Tag: Strategic cost Management

Activity based budgeting is a budgeting method in which budgets are prepared using Activity Based Costing after considering the overhead costs. Activity-based budgeting (ABB) is a budgeting method where activities are thoroughly analyzed to predict costs. ABB does not take historical costs into account when creating a budget. In simple words, activity-based budgeting is management accounting tool which does not consider the past year’s budget to arrive at current year’s budget. Instead, the activities that incur the cost are deeply analyzed and researched. Based on the outcome of the study, the resources are allocated to an activity. Activity-based budgeting (ABB) is more rigorous than traditional budgeting processes, which tend to merely adjust previous budgets to account for inflation or business development.

Components

Components and Process of Activity Based Budgeting are given below:

• It starts with identifying activities which revolve around resource consumption and these activities are mainly classified as main activities and secondary activities which denotes to the degree of involvement and importance of an activity to the organization as per their priority, therefore, main activities are activities which are directly related with the objectives and are essential.
• Secondary activities are those activities that create added value to the customer and change its preference in the organization’s favor which may involve a significant number of resources.
• After defining the activities, the next task is to identify how to distribute the costs or resources accordingly among the activities which are done with the help of inducers which are factors defining the level of consumption in different activities.
• Mainly three such inducers influence such decisions which are time which depicts the duration for the processes, number of resources required by each activity and lastly the number of times an activity is repeated after getting all these facts the appropriate costs can be calculated.

Importance

Improves Relationship

Activity based budgeting system helps in improving the relationship between the organization and its customers. The main aim of this budgeting method is to eliminate unnecessary activities and serve the customers with the best quality at best price. This enforces (indirectly) the employees of the company to serve the customers in the best way possible and ensure customer satisfaction. In turn, the relationship between the organization and the customers improves.

Evaluation

Activity based budgeting method evaluates each and every cost driver. It takes into consideration all the steps involved in an activity. The irrelevant activities are eliminated and only the necessary activities form a part of the business.

Elimination of Bottlenecks

Budgets under activity-based budgeting are prepared after deep research and analysis. This study removes all the unnecessary activities of the business. By doing so, the business eliminates all sorts of bottlenecks associated with an activity and business functions are carried out more smoothly.

Business as a Unit

This budgeting technique helps in viewing the business as a single unit and not in the form of departments. The managers or the top management prepare the budget for the business unit as a whole and not keeping in mind any single department as done in the case of other methods of budgeting.

Competitive Edge:

Activity based budgeting system eliminates all sorts of unnecessary activities, which helps the business to save its costs. The saved cost results in the production of goods and services at lower cost than that of competitors. It also helps the organization to gain a competitive edge in the market.

Issues, Limitations

• It is based on forecasting with the use of historical data and future expectations which may sometimes prove to be unreliable if the situations or scenarios planned do not come out to be what was expected to lead to problems that can hamper the entity and its resources.
• It requires a well-groomed talented team of individuals who are experts in finding gaps and are equally competent in reporting and use of the necessary software as it is a complex process on which the direction of the company is dependent.
• Activity-Based Budgeting is a lengthy and comprehensive process that requires a considerable amount of time and resources on an entity and spending too much on analyzing may prove to be counterproductive.
• Activity-Based Budgeting provides only supplemental information.
• While preparing an Activity Based Budget it is possible that the axis of focus may shift to immediate and short term results and the bigger picture may be ignored causing damage in the long term.

Process

The activity-based budgeting (ABB) process is broken down into three steps.

• Identify relevant activities. These cost drivers are the items responsible for incurring revenue or expenses for the company.
• Determine the number of units related to each activity. This number is the baseline for calculations.
• Delineate the cost per unit of activity and multiply that result by the activity level.

ABC costing focuses on identifying activities, or production processes, that are used to process a job. These individual activities are grouped together with similar processes into a cost pool that relates to single activity cost driver.

The cost pools are then analyzed and assigned a predetermined overhead rate that will eventually be assigned to individual jobs and products.

As you can see, this is a multi-step process, but activity-based costing is a much more accurate way of assigning indirect costs. It’s difficult to determine how much electricity or heat one department or job uses over another without some type of methodical allocation process.

Activity-based costing (ABC) is a costing method that identifies activities in an organization and assigns the cost of each activity to all products and services according to the actual consumption by each. Therefore, this model assigns more indirect costs (overhead) into direct costs compared to conventional costing.

CIMA, the Chartered Institute of Management Accountants, defines ABC as an approach to the costing and monitoring of activities which involves tracing resource consumption and costing final outputs. Resources are assigned to activities, and activities to cost objects based on consumption estimates. The latter utilize cost drivers to attach activity costs to outputs.

The Institute of Cost & Management Accountants of Bangladesh (ICMAB) defines activity-based costing as an accounting method which identifies the activities which a firm performs and then assigns indirect costs to cost objects.

Example

Activity based costing helps allocate overhead expenses to jobs and products based on the amount of the activities required to produce the product instead of simply estimating how much each job uses.

Properly assigning indirect costs is extremely important for management, especially in the case of downsizing or outsourcing. Profitable departments can be assigned too much indirect cost causing them to appear unprofitable on paper. Based an evaluation management can choice to discontinue the operations and close a profitable branch because the costs were properly distributed.

To compound the problems, once the profitable branch is closed the only remaining branches are the unprofitable ones. By shutting down the only profitable department, the company may not be able to cover its fixed costs.

The same scenario is true for outsourcing. Management may estimate outsourcing to be a cheaper option because costs have not been allocated properly. In fact, outsourcing might actually be more expensive.

Objectives

• Identify and eliminate those products and services that are unprofitable and lower the prices of those that are overpriced (product and service portfolio aim), or
• Identify and eliminate production or service processes which are ineffective, and allocate processing concepts that lead to the very same product at a better yield (process re-engineering aim)

Application

• Is applicable throughout company financing, costing and accounting:
• Is a modeling process applicable for full scope as well as for partial views?
• Helps to identify inefficient products, departments and activities.
• Helps to allocate more resources on profitable products, departments and activities.
• Helps to control the costs at any per-product-level level and on a departmental level.
• Helps to find unnecessary costs that may be eliminated.
• Helps fixing the price of a product or service with any desired analytical resolution.

Implementation

• Identify and assess ABC needs: Determine viability of ABC method within an organization.
• Training requirements: Basic training for all employees and workshop sessions for senior managers.
• Define the project scope: Evaluate mission and objectives for the project.
• Identify activities and drivers: Determine what drives what activity.
• Create a cost and operational flow diagram: How resources and activities are related to products and services.
• Collect data: Collecting data where the diagram shows operational relationship.
• Build a software model, validate and reconcile.
• Interpret results and prepare management reports.
• Integrate data collection and reporting.

