Strategic Cost Management-I III Sem M.

Com

STRATEGIC
COST
MANAGEMENT

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Acharya Institute of Graduate Studies Anil B. Malali
Strategic Cost Management-I III Sem M.Com

CHAPTER: I – COSTING STRATEGY

Cost Terms defined

COST:

Cost refers to "the expenditure incurred in producing a product or in rendering a Service ".
Cost means "the price paid for something ".
Cost may be defined as "the amount of expenditure Incurred on a given thing”.

COSTING:
Costing is defined as "the technique and process of ascertaining costs of ascertaining costs of given
thing".

COST ACCOUNTING:
The process of accounting for costs which begins with recording of Income and Expenditure and ends
with the preparation of necessary statements and reports.

COST ACCOUNTANCY:
The application of costing and cost accounting principles, methods and techniques to the science, art and
practice of cost control and the ascertainment of profitability.

Cost Management:
The approaches and activities of Managers, to use resources to increase value to the customers and to
achieve organizational Goals.

Strategic Cost Management

SCM is a tool for improving competitiveness and is defined as the study of the interface between
business strategy and cost system.

Classification of costs:
1. Element wise classification:
a. Direct costs: direct costs are those which are incurred for and may be conveniently identified with a
particular cost centre or cost unit.
Ex: Raw material cost, Labour cost, etc. . . .
b. Indirect costs: Indirect costs are those costs which are incurred for the benefit of a number of cost
centres or cost units and cannot be conveniently identified with a Particular cost centre or cost unit.
Ex: Rent, Salary, Depreciation, etc.

2. Functional classification:
a. Production cost: The production cost refers to costs concerned with manufacturing activity which
starts with supply of material and ends with primary packing of the product.
b. Administration cost: The. Administrative cost IS incurred for carrying the Administrative function
of the organization.
c. Selling &Distribution cost: The selling cost refers to the cost of selling function. The distribution
costs will be incurred on goods made available to the customers.

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Strategic Cost Management-I III Sem M.Com
d. Research and Development cost: The research cost is the cost of searching for new products, new
manufacturing process, improvement of existing products or processes and the development cost is
the cost of putting research result on commercial basis.

3. Classification based on cost behaviour:

a. Variable cost: Variable costs are those which vary in total in direct proportion to the Volume of
output. Variable costs fluctuate in total amount but remain constant per unit as production activity
Changes.
b. Fixed cost: Fixed costs arc those costs which remain fixed in total amount with increase or decrease
in the volume of output or production activity for a given period of time.
c. Semi variable cost: Semi, variable costs are those which are partly fixed and partly variable.

4. Classification based on time:

a. Historical cost: The costs which are ascertained after being incurred arc called historical costs.
b. Predetermined cost: These costs are estimated costs i.e. computed in Advance of production taking
into consideration the ‘previous periods' costs and the factors affecting such costs

5. Classification based on Controllability:

a. Controllable costs: Controllable casts are these which arc at least partly within the control of
management.
b. Uncontrollable cost: Uncontrollable costs are those which are not within the control of
management.

6. Classification for managerial decision:

a. Marginal cost: Marginal cast is the total of variable costs.

b. Out of pocket cost: This is that portion of the costs which 'involves payment to outsiders. Such
costs are relevant for price fixation during recession or when make or buy decision is to be made.
c. Differential cost: The change in costs due to change in the level of activity or pattern or method of
production is known as differential cost.
d. Sunk cost: Sunk costs are costs incurred in the past. They do not have any effect on future decision
making.
Ex: Unappreciated value of machinery at the time of replacement of machinery.
e. Imputed or Notional cost: These costs are national in nature and do not involve any cash outflow,
which are used only for the purpose of decision making and performance evaluation. Notional costs
are the value of a benefit where no actual cost is incurred.
Ex: rent charged on business premises owned by the proprietor, interest on capital charged by the
proprietor on his own investment.
f. Opportunitycost: It is the advantage, in measurable terms, which has been foregone due to not
using the facility in the manner originally planned.
g. Replacement cost: it is the cast of replacement at current market price.
h. Avoidable and Unavoidable Costs: Avoidable costs are those which can be eliminated if a
particular product or department, with which they are directly related, is discontinued. Unavoidable
cost is that cost which will not be eliminated with the discontinuation of a product or department.

