (for hourly rate calculation)

Average gas consumption of the equipment in m3/h. Normally used for furnaces, and can include Natural Gas, Endogas, Hydrogen, etc.

Hierarchy of cost assignability*

An approach to group activity costs at the level of an organization where they are incurred, or can be directly related to.  Examples are the level where individual units are identified (unit-level), where batches of units are organized or processed (batch-level), where a process is operated or supported (process-level), or where costs cannot be objectively assigned to lower level activities or processes (facility-level).  This approach is used to better understand the nature of the costs, including the level in the organization at which they are incurred, the level to which they can be initially assigned (attached) and the degree to which they are assignable to other activity and/or cost object levels, i.e. activity or cost object cost, or sustaining costs. 

Indirect Costs

These are the costs associated with the facility that do not fall into direct (Fixed or Variable), Labor (Direct or Indirect) or SG&A. The key with these costs is to make sure they are not double counted within one of the other categories.

“A resource or activity cost that cannot be directly traced to a final cost object since no direct or repeatable cause-and-effect relationship exists. An indirect cost uses an assignment or allocation to transfer cost.  (See Direct cost, Support costs)”*

Indirect Labor

Any worker that performs other jobs in the shop floor supporting several operations during his/her shift, but is not directly involved in the active conversion of the component into the final product. According to the SOCE, these Indirect Labor includes:

  • Setters
  • Shift Leaders
  • Group Leaders
  • Quality staff
  • Logistics or material handling staff
  • Purchasing staff
  • Manufacturing Engineers staff

Indirect Markup

Indirect markup is a percentage or multiple of Manufacturing cost, either Machine Cost, Labor Cost or a combination of both. This is meant to capture and express all the indirect costs associated with the shop floor. This would include the category of Indirect Labor as well as the Indirect Cost.

Inspection

Inspection can be broken down into two separate categories In cycle and Quality Lab Sampling

  • In Cycle refers to the OPERATOR (direct labor) inspection, measurements and verifications, visual or measure, that occur between parts being produced (within the next parts cycletime). In this case this is basically free as you are continuing to pay the Direct Labor for the entire cycle.
  • Quality Lab inspections are periodic samples being sent to the quality lab for approval. These are usually called out on a process control plan. Although every attempt should be made to capture these within a Cost Model, they usually contribute very little to the end price as these charges get spread over the entire LOT.
  • Sometimes there are “quality gates” which are inspection of the parts by a different operator, visually, or with gauges. These are by definition non-value operations, but add cost to the product (i.e. waste) and should be considered in the part cost, especially if they are requested by the customer. If decided to implement by the manufacturer, these should be minimized or eliminated and focus on built-in quality.

Insurance

It’s the cost of insuring the asset we purchase in case it is destroyed by a Force Majeure not covered by the asset warranty. It must also be part of the equipment hourly rate calculation.

Interest

It is the interest we need to pay to the money lender for the money we have borrowed to purchase any equipment. As for the Amortization or Investment, it is an amount that we must recover and that should be part of the equipment hourly rate calculation. This interest rate varies with respect to the country where the money is lent.

  • Excel formula “PMT”: Calculates the payment for a loan based on constant payments and a constant interest rate. SOCE uses this formula to calculate the Amortization and Interest cost/hour of an operation based on its investment.

Location

Region and place in the world where the operations are taking place.

Labor Rate

The total cost of a direct operator per hour, all inclusive. (Labor Rate) x (number of hours per shift) x (working days per year) = Gross Yearly Salary (Total yearly cost of the operator to the Company where he/she works).

Labor Time

This is the chargeable amount of time an operator (direct labor) is performing a given task.

Example 1: An operator is required to manually fastens a screw for 10 second. Labor time is 10 seconds.

Example 2: A Machine operator maintains 4 CNC’s each with a 1-minute cycle time. The labor time is 15 seconds or ¼ a minute.

Life cycle cost*

A product’s life cycle is the period that starts with the initial product conceptualization and ends with the withdrawal of the product from the marketplace and final disposition. A product life cycle is characterized by certain defined stages, including research, development, introduction, maturity, decline, and abandonment.  Life cycle cost is the accumulated costs incurred by a product during these stages.

Lot

The number of products produced within a BATCH for tracking purposes (usually for quality reasons). This dose not equal and therefore should not be confused with BATCH or MOQ

Machine Hourly Rate

The running cost per hour of any equipment or machine. According to the SOCE, it is composed of the sum of Fixed and Variable Machine Rates

  • Fixed Machine Rate: Are those costs that are incurred regardless of the number of parts produced. For example: building rental, equipment amortization, shop floor heating/cooling, Interest, Insurance, Floorspace
  • Variable Machine Rate: Are those costs that are directly proportional to the numbers of parts produced. If we produce 0 parts, the Direct Costs spent should have been 0. Electricity consumption, Gas or other elements consumptions, Maintenance

Machine Time

This is the amount of time the particular parts spends on the machine having value added to it.