Process Flow

• Identify costs. The first step in ABC is to identify those costs that we want to allocate. This is the most critical step in the entire process, since we do not want to waste time with an excessively broad project scope. For example, if we want to determine the full cost of a distribution channel, we will identify advertising and warehousing costs related to that channel, but will ignore research costs, since they are related to products, not channels.
• Load secondary cost pools. Create cost pools for those costs incurred to provide services to other parts of the company, rather than directly supporting a company’s products or services. The contents of secondary cost pools typically include computer services and administrative salaries, and similar costs. These costs are later allocated to other cost pools that more directly relate to products and services. There may be several of these secondary cost pools, depending upon the nature of the costs and how they will be allocated.
• Load primary cost pools. Create a set of cost pools for those costs more closely aligned with the production of goods or services. It is very common to have separate cost pools for each product line, since costs tend to occur at this level. Such costs can include research and development, advertising, procurement, and distribution. Similarly, you might consider creating cost pools for each distribution channel, or for each facility. If production batches are of greatly varying lengths, then consider creating cost pools at the batch level, so that you can adequately assign costs based on batch size.
• Measure activity drivers. Use a data collection system to collect information about the activity drivers that are used to allocate the costs in secondary cost pools to primary cost pools, as well as to allocate the costs in primary cost pools to cost objects. It can be expensive to accumulate activity driver information, so use activity drivers for which information is already being collected, where possible.
• Allocate costs in secondary pools to primary pools. Use activity drivers to apportion the costs in the secondary cost pools to the primary cost pools.
• Charge costs to cost objects. Use an activity driver to allocate the contents of each primary cost pool to cost objects. There will be a separate activity driver for each cost pool. To allocate the costs, divide the total cost in each cost pool by the total amount of activity in the activity driver, to establish the cost per unit of activity. Then allocate the cost per unit to the cost objects, based on their use of the activity driver.
• Formulate reports. Convert the results of the ABC system into reports for management consumption. For example, if the system was originally designed to accumulate overhead information by geographical sales region, then report on revenues earned in each region, all direct costs, and the overhead derived from the ABC system. This gives management a full cost view of the results generated by each region.
• Act on the information. The most common management reaction to an ABC report is to reduce the quantity of activity drivers used by each cost object. Doing so should reduce the amount of overhead cost being used.

Formula

Activity-Based Costing Formula = Cost Pool in Total / Cost Driver

The ABC formula can be explained with the following core concepts.

Cost Pool: This is an item for which measurement of the cost would require, e.g., a product

Cost Driver: It is a factor that will cause a change in the cost of that activity. There are two kinds of cost driver:

Resource Cost Driver: It is a measure of the number of resources that shall be consumed by an activity. This will be used to assign the cost of a resource to an activity. E.g., Electricity, Staff wages, Advertising, etc.

Activity Cost Driver: This is the measure of the intensity of demand and the frequency that is placed on the activities by the cost pools. It will be used to assign the activity costs to a product or a customer. E.g., Material ordering costs, Machine set up costs, Inspection and testing charges, Material handling and storing costs, etc.

Activity-based management (ABM) is a method of identifying and evaluating activities that a business performs, using activity-based costing to carry out a value chain analysis or a re-engineering initiative to improve strategic and operational decisions in an organization.

Activity-based management follow this premise: products consume activities; activities consume resources. If managers want their products to be competitive, they must know both:

(i) The activities that go into making the goods or providing the services

(ii) The cost of those activities.

To reduce a product’s cost, managers will likely have to change the activities the product consumes.

Activity-based costing is defined as a methodology that measures the cost and performance of activities, resources and cost objects. Specially, resources are assigned to activities based upon consumption rates and activities are assigned to cost objects, again based on consumption. ABC recognizes the causal relationships of cost driver to activities.

Activity-based management is defined as a discipline that focuses on the management of activi­ties as the route to improving the value received by the customer and the profit achieved by provid­ing this value. ABM includes cost driver analysis, activity analysis, and performance measurement, drawing on ABC as its major source of data.

In simple terms, ABC is used to answer the question “what do things cost?” While ABM, using a process view, is concerned with what factors cause costs to occur? Using ABC data, ABM focuses on how to redirect and improve the use of resources to increase the value created for customers and other stakeholders.

Model

• Cost Driver Analysis: For the purpose of managing the activity costs, the factors that result in the activities to take place are to be identified.
• Activity Analysis: Activity Analysis is all about finding out the activities of the organizations and its centres, that are ought to be utilized in the activity-based costing. Based on the costs and benefits of the alternatives, the activities are divided into the number of activity centres. Further, it ascertains value added and non-value added activities:
• Value Added Activities: The activities which are very essential for the completion of the process are categorized as value-added activities.
• Non-Value Added Activities: Those activities which are not having any worth for both external or internal customers are termed as Non-value added activities. Indeed these activities do not enhance the quality of the product rather they have a negative impact on the cost and prices of the product or services as they create wastes, delays, increase the overall value etc.
• Performance Analysis: It involves discovering a proper measure to analyse the performance of the activity centres.

Importance

• Performance Measurement: Nowadays, most of the firms concentrate on activity performance by observing the efficiency and effectiveness of activities, so as to compete successfully in the market.
• Cost Reduction: Activity-based management facilitates the organization to identify the costs against activities to determine the ways to reduce costs and even eliminate the entire activity if it is not adding any value to the products.
• Business Process Reengineering: It entails examining and redesigning the processes and workflows of the organisation for improving the performance and also gaining excellence in business operations. It involves making significant changes regarding the way in which organisation operates currently. ABM helps in improving the business process efficiency and effectiveness.
• Activity-Based Budgeting: ABB supplies a framework for forecasting the input required as per the budgeted level of activity. A comparison is made between actual results and estimated results to outline the activities with a high level of variances from the budget for a probable reduction in the supply of inputs.
• Benchmarking: Benchmarking is the process of making a comparison of the products and services offered by the company with that of the other organisations. It aims at identifying the ways to improve products and services of the firm.

Issues, Limitations

The trouble with ABM is its underlying assumption that all of the benefits and costs of a cost object can be translated into monetary terms. For example, the outcome of an ABM analysis might lead management to the conclusion that the workplace should be downgraded to a lower-grade property in order to save money; in reality, a fancier office space is useful for attracting recruits to the company.

For the same reason, it can be difficult to apply ABM to strategic thinking. The problem in this area is that a new strategic direction may be quite expensive in the short-term, but has prospects for a long-term payoff that are difficult to quantify under an ABM analysis.

