Strategic Cost Analysis, Second Edition
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Strategic Cost Analysis, Second Edition

Roger Hussey, Audra Ong

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eBook - ePub

Strategic Cost Analysis, Second Edition

Roger Hussey, Audra Ong

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About This Book

Increasing business competition is compelling managers not only to develop realistic and achievable strategies but also to analyze goals in financial terms and to evaluate performance. But where do you, as a manager, learn about the key methods and techniques of strategic cost analysis? This text explains in simple language the methods and techniques of cost analysis that can be applied strategically at any level in an organizationā€”be it manufacturing, service, or the nonprofit sector. Since the interaction of the organization's activities, the influences of the external world, and your responsibilities as a manager need to be captured in financial terms to help plan, control, and make decisions, this book is what you'll require in today's world.

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Year
2018
ISBN
9781947098961
CHAPTER 1
Cost and Strategy
About This Chapter
The essence of a successful organization is the ability to plan and control costs and to have the information to make viable financial decisions. To carry out these activities, managers need data that are relevant to their responsibilities and that are received in sufficient time to take action. They also need to understand the terms and definitions used in relation to the costs of various activities and feel confident in engaging, manipulating, and analyzing cost information.
To meet managersā€™ needs for cost information, a significant part of management accounting is concerned with cost accounting, which is based on collecting and analyzing both financial and quantitative data. Traditionally, cost accounting concentrated on specific, detailed historic costs over a short time period. Increasingly, cost accounting is becoming future oriented and more concerned with internal and external costs. The time frame for strategic cost accounting has become elongated, and attention is paid as much to the why of a situation as to the what. Costing has become not just a method of data collection but an important indicator of how to better manage the organization in pursuit of its strategy.
Types of Accounting
Accounting has a long history if one accepts the broad definition of keeping records of economic activities. There is evidence that the practice can be traced back for thousands of years.1 A critical milestone in accounting was the publication in Venice in 1494 of Pacioliā€™s Summa de Arithmetica, Geometria, Proportioni et Proportionalita. It is argued that this guide to bookkeeping revolutionized commerce throughout Europe and accountants apply the same principles today.2
There have been many changes in accounting over the last 500 years. The developments over that time in the UK have been documented,3 and those with a shorter history in the United States.4 Accounting records are a source of historical practices and provide information on changes in accounting applications, organizational structures, and management practices.
Most of the early history is concerned with accounting information that is intended for the owners of a business. Not only would they want to know whether the business was profitable on a yearly basis but they would also wish to scrutinize the money they were owed and the money they owed to others. As businesses became larger and more complex, with managers in charge of daily operations, so did the nature of the accounting information required. The owners required more detailed information, on different sections and activities of the business. They also wanted the information more frequently.
This change in demand for different types of information led to a new type of accounting. The method of accounting for the entire business became known as financial accounting, and the more detailed accounting was named cost accounting. There is general agreement that this ā€œnewā€ type of accounting became firmly established in the 19th century. Businesses were beginning to perform many internal processes that had previously been outsourced to independent craftsmen. There was a need for internal financial information, and cost or management accounting was the answer.5
The term ā€œcostā€ accounting tends to refer to the actual methods and techniques for identifying the total costs of each part of productive activity. These results are usually compared with past or planned results. Management accounting is reporting the results to internal managers. This may be on a monthly, weekly, or in some instances on a daily basis. The terms are sometimes used interchangeably, but we will refer to cost accounting as the process of collecting the data and to management accounting as the reporting of information. Both manufacturing and service organizations use cost/management accounting. It is important to emphasize that there are no regulations requiring organizations to use cost/management accounting.
Before we concentrate on strategic cost analysis (SCA), we will summarize the characteristics of the two types of accounting you may encounter.
The dominant characteristics of financial accounting are as follows:
ā€¢It is intended to provide information in the form of structured financial statements.
ā€¢The information will be the financial performance, financial position, and cash activities.
ā€¢The statements will be for a period of time, at least annually but for larger companies also half-yearly and sometimes quarterly.
ā€¢The recipients of the information are considered to be external and mainly investors or lenders.
ā€¢The form and content of the financial statements are highly regulated. In the United States, the regulations are issued by the Financial Accounting Standards Board. Many other countries, including members of the European Union, follow International Accounting Standards.
ā€¢For larger companies, particularly those whose shares are listed on a Stock Exchange, the financial statements are considered a public document.
The dominant characteristics of cost/management accounting are as follows:
