Strategic cost

management
AE23

BRANDON LEIF L. BIBONIA, CPA

Class Rules

 Recording of the lecture is restricted, unless permission was granted

 Opening of camera is highly encouraged
 Mute your microphone when discussion is ongoing and raise your hands if you
want to ask questions.
 Don’t hesitate to call my attention if emergency arises (need to leave the class)
 Three consecutive absences = FDA (failure due to absences)
 Be present at least 5 minutes before the class
 All students are expected to be academically honest. Cheating, lying and
other forms of unethical behavior will not be tolerated. Any student found guilty
of cheating in examinations or plagiarism in submitted course requirements will
receive an F or failure in the course requirement or in the course.
Grading System

COURSE REQUIREMENTS:
Major Examination 1/3
Quizzes/Graded Seatwork 1/3
Class Standing (project/performance/attitude) 1/3
TOTAL 3/3

 CUMULATIVE GRADING SYSTEM PER PERIOD

 For PRELIM PERIOD
 Prelim Period Grade = (PE x 1/3) + (Q/SW x 1/3) + (CS x 1/3)
 For MIDTERM PERIOD
Midterm Period Grade = (ME x 1/3) + (Q/SW x 1/3) + (CS x 1/3)
Midterm Grade = (Midterm Period Grade x 2/3) + (Prelim Grade x 1/3)
 For FINAL PERIOD
Final Period Grade = (FE x 1/3) + (Q/SW x 1/3) + (CS x 1/3)
Final Grade = (Final Period Grade x 2/3) + (Midterm Grade x 1/3)
Cost Management : Nature and Scope

 Cost Management
 Cost Control, Cost Reduction
 Cost Avoidance and Reduction
 Cost Management System
 Strategic Cost management
 Traditional Cost Management versus Strategic Cost Management
 Strategic Cost Management Linked to Strategies
 Factors Influencing Cost Management
 Key Components of a Cost Management System
At the end of the chapter, the
future CPAs should be able to:
1. Define cost management
2. Explain Cost Management System (CMS) and Objectives of
CMS
3. Explain Strategic Cost Management (SCM).
4. Discuss Strategic Cost Management Linked to Strategies.
5. Explain Factors Influencing Cost Management.
6. Discuss Key Components of a Cost Management System.
COST MANAGEMENT

 Cost management in its broadest sense includes all the activities

and related infrastructures that an enterprise employs to set and
measure the achievement of its goals and objectives. This includes
measuring not only enterprise — wide cost but also each
organizational unit contribution to the overall cost.
 Cost Management identifies, collects, measures, classifies and
reports information that is useful to managers and other internal
users in cost ascertainment, planning, controlling and decision-
making.
 In cost management, the objective is to increase productivity of
resources and factors of production and to relate them to enhance
profitability
COST CONTROL

 Cost control refers to management actions to keep the costs within

standards and/or budget.

 It aims at accomplishing conformity between actual results and

standards or budgets, keeping expenditures within prescribed limits

 Cost control does not necessarily mean reducing the cost, but its
aim is to have the maximum utility of cost incurred. In other words,
the objective of cost control is the performance of the same job at
a lower cost or a better performance for the same cost.
COST CONTROL FEATURES

1. Creation of responsibility centers with defined authority and responsibility

for cost incurrence.
2. Formulation of standards and budgets that incorporate objectives and
goals to be achieved
3. Timely cost control reports (responsibility reporting) describing the
variances between budgets and standards and actual performance.
4. Formulation of corrective measures to eliminate and reduce
unfavorable variances.
5. A systematic and fair plan of motivation to encourage workers to
accomplish budgetary goals
6. Follow-up to ensure that corrective measures are being effectively
applied.
COST REDUCTION