For the two indicated reasons, the information generated by an ABM analysis cannot be used to drive all management decisions; it is simply information that can then be inserted into the general context of how an organization should be operated. Thus, it is one of several decision tools that management can use.

Risks

A risk with ABM is that some activities have an implicit value, not necessarily reflected in a financial value added to any product. For instance, a particularly pleasant workplace can help attract and retain the best staff, but may not be identified as adding value in operational ABM. A customer who represents a loss based on committed activities, but who opens up leads in a new market, may be identified as a low value customer by a strategic ABM process.

Managers should interpret these values and use ABM as a “common, yet neutral, ground. This provides the basis for negotiation”. ABM can give middle managers an understanding of costs to other teams to help them make decisions that benefit the whole organization, not just their activities’ bottom line.

Backflush accounting is a certain type of “postproduction issuing”, it is a product costing approach, used in a Just-In-Time (JIT) operating environment, in which costing is delayed until goods are finished. Backflush accounting delays the recording of costs until after the events have taken place, then standard costs are used to work backwards to ‘flush’ out the manufacturing costs. The result is that detailed tracking of costs is eliminated. Journal entries to inventory accounts may be delayed until the time of product completion or even the time of sale, and standard costs are used to assign costs to units when journal entries are made. Backflushing transaction has two steps: one step of the transaction reports the produced part which serves to increase the quantity on-hand of the produced part and a second step which relieves the inventory of all the component parts. Component part numbers and quantities-per are taken from the standard bill of material (BOM). This represents a huge saving over the traditional method of:

a) issuing component parts one at a time, usually to a discrete work order.

b) receiving the finished parts into inventory

c) returning any unused components, one at a time, back into inventory.

It can be argued that backflush accounting simplifies costing since it ignores both labour variances and work-in-process. Backflush accounting is employed where the overall business cycle time is relatively short and inventory levels are low.

Backflush accounting is inappropriate when production process is long and this has been attributed as a major flaw in the design of the concept. It may also be inappropriate if the bill of materials contains not only piece goods but also many parts with more or less variable consumption. If the parts with variable consumption are just a few, like grease or the ink used to print product-labels, the consumed quantities can be assigned to product-independent cost centers at the withdrawal from stores (preproduction issuing) and can eventually be broken down afterwards to specific products or product groups, just like any other indirect or overhead expense. Difficulties maintaining correct inventories on shop floor may also appear if it is usual practice to use alternative materials and/or quantities without needing derogation. Therefore, in case of a more complex production system, it is a better approach to use a Manufacturing Execution System (MES) which gathers real production data and is able to deliver exact data to the accounting software or Enterprise resource planning-system where the goods issue is recorded. Thus, variances in consumption, in comparison to the standard bill of materials, are taken into account and assigned to the correct product, production order and workplace. Another advantage of using a MES is that it implements also the Production Track & Trace and the status of work in progress is also known in real time. A disadvantage of MES is that it is not suitable for small series or prototype production. Such type of production should be segregated from the series production and mass production.

Backflush costing is an accounting method that records costs after a good is sold or a service is completed. Backflush costing is common among companies that use a Just-in-Time inventory management system. It avoids the costly and complicated reporting of all expenses as they occur, and instead “flushes” all expenses in a single entry once the production process is completed.

Features

• If the product manufactured involves not only one single product but also many parts along with it with high or low variable consumption, backflush costing becomes inappropriate.
• In backflush costing, the cost of materials is not separately calculated, but it is transferred directly to the finished product account.
• When the units of goods are completed, the material cost is deducted from inventory, and finished goods are transferred to the material account.
• Journal entries in inventory accounts get delayed until the time of production or sale, and the standard costing mechanism is used to assign to units when journal entries are passed.
• The cost of conversion is shared with finished goods inventory account based on the operating time of labor.
• Tracking work in the process is not possible, and no other work account is separately maintained during the process.

Process

• Once a company gets an order, it records only the essential information into the system, such as quantity, delivery date, and the item code. Based on this, the list of materials needed to complete the order is made.
• When the production is about to start, the company takes the delivery of the raw material and shifts it to the production floor.
• Now software does the routing of all the components for that production order. The cost manager still has a say on what parts and how much quantity to push in.
• After the end of the production process, the operator enters all information about the product into the computer. The software then prepares the production report.
• Based on that report, the operator in a single transaction assign materials cost to the production order.

Journal Entry of Backflush Costing

• Simple entry is passed by debiting expenses account and crediting payment a/c i.e., bank or cash A/c or creditor A/c when purchased on credit.
• Finished Goods A/c is debited with all costs incurred in point 1. With corresponding credit above Cost A/cs like Direct Material Cost, processing cost (labor), etc.
• At the time of sales, the cost of corresponding goods which are sold is transferred to the cost of goods Sold with credit to Finished goods A/c.

Backflush accounting is entirely automated, with a computer handling all transactions. The formula for it is:

Number of raw material units removed from stock = (Number of units produced) x (unit count listed in the bill of materials for each component)

Problems with Backflush Accounting

• Requires a fast production cycle time. Backflushing does not remove items from inventory until after a product has been completed, so the inventory records will remain incomplete until such time as the backflushing occurs. Thus, a rapid production cycle time is the best way to keep this interval as short as possible. Under a backflushing system, there is no recorded amount of work-in-process inventory.
• Requires an accurate production count. The number of finished goods produced is the multiplier in the backflush equation, so an incorrect count will relieve an incorrect number of components and raw materials from stock.
• Requires an accurate bill of materials. The bill of materials contains a complete itemization of the components and raw materials used to construct a product. If the items in the bill are inaccurate, the backflush equation will relieve an incorrect number of components and raw materials from stock.
• Requires excellent scrap reporting. There will inevitably be unusual amounts of scrap or rework in a production process that are not anticipated in a bill of materials. If you do not separately delete these items from inventory, they will remain in the inventory records, since the backflush equation does not account for them.

Companies using backflush costing generally meet the following three conditions:

• Short production cycles: Backflush costing shouldn’t be used for goods that take a long time to manufacture. As more time goes by, it becomes increasingly difficult to assign standard costs accurately.
• Customized products: The process is not suitable for the fabrication of customized products since this requires the creation of a unique bill of materials for each item manufactured.
• Material inventory levels are either low or constant: When inventories, the array of finished goods held by a company, are low, the bulk of manufacturing costs will flow into the costs of goods sold, and it is not deferred as inventory cost.

