Total Capacity Management

Optimizing at the Operational, Tactical, and Strategic Levels

The Ima Foundation Far, C. J. McNair, Richard Vangermeersch

• Publisher: CRC Press
• Year: 2020
• Print ISBN: 9781574442311
• eBook ISBN: 9781000162219
• Topic: Business
• Subtopic: Industrial Management
• Index: Business

Ten years in discussion and development, Total Capacity Management provides the most complete overview of the history and techniques of capacity cost management-a timely, yet timeless, issue applicable to both capital-intensive and labor-intensive organizations. Through explanations of various capacity cost management models, executives and managers can create the most appropriate model for their organization's distinct needs. Total Capacity Management shows the way for companies and managers to gain and maintain an exceptional competitive edge.

PART I
MODERN PRACTICE IN CAPACITY COST MANAGEMENT

1
THE MOVABLE FEAST

The work of organizations includes taking stock of the resources at one’s command and planning the fullest use of them all.¹

Capacity is the value-creating ability of an organization, an ability that takes form in a wide variety of resources. Lying at the heart of the management process, capacity shapes and defines cost systems.

Every cost estimate used by an organization has an implicit assumption of capacity built into it; every decision made has an impact on this potential to create value. Problematic in nature, capacity and its measurement are topics that have been debated, hotly at times, throughout the 20th century. It is this elusive concept—the capacity of a process, system, or organization to do work—that this monograph is about.

The essence of the capacity issue is the unavoidable fact that resources not used to their fullest represent waste. Waste erodes profits and shortens the life of an organization. Waste is the entropy of business systems, the drag on their current and future performance. Effectively managing an organization starts with making the fullest use of every resource at the company’s command, that is, its theoretical capacity. Using this capacity productively, maximizing its value-creating potential, starts with eliminating resource waste, which is idle or excess capacity.

Capacity is a core issue in cost system design and analysis; capacity has to be defined for every resource or process. Capacity, in essence, defines the denominator in the cost equation. For every cost pool there has to be a driver and for every driver a capacity. The combined results of the historical and empirical analysis detailed in this monograph suggest, then, that while the precise definition of capacity has always been elusive, the motives of business and academe in attempting to define it are more concrete. Understanding and effectively managing capacity is, as suggested by the citation from Whitmore, the key to minimizing waste and ensuring that resources are used to their fullest.

This chapter presents an overview of the findings from an eight-year research project on capacity cost management. As with the concept of capacity itself, the presentation of the results of this study represented unique challenges. Specifically, in contrast to the sequence of the actual monograph, this chapter begins with a summary of the historical development of capacity cost management, which is presented in more depth in Part II.

The historical summary is then followed by a discussion of current trends in the field, based on the results of both archival and field research. These results are more fully detailed in Part I. The motivation for this departure from the “normal” method of introducing and presenting the results of a study is quite simple: this document is intended to serve multiple readers with multiple interests. The results from the field, which represent an overview of best practice in capacity cost management, will likely be of interest to all readers, while the historical analysis may appeal to a smaller, though equally important, audience. The resulting structure is truly a movable feast.

Historical Overview of Capacity Cost Management

□ The Age of Discovery

The history of capacity cost management can be broken into five separate eras, as suggested by Table 1-1. The Age of Discovery, bridging the years 1900 to 1919, was a watershed period when many of the ideas and techniques shaping modern management were born. As detailed in Chapter 7, the Age of Discovery was dominated by the Scientific Management school and one of its strongest proponents, Henry Gantt. Gantt had little time for accountants and their focus on transactions and financial statements; costs were to serve management, not the financier. Gantt’s position brought him into direct conflict with A. H. Church, the father of modern cost accounting. Their 1915 debate, spanning five months and six issues of the then-popular magazine American Machinist, created intense discussion among managers, accountants, and industrial engineers over the “proper” treatment of expense burden.

Gantt’s position in the 1915 debate is summarized in the opening pages of the first “round” in this memorable dialogue:

It has been common practice to make the product of a factory running at a portion of its capacity bear the whole expense of the factory.… Mr. Gantt offers the theory that the amount of expense to be borne by the product should bear the same ratio to the total normal operating expense as the product in question bears to the normal product, and that the expense of maintaining the idle portion of the plant ready to run is a business expense not chargeable to the product made.²

Church did not disagree with the thrust of Gantt’s argument and the logic driving his position—that idle capacity costs needed to be isolated in management reports. Church’s main disagreement centered on the placement of idle capacity expense on the published financial statements. Contrary to Gantt, Church wanted ultimately to charge idle capacity costs to product using a supplementary burden, or overhead, rate. Church felt this treatment would provide management with the information it needed, while reflecting the traditional accounting solution to the problem.

Table 1-1. Eras in Capacity Cost Management

Period	Focus of Reporting	Treatment of Idle Costs	Key Features of the Period
The Age of Discovery 1900–1919 (Chapter 7)	Management	No agreement	Opening period is shaped by the Scientific Management movement and the efforts of its key spokesman, Henry Gantt Gantt, debating A. H. Church, argues for a simple percentage approach to splitting idle capacity costs between the balance sheet and income statement Church holds fast to the supplementary rate method. No agreement is reached during the era.
The Golden Era 1920–1932 (Chapter 8)	Management	Charge to P&L	A period of debates, the Golden Era is marked by a search for “true costs.” GAAP suggests P&L treatment of idle costs, which are equated to unearned burden. Era is dominated by industrial engineering. Management held accountable for idleness. Focus is on decision support and behavioral impact of capacity reporting.
An Era of Crisis 1933–1952 (Chapter 9)	Government	Charge directly to product	Recovery and response to crisis (Depression, World War II). Accounting serves a constituent role in upholding regulations. Idle costs are buried in product costs. Period is dominated by financial accounting. No one held accountable for idle costs. Focus is on external reporting and adherence to governmental regulations.
The Full Cost Era 1953–1978 (Chapter 10)	External reporting	Charge directly to product	Managing prosperity. Full costing is accepted as best perhaps only, acceptable costing method, with no formal promulgation to support this position. Direct costing attempts a brief stand but is soundly defeated, resulting in GAAP and IRS rulings preventing this costing method for inventory valuation. Era is dominated by financial reporting. Idle costs are all but ignored.
The Era of Questioning 1979-present (Chapter 11)	Management	Open to debate and experimentation	Search to regain relevance in management accounting. GAAP treatments of idle capacity costs once again debated. Concensus is reached by SMAC, IMA, and CAM-I to charge at least some forms of idle capacity costs directly to P&L Period is dominated by management experts. Focus on decision support information. Many models emerging for managing capacity and its costs.

□ The Golden Era

The subsequent Golden Era, spanning the period from 1920 to 1932, was marked by lengthy debates and discussions about capacity and the “proper” treatment of the costs it represents. During the Golden Era, the cost of capacity was equated to the burden or total overhead of a plant or process. Reflecting a recognition that the only reason to have burden was to provide the company with the capacity to do work for its customers, the controversy focused on the choice of baseline capacity measures and the treatment of the idle capacity costs that were an inevitable part of business.

By 1926 a consensus appeared to emerge on the “proper” treatment of the burden caused by idle capacity, as reflected in the NACA Bulletin for the 1921, 1924, and 1926 annual meetings of the National Association of Cost Accountants (NACA—now the...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Foreword
• About the Authors
• Acknowledgments
• Executive Summary
• Table of Contents
• Part I Modern Practice in Capacity Cost Management
• Part II Historical Trends in Capacity Cost Management
• Part III Annotated Bibliography
• Index