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Acharya Institute of Graduate Studies Anil B. Malali
Strategic Cost Management-I III Sem M.Com
7. Classification based on normality:
a. Normal cost: Normal cast is an expenditure incurred for a given level of output under normal
conditions.
b. Abnormal cost: Abnormal cost is an expenditure incurred for a given level of output under
abnormal conditions or exceptional circumstances.

Cost Management:

Cost Management is approaches and activities of Managers to use resources to increase value to the
customers and to achieve organizational Goals.

The Purchasing Handbook defines cost management as, "the establishment of programs that
regularly analyze purchase requirements and suppliers to identify lowest total cost and maximize
total value to the company. The development of a savings forecast by commodity is necessary to
define budget parameters for building cost-of-goods structures."

Importance of Analyzing and managing costs:

Cost analysis is an important component of all economic evaluation techniques. It is a useful tool for
planning and self-assessment. Cost analysis is particularly useful for the following purposes:
1. Determine Costs- It provides detailed: analysis of cost of materials, wages and overheads
classified by Functions, departments and nature of expenses.
2. Ascertainment of Profit - It enables the management to ascertain which of the jobs are more
profitable and which are less profitable and which are incurring losses.
3. Operating efficiency – It enables management to determine the operating efficiency of the
different factors of production, production centers & functional units.
4. Formulation of pricing policies - It helps to quote the prices of a standardized product based on
their costs. It also helps formulation of pricing policies.
5. Cost reduction and control - The main objective of this is reduction of costs and control of
costs.
6. Link corporate strategies - It helps the Manager in taking decisions or in decision making
process. It provides information to link corporate strategies to the costing decisions.

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Strategic Cost Management-I III Sem M.Com

Objectives of Cost Management

The main objective of cost management is to reduce the costs expended by an organization while
strengthening the strategic position of the firm. Three ways to institute cost management techniques are
as follows:
1. Establish systems to help streamline the transactions between corporate support departments and
the operating units.

2. Devise transfer pricing systems to coordinate the buyer-supplier interactions between

decentralized organizational operating units
3. Use pseudo profit centers to create profit maximizing behavior in what were formerly cost
centers.
These cost management systems will not only manage costs, but also enhance profit consciousness.
This will help the organizations’ ability to serve its customers because divisions will become
increasingly more focused on operating more efficiently.
Areas of Cost Management:
1. Resource Planning for Cost Management

Resource planning determines what physical resources (i.e., people, equipment, and materials) are
needed to complete a project. It is directly related to cost management because all of those elements
cost the organization something, whether it be in terms of monetary funds or time. The resources
needed for a project to be completed must be evaluated to assess the value the organization will get from
taking a project on or changing its current methods to make it a more efficient organization.

2. Cost Estimating
Summary of the cost assessments of the resources required to complete projects. Costs must be
predicted for ALL resources and are generally expressed in currency terms to compare among projects.
Other units may be used such as hours or days to describe various resources. Cost estimates may be
refined throughout the project. In general, cost estimating is the prediction of teh amount of cost an
organization will have to expend to complete a project.

3. Cost Budgeting
Cost budgeting involves allocating cost estimates to specific accounts within the organization to
establish a baseline
4. Cost control

Cost control defines the procedures by which the baseline may be changed and integrated. It includes
the paperwork, tracking systems, and approval levels for authorization

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Strategic Cost Management-I III Sem M.Com

Tools and Techniques of Cost Management

The various tools and techniques of Cost Management are:

1. Target Costing- Target costing is a pricing method used by firms. It is defined as "a cost
management tool for reducing the overall cost of a product over its entire life-cycle with the help
of production, engineering, research and design"
2. Activity Based Costing- Activity-based costing (ABC) is a costing methodology that identifies
activities in an organization and assigns the cost of each activity with resources to all products
and services according to the actual consumption by each. This model assigns more indirect
costs (overhead) into direct costs compared to conventional costing.
3. Just in Time- Just-in-time (JIT) manufacturing is a production model in which items are created
to meet demand, not created in surplus or in advance of need. The purpose of JIT production is
to avoid the waste associated with overproduction, waiting and excess inventory, three of the
seven waste categories defined in the Toyota Production System.
4. TQM- TQM is an integrative philosophy of management for continuously improving the quality
of products and processes.
TQM is based on the premise that the quality of products and processes is the responsibility of
everyone involved with the creation or consumption of the products or services which are
offered by an organization, requiring the involvement of management, workforce, suppliers, and
customers, to meet or exceed customer expectations.
5. Business Process Re-engineering- - A process' for creating competitive advantage in which a
firm reorganizes its operating and management functions, often with the result that jobs are
modified, combined, or eliminated.
6. Benchmarking- Benchmarking is the process of comparing one's business processes and
performance metrics to industry bests or best practices from other industries. Dimensions
typically measured are quality, time and cost.
7. Balanced Score Card- The balanced scorecard (BSC) is a strategy performance management
tool - a semi-standard structured report, supported by design methods and automation tools, that
can be used by managers to keep track of the execution of activities by the staff within their
control and to monitor the consequences arising from these actions.

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Acharya Institute of Graduate Studies Anil B. Malali
Strategic Cost Management-I III Sem M.Com
8. Life Cycle Costing- Life cycle costing is a method of economic analysis for all costs related to
building, operating, and maintaining a project over a defined period of time. Assumed escalation
rates are used to account for increases in utility costs over time. Future costs are expressed in
present day dollars by applying a discount rate. All costs and savings can then be directly
compared and fully-informed decisions can be made.
9. KAIZEN Costing- A process wherein a product undergoes cost reduction even when it is
already on the production stage. The cost minimization can include strategies in effective waste
management, continuous product improvement or better deals in the acquisition of raw materials.
10. Six Sigma- A standard of operational excellence used in lean manufacturing environments. It is
process that designs and monitors everyday business activities in ways that minimize waste
while increasing customer satisfaction. Six sigma objectives arc directly and quantifiably
connected to the objectives of the business. A six sigma process is one in which 99.99966% of
the products manufactured are statistically expected to be free of defects (3.4 defects per million)
11. The Theory of Constraints- A strategic technique to help firms to effectively improve the rate
at which raw materials are converted to finished product.
12. Mass Customization - A management technique in which marketing and production processes
arc designed to handle the increased variety of delivering customized products and services to
customers.
13. Reverse Engineering- Reverse engineering, also called back engineering, is the processes of
extracting knowledge or design information from anything man-made and re-producing it or re-
producing anything based on the extracted information
14. Value Analysis- VA can be defined as a systematic review that is applied to existing product
design in order to compare the function of the product required by the customer to meet their
requirements at the lowest cost, consistent with the specified performance needed.
COST ACCOUNTING AND COST MANAGEMENT:
1. Cost accounting deals with determining the cost of inventory and goods manufactured. The costs
are classified into manufacturing, administrative, selling and distribution, etc.,
2. The cost management deals with ascel1aining the accurate cost information to integrate product
development, production, marketing and post sales services with an emphasis on quality and
productivity:
3. Cost management uses new methods of guiding and monitoring performance along with
traditional costing techniques.
4. Cost accounting conventionally focuses on historical analysis of cost data and business
enterprises and managers use these analyses for. Their decision making...
5. Traditional costing approach gives more importance to present activities, assuming that they
involve little risk as compared to future activities which are considered too risky to undertake.

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Acharya Institute of Graduate Studies Anil B. Malali
Strategic Cost Management-I III Sem M.Com
6. The cost management does not avoid new activities, risky programs or new than focusing
attention on what occurred
7. The cost management approach is replacing the cost accounting view of a single mix of cost
behavior with a broader examination of how cost interrelationships can be managed to improve
profits
8. Cost Management emphasizes on the future impact of economic conditions rather than focusing
attention on what occurred.