Drawbacks of this costing system are:

• For the results to be accurate, this system needs an accurate production count. In the formula above, the finished goods count is one of the two inputs. So, if this number is wrong, then the resultant figure will not be accurate as well.
• It is relatively difficult to implement.
• Its success also depends on the accuracy of the bill of materials. A bill of material contains the list of all components and raw materials that a product will require. Thus, if there is a discrepancy in the bill of materials, the backflush costing will assign an incorrect amount of raw materials and components.
• Since this system does not record the work-in-process inventory, it needs a fast production cycle time. This costing system does not record inventory until the end of the production. So, during this timeframe, the records will remain incomplete. The only way to ensure records get updated quickly is to shorten or quicken the production cycle.
• Scrap reporting also needs to be accurate. Usually, in a production process, there is a large amount of scrap. The bill of material does not account for this scrap. It is essential to remove these scraps from the inventory to get the right picture.

Investment decision: It is related to capital mix. Firms have scarce resources that must allocated among competitive uses. The financial management provides a framework for firms to take these decisions wisely. The investment decision includes not only those that creates revenues and profits (ex. Introducing product line), but also those that save money (ex. Introduce a more efficient distribution system). The investment decision is the decision related to assets composition of the firm. Investment decision deals with the size and composition of the asset side of the balance sheet. It is also divided into capital budgeting decision (related to fixed asset) and Working capital management (related to current asset).

a) Capital Budgeting: It deals with the size and composition of the fixed assets. The fixed assets of a firm are the primarily determinants of the profitability of the firm. The objective of the capital budgeting decision is to identify those assets which are worth more than their cost. A financial manager therefore has to take utmost care in dealing with the decision.

b) Working capital management: It deals with the management of the current assets of the firms. Though the current asset do not contribute directly to the earnings, yet their existence is necessities for the proper, efficient and optimum utilization of fixed assets. There are the problems of both the excessive working and adequate working capital to the firm. This decision include how much and what inventory to be maintained and how much credit to be given to the customers.

Financing decision: It deals with the financing patterns of the firms. As firms make decisions concerning where to invest resources. They also have to decide how they should raise resources. There are two main resources of finance for any firm, that is shareholders’ funds and the borrowed funds. These sources have their own characteristics. The key distinction between these two resources that the borrowing funds are always repayable but the shareholders’ funds are not always repayable. firms usually adopt a policy of employing both borrowing funds as well as the shareholders’ funds to finance their activities. The employment of these funds in the combination is also known as Financial Leverage. Every such combination has its own implications.

The Dividend Decision: It deals with the appropriation of after-tax profits. These profits are available to be distributed among the shareholders, Or can be retained by the firm for reinvestment within the firm. Every firm, whether it is small or large, have to decide how much of the profits should be reinvested back in the business. And how much should be taken out in form of dividends. these activities are coming under Profit allocation. The distribution of the profits by any firms is required to satisfy the expectation of the shareholders. The profits can be distributed to shareholders either as the Revenue income(ex. expenditure) or as capital receipt(ex. Bonus share). In this attempt the manager has to look into the fund’s requirements of the firms and the shareholders’ interests. so, these are the financial managerial decisions in asset mix, capital mix and profit allocation.

Return on cash Systems

Cash on cash return is a rate of return ratio that calculates the total cash earned on the total cash invested. The amount of the total cash earned is generally based on the annual pre-tax cash flow.

A cash-on-cash return is a rate of return often used in real estate transactions that calculates the cash income earned on the cash invested in a property. Put simply, cash-on-cash return measures the annual return the investor made on the property in relation to the amount of mortgage paid during the same year. It is considered relatively easy to understand and one of the most important real estate ROI calculations.

Cash on cash return is a simple financial metric that allows the assessment of cash flows from a company’s income-generating assets. The ratio is primarily used in commercial real estate transactions. In the real estate industry, the cash-on-cash return is sometimes referred to as the cash yield on a property investment.

The Formula for Cash-on-Cash Return

Cash on Cash Return = Annual Pre-Tax Cash Flow / Total Cash Invested

Annual Pre-Tax Cash Flow​where:

APTCF = (GSR + OI) – (V + OE + AMP)

GSR = Gross scheduled rent

OI = Other incomeV = Vacancy

OE = Operating expenses

AMP = Annual mortgage payments​

A cash-on-cash return is a metric normally used to measure commercial real estate investment performance. It is sometimes referred to as the cash yield on a property investment. The cash-on-cash return rate provides business owners and investors with an analysis of the business plan for a property and the potential cash distributions over the life of the investment.

Cash-on-cash return analysis is often used for investment properties that involve long-term debt borrowing. When debt is included in a real estate transaction, as is the case with most commercial properties, the actual cash return on the investment differs from the standard return on investment (ROI).

Calculations based on standard ROI take into account the total return on an investment. Cash-on-cash return, on the other hand, only measures the return on the actual cash invested, providing a more accurate analysis of the investment’s performance.

Transfer Pricing

Transfer price is the price at which related parties transact with each other, such as during the trade of supplies or labor between departments. Transfer prices are used when individual entities of a larger multi-entity firm are treated and measured as separately run entities. It is common for multi-entity corporations to be consolidated on a financial reporting basis; however, they may report each entity separately for tax purposes.

In taxation and accounting, transfer pricing refers to the rules and methods for pricing transactions within and between enterprises under common ownership or control. Because of the potential for cross-border controlled transactions to distort taxable income, tax authorities in many countries can adjust intragroup transfer prices that differ from what would have been charged by unrelated enterprises dealing at arm’s length (the arm’s-length principle). The OECD and World Bank recommend intragroup pricing rules based on the arm’s-length principle, and 19 of the 20 members of the G20 have adopted similar measures through bilateral treaties and domestic legislation, regulations, or administrative practice. Countries with transfer pricing legislation generally follow the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations in most respects, although their rules can differ on some important details.

Where adopted, transfer pricing rules allow tax authorities to adjust prices for most cross-border intragroup transactions, including transfers of tangible or intangible property, services, and loans. For example, a tax authority may increase a company’s taxable income by reducing the price of goods purchased from an affiliated foreign manufacturer or raising the royalty the company must charge its foreign subsidiaries for rights to use a proprietary technology or brand name. These adjustments are generally calculated using one or more of the transfer pricing methods specified in the OECD guidelines and are subject to judicial review or other dispute resolution mechanisms.

