Cost Accounting

 Traditionally viewed as a process of assessing the financial impact of alternative

managerial decisions
 Establishes budget and actual cost of operations, processes, departments or product
and the analysis of variances, profitability or social use of funds]
 Important tool used is “variance analysis” to show the variation b/w actual cost and
standard costs
– volume variation
– Material cost variation
– Labor cost variation
 Limitations felt in using variance analysis
– Why costs were different from what was planned?
– Lack of integration with organizational goal

Limitations in management accounting and conventional cost accounting

• Cost analysis in terms of products, customers and functions
• Strongly internal focus

• Basic objective in identifying the cost is

– Score keeping (recording and compliance of the profession)

– Attention directing
– Problem solving

• Cost is assumed as a function of output volume (variable cost, fixed cost and mixed cost)

• Standard cost system with normal allowance for scrap, waste, rework; zero defect standard is not
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

Why SCM?
• It is cost analysis in a broader context, where the strategic elements become more conscious, explicit,
and formal

• Cost data is used to develop superior strategies in route to gaining sustainable competitive
Advantage

• SCM gives a clear understanding of the firm’s cost structure in search of sustainable competitive
advantage
• SCM is the managerial use of cost information explicitly directed at one or more of the four stages
(strategy formulation, communicating the strategy, implementing and controlling) of strategic
management
– Overall recognition of the cost relationships among the activities in the value chain, and the
process of managing those cost relationships to a firm's advantage

SCM is the best solution

•Cost analysis in terms of overall value chain of which the firm is a part

•Strongly external focus

•The design of cost management systems changes dramatically depending on the basic strategic
positioning of the firm
Cost leadership or Product differentiation

•Cost is a function of strategic choice about the structure of how to compete and managerial skill in
executing the strategic choices
Structural cost drivers and Executional cost drivers

SCM’s composition
Strategic cost management is a blend of
1. Value chain analysis (how we organize our thinking about cost management?)
2. Strategic positioning analysis (what role does cost management play in the firm?)
3. Cost driver analysis

Value chain analysis

•Organize our thinking about cost management

•A Systematic approach to examining the development of competitive advantage

•The chain consists of a series of activities that create and build value

•They culminate in the total value delivered by an organization

•Helps to determine which type of competitive advantage to pursue, and how to pursue it

•Value is referred to as the price that the customer is willing to pay for a certain offering

Value chain – all it means

External focus perspective, linked with activities from raw material suppliers to ultimate end user

•Multiple cost driver concept

• Structural drivers (scale, scope, experience, technology, complexity)
• Executional drivers (participative management, TQM)
•Cost containment is a function of the cost drivers regulating each value activity
• Exploiting linkages with suppliers, customers and process within the firm
•Insights for strategic decision by
• identifying the cost drivers at the individual activity level
• Develop drivers by controlling those drivers better than competitors or by
reconfiguration of value chain
• Quantify and asses stake holders power and exploit the linkages

Strategic positioning – all it means

•Depends on the firm’s idea, how to compete?
Cost leadership
Product differentiation
•Cost leadership
Mature market
Commodity business
Target cost
•Product differentiation
Market driven
Rapidly growing market
Fast changing business
•Effective control system should be implemented to monitor the cost
Different cost and different strategy

Cost Driver strategy

• Third key to strategic cost
management
• Output cost is seen to capture

very little of the

richness of the
cost behavior
• Cost drivers in SCM can be
classified as
o Structural

drivers
o Executional drivers
• Structural cost drives the
product cost of the organization
o Scale: how big an
investment to make in
manufacturing, R&D, and in marketing resources?
o Scope: Degree if vertical integration
o Experience: how many times in the past the firm has already done
what it is doing again?
o Technology: what process technologies are used at each step of the firm’s value chain?
o Complexity: how wise a line or products of services to offer to customers? (usage of ABC)
•Executional cost determines the firm’s cost position to execute the strategy successfully
•These cost drivers are scaled with the performance
•Basic executional drivers
• Work force involvement (participation) – workforce commitment to continual improvement
• TQM, Capacity utilization, Plan layout efficiency and Product configuration
•For strategic analysis, volume is usually not the most useful way to explain cost behavior
• In a strategic sense, it is more useful to explain cost position in terms of the structural choices about
executional skills that shape the firm’s competitive position
•Not all the strategic drivers are equally important all the time, but some of them are very important in
every case
•For each driver there is a particular cost analysis frame work that is critical to understanding the
positioning of a firm

Tools in SCM

Tools Nature
Value chain analysis Add value to customers reducing costs, and
understanding relation between business
organization and booth customers
Activity based Costing (ABC) To provide accuracy in allocating indirect costs.
Competitive Advantage Analysis Defining strategy that an organization could adopt
to excel over rivals
Target costing Cost that an organization is willing to incur
according to competitive price that could be used
to achieve desired profit
Total quality management (TQM) Adopt necessary polices and procedures to met
customers expectations
Just-in-time (JIT) A comprehensive system to buy materials or
produce commodities when needed in appropriate
time
SWOT analysis Systematic procedure to identify critical success
factors of an organization
Benchmarking Process performed to determine critical success
factor and study ideal procedures of other
organization in order to improve operations and
dominate market
Balanced scorecard Accounting report of critical success factors about
the organization. It is divided into four major
dimensions: financial performance, customers’
satisfaction, internal operation, and innovation
and Growth
Theory of Constraints A tool to improve rate of transferring material into
finished goods
Continuous improvement (Kaizen) Conducting continuous improvements in quality
and other critical success factors

Tools used for Value chain analysis

A firm can create a cost advantage by 2 ways
1. Reducing the cost of individual value chain activities
2. Reconfiguring the value chain

Some of the tools used to find cost in value analysis are

1. Lifecycle costing
2. Supply chain management
3. Return on Asset
4. Discounted cash flow analysis

Life cycle costing