Learning Outcomes

At the end of the session students should be able to:

1. Define management accounting in terms of value
creation

2. Explain the basic concepts of strategy and how

management accounting systems can support
strategies

3. Identify the organizational responses and

management accounting responses to change in the
business environment.
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Accounting
• The process of identifying, measuring and
communicating economic information to permit
informed judgments and decisions by users of
information.

• Accounting is concerned with providing both

financial and non-financial information that will
help decision-makers to make good decisions.
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Financial Accounting (FA)
• Reporting of the financial position and performance of
a firm through financial statements issued to external
users on a periodic basis.

• FA is concerned with the provision of information to

external parties outside the organization and could be
called……………………………………………..

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Cost Accounting
• A method of accounting in which all costs incurred in
carrying out an activity or accomplishing a purpose are
collected, classified, and recorded. This data is then
summarized and analyzed to arrive at a selling price, or
to determine where savings are possible.

• Cost accounting measures and reports information

relating to the cost of acquiring and utilizing resources.

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Functions of Cost Accounting

• Ascertainment of cost of product

• Fixation of selling prices

• Measurement of efficiency

• Cost control procedure

• Reporting to the Management

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Management Accounting (MA)

• Management Accounting is concerned with the

provision of information to people within the
organization to help them make better decisions
and improve the efficiency and effectiveness of
existing operations.

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 Management Accounting
• The basic function of management
accounting is to assist the management in
performing its functions effectively.
• Provides data
• Modifies data
• Analyses and interprets data
• Serves as a means of communicating
• Facilitates control

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Cost and Management
accounting
Vs.
Financial accounting

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MA Vs FA
MA FA
Nature Records material,  Records company’s
labour and overhead transactions and events,
costs in product or job Preparation of financial
statements.
Reports produced for Reports produced for
internal management external stakeholders.
and control

Accounting Not based on the Follows the double entry

system double entry system system

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Accounting No need to use Use Generally Accepted
principles accounting Accounting Principles for
principles recording transactions
Adopt any

accounting
techniques that
generates useful
accounting
information

Users of Used by different Used by external parties:

information levels of shareholders, creditors,
management or government, etc
departments
responsible for
respective
activities

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Operation Based on Conforms to
guidelines or management company
standards instructions and Ordinances,
requirements stock exchange
rules, ect

Time span Reports are Reports are

prepared prepared for a
whenever definite period,
needed usually yearly
They may be and half yearly
prepared on a
weekly or daily
basis

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Time focus Future Past orientation:
orientation: use of historic
forecasts, data for reporting
estimates and and evaluation
historic data for
management
actions

Perspective Detailed analysis Financial

of parts of the summary of the
entity, products, whole organization
regions, etc

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Test Your Knowledge 01

Which of the following statements about

management accounts is/are true?
(i) There is a legal requirement to prepare
management accounts.
(ii)The format of management accounts is
largely determined by law.
(iii)They serve as a future planning tool and are not
used as a historical record.
A (i) and (ii)
B (ii) and
(iii) C (iii)
only
D None of
the Use with Management and Cost Accounting 8e by Colin Drury ISBN 9781408041802 @2012 Colin Drury
14 1
4
AN INTRODUCTION TO COST
TERMS AND CONCEPTS

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 Cost terms and concepts

• Cost object

• Cost and Cost Unit

• Direct and Indirect costs

• Manufacturing Vs Non Manufacturing

• Period and Product costs

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Cost object
• It is an activity or item or operation
for which a separate measurement
of costs is desired
• E.g. the cost of operating the
personnel department of a company,
cost for control.

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Cost & Cost unit

Cost

• It is the amount of expenditure incurred on a specific

cost object

Total cost = quantity used * cost per unit (unit cost)

Cost unit

• It is a quantitative unit of product or service in which

costs are ascertained, e.g. cost per table made
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Cost Accumulation – a collection of cost data in an
organized manner

Cost Allocation - is the process of charging the full

amount of an individual item or cost directly to the cost
center for which the item of cost was incurred

Cost Apportionment - is the process of charging the

proportion of common items of cost to two or more cost
centers on some equitable basis.