Material Overhead

Material Overhead or Inventory carrying cost is the cost of carrying inventory. It is important to understand and determine if you want this to include floorspace and or material schedulers and movers. If so then the Category of SG&A and Indirect Labor may need to be adjusted.

AT SOCE, we recommend to use a fixed “handling fee %” to the material price to cover for all the above plus the other costs related to bringing the raw material to the manufacturing plant.

Minimum Order Quantity (MOQ)

This is the minimum amount of product a supplier with allow you to order at one time. This is not to be confused with Lot, or Batch size. This is usually appearing as the quantity on a set order P.O.

OEE

Overall Equipment Efficiency: It is the ratio of the number of good parts produced over a period of time to the number of parts that could have been produced according to the engineered cycle time. For example, a process has a cycle time of 45 seconds, which means it could produce 80 pcs/hr, but over 8 hours the number of OK parts is 520 pcs. In this case, OEE = 520 / 640 (80 pcs/hr x 8 hours) = 81.25%

There is a lot of debate about how to correctly declare the OEE, for example:

  • Should the set-up time be considered as production time and therefore affect the OEE?
  • If we have 30 minutes per shift to clean the working area, should this time be considered as production time and affect the OEE?

Overhead

It’s part of the SG&A, normally the “G&A” expenses. These are the costs a company must incur to open the doors each day

Pareto analysis*

An analysis that compares cumulative percentages of the rank ordering of costs, cost drivers, profits or other attributes to determine whether a minority of elements have a disproportionate impact.  For example, identifying that 20 percent of a set of independent variables is responsible for 80 percent of the effect.

Payment Terms

The expectations between the buyer and seller so that there won’t be any potential misunderstandings nor disagreements because both parties clearly know what is expected and they are satisfied with the requirements.

  • COD “Cash on Delivery”or “Payable on Receipt,” means that a payment is due at the same time as a product or service is delivered.
  • Net 7, 10, 30, 60, 90 These imply that the net payment is due in either 7, 10, 30, 60, or 90 days after the invoice date. For example, if the invoice was dated June 10 and you used one of the most used payment terms, Net 30, then the payment would be expected before July 9.

Performance measures*

Indicators of the work performed and the results achieved in an activity, process, or organizational unit. Performance measures are both non-financial and financial.  Performance measures enable periodic comparisons and benchmarking.

Process*

A series of time-based activities that are linked to complete a specific output.

Profit

It’s the difference between selling price and product cost including SG&A. Publicly traded companies report this on the year end financials. These year end financials are a great source of information not limited to Profit and SG&A.

Profitability analysis*

The analysis of profit derived from cost objects with the view to improve or optimize profitability. Multiple views may be analyzed, such as market segment, customer, distribution channel, product families, products, technologies, platforms, regions, manufacturing capacity, etc.

Residual Value

It is the value of any machine or equipment for which it could be sold after the amortization period. In SOCE, we typically apply a 10% for standard machines and 5% for custom-made machines, and suggest to rest this residual value in the equipment amortization hourly cost, because this money will be recovered at the end of this period.

Resource driver*

The best single quantitative measure of the frequency and intensity of demands placed on a resource by other resources, activities, or cost objects.  It is used to assign resource costs to activities, and cost objects, or to other resources.

Resources*

Economic elements applied or used in the performance of activities or to directly support cost objects. They include people, materials, supplies, equipment, technologies and facilities. (See Resource driver, Capacity.)

Router or Job Ticket

This is the step by step instructions (usually including charge times and accounts) informing the plan on how a product is produced and where the costs should be allocated.

Scrap

It is the material, components and/or parts of the component that can’t be sold as finished products and must be dispose.  Scrap can be broken down into three categories Designed In, Bad Part, Material Usage Scrap (Gross vs Net).

Designed In Scrap is the predicted scrap required to insure a good part is made. For example, 1 out of every 10 welded parts is submitted to the quality lab for pull texting and sectioning. These requirements should be stated on print or quality control plan

Bad part scrap the fallout of mis-produced and ideally should not be paid accounted for in an Theoretical, Ideal, or Benchmark Should Cost Model.

Material Usage (Gross vs Net) is the difference between part gross weight and part net weight. For example, in order to stamp a ring from sheet metal, the inner area of the sheet metal that must be cut-off is wasted, and is scrapped.

Scrap that can be sold or recycled should be taken into account in the Should Cost calculation.

Setup

The down time it takes to convert to your component. It is measured from last good part of Part A to first good part of Part B. The costs covered by this should include: Machine Down Time (opportunity costs lost), Labor to change over the equipment, Indirect Cost for the process (tool maintenance). This cost is spread over the batch size.

