CH 12

Cost Accounting
Sixteenth Edition
Chapter 12
Strategy, Balanced
Scorecard
and,
Strategic Profitability
Analysis
Copyright © 2018, 2016, 2015 Pearson Education, Inc. All Rights Reserved.
Strategy
• Strategy specifies how an organization matches its own
capabilities with the opportunities in the marketplace to
accomplish its objectives.
• Strategy describes how an organization can create value
for its customers while differentiating itself from its
competitors.
• A thorough understanding of the industry is critical to
implementing a successful strategy. Industry analysis
focuses on five forces.
Industry Analysis Focuses on Five
Forces
1. Number and strength of competitors
2. Potential entrants to the market
3. Availability of equivalent products
4. Bargaining power of customers
5. Bargaining power of input suppliers
Two Basic Business Strategies
1. Product differentiation is an organization’s ability to offer
products or services perceived by its customers to be
superior and unique relative to the products or services
of its competitors.
– Competitive advantage: brand loyalty and the
willingness of customers to pay high prices.
2. Cost leadership is an organization’s ability to achieve
lower costs relative to competitors through productivity
and efficiency improvements, elimination of waste, and
tight cost control.
– Competitive advantage: lower selling prices.
Reengineering
• Reengineering is the fundamental rethinking and redesign
of business processes to achieve improvements in critical
measures of performance, such as cost, quality, service,
speed, and customer satisfaction.
• Stated another way, reengineering is the redesign of
business processes to improve performance by reducing
cost and improving quality.
Implementation of Strategy
Many companies have introduced a balanced scorecard to
track progress and manage the implementation of their
strategies.
A useful first step in designing a balanced scorecard is a
strategy map.
A strategy map is a diagram that describes how an
organization creates value by connecting strategic objectives
in explicit cause-and-effect relationships with each other in
the financial, customer, internal-business-process, and
learning-and-growth perspectives.
Strategy Map, Example
Exhibit 12.2 Strategy Map for Chipset, Inc., for 2017
Structural Analysis of Strategy Maps (1 of
2)
Before developing the balanced scorecard, it is prudent to assess and refine the
strategy map.
Structural analysis is used to think carefully about the causal links in the strategy
map.
There are five types of conditions to consider in a structural analysis:
Strength of ties
Orphan objectives
Focal points
Trigger points
Distinctive objectives
Let’s take a closer look at each of these.

Structural Analysis of Strategy Maps (2 of
2)
There are five types of conditions to consider in a structural
analysis:
Strength of ties—Ties are the causal links between strategic
objectives and can be qualified as strong, moderate, or weak.
Orphan objectives—An orphan objective is a strategic objective
with only weak ties leading out of it to other strategic objectives.
Focal points—A focal point is a strategic objective that has many
other links funneling INTO it.
Trigger points—A trigger point is a strategic objective where
many ties spur OUT from it, resulting in the achievement of many
strategic objectives.
Distinctive objectives—Strategic objectives that distinguish an
organization from its competitors, based on the organization’s strategy,
are distinctive objectives.
The Balanced Scorecard
• The balanced scorecard translates an organization’s
mission and strategy into a set of performance measures
that provides the framework for implementing its strategy.
• Not only does the balanced scorecard focus on achieving
financial objectives, it also highlights the nonfinancial
objectives that an organization must achieve to meet and
sustain its financial objectives.
• The scorecard measures an organization’s performance
from four perspectives.
The Four Perspectives of a Balanced
Scorecard (1 of 5)
1. Financial—profits and value created for shareholders
2. Customer—the success of the company in its target
market
3. Internal business perspective—the internal operations
that create value for customers
4. Learning and growth—the people and systems
capabilities that support operations
The particular measure a company uses to track
performance will depend on its strategy.
Scorecard ( 2 of 5)
FINANCIAL: Evaluates the profitability of the strategy
and the creation of shareholder value
Uses the most objective measures in the scorecard
The other three perspectives eventually feed back into this
dimension
Scorecard ( 3 of 5)
CUSTOMER: Identifies targeted customer and market
segments and measures the company’s success in
these segments
Here we see some measures that might be used including
market share, number of new customers and customer-
satisfaction ratings.
Scorecard ( 4 of 5)
INTERNAL BUSINESS: Focuses on internal operations
that create value for customers which, in turn, help
achieve financial performance
Scorecard ( 5 of 5)
LEARNING AND GROWTH: Identifies the people and
information capabilities necessary for an organization to
learn, improve and grow. These capabilities help
achieve superior internal processes that in turn create
value for customers and shareholders.
Balanced Scorecard Implementation
A successful balanced scorecard implementation:
• Must have commitment and leadership from top
management.
• Must be communicated to all employees.
• For the balanced scorecard to be effective, managers must
view it as a fair way to assess and reward all important
aspects of a manager’s performance and promotion
prospects.
Common Balanced Scorecard
Measures
Different Strategies Lead to Different
Scorecards
A company that follows a cost-leadership strategy will likely have
designed their balanced scorecard to be different from a company
that follows a product-differentiation strategy.
Companies are increasingly recognizing that they must continually
earn the right to operate in the communities and countries in
which they do business. Failure to perform adequately on
environmental and social outcomes puts at risk a company’s
ability to deliver future value to shareholders.
Managers interested in measuring environmental and social
performance incorporate these factors into their balanced
scorecards to set priorities for initiatives, guide decisions and
actions and fuel discussions around strategies and business
models to improve performance.
Features of a Good Balanced Scorecard
(1 of 2)
1. Tells the story of a firms strategy, articulating a sequence

