COST MANAGEMENT
Accounting & Control
Hansen▪Mowen▪Guan
Chapter 11
Strategic Cost Management
COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning.
Cengage Learning and South-Western are trademarks used herein under license.
1
Study Objectives
1. Explain what strategic cost management is and how it
can be used to help a firm create a competitive
advantage.
2. Discuss value-chain analysis and the strategic role of
activity-based customer and supplier costing.
3. Tell what life-cycle cost management is and how it can
be used to maximize profits over a product’s life cycle.
4. Identify the basic features of JIT purchasing and
manufacturing.
5. Describe the effect JIT has on cost traceability and
product costing.
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Strategic Cost Management:
Basic Concepts
• Three general strategies have been
identified:
– Cost leadership
– Product differentiation
– Focusing
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Strategic Cost Management:
Basic Concepts
Cost leadership strategy
To provide the same or better value to
customers at a lower cost than offered by
competitors.
A company might redesign a product so that fewer
parts are needed, lowering production costs and the
costs of maintaining the product after purchase.
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Strategic Cost Management:
Basic Concepts
Differentiation strategy
Strives to increase customer value by
increasing what the customer receives
(customer realization).
A retailer of computers might offer on-site repair
service, a feature not offered by other rivals in the local
market
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Strategic Cost Management:
Basic Concepts
Focusing strategy
A firm selects or emphasizes a market or
customer segment in which to compete.
Paging Network, Inc., a paging services provider, has
targeted particular kinds of customers and is in the
process of weeding out the nontargeted customers.
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Strategic Cost Management:
Basic Concepts
The industrial value chain
• The linked set of value-creating activities from
basic raw materials to the disposal of the
finished product by end-use customers.
• Fundamental to a value-chain framework is the
recognition that there exist complex linkages
and interrelationships among activities both
within and external to the firm.
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Strategic Cost Management:
Basic Concepts
Value-chain framework linkages
– Internal linkages: relationships among
activities that are performed within a firm’s
portion of the value chain
– External linkages: the firm’s value-chain
activities that are performed with its suppliers
and customers
• Supplier linkages
• Customer linkages
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Strategic Cost Management:
Basic Concepts
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Strategic Cost Management:
Basic Concepts
Organizational activities:
– Structural activities: activities that determine
the underlying economic structure of the
organization.
– Executional activities: activities that define
the processes and capabilities of an
organization and thus are directly related to
the ability of an organization to execute
successfully.
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Strategic Cost Management:
Basic Concepts
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Strategic Cost Management:
Basic Concepts
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Strategic Cost Management:
Basic Concepts
13
Value-Chain Analysis
14
Value-Chain Analysis
Internal Linkage Analysis Example
Activities
Activity Driver
Material usage
Assembling parts
Purchasing parts
Warranty repair
Current Expected
Activity
Activity
Activity
Capacity Demand Demand
Number of parts
200,000 200,000
Direct labor hours
10,000 10,000
Number of orders
15,000 12,500
Number of defective products
1,000
800
80,000
5,000
6,500
500
Additionally, the following activity cost data are provided:
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Value-Chain Analysis
Internal Linkage Analysis Example
Material usage: $3 per part used; no fixed activity cost.
Assembly: $12 per direct labor hour; no fixed activity cost
Purchasing: Three salaried clerks, each earning a $30,000
annual salary; each clerk is capable of processing 5,000
purchase orders annually. Variable activity costs: $0.50
per purchase order processed for forms, postage, etc.
Warranty: Two repair agents, each paid a salary of $28,000 per
year; each repair agent is capable of repairing 500 units
per year. Variable activity costs: $20 per product repaired.
