strategic cost management 1219652300879738 9

7/31/2019 Strategic Cost Management 1219652300879738 9

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Strategic Cost Management

By

Augustin AmaladasProf. Augustin Amaladas


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Strategic Management

Traditional Management accounting is based oncomparing actual results against pre setstandard (Typically budget), identifying and

analysing variances and taking remedial actionto ensure that future outcomes confirm withbudgeted outcomes.

Existing activities are not reviewed.

They are based on cost containment rather thancost reduction. But strategic management is focuses on cost

reduction and continuous improvement.


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Value analysis/value engineering

Aims at the assigned target cost byA)identifying improved product design

Eliminating unnecessary functions thatincreases product cost and for whichcustomers are not willing to pay for it.

Requires functional analysis

The value for each element is determined whichcustomer is willing to pay.


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Value analysis/value engineering

Cost of each function of a product iscompared with the benefits perceived by

the customers. If the cost of the function exceeds the

benefit to the customer, the function is

either eliminated, modified to reduce thecost or enhanced in terms of its perceivedvalue so that its value exceeds the cost.


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2.Business process reengineering

Examining business process and makingsubstantial changes

Redesign of how work done throughactivities.

Collection of activities that are linked

together in a coordinated manner toachieve a specific objective

Example: See next slide


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Material handling

Scheduling production

Storing material

Processing business orders

Inspectingmaterials

Paying suppliers


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Aims of reengineering

Improve the key business processes Simplification, cost reduction, improved

quality and enhanced customersatisfaction.


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Process

Sending production schedule direct to thenominated suppliers and ask the suppliers

to deliver according to the productionschedule.

Inspection done for quality in the

suppliers centre. Benefit: permanent reduction of storage

cost, handling cost, inspection cost


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Reengineering

Features: 1. radical and dramatic changesin the processes

2. Abandoning current practices andreinventing completely new methods ofperforming business processes.

3. Focus on major changes rather thanmarginal change.

4.It also involves adopting JIT system


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3.TQM

All business functions are involved in a process ofcontinuous quality improvement

Moved from statistical monitoring of manufacturingprocesses to customer oriented process of continuousimprovement

High quality but on time Earlier belief is that quality increases cost but it has

saved many companies because of quality.

Better to produce product at cheaper rate first ratherthan wasting resources by making substandard productand spending on rework, rejection, scraped or return tocustomers

How is it done?


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TQM

Management accounting can providereports and measures that motivate and

evaluate managerial efforts to improvequality

The reports are divided into 1.prevention cost 2.appraisal cost 3.Internal failure cost 4.external failure cost


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Cost of quality report

1.Prevention costs

Percentage of sales

Quality trainingSupplier reviews

Quality engineering

Preventivemaintenance


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2. Appraisal costs Inspection of materialreceived

Inspection of WIP andcompleted units

Testing equipment

Quality audits


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3. Internal failure cost Scrap

Rework

Down due to qualityproblems

retesting


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4. External failure costs Returns

Recalls

Warranty repairsHandling customercomplaints

Foregone contributionfrom lost sales


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How Zero defects policydetermined?

Do not use percentages as a unit ofmeasurement

Use parts per million (PPM) It creates pressure for action and trend in defectrates.

Quality reports are useful to top managementwhere as non financial quality measures providemore timely and appropriate target measure forquality improvement.


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Statistical tools

Quality control chart used to distinguishbetween random and non-randomvariations in operating processes. We useX+1SD: X+2SD

days

u

sage

Operation-A

_

X+1SD

_

X+2sd

Statistical quality control chart

_

X_X-1sd_

X-2d


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Control chart-explanations

The control limits are based on a series of pastobservations of a process when it is under control andworking efficiently.

The Past observations are used to estimate thepopulation mean and the population standard deviation. If control limits are say X+2sd , so that all observations

are outside the range are investigated.

X+/- 2sd covers 95.45% of the population therefore4.55% of future operations would result from purechance when process is under control.