Cost Absorption - is charging cost from cost centers to

products or services by means of a pre-determined
absorption rate.
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Use with Management and Cost Accounting 8e 20
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 Classification of costs
Cost objects are divided into three board categories;

• Costs for Stock valuation

• Costs for Decision-making

• Costs for Control

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1.
Classification of Costs cont:
Cost classification for inventory valuation and profit measurement
I. Unexpired costs and Expired costs
II. Product and Period costs
III. Elements of manufacturing cost
IV. Job and Process costs

2. Cost classification for decision making

I. Cost behaviour
II. Relevant and Irrelevant costs
III. Avoidable and Unavoidable costs
IV. Sunk costs
V. Opportunity costs
VI. Marginal and Incremental costs

3. Cost classification for control

I. Controllable cost and Uncontrollable cost
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1.Cost classification for inventory valuation and
profit measurement

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 1.Unexpired and Expired
Unexpired Costs Costs
Recorded as an asset in the balance sheet and
become an expense in the profit and loss account
in a later accounting period.

Expired Costs

Recorded as an expense in the profit and loss

account in the current accounting period
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 2.Product
Product costs
and Period Costs
Product costs are those costs that are identified with good purchased
or produced for resale.
Period costs

Period costs are those costs, which are attached to a specific period,
and therefore they are not included in the inventory valuation.

Normally all manufacturing costs are treated as product costs and

non-manufacturing costs are treated as period cost. However under
some costing system (Example. Marginal costing) a part of
manufacturing costs are treated as period costs.

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Period and Product costs

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3.Elements of Manufacturing Costs

• Direct Materials

• Direct Labour

• Direct Expenses

• Manufacturing Overhead

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 Direct cost and Indirect costs
Direct Costs
Direct costs are those costs that can be specifically and exclusively
identified with a particular cost object.

Eg. Direct costs of manufacturing a desk

Direct cost can further be classified into three parts by considering
the elements of cost.
Direct material cost
Direct labour cost
Direct expenses

Indirect Costs
Indirect costs can not be identified specifically and exclusively with a
given cost object.
Eg. Indirect costs of manufacturing a desk

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 Manufacturing and non-manufacturing
cost
Manufacturing Cost
The costs incurred for manufacturing a product is termed as
manufacturing cost.
Direct materials xxx
Direct labour xxx
Direct expenses xxx
Prime Cost xxx
Manufacturing Overhead xxx
Total manufacturing Cost xxx

Non- manufacturing costs

The cost incurred for the activities other than manufacturing of a
product is called non manufacturing cost.
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Direct and Indirect costs

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Test Your Knowledge 02
The following information was extracted from the accounting
records of Rovan Manufacturing Company:
Direct materials purchased 80,000
Direct materials used 76,000
Direct manufacturing labor costs 10,000
Indirect manufacturing labor costs 12,000
Sales salaries 14,000
Other plant expenses 22,000
Selling and administrative expenses 20,000

Calculate Manufacturing cost of a product?

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 4. Job and Process costs
This Classification is used for inventory valuation where
job and process costs systems are applied.
Job costing system
Applicable where a wide range of jobs or orders are
received and every job is not equal.

Process Costing system

Applicable where many units of the same product are
manufactured. Cost of a single unit is to be measured by
dividing the cost of production for the period by the
number of units produced.

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2. Cost classification for decision making

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 1.Cost Behaviour
Variable Costs
Variable costs vary in direct proportion to the volume of
activity.
Fixed Costs
Fixed Costs remain constant over wide ranges of activity
for a specified time period.
Semi Variable Costs
These include both a fixed and a variable component.
Semi Fixed Costs
Those costs that jump into different fixed levels at critical
points of activity within short run.

