Strategic Cost Management-I

Introduction:

We have entered into the Era of liberalisation process has opened the doors of economy and
in globalised economic environment, it is necessary to protect the interest of consumer,
investor, company and the country as a whole. In liberalised economy, there is no role of
traditional management in corporate world. Now only professional management is required to
control the present day organisation.

The globalisation process has changed the focus of business and industry all over the world.
Customer satisfaction is the driving force of all economic activity. After liberalisation the two
major factors which have direct bearing on corporate performance are quality and cost. The
quality and cost are the twin canons which will determine whether the enterprise will grow or
wither away. As competition hots up, these two forces will receive sharper focus and emphasis.

Concept of Strategy:

Strategy is the overused world in the vocabulary of business. A strategy in general terms refers
to a plan of action that will shape the direction of organisation’s success or a strategy is a set of
policies procedures and approaches to business that produce long term success. Strategy
indicates something like an activity, goal, objective, which are of great importance to an
enterprise and which have vital impact on the achievement of an organisation’s objective.
Strategy includes cost leadership, product differentiation, focusing on quality and long term
growth. It is a key to creating and sustaining a competitive advantage. Competitive advantages
create better customer satisfaction at lower cost.

Concept of Cost Management: Cost management is a broad concept than cost accounting,
cost control, cost reduction. Cost management is an integral part of profit planning and total
management of an enterprise. A cost management system is a management planning and
control system with primary objective of producing quality goods and services at the lowest
possible cost. Cost management is a dynamic management accounting which identifies, plans
and controls resources consumed in achieving certain activities, with the effectiveness of
utilising these resources and suggesting the alternative courses of action.

Costing, Cost accounting and Cost accountancy:

The term ‘Costing’ ‘Cost accounting’ and ‘Cost accountancy’ are broadly used to convey
the same meaning, however they have different connotations.

Concept of cost-cost (expenditure)

(i) Cost is the amount of expenditure (actual or notional) incurred on attributable to a

given thing.

(ii) Cost is the price paid for something-Oxford Dictionary

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 Costing: It is technique and process of ascertaining costs. This technique consists of
principles and rules which governs procedure of ascertaining cost of product or services.
The process of costing includes routines of ascertaining cost by historical or conventional
costing, standard costing or managerial costing.

Cost Accounting:

Cost accounting means recording of expenditure and income in a systematic way that
would be useful in arriving at the cost of production process, etc.

Cost accounting is concerned with accumulation, classification, analysis, presentation and

interpretation of cost data for three main purposes, namely: (a) ascertainment of cost (b)
operational planning and control and (c) decision making.

Cost accounting is the science, arts and practice of cost accountant.

Cost Accountancy:

It is widest of all terms and it embraces not only costing and cost accounting but also cost
control, cost audit and budgetary control.

CIMA London:

As “the application of costing and cost accounting principles, methods and techniques to
the science, arts and practice of cost control and ascertainment of profitability as well
presentation of information for the purpose of managerial decision making”

Difference between the costing, cost accounting and cost accountancy.

Points Costing Cost accounting Cost accountancy

Scope and Area It is broad in its It is narrow in its It is broadest in its
scope and area scope and area scope and area
Function It is concerned with It is concerned with It is concerned with
ascertainment ofcost various types of costformulation of costing
concepts, principles,
methods and techniques
Productivity of It begins where cost It begins where It is staring point
functioning accounting ends costing ends

Elements of Cost:

The total cost of a product is composed of three main elements

▪ Material cost
▪ Labour cost (Wage) and
▪ Expenses

Each of three elements may be further divided into two parts: 1. Direct cost 2. Indirect cost
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Direct costs are those which can be identified with and allocated directly to a cost unit or cost
centre.

Indirect cost cannot conveniently be allocated but can be apportioned to or absorbed to cost
units ors cost centres.

Total costs:-Direct cost and indirect costs

Direct cost-Direct Material, Direct Labour and Direct Expenses

Indirect cost-Indirect material, indirect labour and indirect expenses

Overheads-Factory, Administrative, selling and Distribution overheads

Classification of costs: Total costs can be classified or divided in any one of the following
ways:

▪ Element wise classification

▪ Functional classification
▪ Behavioural classification
▪ On the basis of controllability
▪ On the basis of normality
▪ Managerial concepts of costs
▪ Classification on the basis of time

Element wise classification:

1. Material cost: This is the cost of commodities supplied to an undertaking (a) Direct
material cost (b) Indirect material cost.
Direct material cost: Direct materials are those materials which can be entered into
and part of finished product. Direct material cost is that which can be conveniently
identified and allocated to cost units. e.g. Timber in furniture, Leather in shows, cloth
in garments.
Indirect materials: Indirect materials cannot be allocated to cost units but are
apportioned to them on some equitable basis. E.g. Nails used in furniture, Threads used
in stitching garments, Nuts and bolts.