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Problems

Page-958 views 22.2 in Drury


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4.Value chain analysis

Performance of one activity affects theperformance and cost of other activities.

It gives link performance of one and itseffects on the other.

There are interdependent exist between

activities and greater amount ofcoordination required


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5.Product life cycle costing

Traditional management accountingcontrol procedures have focused primarily

on the manufacturing stage of a productslife cycle.

Pre-manufacturing costs such as R&D,design, post manufacturing abandonment

and disposal costs are treated as periodcost .They are not incorporated in theproduct cost calculation.


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Product life cycle costing-continuation

Life cycle costing estimates andaccumulates costs over the entire product

life cycle so that the profit earned willcover the entire life cycle cost.

It helps management to understand the

cost consequence of developing andmaking a product and identify areas forcost reduction.


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Tradition vs life cycle reporting

Most of the reporting on a perodby-period basis

Profits are not monitored over the life ofthe product

LCR traces costs and revenues over

various calendar periods. Hurdles: tracing all costs inadequate feed back

information


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Product life cycle phases-relationshipbetween costs committed and costs incurred

Percenta

geofcostsand

committed

Product life cycle

Postsalesandservice

Andaban

donmentphas

e

20%

40%

60%

80%

100%


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Explanations

1.80% of the costs are committedduring the planning and designstage

2.Majority of costs are incurred atthe manufacturing stage but theyhave aready become locked in atthe planning and design stage anddifficult to alter.

3.The pattern of cost commitmentand incurrence will differ based onthe industry and specific productintroduced.

1.Cost management can be mosteffectively exercised duringplanning and design stage and notat the manufacturing stage.

2.Later stage more focus on costcontainment than costmanagement.

3. Aeroplanes manufacturing-highcosts at planning and developmentbut huge abandonment costs atnuclear waste and other toxicchemicals.


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problems

Advanced cost and managementAccounting-by Saxana and Vasist

Prob.16.48-P.16.59 Prob.16.49-P.16.61 Cost and management accounting by

Drury-prob.22.18-P979-981


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Activity Based Costing Historical development

Traditionally cost accountants had arbitrarily added abroad percentage of expenses onto the direct costs toallow for the indirect costs.

However as the percentages of indirect or overheadcosts had risen, this technique became increasingly

inaccurate because the indirect costs were not causedequally by all the products. For example, one productmight take more time in one expensive machine thananother product, but since the amount of direct laborand materials might be the same, the additional cost forthe use of the machine would not be recognised whenthe same broad 'on-cost' percentage is added to allproducts. Consequently, when multiple products sharecommon costs, there is a danger of one productsubsidizing another.
http://en.wikipedia.org/wiki/Accountanthttp://en.wikipedia.org/wiki/Direct_costhttp://en.wikipedia.org/wiki/Indirect_costhttp://en.wikipedia.org/wiki/Direct_costhttp://en.wikipedia.org/wiki/Indirect_costhttp://en.wikipedia.org/wiki/Overhead_costhttp://en.wikipedia.org/wiki/Overhead_costhttp://en.wikipedia.org/wiki/Overhead_costhttp://en.wikipedia.org/wiki/Overhead_costhttp://en.wikipedia.org/wiki/Overhead_costhttp://en.wikipedia.org/wiki/Indirect_costhttp://en.wikipedia.org/wiki/Direct_costhttp://en.wikipedia.org/wiki/Accountant


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The 1970s and 1980s

The concepts of ABC were developed in themanufacturing sector of the United States duringthe 1970s and 1980s. During this time, theConsortium for Advanced Manufacturing-International, now known simply as CAM-I,provided a formative role for studying and

formalizing the principles that have becomemore formally known as Activity-BasedCosting.[1]
http://en.wikipedia.org/wiki/Manufacturing_sectorhttp://en.wikipedia.org/w/index.php?title=Consortium_for_Advanced_Manufacturing-International&action=edithttp://en.wikipedia.org/w/index.php?title=Consortium_for_Advanced_Manufacturing-International&action=edithttp://en.wikipedia.org/wiki/Activity-based_costinghttp://en.wikipedia.org/wiki/Activity-based_costinghttp://en.wikipedia.org/w/index.php?title=Consortium_for_Advanced_Manufacturing-International&action=edithttp://en.wikipedia.org/w/index.php?title=Consortium_for_Advanced_Manufacturing-International&action=edithttp://en.wikipedia.org/w/index.php?title=Consortium_for_Advanced_Manufacturing-International&action=edithttp://en.wikipedia.org/wiki/Manufacturing_sector