 Cost reduction may be defined as a planned, positive approach to

bring costs down.
 It implies real and permanent reduction in the unit cost of goods
manufactured or services rendered without impairing the quality or
suitability for the use intended, that is, without reducing their value in
terms of utility or satisfaction to the customers.
 The goal of cost reduction is achieved in two ways: (i) by reducing
the cost per unit and (ii) by increasing productivity.
 The steps for cost reduction include elimination of waste, improving
operations, increasing productivity, search for cheaper materials,
improved standards of quality, finding other means to reduce unit
costs.
DIFFERENCES OF COST CONTROL
AND COST REDUCTION
COST CONTROL COST REDUCTION
In cost control, standards form benchmarks Cost reduction is not concerned with
for evaluating actual performance. setting targets and standards and
maintaining performance according to
standards.
It aims at adherence to and achieving It aims at real and permanent reduction in
standards, that is, cost targets. It assumes costs. It aims at improving the standards. It
existence of standards and these challenges standards and assumes
standards are not challenged over the existence of concealed potential savings
period. in the standards.
It lacks a dynamic approach as the only It is continuous, dynamic and innovative in
objective is not to exceed the standards. nature, looking always for measures and
alternative to reduce costs.
It is a preventive function. It is a never-ending corrective function.
COST AVOIDANCE AND COST
REDUCTION
 Cost avoidance means finding acceptable alternatives to high-cost
items and/or not spending money for unnecessary goods or services
 Avoiding one cost may require that an alternative, lower cost be
incurred. For example, some companies might decide to self-insure
for many workers’ compensation claims rather than pay high
insurance premiums.
 Closely related to cost avoidance, cost reduction refers to lowering
current costs.
 Companies may also reduce costs by outsourcing rather than
maintaining internal departments. Data processing and the
financial and legal functions are prime targets for outsourcing in
many companies.
COST MANAGEMENT SYSTEM (CMS)

 CMS includes a group of formal methods developed for controlling

the costs of an organization’s activities in its value creation chain
relative to its goals and objectives
 A CMS is not merely a system for minimizing the costs incurred by an
organization. Instead, it should help an organization to obtain
maximum benefits from incurring costs.
 According to Guan, Hansen and Mowen, a cost management
system consists of two subsystems: the cost accounting system and
the operational control system.
COST ACCOUNTING SYSTEM

 It is cost management subsystem designed to assign costs to

individual products and services and other cost objects as specified
by management.
 At the individual product level, incorrect product costs can cause
managers to make wrong decisions. For example, a manager might
wrongly deemphasize a product that is highly profitable. For
decision making, accurate product costs are needed.
 If possible, the cost accounting system should produce product
costs that simultaneously are accurate and satisfy financial
reporting principles. If not, then the cost system must produce two
sets of product costs: one that satisfies financial reporting criteria
and one that satisfies management decision making needs
OPERATIONAL CONTROL SYSTEM

 It is a cost management subsystem designed to provide accurate

and timely feedback concerning the performance of managers
and others relative to their planning and control of activities.
 Operational control is concerned with what activities should be
performed and assessing how well they are performed.
KEY COMPONENTS OF CMS

 Activity Investment Management - Activity investment analysis

evaluates the impact of changing an activity process, such as
introducing a new technology, on the cost, performance, and
interdependences of activities.
 Cost Driver Analysis - Cost driver analysis identifies activities that
influence the cost and performance of subsequent activities. By
reducing or eliminating the event that triggers the first activity in the
chain, it may eliminate the need for all subsequent activities.
 Activity Budgeting - Assessing the factors that control activity
volume is an important technique for budgeting the resources
necessary to perform an activity.
KEY COMPONENTS OF CMS
 Non-Value-Added Analysis - Non-value-added activities result in profitless
expense of time, money, and resources and add unnecessary cost to the
products.
 Best-Practice Analysis - Best-practice analysis compares activity cost and
performance between different departments, divisions, suppliers, and/or
competitors to identify the most efficient way to perform an activity.
 Activity Target Cost Analysis - Activity target cost analysis determines activity
cost and performance goals based on market demand for a product. Target
costs are derived by estimating the market price necessary to capture a
certain market share and then subtracting the desired profit margin.
 Activity Strategic Analysis: Activity strategic cost analysis uses activity cost
and performance data to develop enterprise strategies. Strategic cost
analysis evaluates a company’s activities, from design to distribution, and
determines where value to the customer can be enhanced or costs lowered.
STRATEGIC COST MANAGEMENT
(SCM)
 Strategic cost management is the use of cost data to develop and
identify superior strategies that will produce a sustainable
competitive advantage. It refers to a simultaneous focus on
reducing costs and strengthening an organization’s strategic
position.

