Chapter 14

1. Chapter 14 Contemporary cost management

2. Cost management • Improvement of an organisation’s cost effectiveness through understanding and managing the real causes of cost

3. Conventional cost control vs contemporary cost management • Drivers of cost • conventional - managers control costs by bringing them into line with some predetermined goal • focus is on cost results or outcomes • contemporary - reduces costs by identifying waste and eliminating it through identifying the real cost drivers • focus is on determinants of cost Cont.

4. Conventional cost control vs contemporary cost management • Strategic perspective • conventional - control costs within the organisation • internal perspective • contemporary - cost management also concerned with achieving value for the customer • a strategic perspective

5. Conventional cost control vs contemporary cost management • Process perspective • conventional - control costs by reporting results for responsibility centres based on functional areas of the business • contemporary - recognises that customers’ needs are met by processes which flow across the business • may cross functional areas

6. Activity-based management (ABM) • Process of using information from activity-based costing to analyse activities, cost drivers and performance so that customer value and profitability are improved • Customer value • features of a product which customers are willing to pay

7. Using ABM to reduce costs • Identify the major opportunities for cost reduction • Determine the real causes of these costs • Develop a program to eliminate the causes, and, therefore, the costs • Introduce performance measures to monitor the effectiveness of cost reduction efforts

8. Identifying the major opportunities for cost reduction • Value-added activities • provide essential value to the customer, or are essential to the functioning of the business • Non-value-added activities • do not add value to a product or service from the customer’s perspective or for the business and, therefore, can be eliminated without detriment to either

9. Building activities into processes • Eliminating non-value-added activities requires a clear understanding of the way work is done in an organisation • Linking activities into processes • a series of activities that are linked together to achieve a specific objective • often cross the boundaries of responsibility centres, such as functional departments

10. Cost driver analysis • Identification of root-cause cost drivers for the major non-value-added activities • Analysis of root-cause cost drivers of value-added activities may also lead to more efficient use of resources • Value-added management (or value analysis) • the process of targeting and eliminating non-value-added activities

11. Measuring performance in cost reduction • Activity-based performance measures can be used to monitor the effectiveness of cost reduction effort • Performance measures may be based on previous activities

12. Using the costing dimension of ABC to help manage costs • Customer cost analysis • the costs of products purchased by the customer are assigned to the customer, along with the cost of any other customer-driven activities • Customer profitability analysis • estimating the profits from individual customers, or customer groups, by comparing customer costs and revenues

13. Other activity-based management issues • Impediments to implementing ABM • lack of awareness of ABM • uncertainty over potential benefits • extensive resource requirements to implement • resistance to change Cont.

14. Other activity-based management issues • Behavioural aspects of activity-based management • resistance to change • using activity-based information to create particular incentives • The role of strategy and activity-based costing • enables strategies to be managed taking a customer perspective

15. Business process re-engineering • The fundamental rethinking and radical redesign of business processes to achieve dramatic improvements in critical areas of performance such as cost, quality and delivery • Focus is on strategic processes • those processes that focus on achieving a company’s business objectives and strategies Cont.

16. Business process re-engineering • Four major steps • preparing a business process map • a flow chart of the activities that make up the business process • establishing goals • reorganising work flow • implementation of the program

17. Business process re-engineering vs ABM • ABM focuses on process improvement • the incremental, continuous improvement of processes • Business process re-engineering involves fundamental changes to the way processes are structured • Both use activity analysis to identify processes and activities

18. Managing throughput • Another approach to managing costs and improving performance in quality and delivery • The theory of constraints • focuses on identifying and removing bottlenecks to improve the rate of throughput • recognises that the rate of production is limited to the capacity of the constraints (or bottlenecks) that exist in the organisation

19. Life cycle costing • Analyse the costs of activities, including both upstream and downstream costs, that occur over the life cycle of the product • Four stages of the product life cycle • product planning and initial concept design • product design and development • production • distribution and customer (logistic) support

20. Life cycle budgeting • Involves estimating the expected costs and revenues for each year of the expected life of a product • Useful in product mix or pricing decisions

21. Impediments to life cycle costing • A lack of awareness, or uncertainty about how to calculate life cycle costs • Not easy for products with longer lives as it is more difficult to assess • changes in consumer tastes • impact of competitors’ actions • effects of inflation

22. Target costing • A tool for planning profits and reducing costs • Reducing a product’s cost to a target cost, by working on the design to decrease production (and customer support) costs • Target cost - the product cost that must be achieved for a product to be viable in the long term

23. The three steps in target costing • Developing the target cost • Driving down the planned cost towards the target cost during the design phase • value engineering (or value analysis)- reviewing the product or process design to make changes to reduce cost, while still maintaining the functionality of the product • Pursuing continuous improvement once production begins

24. Exhibit 14.3