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cost management systems

Robin Cooper and Robert Kaplan, proponent of theBalanced Scorecard, brought notice to these concepts ina number of articles published in Harvard BusinessReview

beginning in 1988. Cooper and Kaplan describedABC as an approach to solve the problems of traditionalcost management systems. These traditional costingsystems are often unable to determine accurately theactual costs ofproduction and of the costs of related

services. Consequently managers were making decisionsbased on inaccurate data especially where there aremultiple products.
http://en.wikipedia.org/wiki/Cost_managementhttp://en.wikipedia.org/wiki/Robin_Cooperhttp://en.wikipedia.org/wiki/Robert_Kaplanhttp://en.wikipedia.org/wiki/Balanced_Scorecardhttp://en.wikipedia.org/wiki/Cost_managementhttp://en.wikipedia.org/wiki/Factors_of_productionhttp://en.wikipedia.org/wiki/Factors_of_productionhttp://en.wikipedia.org/wiki/Cost_managementhttp://en.wikipedia.org/wiki/Balanced_Scorecardhttp://en.wikipedia.org/wiki/Robert_Kaplanhttp://en.wikipedia.org/wiki/Robin_Cooperhttp://en.wikipedia.org/wiki/Cost_management


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Instead of using broad arbitrary percentages toallocate costs, ABC seeks to identify cause andeffect relationships to objectively assign costs.

Once costs of the activities have been identified,the cost of each activity is attributed to eachproduct to the extent that the product uses theactivity. In this way ABC often identifies areas of

high overhead costs per unit and so directsattention to finding ways to reduce the costs orto charge more for costly products.


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They initially focused on manufacturing industrywhere increasing technology and productivityimprovements have reduced the relativeproportion of the direct costs of labor andmaterials, but have increased relative proportionof indirect costs. For example, increased

automation has reduced labor, which is a directcost, but has increased depreciation, which is anindirect cost.


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Like manufacturing industries, financialinstitutions also have diverse products andcustomers which can cause cross-product cross-

customer subsidies. Since personnel expensesrepresent the largest single component of non-interest expense in financial institutions, thesecosts must also be attributed more accurately toproducts and customers. Activity based costing,

even though originally developed formanufacturing, may even be a more useful toolfor doing this
http://en.wikipedia.org/wiki/Financial_institutionhttp://en.wikipedia.org/wiki/Financial_institutionhttp://en.wikipedia.org/wiki/Financial_institutionhttp://en.wikipedia.org/wiki/Financial_institutionhttp://en.wikipedia.org/wiki/Financial_institution


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cost driver

Direct labor and materials are relatively easy to tracedirectly to products, but it is more difficult to directlyallocate indirect costs to products. Where products usecommon resources differently, some sort of weighting isneeded in the cost allocation process. The measure ofthe use of a shared activity by each of the products isknown as the cost driver. For example, the cost of theactivity of bank tellers can be ascribed to each product

by measuring how long each product's transactionstakes at the counter and then by measuring the numberof each type of transaction.
http://en.wikipedia.org/wiki/Cost_driverhttp://en.wikipedia.org/wiki/Cost_driverhttp://en.wikipedia.org/wiki/Cost_driverhttp://en.wikipedia.org/wiki/Cost_driver


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Limitations

Even in activity-based costing, some overheadcosts are difficult to assign to products andcustomers, for example the chief executive's

salary. These costs are termed 'businesssustaining' and are not assigned to products andcustomers because there is no meaningfulmethod. This lump of unallocated overhead

costs must nevertheless be met by contributionsfrom each of the products, but it is not as largeas the overhead costs before ABC is employed.