2. Labour cost: It is cost of remuneration (Wages, Salaries, Commission, Bonus etc) of

employees of an undertaking. (a) direct labour cost (b) indirect labour cost
Direct Labour/Direct Wages: Wages paid to labourers who are directly engaged in
converting raw materials into finished products. All labour expended in altering
constriction, composition, conformation or condition of a product may be regarded as
direct labour. E.g. Tailor, Shoe maker, Carpenter and Weaver
Indirect Labour: Indirect labour is not directly engaged in the production of goods but
only to assist or help in production of goods or services. Indirect wages are treated as
overheads. E.g. Watchman, Inspector, Cleaner, Peon, Clerk Supervision, Timekeeper,
Office staff, Storekeeper.
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 3. Expenses: It means cost of services provided to undertaking and the notional cost of
the use or owned assets. In other words, costs other than the material and labour are
called expenses. The expenses are further divided into two parts (a) Direct expenses
(b) Indirect expenses.
There are expenses, which are specifically incurred for a product or process are called
direct expenses. E.g. carriage inwards, Octroi, freight, customs duty, dock charges,
royalty, excise and import duty etc.
Indirect expenses: (Overheads) these include expenses which cannot be allocated but
can be apportioned or absorbed by cost unit and cost centres. E.g. rent and taxes, power
and lighting, carriage, insurance, advertising

Classification of Overhead:
▪ Functional classification
▪ Element wise classification
▪ Behavioural classification
▪ Controllable and uncontrollable overhead
▪ Normal and abnormal overhead

Cost Control and Cost Reduction:

Now a day’s management are facing problems of several because of acute competition. Only
those organisations can meet the competition effectively and have a hold on a market, which
are in position to keep their cost minimum and cost accounting can be instrumental in this
regard by eliminating all inefficiencies and wastages by exercising cost control.

Cost control can be defined as the comparative analysis actual cost with appropriate standard
or budgets. The objective of cost control is the performance of the same job at lower cost or a
better performance for the same cost.

Cost control aims at reducing inefficiency and wastages and setting up predetermined costs
and in achieving them.

Elements of cost control scheme:

⮚ Set down a norm or standard or target

⮚ Select a yards stick for measuring the standard or target
⮚ Ascertain the actual performance by applying yard sticks
⮚ Compare the actual performance with standard or target and compute variance
⮚ Analyse the variance by causes and fix responsibility of variances
⮚ Take corrective action to eliminate the causes of variances
⮚ Periodically review the standards or targets

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 Cost control techniques:

The techniques of the cost control are

▪ Managerial control * Control of capital and expenditure

▪ Labour control * Profitability and accounting ratio
▪ Overhead control
▪ Standard costing
▪ Budgetary control

Cost Reduction:

The profit can be maximised either by increasing sales or by reducing costs. Every
organisation’s aim is to maximise the profit. In competition less market i.e. in the case of
monopoly products, it may perhaps be possible to increase price to earn more profits and the
need of reducing cost may not be felt. Such conditions cannot however permanently exist,
when competition comes into play, it may not be possible to increase the sales price without
its having an adverse effect on the sale volume which in turn reduce profit.

In short, cost reduction should mean maximisation of profit by reducing costs through
economies and savings in cost of manufacturing, administration, selling and distribution

The goal of cost reduction is achieved in two ways (i) by reducing the cost per unit and (ii) by
increasing productivity.

As per CIMA-“cost reduction is to be understood as the achievement of real and permanent

reduction in the unit cost of goods manufactured or service rendered without impairing their
suitability for the use intended”

Essentials of success of cost reduction programme:

⮚ Cost reduction programme must be appropriate to the the organisation

⮚ It is continuous activity aimed at reducing cost continuously by innovating new ideas
from time to time
⮚ It should be real and permanent reduction of cost
⮚ To make cost reduction programme acceptable to the employee of the organisation\
⮚ The persons giving innovative ideas for cost reduction should suitably rewarded by
giving raise in wages and salaries, promotions and special awards
⮚ The cost reduction programme should not merely take into consideration reduction in
cost but it should also consider all other factors (i.e. social and legal aspects)
⮚ There should not be any overlap between the cost reduction measure

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Distinction between cost control and cost reduction:

Points Cost control Cost Reduction

Aims It aims at achieving It aims at reduction of cost by finding
predetermined cost new ways or method
Exercised It is routine exercise It is dynamic and innovative in nature
Concerned with The process of cost control is to It is not concerned with maintenance of
lay down a target ascertain actual performance according to
performance compare with target predetermined standard
Approach It seeks adherence to standards It is challenges to the standard
themselves
Function It is preventive function It is corrective function
Applicability It is generally applicable to the It is application to every activity of
items of cost, which have business
standards
Operation/Researc It is operation oriented It is research oriented
h oriented
Tools of techniques Budgetary control and standard It uses techniques like value
costing are important tools engineering and value analysis
When achieved It is achieved once the costs do Cost reduction begins when cost control
not exceed the standards ends