of cause-and-effect relationships—the links among the
various perspectives that align implementation of the
strategy.
2. Helps to communicate the strategy to all members of the
organization by translating the strategy into a coherent and
linked set of understandable and measurable operational
targets.
Features of a Good Balanced Scorecard
(2 of 2)
3. Must motivate managers to take actions that eventually

result in improvements in financial performance.
– Applies primarily to for-profit entities, but has some application to
not-for-profit entities as well.
4. Limits the number of measures, identifying only the most

critical ones.
5. Highlights less-than-optimal tradeoffs that managers may
make when they fail to consider operational and financial
measures together.
Pitfalls in Implementing a Balanced
Scorecard
• Managers should not assume the cause-and-effect
linkages are precise: they are merely hypotheses.
• Managers should not seek improvements across all of the
measures all of the time.
• Managers should not use only objective measures;
subjective measures are important as well.
• Despite challenges of measurement, top management
should not ignore nonfinancial measures when evaluating
managers and other employees.
Evaluating the Success of Strategy and
Implementation
• To evaluate how successful a company’s strategy and
implementation have been, its management must compare the
target and actual performance columns in the balanced
scorecard.
• If a company does not meet its targets on the two perspectives
that are more internally focused (learning and growth, and
internal business processes), it would conclude that it did not
implement its strategy because id did not implement the
activities that would give it competitive advantage.
• If a company performs well in the internally focused
perspectives but not customer and financial measures, it may
conclude that the strategy was faulty because there was no
effect on customers or on long-run financial performance and
value creation.
Strategic Analysis of Operating Income
(1 of 2)
To evaluate the success of a strategy, managers and

management accountants need to link strategy to the
sources of operating-income increases.
To do this evaluation, management accountants start by
analyzing three main factors:
1) The Growth component measures the change in
operating income attributable solely to the change in quantity
of output sold between years.
Strategic Analysis of Operating Income
(2 of 2)
2) The Price-recovery component measures the change in

operating income attributable solely to changes in prices of
inputs and outputs between years. This component
measures the change in revenues as a result of a change in
output price compared with the change in costs as a result of
change in input prices.
3) The Productivity component measures the change in
costs attributable to a change in the quantity of inputs used
in current year relative to the quantity of inputs that would
have been used in the prior year to produce the current year
output. This component measures the amount by which
operating income increases by using inputs efficiently to
lower costs.
Formulas Used for Strategic Analysis of
Income Summary (1 of 2)
Here are the formulas used in the strategic analysis of income:
Growth Component
• Revenue effect of growth (Slide #28)
• Cost effect of growth (Slide #29)
• Cost effect of growth for Fixed costs (Slide #30)
Price-Recovery Component
• Revenue effect of price recovery (Slide #31)
• Cost effect of price recovery (Slide #32)
• Cost effect of price recovery for Fixed costs (Slide #33)
Income Summary (2 of 2)
Here are the formulas used in the strategic analysis of
income:
Productivity Component
• Cost effect of productivity for variable costs (Slide #34)
• Cost effect of productivity for fixed costs (Slide #35)
Let’s review the formulas for each of these components.
Income Details (1 of 8)
REVENUE EFFECT OF GROWTH
Revenue Actual Units of Actual Units of Prior
Effect = Output Sold in _ Output Sold in X Period
of the Current the Prior Selling
Growth Period Period Price
Throughout these slides, we’ll use values from the textbook example to
illustrate the formulas:
Here, actual units of output sold in the current period are 1,150,000;
Actual units of output sold in the prior period are 1,000,000, and
the selling price in the prior period was $23/unit, therefore:
(1,150,000 – 1,000,000) x $23 = $3,450,000F Revenue Effect of Growth
COST EFFECT OF GROWTH
Cost Effect Units of Input Actual Units of Prior

of Growth = Required to Produce _ Input Used to X Period
for Variable Current Output in the Produce Prior Input
Costs Prior Period Period Output Price
(3,000,000 sq cm x (1,150,000/1,000,000)) – 3,000,000 sq cm x $1.40