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Although some may argue that costsuntraceable to activities should be

"arbitrarily allocated" to products, it isimportant to realize that the only purposeof ABC is to provide information tomanagement. Therefore, there is noreason to assign any cost in an arbitrarymanner.


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The Four Steps to ABCImplementation

1. Identify activitiesperform an in-depth analysis of the operating

processes of each responsibilitysegment. Each process may consist ofone or more activities required byoutputs.


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Assign resource costs toactivities

this is sometimes called "tracing." Traceability refers to tracingcosts to cost objects to determine why costs were incurred. DoDcategorizes costs in three ways:

Directcosts that can be traced directly to one output. Example: thematerial costs (varnish, wood, paint) to build a chair.

Indirectcosts that cannot be allocated to an individual output; inother words, they benefit two or more outputs, but not all outputs.Examples: maintenance costs for the saws that cut the wood, storagecosts, other construction materials, and quality assurance.)

General & Administrativecosts that cannot reasonably beassociated with any particular product or service produced

(overhead). These costs would remain the same no matter whatoutput the activity produced. Examples: salaries of personnel inpurchasing department, depreciation on equipment, and plantsecurity


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Identify outputsy

Identify all of the outputs for which anactivity segment performs activities and

consumes resources. Outputs can beproducts, services, or customers (personsor entities to whom a federal agency isrequired to provide goods or services


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Assign activity costs to outputs

1. activity costs to outputs using activitydrivers. Activity drivers assign activitycosts to outputs based on individualoutputs consumption or demand foractivities. For example, a driver may bethe number of times an activity is

performed (transaction driver) or thelength of time an activity is performed(duration driver).


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Activity-Based Costing encouragesmanagers to identify which activities are

value-addedthose that will bestaccomplish a mission, deliver a service, ormeet a customer demand. It improvesoperational efficiency and enhancesdecision-making through better, moremeaningful cost information


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6.Activity based costing/Targetcosting

Mechanism for determining selling prices. It is a cost management tool.

TATA tries to manufacture a car at Rs. 1,00,000. is a typical example for targetcosting.


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Stages of target costing

1. Determine the target price whichcustomers will be prepared to pay for theproduct

2.Deduct a target profit margin fro thetarget price to determine the target cost

3. Estimate the actual cost of the product 4.If estimated actual cost exceeds the

target cost , investigate ways of drivingdown the actual cost to the target cost


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Target costing-Continues

Customer oriented approach Used by Japanese copanies and recently

adopted by Europe and the USA.

Recently call canters are trying to adopt

this as Indian currency strengthened.

P d


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Procedures:

1.Market research to find the customersperceived value-tear down analysis-examining

the competitors products-dismantling of thecompetitor's product.use value engineering

2.How customers differentiate the product fromthe competitors

3.Target profit margin depends on planned returnon investment and fix % of profits on sales

4.Decomposed into a target profit for eachproduct.

5.Deduct the target profit from target price

6.Compare with the predicted actual cost.

7. If predicted cost>target cost then efforts are

made to close the gap.


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What is required?

Team approach Team members include: 1.designers 2.

engineers 3. Purchasing 4. manufacturing 5.

marketing 6. management accounting personnel The discipline of a team approach ensures that

no particular group is able to impose functionalpreferences.

Aim During product design process is thatelimination of product functions that add costswhich do not increase market price.


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Role of suppliers

Suppliers are included in the design team They can suggest standard

parts/alternative parts instead of custom-design parts which will reduce the productcost.


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If target costs not achieved ?

Product should not be launched Design teams should not be allowed to

achieve target cost by eliminatingdesirable product functions.

Design teams use tear-down analysis

Value engineering is to achieve the targetcost.


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Problems

1. Illustration of target costing-Management and cost accounting by Colin

Drury-page 948


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7. Kaizen costing

It is a mechanism for reducing and managing costs. Improvement to the process rather than applied during

design stage.

