1. Use with Management and Cost Accounting 9e by Colin Drury ISBN 9781408093931 © 2015 Colin Drury Part Five: Cost management and strategic performance management Chapter Twenty-one: Strategic cost management

2. Use with Management and Cost Accounting 9e by Colin Drury ISBN 9781408093931 © 2015 Colin Drury 21.1a 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

3. Use with Management and Cost Accounting 9e by Colin Drury ISBN 9781408093931 © 2015 Colin Drury 21.1b Life-cycle costing (LCC) Traditional management accounting procedures have focused primarily on the manufacturing stage of a product’s life cycle. LCC 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 Figure 21.1 on slide 2). Cost management can be most effectively exercised during the planning and design stage.

4. Use with Management and Cost Accounting 9e by Colin Drury ISBN 9781408093931 © 2015 Colin Drury 21.2

5. Use with Management and Cost Accounting 9e by Colin Drury ISBN 9781408093931 © 2015 Colin Drury 21.3a 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.

6. Use with Management and Cost Accounting 9e by Colin Drury ISBN 9781408093931 © 2015 Colin Drury 21.3b Kaizen Costing Kaizen costing is applied during manufacturing stage whereas target costing is during planning stage. Kaizen costing focuses on production processes whereas target costing focuses on the product. Kaizen costing aims to reduce costs of processes by a pre-specified amount relying on employee empowerment.

7. Use with Management and Cost Accounting 9e by Colin Drury ISBN 9781408093931 © 2015 Colin Drury 21.4 An example of target costing

8. Use with Management and Cost Accounting 9e by Colin Drury ISBN 9781408093931 © 2015 Colin Drury 21.5a 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 10 for an illustration). Knowing the cost of activities is a catalyst for triggering action to become competitive.

9. Use with Management and Cost Accounting 9e by Colin Drury ISBN 9781408093931 © 2015 Colin Drury 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: 1.As value-added or non-value-added. 2.According to a scale similar to that advocated by Kaplan and Cooper. 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).

10. Use with Management and Cost Accounting 9e by Colin Drury ISBN 9781408093931 © 2015 Colin Drury 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. Use with Management and Cost Accounting 9e by Colin Drury ISBN 9781408093931 © 2015 Colin Drury 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. Use with Management and Cost Accounting 9e by Colin Drury ISBN 9781408093931 © 2015 Colin Drury 21.8 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.

13. Use with Management and Cost Accounting 9e by Colin Drury ISBN 9781408093931 © 2015 Colin Drury 21.9 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.

14. Use with Management and Cost Accounting 9e by Colin Drury ISBN 9781408093931 © 2015 Colin Drury 21.10a Cost of quality report

15. Use with Management and Cost Accounting 9e by Colin Drury ISBN 9781408093931 © 2015 Colin Drury 21.10b Cost of quality report (contd)

16. Use with Management and Cost Accounting 9e by Colin Drury ISBN 9781408093931 © 2015 Colin Drury 21.11a Environmental cost management Becoming of increasing importance because: 1.Environmental costs can represent a large proportion of operating costs in some companies. 2.Demands from society for companies to become environmentally friendly

17. Use with Management and Cost Accounting 9e by Colin Drury ISBN 9781408093931 © 2015 Colin Drury 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: 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.

18. Use with Management and Cost Accounting 9e by Colin Drury ISBN 9781408093931 © 2015 Colin Drury 21.12a Cost management and the value chain The value chain (see Fig.21.3 - slide 19) is the linked set of value-creating activities from supplier to customer. Objective is to perform value chain activities more efficiently 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 accounting starts too late and finishes too soon in terms of the value chain.

19. Use with Management and Cost Accounting 9e by Colin Drury ISBN 9781408093931 © 2015 Colin Drury 21.12b Figure 21.3 The value chain