 Strategic cost management has a long-run orientation, focusing on

structural cost drivers (such as the location and size of a hospital) or
on organizational cost drivers (such as designing processes for billing
credit card customers).
STRATEGIC COST MANAGEMENT
(SCM)
 The strategic cost management system develops strategic
information, including both financial and non-financial information.
 In the past, firms tended to focus primarily on financial performance
measures, such as growth in sales and earnings, cash flow, and
stock price.
 In contrast, firms in the today’s business environment use strategic
management to focus primarily on strategic measures of success,
many of which are non-financial measures of operations, such as
market share, product quality, customer satisfaction, and growth
opportunities
STRATEGIC COST MANAGEMENT
(SCM)
 The financial measures show the impact of the firm’s policies and
procedures on the firm’s current financial position and therefore, its
current return to the shareholders.
 In contrast, the non-financial factors show the firm’s current and
potential competitive position as measured from at least three
additional perspectives from the balance scorecard: (1) the
customer, (2) internal business processes, and (3) innovation and
learning
 Additional perspectives include community and social impact,
government relations, and ethical or professional management
behavior. Strategic financial and nonfinancial measures of success
are also commonly called critical success factors (CSFs)
TRADITIONAL COST MANAGEMENT
VS. STRATEGIC COST MANAGEMENT
COST CONTROL COST REDUCTION
Standard cost system with normal allowance for No allowance for scrap, waste, rework; zero
scrap, waste, rework; zero defect standard is defect is the concept
not practical
Overhead variance analysis; maximize Overhead absorption is not the key; standard
production volume (not quality) to absorb costs and variance analysis are
overhead deemphasized, in general
Variance analysis on raw material price; Heavy use of nonfinancial measures (parts-
procurement from multiple suppliers to avoid per-million defects, percentage yields, scrap,
unfavorable price variance; low unscheduled machine down times, first-pass
price/low-quality raw materials yields, number of employee
suggestions)
No tracking of customer acceptance Systematic tracking of customer acceptance
No cost of quality analysis Quality costing as a diagnostic and
management control tool
ELEMENTS RELATED TO SCM

 Strategies - As said earlier, strategic cost management is tied with

strategies that provides a company with reasonable assurance of
long-term growth and survival which, in turn, yields sustainable
competitive advantage.
 Competitive Advantage - Competitive advantage is creating better
customer value for the same or lower cost than offered by
competitors or creating equivalent value for lower cost than offered
by competitors.
 Customer sacrifice includes the cost of purchasing the product, the
time and effort spent acquiring and learning to use the product,
and post purchase costs, which are the costs of using, maintaining,
and disposing of the product.
ELEMENTS RELATED TO SCM

 Customer value is the difference between what a customer

receives (customer realization) and what the customer gives up
(customer sacrifice). What is received by a customer is called the
total product. The total product is the complete range of tangible
and intangible benefits that a customer receives from a purchased
product.
 Increasing customer value to achieve a competitive advantage is
tied closely to judicious strategy selection.* Three general strategies
have been identified: cost leadership, product differentiation, and
focusing
ELEMENTS RELATED TO SCM

 Cost Leadership - The objective of a cost leadership strategy is to

provide the same or better value to customers at a lower cost than
offered by competitors. Essentially, if customer value is defined as
the difference between realization and sacrifice, a low-cost strategy
increases customer value by minimizing customer sacrifice. In this
case, cost leadership is the goal of the organization.
 A drawback of the cost leadership-strategy is that the firm has the
tendency to cut costs in a way that undermines demand for the
product or service, for example, by deleting key features of the
product. The cost leader remains competitive only so long as the
consumer sees that the product or service is (at least nearly)
equivalent to competing products that cost somewhat more
ELEMENTS RELATED TO SCM