Cost reduction through the increased efficiency of theproduction process. To reduce the cost of components and the products by a

pre-specified amount

It is heavily on empowerment of employees Workers are given more responsibilities to improve the

processes and reduce costs.


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8.The balanced score card

The most recent contribution to strategicmanagement accounting

Integrated framework of performancemeasurement

Balanced score card analysis by Southwest

Airlines-Next page


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Balanced score card analysis bySouthwest by Kaplan and Norton

Balanced

score card

analysis

2.Customer

How do customer

See us?

3.Internal

What must we excel

At?

4.LearningCan we continue to

Improve and

Create value?

1.Financial

How do we look

To shareholders?

1 Fi i l


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1.Financialpotential score cardmeasures(Looking back)

Market shareRevenue growthOperating profitReturn on equity

Stock MarketPerformance

Growth in margin

Patient censesUnit profitability

Fund raisedFor capital

ImprovementCost per care% of revenue

-new program

Revenue/cost

Per available

Passenger mile

Mix of freightMix of full fare

To discounted

Average age

of fleet

Available seat

Miles and

related

yields

Outstanding

Loan balances

Deposit balances

Non interest income

Generic Health care Airlines Banking


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2.Customer serviceand satisfaction(Lookingfrom

the outside in)

Customersatisfaction

Customer retentionQuality customer

ServiceSales from new

Products/services

Patientsatisfactory

SurveyPatient retentionPatient referral

RateAdmission or disCharge timeliness

Medical planawareness

Lost bag report

Per 10000Passangers

Denied boarding

Rate

Flight cancellation

Rate

Customer complaIns.

Customer retention

No. of new

Customers

No.of products

Per customer

Face time spent

Between loan

Officers and

customersGeneric

Health careAirlines Banking

l


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3. Internal operatingefficiency(Inside out)

Delivery time costProcess qualityError rates on

ShipmentsSupplier

satisfaction

Weekly patientComplaints

Patient loadsBreakthroughs

In treatments andMedicines

Infection ratesRe-admission

Rate

Length of stay

Load factors

(% of seat occupied)

Utilisation factor

On time performance

Sales calls to

Potential

Customers

thank you calls

Cards to new

Customers

Cross selling

statistics



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4. Learning andGrowth(looking ahed)

Employee skill

LevelTraining availa

BilityEmployee

satisfactionJob retention

Over time worked

VacationTime taken

TraininghoursPer care giver

No. of peerviewed

Papers publishedNo.of grants

awardedReferring MDs

Employee turnover

rate

EmployeeAbsenteeism

Work safety statistics

Performance

Appraisals completed

Training programs

Hours per employee

Test results from

Training knowledge

Of product offering,

Sales, and service

Employee satis

Faction survey


S t Ai li B l d S d f k


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Soutern Airlines Balanced Scorecard frame workStrategic theme

Operating efficiency

Objectives

(achieve&critical to

success)

Measurement

How success aremeasured)

Target(rate

Ofimprovement

needed)

Initiative

(Key action)

Financial Profitability

Morecustomers

Fewer planes

Market value

Seat revenue

Plane least cost

30% CAGR

20% CAGR

5% CAGR

Customer Flight is ontime

Lowest prices

FAA on timearrival rating

Customerranking(Market)

1

1

Qualitymanagement

Customerloyaltyprogram

Internal

learning

Fast internal

Turnaround

Ground crewalignment

On ground time

On timedeparture

%ground crewtrained

% Ground crewstockholders

30 minutes

90%

Yr.1 70%

Yr.3 90%

Yr.5 100%

Cycle timeoptimisation

ESOP

Ground crew

training


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Benefits and limitations

1. single report but four differentperspective

2.Specific performance measure Operational measurements together Improves communications within

organisation


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Problems

Drury-27.17 page-1024 Drury-23.18 page 1025


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Activity Based costing

Learning objectives: Explain why a cost accumulation system is required for generating

relevant cost information for decision making;

Describe the differences between activity-based and traditional

strategic cost management 1219652300879738 9

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