Although transfer pricing is sometimes inaccurately presented by commentators as a tax avoidance practice or technique (transfer mispricing), the term refers to a set of substantive and administrative regulatory requirements imposed by governments on certain taxpayers. However, aggressive intragroup pricing especially for debt and intangibles has played a major role in corporate tax avoidance, and it was one of the issues identified when the OECD released its base erosion and profit shifting (BEPS) action plan in 2013. The OECD’s 2015 final BEPS reports called for country-by-country reporting and stricter rules for transfers of risk and intangibles but recommended continued adherence to the arm’s-length principle. These recommendations have been criticized by many taxpayers and professional service firms for departing from established principles and by some academics and advocacy groups for failing to make adequate changes.

Transfer pricing should not be conflated with fraudulent trade mis-invoicing, which is a technique for concealing illicit transfers by reporting falsified prices on invoices submitted to customs officials. “Because they often both involve mispricing, many aggressive tax avoidance schemes by multinational corporations can easily be confused with trade misinvoicing. However, they should be regarded as separate policy problems with separate solutions,” according to Global Financial Integrity, a non-profit research and advocacy group focused on countering illicit financial flows.

Risks:

1. There can be a disagreement among the organizational division managers as what the policies should be regarding the transfer policies.
2. There are a lot of additional costs that are linked with the required time and manpower which is required to execute transfer pricing and help in designing the accounting system.
3. It gets difficult to estimate the right amount of pricing policy for intangibles such as services, as transfer pricing does not work well as these departments do not provide measurable benefits.
4. The issue of transfer pricing may give rise to dysfunctional behavior among managers of organizational units. Another matter of concern is the process of transfer pricing is highly complicated and time-consuming in large multi-nationals.
5. Buyer and seller perform different functions from each other that undertakes different types of risks. For instance, the seller may or may not provide the warranty for the product. But the price a buyer would pay would be affected by the difference. The risks that impact prices are as follows

• Financial & currency risk
• Collection risk
• Market and entrepreneurial risk
• Product obsolescence risk
• Credit risk

Benefits:

1. Transfer pricing helps in reducing the duty costs by shipping goods into high tariff countries at minimal transfer prices so that duty base associated with these transactions are low.
2. Reducing income taxes in high tax countries by overpricing goods that are transferred to units in those countries where the tax rate is comparatively lower thereby giving them a higher profit margin.

Divisional Performance

1. The Economic Value Added (EVA)

ROI and RI cannot stand alone as a financial measure of divisional performance. One of the factors contribute to a company’s long-run objectives is short-run profit ability. ROI and RI are short-run concepts that deal only with the current reporting period whereas managerial performance measures should focus on future results that can be expected because of present actions.

RI has been refined and re-named as economic value added (EVA) by the Stern Stewart & Co. EVA is a financial performance measure based on operating income after taxes, the investment in assets required to generate that income and the cost of the investment in assets (or, weighted average cost of capital). The objective of EVA is to develop a performance measure that find the ways in which company value can be added or lost. The EVA concept extends the traditional residual income measure by incorporating adjustments to the divisional financial performance measure for distortions introduced by GAAP. Thus, by linking divisional performance to EVA, managers are motivated to focus on increasing shareholder value.

2. The Residual Income (RI)

Residual income overcomes the dysfunctional aspect of ROI. It is because the use of ROI as a performance measurement can lead to under-investment. For example, a manager currently achieving a high rate of return (say 30 percent) may not wish to pursue a project yielding a lower rate of return (say 20 percent) even though such as a project may be desirable to a company which can raise capital at an even lower rate. Thus, used RI is better than ROI.

The purpose of evaluating the performance of divisional managers, RI is defined as controllable contribution less a cost of capital charge on the investment controllable by the divisional manager. For evaluating the economic performance of the division RI can be defined as divisional contribution less a cost of capital charge on the total investment in assets employed by the division.

Besides, RI is favour than ROI and it more flexible because different cost of capital percentage rates can be applied to investments that have different levels of risk. There is not only will the cost of capital of divisions that have different levels of risk differ so may the risk and cost of capital of assets within the same division. The RI measure enables to calculate the different risk-adjusted in capital cost while ROI cannot incorporate these differences.

While ROI is a ratio, RI is an absolute figure. RI deals with the problems of ROI adequately because any investment, which will earn higher than the capital charge will improve the RI. Therefore, use of RI motivates divisional managers to acquire only those assets, which will improve the performance of the company as a whole. Thus, the RI method sets the same profit objective for same assets in different divisions.

A sophisticated system also solves the problem of the same profit objective for different assets in the same division by using different rate of capital charges for different class of assets. RI is definitely a superior measure compared to ROI for measuring divisional performance.

3. The Return on Investment (ROI)

Nowadays, most of companies concentrate on the return on investment (ROI) of a division that is profit as a percentage in direct relation to investment of division which instead of focusing on the size of a division’s profits. ROI addressed divisional profit as a percentage of the assets employed in the division. Assets employed can be defined as total divisional assets, assets controllable by the divisional manager, or net assets.

The main advantage of using ROI is provides a valuable information about the overall approximation on the success of a firm’s past investment policy by providing a abstract of the ex post return on capital invested. According to Kaplan and Atkinson, they state that however, lack of some form of measurement of the ex post returns on capital, there is still useful for accurate estimates of future cash flows during the capital budgeting process. When ROI is used as a managerial performance measure, Measuring returns on invested capital also focuses managers’ attention on the impact of levels of working capital (in particular, stocks and debtors) on the ROI. It can lead to decisions making that are optimal for individual divisions but sub-optimal for the company. ROI focuses on short-term profitability, looking only at the last quarter or last year for performance evaluation. This time horizon may not be long enough for many projects to be evaluated.

(a) It is a comprehensive measure and captures all the factors which influence figures in financial statements.

(b) It is easy to calculate and understand.

(c) It makes comparison of performances of different divisions easy.

(d) Data on ROI of different companies are easily available and that helps in inter-firm comparison.

Kaizen costing is the process of continual cost reduction that occurs after a product design has been completed and is now in production. Cost reduction techniques can include working with suppliers to reduce the costs in their processes, or implementing less costly re-designs of the product, or reducing waste costs. These reductions are needed to give the seller the option to reduce prices in the face of increased competition later in the life of a product.

Characteristics

• Kaizen involves setting standards and then continually improving these standards to achieve long-term sustainable improvements.
• The focus is on eliminating waste, improving processes and systems and improving productivity.
• Involves all employees and all areas of the business.

Kaizen costing is a cost reduction system. Yasuhiro Monden defines kaizen costing as “the maintenance of present cost levels for products currently being manufactured via systematic efforts to achieve the desired cost level.” The word kaizen is a Japanese word meaning continuous improvement.

Monden has described two types of kaizen costing:

• Asset and organization specific kaizen costing activities planned according to the exigencies of each deal.
• Product model specific costing activities carried out in special projects with added emphasis on value analysis.