input price = $630,000 Unfavorable
The cost effect of growth measures how much costs would have
changed
in the prior year if production would have been at current year levels.
This is done separately for Variable and Fixed costs.
COST EFFECT OF GROWTH FOR FIXED COSTS
Assuming adequate current capacity:sq cm = $0.00
Cost
Effect Actual Units of Actual Units Prior
Of capacity in of Capacity Period
Growth = Prior Period to in the X Price
For Produce Current Prior per unit
Fixed Period Output Period of
Costs capacity
(3,750,000 sq cm – 3,750,000 sq cm) X $4.28 per
REVENUE EFFECT OF PRICE RECOVERY
Revenue
Effect Current
Current Period Prior Period Period
Of = X
Selling Price Selling Price Units
Price-
Recovery Sold
($22 per unit current year - $23 per unit prior year) X 1,150,000 actual
units of output sold in current year = $1,140,000 Unfavorable
COST EFFECT OF PRICE RECOVERY
Cost Units of
Effect Input
Of required to
Price- Current Period Prior Period produce
= X Current
Recovery Input Price Input Price
for Period’s
Variable Output in
Costs the Prior
Period
($1.50 per sq cm current year - $1.40 per sq cm prior year) X 3,450,000

sq cm required for current year output in prior year = $345,000
Unfavorable
COST EFFECT OF PRICE RECOVERY FOR FIXED
COSTS
Cost
Effect Actual Units of
Of Current Period Prior Period Capacity on
Price- = Price per Unit Price per Unit X Prior Period to
Recovery of Capacity of Capacity Produce
for Fixed Current
Costs Period’s Output
($4.35 per sq cm - $4.28 per sq cm) X 3,750,000 sq cm = $262,500

Unfavorable
COST EFFECT OF PRODUCTIVITY FOR VARIABLE
COSTS
Cost
Actual Units of Units of Input
Effect
Input used to Required to
Of Input Price in
= Produce Produce Current X
Productivity Current Period
Current Period Period’s Output
for Variable
Output in Prior Period
Costs
$2,900,000 sq cm for current period output – 3,450,000 sq cm for current

period output in prior period) X $1.50 per sq cm = $825,000 Favorable
COST EFFECT OF PRODUCTIVITY FOR FIXED COSTS
Assuming adequate current capacity:
Cost
Actual Actual Units of
Effect
Units of Capacity in Prior Price Per Unit of
Of
= Capacity in Period to X Capacity in
Productivity
Current Produce Current Current Period
for Fixed
Period Period’s Output
Costs
(3,500,000 sq cm – 3,750,000 sq cm) X $4.35 per sq cm = $1,087,500

Favorable
Further Analysis of Growth, Price-
Recovery and Productivity Components
EXHIBIT 12.6 Strategic Analysis of Profitability
• Consistent with a cost-leadership strategy, the productivity gains of $1,912,500 in 2017

were a big part of the increase in operating income for prior year to current year.
• Under different assumptions about the change in selling price, the analysis will attribute
different amounts to the different strategies.
Downsizing and the Management of
Processing Capacity
• Managers can reduce capacity-based fixed costs by
measuring and managing unused capacity.
• Unused capacity is the amount of productive capacity
available over and above the productive capacity
employed to meet consumer demand in the current period.
• To better understand this concept of unused capacity, it is
necessary to distinguish engineered costs from
discretionary costs.
Analysis of Unused Capacity:
Engineered and Discretionary Costs
1. Engineered costs result from a cause-and-effect
relationship between the cost driver (output) and the
(direct or indirect) resources used to produce that
output. Engineered costs have a detailed, physically
observable and repetitive relationship with output.
2. Discretionary costs have two important features:
1. They arise from periodic (usually annual)
decisions regarding the maximum amount to be
incurred.
2. They have no measurable cause-and-effect
relationship between output and resources used.
Managing Unused Capacity
• Downsizing (rightsizing) is an integrated approach of
configuring processes, products, and people to match
costs to the activities that need to be performed to operate
effectively and efficiently in the present and future.
• Downsizing often means eliminating jobs, which can
adversely affect employee morale and the culture of a
company.

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Cost Accounting

There are five types of conditions to consider in a structural analysis:

Let’s take a closer look at each of these.

1. Tells the story of a firms strategy, articulating a sequence

3. Must motivate managers to take actions that eventually

4. Limits the number of measures, identifying only the most

To evaluate the success of a strategy, managers and

2) The Price-recovery component measures the change in

Cost Effect Units of Input Actual Units of Prior

(3,000,000 sq cm x (1,150,000/1,000,000)) – 3,000,000 sq cm x $1.40

(3,750,000 sq cm – 3,750,000 sq cm) X $4.28 per

($1.50 per sq cm current year - $1.40 per sq cm prior year) X 3,450,000

($4.35 per sq cm - $4.28 per sq cm) X 3,750,000 sq cm = $262,500

$2,900,000 sq cm for current period output – 3,450,000 sq cm for current

(3,500,000 sq cm – 3,750,000 sq cm) X $4.35 per sq cm = $1,087,500

• Consistent with a cost-leadership strategy, the productivity gains of $1,912,500 in 2017

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