MANAGEMENT

ACCOUNTING FOR
BUSINESS
SIXTH EDITION

COLIN DRURY

For use with Management Accounting for Business 6e

By Colin Drury
9781408093818 © 2016 Cengage Learning
 Part Five:
Strategic cost management and
performance management

Chapter Fourteen:
Strategic cost management

For use with Management Accounting for Business 6e

By Colin Drury
9781408093818 © 2016 Cengage Learning
 14.1a

• Traditional management accounting control techniques tend to

focus on cost containment whereas cost management
concentrates on cost reduction.

• Traditional management accounting control techniques are

routinely applied on a continuous basis whereas cost
management tends to be applied on an ad hoc basis.

• Many of the approaches that fall within the area of cost

management do not rely exclusively on accounting techniques

For use with Management Accounting for Business 6e

By Colin Drury
9781408093818 © 2016 Cengage Learning
 14.1b

Life-cycle cost management (LCM)

• Traditional management accounting procedures have focused primarily on the
manufacturing stage of a product’s life cycle.

• LCM focuses on costs over the product’s entire life cycle to determine whether
profits earned during the manufacturing phase will cover the costs incurred during
the pre-and post-manufacturing stages.

• A large proportion of a product’s costs can be committed or ‘locked in ’during the

planning and design stage (see slide 14.2 Figure 1 ).

• Cost management can be most effectively exercised during the planning and
design stage.

For use with Management Accounting for Business 6e

By Colin Drury
9781408093818 © 2016 Cengage Learning
 14.2

Figure 1 Product life-cycle phase relationship between costs

committed and costs incurred

For use with Management Accounting for Business 6e

By Colin Drury
9781408093818 © 2016 Cengage Learning
 14.3

Target costing
• Focuses on managing costs during a product/service’s planning and
design phase.

• Involves the following stages:

1. Determine the target price which customers will be prepared to
pay for the product.
2. Deduct a target profit margin from the target 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 driving down the actual cost to the target cost.

• Iterative process involving:

1. Tear-down analysis
2. Value analysis and functional analysis

• It is important that target costing is supported by an accurate costing

system using appropriate cause-and-effect cost drivers.

For use with Management Accounting for Business 6e

By Colin Drury
9781408093818 © 2016 Cengage Learning
 14.5a
Activity-based management (ABM)
• Involves the following stages:
1. Identifying the major activities that take place in an
organization.
2. Assigning costs to cost pools/cost centres for each activity.
3. 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

activities that make up the organization — by managing the
activities costs are managed in the long term.

• Traditional control reports analyze costs by types of expenses for

each responsibility centre whereas ABM analyses costs by activities
(See slide 14.6 for an illustration).

• Knowing the cost of activities is a catalyst for triggering action to

become competitive.

For use with Management Accounting for Business 6e

By Colin Drury
9781408093818 © 2016 Cengage Learning
 14.5b
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:
1. As value-added or non-value-added.
2. According to a scale similar to that advocated by Kaplan and
Cooper. (See next slide on prioritization)

• Activity-based systems can also be used to manage costs at

the design stage using behavioural drivers.

• Surveys also suggest that many organizations use cost driver

rates as measures of cost efficiency

Example

Cost of purchasing activity = £100,000 Orders processed =10,000

Cost per order = £10 (Used for relative, trend and budget
comparisons).

For use with Management Accounting for Business 6e

By Colin Drury
9781408093818 © 2016 Cengage Learning
 14.6
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

For use with Management Accounting for Business 6e

By Colin Drury
9781408093818 © 2016 Cengage Learning
 14.7

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.

Business process re-engineering (BPR)

• A business process consists of a collection of activities that are linked

together in a co-ordinated manner to achieve a specific objective.

• BPR involves examining business processes and making substantial

changes to how the organization operates by focusing on:
1. Cost reduction
2. Simplification
3. Improved quality and enhanced customer satisfaction.

For use with Management Accounting for Business 6e

By Colin Drury
9781408093818 © 2016 Cengage Learning
 14.8

Just-in-time systems
 JIT production is an example of BPR.
 The major features of JIT are:
1. Rearrangement of the production process by replacing batch production with a
cellular flow lines of similar machines based on pull systems instead of push
systems.
2. Reducing set-up times.
3. Elimination of non-value added activities.
4. Increased emphasis on total quality management
5. Training cell workers to multi-task.
6. Adoption of JIT purchasing whereby delivery of supplies immediately precedes
demand or use.
7. The modification of management accounting performance measures and product
costing systems so that they support JIT production systems.

For use with Management Accounting for Business 6e

By Colin Drury
9781408093818 © 2016 Cengage Learning
 14.9

Quality cost management

• Quality is now one of the key competitive variables.

• Management accountants are now placing greater emphasis on

the provision of information relating to the cost of quality.

• Cost of quality reports prepared periodically:

1. Prevention costs
2. Appraisal costs
3. Internal failure costs
4. External failure costs

• Increasing attention is also being given to continuous improvement

with the aim of zero defects.

• Non-financial measures and statistical quality control tools also

play a key role in improving quality and reducing internal and
external failure costs.

For use with Management Accounting for Business 6e

By Colin Drury
9781408093818 © 2016 Cengage Learning
 14.10a

Cost of quality report

For use with Management Accounting for Business 6e

By Colin Drury
9781408093818 © 2016 Cengage Learning
 14.10b

Cost of quality report (contd.)

For use with Management Accounting for Business 6e

By Colin Drury
9781408093818 © 2016 Cengage Learning
 14.11a

Environmental cost management (ECM)

ECM is 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

For use with Management Accounting for Business 6e

By Colin Drury
9781408093818 © 2016 Cengage Learning
 14.11b

• 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 slide 14.9) should be periodically produced that reports costs by the
following categories:
1. Environmental protection costs
2. Environmental appraisal costs
3. Environmental internal failure costs
4. Environmental external failure costs
• Some companies have incorporated an environmental perspective within
the balanced scorecard.

For use with Management Accounting for Business 6e

By Colin Drury
9781408093818 © 2016 Cengage Learning