Kaizen costing is applied to products that are already in production phase. Prior to kaizen costing, when the products are under development phase, target costing is applied. After targets have been set, they are continuously updated to display past improvements, and projected (expected) improvements. Adopting Kaizen costing requires a change in the method of setting standards. Kaizen costing focuses on “cost reduction” rather than “cost control”.

Types of costs under consideration

Kaizen costing takes into consideration costs related to manufacturing stage, which include:

• Costs of supply chain
• Legal costs
• Manufacturing costs
• Waste
• Recruitment costs
• Marketing, sales and distribution
• Product disposal

5S in Kaizen Costing

• Seiri (Sort): Must start from all tools within the workplace by scan through all of them and evaluate their usefulness. Only the necessary tools should keep in the workplace, the useless items should be removed to save the space and enhance the working experience.
• Seiton (Strengthen): The concept that the tools and material must keep in their own place with proper labels or categories. The most frequently used item must place near us while less one should keep in the corner. It will save time for us to look for each specific item.
• Seiso (Shine): The workplace must be clean and tidy every day. All the tools are ready to use and space is available for new work. It will improve the productivity of the employee.
• Seiketsu (Standardize): We must keep the workplace from getting back to the previous condition. There must be a sign, banners, or board to ensure everybody understands and practice as part of daily operation.
• Shitsuke(Sustain): The last step is to inform all staff and departments to practice this culture every day. It is the continuous task that needs to maintain for long.

Principles

Less waste: This method focuses to decrease all kind of wastage since the product design and production and after-sale services.

Increase employee satisfaction: The employees are the key person to identify non-value-added activities and aim to decrease it. They will be able to

Improve working commitment: All the staff levels will commit to their work as they know the company goa, which looking for improvement at all levels. They will leave behind if they not improve, so it encourages them to work harder to archive it.

Increase competitiveness: It will, the advantage when we can improve our product’s quality and sell it at a lower price. We will gain more market share and increase profit in the long term.

Advantages

Waste reduction

Kaizen reduces wastes in business processes. This is another major kaizen advantage. Kaizen is the responsibility of everyone. Therefore, management and staff are responsible for identifying areas that constitute waste in the business process. By implementing constant changes, they can determine the root cause of wastage and fix them. By so doing, waste is eradicated from the business process and cost is reduced.

Improved Standard Work Document

Implementing changes during kaizen results to a new and improved Standard Work Document. Standard Work Document, also called standardized work, is a tool that forms the foundation of kaizen improvements. It contains the current best practice guiding a business. Sometimes, this is the main aim of implementing kaizen. In addition, Standard Work Document serves as the base for future improvements. It also serves as a tool for measuring employee performance and educating new employees about improvements.

Better safety

Improving safety on the work floor is a kaizen advantage for business. Safety is improved when businesses implement ideas that clean up and organize workspace. By so doing, employees have better control of business process equipment. Employees are also encouraged to make suggestions to improve safety on the work floor. This helps to minimize accidents and other related injuries. Hence, employees become more efficient and manage their time properly. However, safety is a responsibility of management as well.

Improved employee satisfaction

Another kaizen advantage is that it improves employee satisfaction. Kaizen involves the employees when implementing changes for improvements. Employees can make suggestions and creative input for changes through a suggestion system like team meetings. When employees are involved in decision making, it gives them a sense of belonging and worth.

Improved teamwork

One of the major kaizen advantages is improved teamwork. Kaizen is a quality improvement tool driven by teamwork. It does not benefit only a selected few, but everyone involved in the business process. As the kaizen team solves problems together, they develop a bond and build team spirit. Thus, employees are able to work with a fresh perspective, an unbiased mind and without prejudice.

Improved efficiency

A major kaizen advantage is improved efficiency. Kaizen improvements boost the quality of services. It helps businesses implement new process improvements, boost efficiency and enhance time management.  For example, Toyota Manufacturing Company employs kaizen in its production process. First of all, they deploy muscle-memory training to train their employees on how to assemble a car. Muscle-memory training helps them to achieve accurate results. Hence, their employees are able to work with precision.

Kaizen builds leadership skills

Every kaizen team must have a team leader. The team leader is responsible for organizing the kaizen team and coordinating implementation. The kaizen team leader makes sure that everyone is performing their roles successfully. The team leader is also responsible for sourcing for help when additional resources are required. Nevertheless, s/he does not have to be in a management role to qualify as a team leader. Thus, another kaizen advantage is that it presents an opportunity for employees to take on leadership roles.

Transfer pricing is arbitrary pricing of exports and imports that may be greater than or less than the arm’s-length prices. It is basically the pricing of intra-corporate transactions. Different units of an MNC operate in different countries on the basis of vertical and horizontal linkages.

Price = Quantity of money received by the seller/Quantity of goods and services rendered received by the buyer

The term ‘price’ needs not be confused with the term ‘pricing’. Pricing is the art of translating into quantitative terms (rupees and paise) the value of the product or a unit of a service to customers at a point in time.

Companies operating in international markets have to identify:

1) The variables those are important in determining prices in international markets.

2) The best approach for setting prices worldwide.

3) The variance in prices across markets.

4) The level of importance that needs to be given to each variable.

5) The variance in prices across customer types.

6) The factors to be considered while determining transfer prices.

Objectives of Transfer Pricing:

1) Reducing incident of customs duty payments

2) Maximizing overall after-tax profits.

3) Circumventing the quota restrictions (in value terms) on imports.

4) Transferring of funds in locations so as to suit corporate working capital policies.

5) Reducing exchange exposure, circumventing exchange controls and restricting profit repatriation so that transfer firms affiliate to the parent can be maximized.

6) ‘Window dressing’ operations to improve the apparent (i.e., reported) financial position of an affiliate so as to enhance its credit ratings.

Types

1) Cost-Plus Pricing:

Companies that follow the cost-plus pricing method are taking the position that profit must be shown for any product or service at every stage of movement through the corporate system. While cost-plus pricing may result in a price that is completely unrelated to competitive or demand conditions in in­ternational markets, many exporters use this approach successfully.

2) Transfer at Cost:

Companies using the transfer-at-cost approach recognize that sales by international affiliates contribute to corporate profitability by generating scale economies in domestic manufacturing operations. This approach assumes lower costs lead to better affiliate performance, which ultimately benefits the entire organisation.

The transfer-at-cost method helps keep duties at a minimum. Companies using this approach have no profit expectation on transfer sales; rather, the expectation is that the affiliate will generate the profit by subsequent resale.