 Differentiation - The differentiation strategy is implemented by

creating a perception among consumers that the product or
service is unique in some important way, usually by being of higher
quality. This perception allows the firm to charge higher prices and
outperform the competition in profits without reducing costs
significantly.
 Most competitive advantage is created by providing something to
customers that is not provided by competitors. Thus, product
characteristics must be created that set the product apart from its
competitors. Differences in products can be functional, aesthetic, or
stylistic.
ELEMENTS RELATED TO SCM

 Focusing - A focusing strategy is selecting or emphasizing a market

or customer segment in which to compete. One possibility is to
select the markets and customers that appear attractive and then
develop the capabilities to serve these targeted segments.
 Another possibility is to select specific segments where the firm’s
core competencies in the segments are superior to those of
competitors. A focusing strategy recognizes that not all segments
(e.g., customers and geographic regions) are the same. Given the
capabilities and potential capabilities of the organization, some
segments are more attractive than others.
ELEMENTS RELATED TO SCM

 Focusing - A focusing to compete. One possibility is to select the

markets and strategy is selecting or emphasizing a market or
customer segment in which customers that appear attractive and
then develop the capabilities to serve these targeted segments.
 Another possibility is to select specific segments where the firm’s
core competencies in the segments are superior to those of
competitors. A focusing strategy recognizes that not all segments
(e.g., customers and geographic regions) are the same. Given the
capabilities and potential capabilities of the organization, some
segments are more attractive than others.
FACTORS INFLUENCING COST
MANAGEMENT
 Changes in Business Environment and Competition - The
comprehensive changes in the today business environment has
taken place due to growth of international markets and trade.
Businesses and not-for-profit organizations, as well as consumers and
regulators, are all significantly affected by the rapid growth of
economic interdependence and increased competition from other
countries.
 Manufacturing Technologies - To remain competitive in the face of
the increased global competition, firms around the world are
adopting new manufacturing technologies. These include just-in-
time inventory methods to reduce the cost and waste of
maintaining large levels of raw materials and unfinished product.
FACTORS INFLUENCING COST
MANAGEMENT
 Growth of the Service Industry - The service sector in a country’s
economy has increased in importance. The service sector now
constitutes a large segment of a country’s economy and its
manpower.
 Focus on the Customer- key change in the business environment is
increased consumer expectation for product functionality and
quality. Firms are concentrating on the delivery of value to the
customer with the objective of establishing customer loyalty. This has
resulted into shorter product life cycle, as firms seek to add new
features and make new products as quickly as possible, thereby
increasing the overall intensity of competition.
FACTORS INFLUENCING COST
MANAGEMENT
 Advances in Information Technology and E-commerce - Perhaps
the most fundamental of all business changes in recent years has
been the increasing use of information technology, the Internet,
and e-commerce. Many significant developments have taken
place in the areas of information technology. With automated
manufacturing, computers are used to monitor and control
operations.
 Organizational Management - Management in organization has
changed in response to the changes in marketing and
manufacturing. Because of the focus on customer satisfaction and
value, the emphasis has shifted from financial and profit-based
measures of performance to customer-related, nonfinancial
performance measured such as quality, time to delivery, and
service
FACTORS INFLUENCING COST
MANAGEMENT
 Advances in Information Technology and E-commerce - Perhaps
the most fundamental of all business changes in recent years has
been the increasing use of information technology, the Internet,
and e-commerce. Many significant developments have taken
place in the areas of information technology. With automated
manufacturing, computers are used to monitor and control
operations.
 Organizational Management - Management in organization has
changed in response to the changes in marketing and
manufacturing. Because of the focus on customer satisfaction and
value, the emphasis has shifted from financial and profit-based
measures of performance to customer-related, nonfinancial
performance measured such as quality, time to delivery, and
service