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Cost behavior

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Use with Management and Cost Accounting 8e 36
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Use with Management and Cost Accounting 8e 37
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Test Your Knowledge 03
Frisco Corporation is analyzing its fixed and variable costs within its
current relevant range. As its cost driver activity changes within the
relevant range, which of the following statements is/are correct?
I.As the cost driver level increases, total fixed cost remains
unchanged.
II.As the cost driver level increases, unit fixed cost increases.
III.As the cost driver level decreases, unit variable cost decreases.
1. I, II, and III are correct.
2. I and II only are correct.
3. I only is correct.
4. II and III only are correct.

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2.Relevant and irrelevant Costs
• Relevant Costs

Are those future costs that will be changed

by a decision.

• Irrelevant Costs

Are those that will not be affected by the

decision
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3.Avoidable and unavoidable costs

Avoidable costs are those costs that may be

saved by not adopting a given alternative,
whereas unavoidable costs cannot be saved.
Therefore only avoidable costs are relevant for
decision-making purpose.

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 4.Sunk Cost , Opportunity Cost
Sunk cost

These costs are the cost of recourses already acquired

where the total will be unaffected by the choice between
various alternatives.

Opportunity cost

A cost that measures the opportunity that is lost or

sacrificed when the choice of one course of action
requires that an alternative course of action be given up.

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 Test Your Knowledge 05
The management of a firm intends to manufacture a
product which has limited market demand and based on
the following available data, it has to decide which of the
two projects it should undertake:
Project A Project B
Market research expenses already incurredRs.100,000 Rs.40,000
Estimated completion cost of the project Rs.140,000 Rs.160,000
Total Cost Rs.240,000 Rs.200,00
Expected revenue Rs.300,000 Rs.280,000

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5.Incremental and marginal costs
Incremental costs are the difference between
costs for the corresponding items under each
alternative being considered.

Marginal costs represent the additional cost of

one extra unit of output, whereas incremental cost
represents the additional cost resulting from a
group of additional units of output.

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3. Cost classification for control

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 1.Controllable and Uncontrollable costs
• Controllable costs are those that may be directly influenced
by unit managers in a given time period.

For example: where managers have the authority of

acquisition and use, the cost may be considered to be
controllable by them.

• Non-controllable costs are those costs that are not directly

administered at a given level of management authority.

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 Strategy and how management
accounting systems can support
strategies
?

46
 Definition of Strategy

Strategy is the determination of basic

long term goals of an enterprise, and the
adoption of courses of action and the
allocation of resources necessary for
carrying out theses goals (Chandler,
1962).
47
 Strategic Decisions are
About …
 The long term direction of the organization
 The scope of an organization’s activities
 Gaining advantage over competitors
 Addressing changes in business environment
 Building on resources and competencies
 Values and expectations of stakeholders which affect
operational decisions
48
 Strategic decisions are Likely to:
 Be complex in nature
 Be made in situations of uncertainty
 Affect operational decisions
 Require an integrated approach (both inside
and outside an organization)
 Involve considerable change
49
 Strategic Cost Management:
Basic Concepts
The most important strategic elements for a
firm are its long term growth and survival.

The key to achieving this goal is to gain a

competitive advantage. Strategic Cost
Management is the use of cost data to
develop and identify superior strategies
that will produce a sustainable competitive
advantage.
50
 Strategic Positioning
Strategic positioning is the key to creating and
sustaining a 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.

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. 51
 Customer value
Customer value is the difference between what a
customer receives (customer realization) and
what the customer gives up (customer sacrifice).