ā€¢It is collected, collated, and communicated to managers for planning, control, and decision making.
ā€¢It is intended for an internal audience and is voluntarily implemented by an organization to meet its own needs.
ā€¢There are no regulations controlling the cost information an organization uses.
ā€¢There are several techniques that fall under the heading of cost accounting. Organizations use the techniques that best meet their needs and will revise and refine the techniques, if necessary, to be applicable to their own detailed operations.
ā€¢Management accounting information is private to the organization and usually is not publicly available.
Some organizations may extract their data from the same records both for financial and for management accounting reporting. The main purpose of the original records is to produce data for financial accounting. Although the records may be suitably flexible to extract appropriate cost data, the core concepts of financial accounting tend to be pervasive, for example, determining which transactions are deemed as revenue expenses and counted as costs in the current financial period and which transactions are capital expenses and appear on the organizationā€™s balance sheet. In this book, we assume that organizations have the technology and knowledge to have a specific cost accounting system.
The relationship of the two accounting systems is most visible in the following:
1.Listed companies in North America are required to produce interim financial statements quarterly and in the UK biannually. Usually, the cost data for these periods must be aligned with the financial disclosures. It would be imprudent for a company to disclose quarterly or biannual financial information that does not relate to the cost information available internally and that does not produce information that enables reasonable predictions of the annual financial results.
2.Different cost accounting methods have their own specific issues. Process costing used in many companies has some specific problems, one being finding the cost of finished inventory and work in process. This information is required to meet financial accounting regulations. It also meets financial disclosure needs and provides valuable cost information. We will consider process costing in Chapter 2.
3.Cost accounting, as with financial accounting, uses the ā€œaccrualsā€ concept of accounting for transactions. This means that transactions are recognized when they take place and not when cash is received or paid. Although the events may be simultaneous, such as when you pay at the checkout of a supermarket, in business there is frequently a delay between delivery of goods and payment for them. Often, transactions are complex, and accounting standards set out the requirements for these transactions to be recognized for financial accounting purposes, but these also frame the cost for strategic cost purposes.
Financial accounting requirements are complex. We do not wish to overemphasize the influence of these requirements on strategic cost accounting, but it is important that you are aware that sometimes the reasons for unresolved issues may lie with financial accounting requirements and not the methods and techniques of strategic cost accounting.
Strategic Cost Analysis
SCA helps companies identify, analyze, and use strategically important resources for continuing success.6 The technique focuses on an organizationā€™s various activities, identifies the reasons for their costs, and evaluates strategies for creating a sustainable competitive advantage. The technique provides organizations with the total costs and revenues of strategic decisions. This requires creative thinking, and managers need to identify and solve problems from an integrative and cross-functional viewpoint. Examples of SCA include the following:
ā€¢Deciding on product mixes and production volumes
ā€¢Outsourcing decisions
ā€¢Cost reductions
ā€¢Investment and profit growth in different markets
ā€¢Responses to suppliersā€™ and competitorsā€™ activities
ā€¢Changes in consumer demand
In this chapter, we explain the four key questions to which, as a manager and regardless of the type of organization, you will need the answers. We consider the different types of organizations and how the nature of their activities influences cost methods and techniques. We also explain your need for different forms of cost information to plan, control, and make decisions. The penultimate section explains the process of SCA.
Before you continue with the chapter, we wish to emphasize that strategic cost accounting is entirely a voluntary practice carried out by organizations. There are no rules or regulations that indicate how strategic cost accounting should be conducted. It is entirely the responsibility of management to determine their needs. If the cost information generated is of no value to managers, it should be abandoned.
As strategic costing systems are designed to satisfy the needs of managers within an organization, the application and terminology of specific costing methods and techniques may develop within the culture of that organization and not correspond exactly with the terms commonly used in the literature. As long as you understand the concepts and the principles, this should cause no problems.
The Four Key Questions
What Did It Cost and Why?
This is possibly the most frequent question asked by managers, to which the answers given by accountants are usually misunderstood. The term ā€œcostā€ is slippery and defies one simple definition. It is therefore helpful to describe and classify the term in a variety of ways. Precision can first be given to the question by defining what is meant by ā€œit,ā€ which is known as the cost object.
A broad definition of a cost object is anything for which cost data are required. This can refer to labor, materials, products, services, organizational subdivisions such as departments or divisions of a company, or specific activities. The term is also used to refer to a measure of organizational output, and we discuss the various types of output later in the chapter.
As well as defining the ā€œitā€ for which you require cost data, you will also need to specify the nature of the cost. Are you only interested in the cost of material used in manufacturing a product, or do you also need to know the cost of the machine time taken in manufactu...

Table of contents