Field covered by cost reduction:

❖ Product design
❖ Organisation
❖ Factory layout and equipment
❖ Production plan, programme and methods
❖ Administration
❖ Marketing
❖ Personal Management
❖ Material control

● Methods and Techniques of cost control and cost reduction:

The various methods techniques which are used in cost control and cost reduction
process isdiscussed in the following paragraph:

1. Value analysis and engineering: value analysis aims at reducing cost by

economising expenditure and increasing productivity and it probes in to
economic attributes of value and through continuous process of planned action
aims to improve performance, and increase the value in a product and thereby
reduce a cost. Value engineering mainly concentrated on direct costs. Value

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 engineering may be applied in the production stage i.e. in the design and
development stage but value analysis applied to existing products already being
marketed.
2. Equipment maintenance: the objective of equipment maintenance is
maximisation of the performance of production facilities by attempting to
prevent break downs and minimising the loss or inconvenience caused by
unavoidable breakdowns. The purpose of maintenance therefore, is to improve
the reliability of equipment.
3. Control or waste, Scrap, spoilage, defectives: “Waste” is a material loss
during production or storage due to evaporation, chemical reaction, and
unrecoverable residue shrinkage etc wastage may be visible or invisible.
Wastage may be normal waste incidental to manufacturing activities or
abnormal waste which is in excess of material loss over normal loss. “Scrap”
control is the residue material that has a recovery value steps to be taken to
dispose it out. “Defective” represents a part production that does not meet
quality specification of a product.
4. Improvement in material handling system: is an important part of operations
and usually requires major part of operation. It adds cost to the product and the
more it can be reduced, the competitive will be the product.
5. Plant layout study and plant location: in many organisations the most fruitful
sources of reduction may come from good plant layout. Good plant layout
involves designing a plant to the right equipment in a manner and location that
will introduce maximum economy during manufacturing process.
6. Economies of multi shift working: one way of achieving the maximum
possible run inrelation to capital is by way of shift working when system is in
operation activity can continue over periods longer than the normal working
day when supplemented by overtime.

7. Accident prevention: Accidents dislocate production, undermine productivity

andefficiency by affecting morale of workers and others, cause payments of
huge compensation, result in serious damage to plants and assets and denote
inadequate maintenance, inadequate safety measures and perfunctory control
and supervision. Accident prevention measures will undoubtedly avert losses
arising from drop in production and avoidable unproductive expenses thus help
to reduce cost.
8. Production planning and control: production planning is a preproduction
function for arranging facilities by designing the production system. Production
control is concerned with the implementation of the objective of the production
planning or schedule by plans depending on circumstances.
9. Factory automation: has recently become an increasingly popular term.

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 Factory automation can be defined as the automation of the factory through the
use of flexible manufacturing system, computer aided design/computer aided
manufacturing andoffice automation etc.
10. Budgetary control: process consist of establishing objectives for the whole
organisation, revising plans and standards of performance for every area of
activity, comparing actual results with planned results and taking of corrective
Action on the basis of significant variation from planned results.
11. Standard costing: is a technique which uses standards for costs and revenue
for the purpose of control through variance analysis. It analysis and comparison
of the factors, which have caused the differences between predetermined
standards andactual results with a view to eliminating inefficiency.
12. Cost volume profit analysis: is useful in developing flexible budgeting, in
which both costs and revenues are related to an activity. This will show how
costs vary with volume of production.

Cost management
Cost management is the process of planning and controlling the budget of a business. Having a
good cost management system in place makes it easier for an organization to estimate and allocate
its budget.

Cost management is a form of management accounting that helps a business reduce the chance of
going over budget with more accurate forecasts of impending expenditures. Many businesses use
cost management tactics for specific projects and for the overall business.

Areas, Tools and techniques of management accounting

Budgeting
Contract costing
Activity-based costing
Three-point estimation
Analogous estimation
Budget planning
Cost estimation
Decision making
Parametric estimation
Difference between cost control and cost reduction

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Difference between cost control and cost reduction
Basis Cost Control Cost Reduction

Meaning A technique used for A technique used to

maintaining the costs as economise the unit cost
per the set standard without lowering the quality
of the product

Savings in Total cost Cost per unit

Retention of quality Not guaranteed Guaranteed

Nature temporary Permanent

Emphasis on past and present cost Present and future cost

Ends on the pre determined cost No end

is achieved

Type of function preventive function Corrective function

Tools standard costing, value engineering, market

budgetary control research, job evaluation &
merit rating

when it is achieved it is achieved through it can be achieved by way of

compliance with the continuos process of critical
standard examination

Aim it aims at maintaing the it is concerned with reducing

cost in accordance with cost
established standard

condition it seeks to attain lower there is no condition as

possible cost under permanent since a charge
existing condition will result in lesser cost

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Role of cost accounting in strategic planning and management control

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