3) “Arm’s-Length” Transfer Pricing:

The price that would have been reached by unrelated parties in a similar transaction is referred to as “arm’s-length” transfer pricing. This approach requires identifying an arm’s-length price, which may be difficult to do except in the case of commodity-type products. The arm’s-length price can be a useful target if it is viewed not as a single point but rather as a range of prices. The important thing to remember is that pricing at arm’s length in differentiated products results not in pre- determinable specific prices but in prices that fall within a pre- determinable range.

4) Market-Based Transfer Price:

A market-based transfer price is derived from the price required to be competitive in the international market. The constraint on this price is cost. However, there is a considerable degree of variation in how costs are defined. Since costs generally decline with volume, a decision must be made regarding whether to price on the basis of current or planned volume levels. To use market-based transfer prices to enter a new market that is too small to support local manufacturing, third-country sourcing may be required. This enables a company to establish its name or franchise in the market without investing in bricks and mortar.

5) Tax Regulations and Transfer Prices:

Since the global corporation conducts business in a world characterized by different corporate tax rates, there is an incentive to maximize system income in countries with the lowest tax rates and to minimize income in high-tax countries. Governments, naturally, are well aware of this. In recent years, many governments have tried to maximize national tax revenues by examining company returns and mandating reallocation of income and expenses.

Environmental cost management enables your business to control the costs associated with the environmental impact of your company’s business operations. Your company may impact the environment in a number of ways, including air pollution, manufacturing emissions, wet land impact and waste disposal.

Environmental costs include current and future environmental impacts your company is responsible for and labor costs associated with accounting for environmental costs. Effective control of environmental costs and promotion of environmental benefits will increase your business’s overall profitability.

Management information included:

• Identifying and estimating the costs of environment-related activities
• Identifying and monitoring the use and cost of resources such as water, electricity and fuel, so costs can be reduced
• Making sure environmental considerations form part of capital investment decisions
• Assessing the likelihood and impact of environmental risks
• Including environment-related indicators as part of routine performance monitoring
• Benchmarking activities against environmental best practice.

Benefits provided:

• Improving sales or reducing sales erosion: consumer awareness of products and services’ environmental impact is increasingly influencing their preferences and buying behaviours.
• Reducing costs: reducing wasteful consumption of input resources has a direct positive impact on reducing costs. Also, improvements to processes can bear down on costs.
• Reducing the cost of failure: investing in processes that reduce the likelihood and cost impact of failure, such as the need to process waste or clean up environmental impacts.
• Improving the image of the organisation: this can enable it to attract better talent, reduce talent attrition and charge higher prices.

Environmental Planning

Trying to manage environmental costs on the spur of the moment will eventually lead to a serious mistake that will cause significant damage to the environment. Effective planning is best accomplished through the efforts of well-designed teams that have the resources available to research all of the possible ramifications of every action the company may take over the next year, and maybe over the next five years.

Environmental planning includes making assessments, studies, evaluating safety features and cost evaluations. Once all of the possible environmental ramifications have been considered, you can make an accurate determination of how much your company’s environmental impact will cost. For example, a new construction project may cause excessive run-off and potential flooding which is easier and less expensive to correct with proper drainage in advance.

Preventing Environmental Damage

When business operations cause significant environmental damage, the costs of recovery may be great enough to cause your company to fail and may bring about lawsuits that may take years to close. Preventing environmental damage is a matter of educating everyone in the company on how to do their job without harming the environment.

Establish policies that clearly outline how you expect the job to be done, while at the same time protecting the environment. This can be as simple as establishing guidelines on proper disposal of chemicals and other waste products. When you achieve these goals, you will increase the potential value of your company.

Environmental Priorities

Begin by evaluating all of your internal and external operations. If protecting the environment is a company priority or subject of regulations, you will need to make sure that business operations that negatively impact the environment are eliminated or mitigated. Engage your employees in the environmental priorities you have set for the company.

As an example, if your company has an impact on water resources, it is important for your employees to ensure every action the company takes does not allow toxins to leave your facility and enter nearby streams and aquifers. Remember, there are significant costs associated with environmental cleanup if toxins are inadvertently released into the environment.

Integrated Accounting Activities

Controlling environmental impact costs is best accomplished by integrating all of your accounting activities. Costs you need to control include labor costs related to your environmental impact, material costs, cost related to administration activities and costs related to manufacturing activities. All of these costs should be brought together into a single accounting system that produces reports that allow you to consider and manage all of your environmental costs through understandable graphs and metrics.

Environmental costs can be categorised as follows:

• Prevention costs: costs associated with preventing adverse environmental impacts.
• Appraisal costs: costs of assessing compliance with environmental policies.
• Internal failure costs: costs of eliminating environmental impacts that have been created by the organisation.
• External failure costs: costs incurred after environmental damage has been caused outside the organisation.

The management and control of the resources used in most commercial organisations leaves a great deal to be desired. Waste is growing at such an enormous rate that it has spawned a new industry for recycling and extracting useful materials.

Materials are wasted in a number of ways such as effluents, breakage, contamination, inefficient storage, poor workmanship, low quality, pilfering and obsolescence. All these contribute to significantly increased material costs and all can be controlled by efficient working methods and effective control.

Total productive Maintenance

Total Productive Maintenance (TPM) was developed by Seiichi Nakajima in Japan between 1950 and 1970. This experience led to the recognition that a leadership mindset engaging front line teams in small group improvement activity is an essential element of effective operation. The outcome of his work was the application of the TPM process in 1971.

Total Productive Maintenance (TPM) started as a method of physical asset management focused on maintaining and improving manufacturing machinery, in order to reduce the operating cost to an organization. After the PM award was created and awarded to Nippon Denso in 1971, the JIPM (Japanese Institute of Plant Maintenance), expanded it to include 8 pillars of TPM that required involvement from all areas of manufacturing in the concepts of lean Manufacturing.

Total productive maintenance (TPM) is the process of using machines, equipment, employees and supporting processes to maintain and improve the integrity of production and the quality of systems. Put simply, it’s the process of getting employees involved in maintaining their own equipment while emphasizing proactive and preventive maintenance techniques. Total productive maintenance strives for perfect production. That is:

• No breakdowns
• No stops or running slowly
• No defects
• No accidents

TPM is designed to disseminate the responsibility for maintenance and machine performance, improving employee engagement and teamwork within management, engineering, maintenance, and operations.

