TOPIC 3

Strategic Management Accounting

Outline
⚫ Contemporary SMA techniques:
Life cycle costing
Target costing
Kaizen costing
Theory of constraints
Throughput accounting

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Life Cycle Costing
⚫ A cost management approach where costs are
accumulated and managed over the life cycle of the
product.
⚫ Includes upstream and downstream costs.
⚫ ‘Cradle to grave’.
⚫ Four stages of the product life cycle:
◦ Product planning and initial concept design
◦ Product design and development
◦ Production
◦ Distribution and customer (logistic) support

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Life Cycle Costing (cont’d)

Source: Adapted from Burstein (1988, p. 261)

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Life Cycle Costing (cont’d)

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Life Cycle Costing (cont’d)
Life Cycle Budgeting
⚫ Involves estimating the expected costs and revenues
for each year of the expected life of a product.
⚫ Allows for comprehensive assessment of the
profitability of a product over its entire life.
⚫ Comparison between budgeted cost and revenue
with actual costs and revenues each year.
⚫ Considers all relevant costs over the value chain.
⚫ Useful in product mix or pricing decisions.

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Life Cycle Costing (cont’d)
⚫ Concepts of life cycle costing not widely used
because:
◦ There is a lack of awareness, or uncertainty about how to
calculate life cycle costs.
◦ Short-term orientation of budgeting systems may discourage a
life-cycle approach.
◦ Life time costs for products with longer lives are difficult to
estimate:
● Changes in consumer tastes
● Impact of competitors’ actions
● Effects of inflation

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Life Cycle Costing (cont’d)
How is it different from the traditional management
accounting system (MAS)?
Traditional MAS LCC
Focuses on cost containment/cost Focuses on cost reduction – a cost
control management technique
Focuses primarily on the Focuses on the entire stages of
manufacturing product’s life cycle
stage of a product’s life cycle
Pre-manufacturing costs (R&D Pre-manufacturing costs (R&D and
and design costs) are treated as design costs) are
period cost. treated as product cost.
Report on a period-by-period Report on a product-by-product basis
basis – short term perspective over entire life-cycle – long term
perspective 8
Target Costing
⚫ A system of profit planning and cost management that
determines the life cycle cost at which a proposed
product must be produced to generate the desired
level of profit, given the product’s anticipated selling
price.
⚫ It is a cost management technique, not a product
costing technique.
⚫ The cost target for a product is driven by the need to
sell the product at a certain market price and to
achieve a target profit margin.

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Target Costing (cont’d)
⚫ Estimate the target selling price based on market
considerations, customer needs and expectations,
and competitor behaviour.
⚫ Determine target profit margin and the target cost.
⚫ Identify the cost reduction objective – difference
between the current product cost and target cost.
⚫ Reduce cost and enhance customer value across the
value chain
◦ Value engineering to eliminate non-value-added aspects of the
product design
◦ Value analysis of manufacturing processes to eliminate
non-value-added activities in manufacturing
◦ Work with suppliers to reduce component/material costs 10
Target Costing (cont’d)

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Target Costing (cont’d)
⚫ It is price led.
⚫ Focuses on customer expectations for product
features and quality.
⚫ Based on principles of life cycle management, placing
primary emphasis on managing downstream and
manufacturing costs.
⚫ Cross-functional – involving managers from across
the value chain.

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Target Costing (cont’d)
Target Costing and Value Engineering
⚫ It is a systematic interdisciplinary examination of factors
affecting the cost of a product or service in order to devise
means of achieving the specified purpose at the required
standard of quality and reliability at the target cost.
⚫ Encompasses improvements in product designs, changes in
materials specifications, and modifications in process
methods.
⚫ The aim of value engineering:
◦ to improve product design that reduce the product’s cost without
sacrificing functionality.
◦ to eliminate unnecessary functions that increase the product’s
cost and for which customers are not prepared to pay extra cost
(non value-added cost). 13
Target Costing (cont’d)
Major Strength of Target Costing
⚫ Team work – members from all divisions and various
functions (designers, engineers, purchasing, manufacturing,
marketing, personnel)– reduce product development time
& costs.

⚫ Target costing is carried out before actual production

(during planning & design stage), therefore help to reduce
future manufacturing costs that are locked in/committed.

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Kaizen Costing
⚫ Kaizen = Japanese term for continuous and incremental
improvements to the current production process.
⚫ Kaizen costing (KC) – like target costing (TC), widely used
by Japanese firms.
⚫ TC – used before product is in production (in planning &
design stage).
⚫ KC - used when product is in production (manufacturing
stage).

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Kaizen Costing (cont’d)
⚫ KC relies heavily on employee empowerment.
⚫ Workers are given the responsibility to improve processes
and reduce costs because they are closest to the
manufacturing processes and customers.
⚫ KC assumes dynamic conditions where constraints such as
causes of waste, excess, and variations can be continuously
reduced.
⚫ KC focuses on cost reduction efforts in the production
stage of the product life-cycle.
⚫ e.g. improve set up process, improve machine performance
to reduce waste, increase employee training & motivation
in order to encourage them to suggest ways to reduce
costs & improve quality.
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Kaizen Costing (cont’d)
⚫ KC focuses on the process, not the product through
increased efficiency of the production process.
⚫ Continuously reduce costs based on cost reduction targets
– assume dynamic condition.
⚫ Each period kaizen standard is set based on prior period’s
improvements – locking in these improvements to push for
greater improvements in future.

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Managing Throughput
1. The Theory of Constraints
2. Throughput Accounting

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The Theory of Constraints
⚫ An approach to managing costs and improving quality and
delivery performance by focusing on identifying and
removing constraints (bottlenecks) in the manufacturing
process to speed up the flow of product through the plant
(to improve the rate of throughput).
⚫ Recognises the rate of production is limited to the capacity
of the constraints (or bottlenecks) that exist.
⚫ Aims to maximize operating income when faced with some
bottleneck and some non-bottleneck operations.
⚫ It helps managers reduce cycle times and operating costs.
⚫ TOC focuses on a short-run time horizon and assumes that
operating costs are fixed costs. 19
Throughput Accounting
⚫ Measures the effect of bottlenecks and other operational
decisions using 3 financial measures:
◦ Throughput – profit rate based on sales: Sales revenue – variable costs
◦ Investment – resources tied up in inventory, buildings, machinery, other
assets/liabilities
◦ Operating expenses – the cost of converting inventory into output
such as labour cost, machine maintenance and utilities.
⚫ When throughput is increased with no change in investment
or operating expenses, then profit, ROI and CF will increase.
⚫ When operating expenses decrease with no change in
throughput or investment, then profit, ROI and CF will
increase.
⚫ Decreases in investment will also increase profit, ROI and CF.
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Managing Throughput (cont’d)
Methods to Relieve Bottlenecks:
⚫ Eliminate idle time at the bottleneck operation
⚫ Reduce setup time and processing time at bottleneck operations
⚫ Improve the quality of parts or products manufactured at the bottleneck
operation
⚫ Reduce other delays due to unscheduled and non-value-added activities,
such as inspections, machine break-downs, etc.
⚫ Look for quality defects in raw materials that might be slowing things
down.
⚫ Simplify the operation:
a. simplify the product design
b. simplify the manufacturing process

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Managing Throughput (cont’d)

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Managing Throughput (cont’d)

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Managing Throughput (cont’d)

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Managing Throughput (cont’d)
⚫ http://www.youtube.com/watch?feature=play
er_detailpage&v=mWh0cSsNmGY
⚫ http://www.youtube.com/watch?feature=play
er_detailpage&v=6_N_uvq41Pg

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End of Lecture 3

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