What a customer receives is more than simply

the basic level of performance provided by a
product. What is received 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.
52
 The Management Accounting
versus the
Strategic Cost Paradigm
Management Accounting Strategic Cost Management
What is the most In terms of products, In terms of the various stages of the
useful way to customers, and functions overall
analyze costs? Strongly internal focus value chain of which the firm is a part
Value added is a key Strongly external focus
Value-added considered a dangerously
concept
narrow concept
What is the
objective of Three objectives, all apply Although the three objectives are always
cost analysis? without regard to the present, the design of cost management
strategic context: score systems changes dramatically depending
keeping, attention on the basic strategic positioning of the
directing, firm, i.e., a cost leadership or product
and problem solving. differentiation strategy.
How should we
try to Cost is primarily a function Cost is a function of strategic choice
understand of output volume: variable about
cost behavior? cost, fixed cost, step cost, the structure of how to compete and
mixed cost managerial skill in executing the strategic
choices: in terms of structural cost drivers
and executional cost drivers

53
Value chain

54
 Contrasting Cost Management Paradigms:
Conventional Cost Management vs Strategic Cost
Management
Conventional Cost Management Strategic Cost Management
Standard cost system with normal allowance for No allowance for scrap, waste, rework; zero defect is
scrap, waste, rework; zero defect standard is not the concept
practical.

Overhead variance analysis; maximize
production volume (not quality) to absorb
overhead.
Variance analysis on raw material price;
procedure from multiple suppliers to avoid
unfavorable price variance; low price/low-quality
raw materials
No emphasis on nonfinancial performance
measure
Overhead absorption is not the key; standard costs
and variance analysis are deemphasized, in general
No control on raw material price; certify
vendors who can deliver right quantity, right quality,
and on time
Heavy use of nonfinancial measures(part-per-
-million defects, percentage yields, scrap,
unscheduled machine down-times, first-pass yields,
number of employee suggestions)

55
 Contrasting Cost Management Paradigms:
Traditional Cost Management vs Strategic
Cost Management

Conventional Cost Management Strategic Cost Management

No tracking of customer acceptance
No cost of quality analysis
Systematic tracking of customer acceptance
(customer complaints, order lead time, on-time
delivery, incidence of failures in customers’
locations)
Quality costing as a diagnostic and management
control tool

CONTROL PHILOSOPHY
The goal is to be in the top tier of the The goal is kaizen
reference group
The annual target is to meet the standards Industry norms set the floor
Standards are to be met, not exceeded The annual target is to beat last year’s performance
A regularly exceeded standard is not Each achievement level sets a new floor for future
tough enough achievement

56
SCM’s Three Underlying Themes

 Value Chain Analysis

 Cost Driver Analysis
 Strategic Positioning Analysis

57
 Value Chain Analysis
(concerned with the focus of Cost Management efforts)

 Strategic View – a linked set of value-creating activities from

basic raw material sources to the final consumer. External
focus identifies places in activity chain to enhance customer
value or reduce costs in order to achieve sustainable
competitive advantage.

 Conventional View – a linked set of value-creating activities

taking place within the boundaries of an organization.
Objective is to maximize value added, i.e., the difference
between sales and purchases.

58
 Value Chain in the Paper Products Industry

Competitor B Silvaculture and Timber Farming

Logging and Chipping

Competitor C

Pulp Manufacturing
Competitor D

Paper Manufacturing

Competitor G
Competitor A

Converting Operations

Competitor E
Competitor F
Distribution

End-Use Customer

59
 A Summary of Value Chain Versus
Conventional
Management Accounting
Conventional Value Chain Analysis
Management Accounting in the SCM Framework
Focus Internal Value added External
Perspective Entire set of linked activities from raw material
suppliers to ultimate end-used customers

Cost driver A single fundamental cost Multiple cost drivers

concept driver pervades the Structural drivers(e.g., scale, scope, experience,
literature—cost is a technology, complexity)
function of volume Executional drivers(e.g., participative
Applied too often only at management,
the overall firm level total quality management)
Each value activity has a set of unique cost
drivers
Cost Cost reduction Cost containment is a function of the cost
containment approached driver(s) regulating each value activity
philosophy via responsibility centers Exploit linkages with suppliers
or product cost issues Exploit linkages with customers
Exploit linkages within the firm