Principles

The eight pillars of TPM are mostly focused on proactive and preventive techniques for improving equipment reliability:

• Autonomous Maintenance: Operators who use all of their senses to help identify causes for losses
• Focused Improvement: Scientific approach to problem solving to eliminate losses from the factory
• Planned Maintenance: Professional maintenance activities performed by trained mechanics and engineers
• Quality management: Scientific and statistical approach to identifying defects and eliminating the cause of them
• Early/equipment management: Scientific introduction of equipment and design concepts that eliminate losses and make it easier to make defect free production efficienly.
• Education and Training: Support to continuous improvement of knowledge of all workers and management
• Administrative & office TPM: Using TPM tools to improve all the support aspects of a manufacturing plant including production scheduling, materials management and information flow, As well as increasing moral of individuals and offering awards to well deserving employees for increasing their morals.
• Safety Health Environmental condition’s

The main objective of TPM is to increase the Overall Equipment Effectiveness (OEE) of plant equipment. TPM addresses the causes for accelerated deterioration and production losses while creating the correct environment between operators and equipment to create ownership.

OEE has three factors which are multiplied to give one measure called OEE

Performance x Availability x Quality = OEE

Each factor has two associated losses making 6 in total, these 6 losses are as follows:

Performance = (1) running at reduced speed – (2) Minor Stops

Availability = (3) Breakdowns – (4) Product changeover

Quality = (5) Startup rejects – (6) Running rejects

Implementation

Following are the steps involved by the implementation of TPM in an organization:

• Initial evaluation of TPM level,
• Introductory Education and Propaganda (IEP) for TPM,
• Formation of TPM committee,
• Development of a master plan for TPM implementation,
• Stage by stage training to the employees and stakeholders on all eight pillars of TPM,
• Implementation preparation process,
• Establishing the TPM policies and goals and development of a road map for TPM implementation.

Pillars of TPM

TPM in administration: A good TPM program is only as good as the sum of its parts. Total productive maintenance should look beyond the plant floor by addressing and eliminating areas of waste in administrative functions. This means supporting production by improving things like order processing, procurement and scheduling. Administrative functions are often the first step in the entire manufacturing process, so it’s important they are streamlined and waste-free. For example, if order-processing procedures become more streamlined, then material gets to the plant floor quicker and with fewer errors, eliminating potential downtime while missing parts are tracked down.

Safety, health and environment: Maintaining a safe working environment means employees can perform their tasks in a safe place without health risks. It’s important to produce an environment that makes production more efficient, but it should not be at the risk of an employee’s safety and health. To achieve this, any solutions introduced in the TPM process should always consider safety, health and the environment.

Training and education: Lack of knowledge about equipment can derail a TPM program. Training and education applies to operators, managers and maintenance personnel. They are intended to ensure everyone is on the same page with the TPM process and to address any knowledge gaps so TPM goals are achievable. This is where operators learn skills to proactively maintain equipment and identify emerging problems. The maintenance team learns how to implement a proactive and preventive maintenance schedule, and managers become well-versed in TPM principles, employee development and coaching.

Early equipment management: The TPM pillar of early equipment management takes the practical knowledge and overall understanding of manufacturing equipment acquired through total productive maintenance and uses it to improve the design of new equipment. Designing equipment with the input of people who use it most allows suppliers to improve maintainability and the way in which the machine operates in future designs.

Quality maintenance: All the maintenance planning and strategizing in the world is all for naught if the quality of the maintenance being performed is inadequate. The quality maintenance pillar focuses on working design error detection and prevention into the production process.

Planned maintenance: Planned maintenance involves studying metrics like failure rates and historical downtime and then scheduling maintenance tasks based around these predicted or measured failure rates or downtime periods. In other words, since there is a specific time to perform maintenance on equipment, you can schedule maintenance around the time when equipment is idle or producing at low capacity, rarely interrupting production.

Focused improvement: Focused improvement is based around the Japanese term “kaizen,” meaning “improvement.” In manufacturing, kaizen requires improving functions and processes continually. Focused improvement looks at the process as a whole and brainstorms idea for how to improve it. Getting small teams in the mindset of proactively working together to implement regular, incremental improvements to processes pertaining to equipment operation is key for TPM. Diversifying team members allows for the identification of recurring problems through cross-functional brainstorming. It also combines input from across the company so teams can see how processes affect different departments.

Autonomous maintenance: Autonomous maintenance means ensuring your operators are fully trained on routine maintenance like cleaning, lubricating and inspecting, as well as placing that responsibility solely in their hands. This gives machine operators a feeling of ownership of their equipment and increases their knowledge of the particular piece of equipment. It also guarantees the machinery is always clean and lubricated, helps identify issues before they become failures, and frees up maintenance staff for higher-level tasks.

Energy Audit

An energy audit is an inspection survey and an analysis of energy flows for energy conservation in a building. It may include a process or system to reduce the amount of energy input into the system without negatively affecting the output. In commercial and industrial real estate, an energy audit is the first step in identifying opportunities to reduce energy expense and carbon footprint.

When looking to the existing audit methodologies developed in IEA EBC Annex 11, by ASHRAE and by Krarti (2000), it appears that the main issues of an audit process are:

• The analysis of building and utility data, including study of the installed equipment and analysis of energy bills;
• The survey of the real operating conditions;
• The understanding of the building behaviour and of the interactions with weather, occupancy and operating schedules;
• The selection and the evaluation of energy conservation measures;
• The estimation of energy saving potential;
• The identification of customer concerns and needs.

Generally, four levels of analysis can be outlined (ASHRAE):

• Level 0: Benchmarking: This first analysis consists in a preliminary Whole Building Energy Use (WBEU) analysis based on the analysis of the historic utility use and costs and the comparison of the performances of the buildings to those of similar buildings. This benchmarking of the studied installation allows determining if further analysis is required.
• Level I: Walk-through audit: Preliminary analysis made to assess building energy efficiency to identify not only simple and low-cost improvements but also a list of energy conservation measures (ECMs, or energy conservation opportunities, ECOs) to orient the future detailed audit. This inspection is based on visual verifications, study of installed equipment and operating data and detailed analysis of recorded energy consumption collected during the benchmarking phase;
• Level II: Detailed/General energy audit: Based on the results of the pre-audit, this type of energy audit consists in energy use survey in order to provide a comprehensive analysis of the studied installation, a more detailed analysis of the facility, a breakdown of the energy use and a first quantitative evaluation of the ECOs/ECMs selected to correct the defects or improve the existing installation. This level of analysis can involve advanced on-site measurements and sophisticated computer-based simulation tools to evaluate precisely the selected energy retrofits;
• Level III: Investment-Grade audit: Detailed Analysis of Capital-Intensive Modifications focusing on potential costly ECOs requiring rigorous engineering study.