1. Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury MANAGEMENT AND COST ACCOUNTING SIXTH EDITION COLIN DRURY

2. Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury © 2000 Colin Drury Part Five: Cost management and strategic management accounting Chapter Twenty-two: Cost management

3. Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury 22.1a © 2000 Colin Drury 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

4. Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury 22.1b © 2000 Colin Drury 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 22.1 on sheet 22.2). Cost management can be most effectively exercised during the planning and design stage.

5. Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury 22.2 © 2000 Colin Drury Figure 22.1 Cost committed and incurred during a products lifecycle

6. Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury 22.3a © 2000 Colin Drury 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.

7. Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury 22.3b © 2000 Colin Drury 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.

8. Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury 22.4 An example of target costing

9. Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury 22.5a © 2000 Colin Drury 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 sheet 22.6 for an illustration). Knowing the cost of activities is a catalyst for triggering action to become competitive.

10. Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury 22.5b © 2000 Colin Drury Activity-based management (ABM) - contd. Activity cost information is useful for prioritizing thos 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).

11. Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury 22.6 © 2000 Colin Drury 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

12. Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury 22.7 © 2000 Colin Drury 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. Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury 22.7b © 2000 Colin Drury Cost of quality 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. Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury 22.8a © 2000 Colin Drury Cost of quality report

15. Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury 22.8b © 2000 Colin Drury Cost of quality report (contd.)

16. Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury 22.9a © 2000 Colin Drury Cost management and the value chain The value chain (see Fig.22.3 - slide 22.9b) 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.

17. Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury 22.9b © 2000 Colin Drury Figure 22.3 The value chain

18. Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury 22.10a © 2000 Colin Drury Benchmarking Objective is to improve key activities/processes Compares key activites/processes with world-class best practices. 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

19. Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury 22.10b © 2000 Colin Drury  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 sheet 22.8) 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.

20. Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury 22.11a © 2000 Colin Drury Just-in-time systems JIT seeks to achieve the following goals: Elimination of non-value added activities 1.Many activities add cost but no value to the product 2.The aim of JIT is to convert raw materials to finished products with a lead time equal to processing time. Zero inventory Zero defects 1.Emphasis on preventative maintenance and doing the job right first time. Batch sizes of one The aim is to reduce set-up times, batch sizes and throughput times, thus minimizing inventories. Zero breakdowns A 100% on-time delivery service

21. Management and Cost Accounting, 6 th edition, ISBN 1-84480-028-8 © 2004 Colin Drury 22.11b © 2000 Colin Drury Just-in-time systems contd. JIT also involves a change in factory layout: 1.Move from batch production to cellular flowlines of dissimilar machines (with products grouped into families of similar products or components) 2.Pull systems (instead of a push system) used and material movements minimized. 3.Considered more beneficial to add to short-run idle time rather than adding to inventory. JIT purchasing arrangements: More frequent deliveries of materials that immediately precede their use.