Part Five: Cost m anagement and s trategic performance management Chapter Twenty-one:

1. Part Five: Cost management and strategic performance management Chapter Twenty-one: Strategic cost management

2. 21.1a • Traditional management accounting control techniquestend to focus on cost containment whereas costmanagement concentrates on cost reduction. • Traditional management accounting control techniquesare routinely applied on a continuous basis whereas costmanagement tends to be applied on an ad hoc basis. • Many of the approaches that fall within the area of costmanagement do not rely exclusively on accounting techniques

3. 21.1b Life-cycle costing (LCC) • Traditional management accounting procedures havefocused primarily on the manufacturing stage of aproduct’s life cycle. • LCC focuses on costs over the product’s entire life cycle to determine whether profits earned during themanufacturing phase will cover the costs incurred duringthe pre-and post-manufacturing stages. • A large proportion of a product’s costs can be committedor ‘locked in ’during the planning and design stage (seeFigure 21.1 on slide 2). • Cost management can be most effectively exercised duringthe planning and design stage.

4. 21.2

5. 21.3a • Target costing • • Focuses on managing costs during a product/service’s planning anddesign phase. • • Involves the following stages: • Determine the target price which customers will be prepared to payfor the product. • Deduct a target profit margin from the target price to determine thetarget cost. • Estimate the actual cost of the product. • If estimated actual cost exceeds the target cost investigate ways ofdriving down the actual cost to the target cost. • Iterative process involving: • Tear-down analysis • Value analysis and functional analysis • • It is important that target costing is supported by an accurate costingsystem using appropriate cause-and-effect cost drivers.

6. 21.3b Kaizen Costing • Kaizen costing is applied during manufacturing stage whereas target costing is during planning stage. • Kaizen costing focuses on production processes whereastarget costing focuses on the product. • Kaizen costing aims to reduce costs of processes by a pre-specified amount relying on employee empowerment.

7. 21.4 An example of target costing

8. 21.5a • Activity-based management (ABM) • • Involves the following stages: • Identifying the major activities that take place in an organization. • Assigning costs to cost pools/cost centres for each activity. • Determining the cost driver for each activity. • • Omits the fourth stage required for product costing ABC. • • ABM focuses on managing the business on the basis of the activitiesthat make up the organization — by managing the activities costs aremanaged in the long term. • • Traditional control reports analyze costs by types of expenses for eachresponsibility centre whereas ABM analyses costs by activities (see slide 10 for an illustration). • • Knowing the cost of activities is a catalyst for triggering action tobecome competitive.

9. 21.5b • Activity-based management (ABM) - contd • Activity cost information is useful for prioritizing those activities that need to • be studied more closely. Activities can be classified: • As value-added or non-value-added. • According to a scale similar to that advocated by Kaplan and Cooper. • Activity-based systems can also be used to manage costs at the designstage using behavioural drivers. • Surveys also suggest that many organizations use cost driver rates asmeasures of cost efficiency • Example • Cost of purchasing activity = £100,000 Orders processed = 10,000 • Cost per order = £10 (Used for relative, trend and budgetcomparisons).

10. 21.6 Example Customer order processing activity Traditional analysis (customer order processing department)£000 ’s Salaries 320 Stationery 40 Travel 140 Telephone 40 Depreciation of equipment 40 580 ABM analysis Preparing quotations 120 Receiving customer orders 190 Assessing the credit-worthiness of customers 100 Expediting 80 Resolving customer problems 90 580

11. 21.7 • Benchmarking • Objective is to improve key activities/processes • Compares key activities/processes with world-class best practices. • Widely used in public sector organizations. • League tables widely used • Can result in dysfunctional consequences.

12. 21.8 • Business process re-engineering (BPR) • • A business process consists of a collection of activitiesthat are linked together in a co-ordinated manner toachieve a specific objective. • • BPR involves examining business processes and makingsubstantial changes to how the organization operates byfocusing on: • Cost reduction • Simplification • Improved quality and enhanced customer satisfaction.

13. 21.9 • Quality cost management • • Quality is now one of the key competitive variables. • • Management accountants are now placing greater emphasis on theprovision of information relating to the cost of quality. • • Cost of quality reports prepared periodically: • Prevention costs • Appraisal costs • Internal failure costs • External failure costs • • Increasing attention is also being given to continuous improvementwith the aim of zero defects. • • Non-financial measures and statistical quality control tools also play akey role in improving quality and reducing internal and external failurecosts.

14. 21.10a Cost of quality report

15. 21.10b Cost of quality report (contd)

16. 21.11a • Environmental cost management • Becoming of increasing importance because: • Environmental costs can represent a large proportion of operating costs in some companies. • Demands from society for companies to become environmentally friendly

17. 21.11b • Information should be reported relating to the amount and categories of environmental costs and their causes. • Proposed that an environmental cost report similar to a quality cost report (see slides 15 and 16) should be periodically produced that reports costs by the following categories: • Environmental protection costs • Environmental appraisal costs • Environmental internal failure costs • Environmental external failure costs • Some companies have incorporated an environmental perspective within the balanced scorecard.

18. 21.12a Cost management and the value chain • The value chain (see Fig.21.3 - slide 19) is the linked setof value-creating activities from supplier to customer. • Objective is to perform value chain activities moreefficiently and at a lower cost than the competitors. • Focus should be on each link in the chain from the customer’s perspective. • Critics claim that traditional management accountingstarts too late and finishes too soon in terms of the valuechain.

19. 21.12b Figure 21.3 The value chain