Should Cost

Calculated cost of a part or assembly using a determined equipment, cycle time and operator content at any given location. If any of these factors change (equipment, cycle time, number of operators, or location), then Should Cost changes.

Typical types of “Should Cost Include Theoretical Optimal, Ideal, Benchmark, Suppler Specific, and Does Cost

SG&A (Sales, General and Administrative)

These are all the costs not directly tied to making a product or performing a service, including:

  • Sales persons, Marketing, Advertisement, etc.
  • Plant, Engineering, Quality and Logistics Managers, and other High-Level staff salaries
  • Finance Managers and Finance staff
  • IT, Phone, Internet and communications
  • Rentals
  • Travel expenses
  • Office supplies and utilities
  • Bad Part Scrap: During the normal production, a certain minimal number of parts may come out incorrect. Depending on your object for modeling you may want to assume either 0, a benchmark or actual percentages.

Publicly traded companies report this on the year end financials. These yearend financials are a great source of information not limited to Profit and SG&A.

Support costs*

Costs of activities not directly associated with producing or delivering products or services. Examples are the costs of information systems, process engineering and purchasing. (See Indirect cost)

Surrogate <item> driver*

A substitute for the ideal driver, but is closely correlated to the ideal driver, where <item> is Resource, Activity, Cost Object.  A surrogate driver is used to significantly reduce the cost of measurement while not significantly reducing accuracy.  For example, the number of production runs is not descriptive of the material disbursing activity, but the number of production runs may be used as an activity driver if material disbursements correlate well with the number of production runs.

 Sustaining activity*

An activity that benefits an organizational unit as a whole, but not any specific cost object.

Takt Time

This is the amount of time you need to produce the required parts over the expected production time. Often called the drumbeat. Some times referred to as “As slow as necessary”.

Example: If you have a part that takes 15 seconds to produce but need to make 1 part per year your TAKT time is 1 Year and your CYCLETIME is 15 seconds.

Target costing*

A target cost is calculated by subtracting a desired profit margin from an estimated or a market-based price to arrive at a desired production, engineering, or marketing cost. This may not be the initial production cost, but one expected to be achieved during the mature production stage.  Target costing is a method used in the analysis of product design that involves estimating a target cost and then designing the product/service to meet that cost.  (See Value analysis.)

Tasks*

The breakdown of the work in an activity into smaller elements.

Throughput

Throughput is the number of units that pass through a process during a period of time.  It can be parts per hour, parts per shift, or parts per week. If is a combination of cycle time and OEE

Tracing*

The practice of relating resources, activities and cost objects using the drivers underlying their cost causal relationships.  The purpose of tracing is to observe and understand how costs are arising in the normal course of business operations.  (Synonymous with Assignment.  Contrast with Allocation.)

Throughput

Throughput is the number of units that pass through a process during a period of time.  It can be parts per hour, parts per shift, or parts per week. If is a combination of cycle time and OEE

Unit cost*

The cost associated with a single unit of measure underlying a resource, activity, product or service.  It is calculated by dividing the total cost by the measured volume.  Unit cost measurement must be used with caution as it may not always be practical or relevant in all aspects of cost management.

Unit of driver measure*

The common denominator between groupings of similar activities.  Example:  20 hours of process time is performed in an activity center.  This time equates to a number of common activities varying in process time duration.  The unit of measure is a standard measure of time such as a minute or an hour.

Value-adding/Non-value-adding*

Assessing the relative value of activities according to how they contribute to customer value or to meeting an organization’s needs.  The degree of contribution reflects the influence of an activity’s cost driver(s).

Value analysis*

A method to determine how features of a product or service relate to cost, functionality, appeal and utility to a customer. (i.e., engineering value analysis) (See Target costing.)

Value chain analysis* 

A method to identify all the elements in the linkage of activities a firm relies on to secure the necessary materials and services, starting from their point of origin, to manufacture, and to distribute their products and services to an end user.

Value Stream  

The value stream is the entire process from end to end.  This lists every step of the process from initial creating of the product or service to the delivery to the customer.  It sometime can go from “dirt to dirt” but is often limited to the activities just prior to the start of a manufacturing or service provided to the delivery to the customer.

Value Stream Map 

Value Stream Map is a technical depiction and analysis of each step in the manufacturing or service steps required to deliver the product.  This can start as early as “dirt” and end as late as “dirt” but usually is limit to the process in question.  The map included technical data such as but not limited to cycle times, labor content, wait time batch size and many other important factors.

NOTE:  Definitions indicated by “*” Provided by The CAM-I Glossary of Activity-Based Management, Version 3.0 Edited by Paul A. Dierks and Gary Cokins, (Bedford: CAM-I, 2000)

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