60
 A Summary of Value Chain Versus
Conventional
Management Accounting
Conventional Management Value Chain Analysis
Accounting in the SCM Framework
Insights for None are readily apparent. Identify cost drivers at the individual activity
strategic This is a major reason level; develop cost/differentiation advantage
decisions why strategy consulting either by controlling those drivers better than
firms typically throw away competitors or by reconfiguring the value chain
conventional reports as they
begin their cost analysis For each value activity, ask strategic questions
pertaining to make versus buy and forward
versus backward integration

Quantify and assess supplier power and buyer

power; exploit linkages with suppliers and
buyers

61
 Strategic positioning: Generic
Strategies
Cost Leadership
The objective of cost leadership strategy is to provide the same or better
value to customers at a lower cost than offered by competitors.

Differentiation
Through differentiation a competitive advantage is created by providing
something to customers that is not provided by competitors.

Focusing
A focusing strategy is selecting or emphasizing a market or customer segment
in which to compete. A focusing strategy recognizes that not all segments
are the same.

62
 Strategic positioning
Strategic positioning is the process of selecting the optimal
mix of these three general strategic approaches. The mix is
selected with the objective of creating a sustainable
competitive advantage.

A strategy, reflecting combinations of the three general

strategies, can be defined as,
………..choosing the market and customer segments the business unit
intends to serve, identifying the critical internal business processes
that the unit must excel at to deliver the value propositions to
customers in the target market segments, and selecting the individual
and organizational capabilities required for the internal, customer, and
financial objectives.

63
 Strategic Positioning Analysis
(concerned with role of Cost Management in the firm)

 Firms choose to compete either through cost

leadership or product differentiation
 Strategy chosen influences cost management
perspective

64
 Differences in Cost Management Caused by
Differences in Strategy

Primary Strategic Emphasis

Product Differentiation Cost Leadership
Role of engineered product costs Not very important Very important
in assessing performance

Importance of such concepts as Moderate to low High to very high

flexible budgeting for
manufacturing cost control
Perceived importance of meeting Moderate to low High to very high
budgets

Importance of marketing cost Critical to success Often not done on a formal

analysis basis

Importance of product cost as an low high

input to pricing decisions

Importance of competitor cost low high

analysis

65
 Cost Driver Analysis
(concerned with analyzing cost behavior in a manner supportive to
strategic choices)

 Understanding cost behavior requires identifying the

cost drivers present in any given situation
 Understanding cost behavior depends on
understanding the complex interplay among the
relevant cost drivers in any given situation

66
 Cost Driver Categories

 Structural -- related to strategic choices that drive

costs
 Executional – related to an organization’s ability to
execute successfully

67
 Structural Cost Drivers
(Related to organizational choices)
 Scale: Investment size in manufacturing, R&D, and
marketing
 Scope: Degree of vertical integration
 Experience: Previous repetitions of current work
 Technology: Process technologies used at each
step in value chain
 Complexity: Broadness of product line

68
 Executional Cost Drivers
(Related to organizational skills)

 Work Force Involvement: participation; empowerment;

commitment to continuous improvement
 Capacity Utilization: given scale choices on plant
construction
 Plant Layout Efficiency: compared to current norms
 Product Configuration: design or formulation
effectiveness
 Exploiting Linkages with Suppliers/Customers: in relation
to the value chain 69
 Cost Driver Analysis – Some Key
Ideas

 Volume is usually not the best way to explain cost

behavior
 More useful to explain cost position in terms of
structural choices and executional skills
 Not all strategic cost drivers applicable or equally
important all the time but some are probably very
important in every instance.
70
 Linkages Among Value Chain Analysis,
Strategic Positioning Analysis and Cost
Driver Analysis

 Understanding the value chain helps define the

optimal positioning strategy

 Understanding the value chain and positioning

strategy helps identify the relevant cost drivers

71
Thank You !

72