Major Difference between Cost Accounting and Cost Management

Cost Accounting Cost Management
1. Recording & analysis activity Managerial Activity
2. Gives inputs to Cost Management Broader Concept
3. Focus on Cost containment Focus is on Customer Satisfaction

COST CONTROL AND COST REDUCTION

Cost Control:

Cost control is simply the prevention of waste within the existing environment. This environment is
made-up of the agreed operating methods for which- standards have been developed. These standards
may be expressed in a variety of ways, from broad levels to detailed standard costs

Cost control is the procedure whereby actual results are compared against the standards so that waste
can be measured and where appropriate, action can be taken to correct the activities. Cost control is the
Process of regulating the action so as to keep the elements of Cost within the parameters.

Cost reduction:

Cost reduction is the process used by companies to reduce their costs and increase their profits.
Depending on a company's services or Product, the strategies can vary. Every decision in the product
development process affects cost.

Cost Reduction is the achievement of the real and permanent reduction in the unit cost of goods
manufactured or services rendered without impairing their suitability for, the use intended or diminution
in the quality of the product

The Cost Reduction efforts generally focus on the following two key areas –

a. Reduction in Expenditure: Reduction in unit cost resulting from reduction in expenditure in

respect of a given volume of output.

b. Increased Productivity: Reduction in unit cost by an increase in productivity i.e. increases in

yield or rate of output for a given expenditure.

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Acharya Institute of Graduate Studies Anil B. Malali
Strategic Cost Management-I III Sem M.Com

DIFFERENCES BETWEEN COST CONTROL AND COST REDUCTION

Cost Control Cost Reduction
 This process undertakes the competitive  This process finds out the substitute by
analysis of actual results with established finding new ways or methods.
norms.
 The emphasis is partly on the present costs
 The main emphasis is on the present and past and largely on future costs.
behaviour of costs.
 It is a corrective function. It operates even
 It is a preventive function. Costs are optimized when efficient cost control system exists.
before they are incurred. There is a possibility of reduction in the
achieved costs
 It starts from established cost standards and  It challenges the standards and attempts to
attempts to keep the costs of operation of reduce cost on a continuous basis
process in line with those standards.  Under this no condition is considered to be
permanent, where a change will secure a
 It attempts to achieve the best possible result at lower cost figure.
the least cost under given conditions  It is a continuous process of analysis by
various methods. Of all the factors affecting
 It sometimes lacks the dynamic approach costs. The main aim is to have continuous
economy in costs.
 It has limited applicability to those items 0f  It is universally applicable. It does not
costs for' which' standards' have already been set depend" on Standards though" target amount
may be set.
 Under this process the variances are appraised  Under this process, necessary steps are taken
and reported and necessary action will be taken for further modification in the method
to revise norms, standards etc.

METHODS AND TECHNIQUES FOR COST CONTROL AND COST REDUCTION:

 Production planning and control.  Cost benefit analysis

 Budgeting  Control of waste, scrap, defectives
 Standard costing and Variance analysis  Process automation
 Work study  Operation Research
 Business Process re-engineering  Just intimae System
 Quality control  Life Cycle Costing
 Value analysis  Activity Based Management
 Inventory control  Kaizen Costing
 Standardization and Simplification  Total Quality Management
 Target Costing  Benchmarking
 Economics of maintenance  Management Audits

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Acharya Institute of Graduate Studies Anil B. Malali
Strategic Cost Management-I III Sem M.Com

Role of Cost Accounting in strategic planning and control:

Cost accounting provides vital information to help management take crucial decisions. Some of the
major areas are-
1. Functional Restructuring Change Agent
2. Using Value Chain Analysis to integrate costing and strategies
3. Best use of Resources
4. Price determination
5. Cost Control and Reduction

Cost Management System:

Cost Management System is a set of Formal methods developed for planning and controlling
organizational costs to achieve profitability in the short run and competitive advantage in the long run.

6 Primary Goals of Cost Management System

1. Accurate product costs
2. Assess P&L cycle performance
3. Improve processes
4. Control cost
5. Measure performance
6. Allow the pursuit of organizational strategies

Factors to be considered in designing Cost Management system:

1. Type of Organization, Product and culture
2. Organizational Mission
3. Available core competency
4. Competitors

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