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Value-Chain Analysis
Internal Linkage Analysis Example
Cost Reduction from Exploiting Internal Linkages
Material usage
$ 360,000
(200,000 - 80,000)$3
Labor usage
60,000
(10,000 - 5,000)$12
Purchasing
33,000
[$30,000 + $0.50(12,500 - 6,500)]
Warranty repair
34,000
[$28,000 + $20(800 - 500)]
Total
$ 487,000
Units
Unit savings
10,000
$ 48.70
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Value-Chain Analysis
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Value-Chain Analysis
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Value-Chain Analysis
Internal Linkage Analysis Example
(800 + 190 + 5 + 5)
Reworking rate = $200,000 ÷ 1,000
= $200 per failed component
(30 + 20)
Expediting rate = $50,000 ÷ 50
= $1,000 per late delivery
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Value-Chain Analysis
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Value-Chain Analysis
One Large
Customer
Units purchased
Orders placed
Manufacturing cost
Order-filling cost allocated*
Order cost per unit
$
$
$
500,000
2
3,000,000
303,000
0.6060
Ten Smaller
Customers
$
$
$
500,000
200
3,000,000
303,000
0.6060
* Order-filling capacity is purchased in blocks of 45 (225
capacity), each block costing $40,400; variable order-filling
activity costs are $2,000 per order; thus, the cost is
[(5 × $40,400) + (202 × $2,000)]
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Life-Cycle Cost Management
Basic views of the product life cycle:
 Marketing viewpoint
 Production viewpoint
 Consumable life viewpoint
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Life-Cycle Cost Management
24
Life-Cycle Cost Management
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Life-Cycle Cost Management
Cost Reduction Example
Cost Behavior
Functional-based system:
Variable conversion activity rate: $40
Material usage rate:
$8
ABC system:
Labor usage
$10
Material usage:
$8
Machining:
$28
Purchasing activity:
$60
Setup activity:
$1,000
Warranty activity:
$200
Customer repair cost
$10
per direct labor hour
per part
per direct labor hour
per part
per machine hour
per purchase order
per setup hour
per returned unit
per hour
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Life-Cycle Cost Management
Cost Reduction Example
Activity and Resource Information (annual estimates)
Design A
Design B
United produced
10,000
10,000
Direct material usages
100,000 parts
60,000 parts
Labor usage
50,000 hours
80,000 hours
Machine hours
25,000
20,000
Purchase orders
300
200
Setup hours
200
100
Returned units
400
75
Repair time (customer)
800
150
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Life-Cycle Cost Management
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Life-Cycle Cost Management
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Life-Cycle Cost Management
Cost reduction methods:
– reverse engineering
– value analysis
– process improvement
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Life-Cycle Cost Management
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JIT and Its Effect on the Cost
Management System
JIT
•
•
•
•
•
•
•
•
•
•
•
•
Pull-through system
Insignificant inventories
Small supplier base
Long-term supplier contracts
Cellular structure
Multiskilled labor
Decentralized services
High employee involvement
Facilitating management
style
Total quality control
Buyers’ market
Value-chain focus
Traditional
•
•
•
•
•
•
•
•
•
•
•
•
Push-through system
Significant inventories
Large supplier base
Short-term supplier contracts
Departmental structure
Specialized labor
Centralized services
Low employee involvement
Supervisory management
style
Acceptable quality level
Sellers’ market
Value-added focus
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Cost Flows:
Traditional Compared with JIT
Transaction 1: Purchase of raw materials.
Traditional Journal Entry
Materials Inventory
Accounts Payable
Back-Flush Journal Entry
Raw Materials and In-Process Inven
Accounts Payable
160,000
160,000
160,000
160,000
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Cost Flows:
Traditional Compared with JIT
Transaction 2: Materials issued to production.
Traditional Journal Entry
Work-in-Process Inventory
Materials Inventory
160,000
160,000
Back-Flush Journal Entry
No entry
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Cost Flows:
Traditional Compared with JIT
Transaction 3: Direct labor cost incurred.
Traditional Journal Entry
Work-in-Process Inventory
Wages Payable
25,000
25,000
Back-Flush Journal Entry
Combined with overhead: See next entry.
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Cost Flows:
Traditional Compared with JIT
Transaction 4: Overhead cost incurred.
Traditional Journal Entry
Overhead Control
Accounts Payable
225,000
225,000
Back-Flush Journal Entry
Conversion Cost Control
Wages Payable
Accounts Payable
250,000
25,000
225,000
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Cost Flows:
Traditional Compared with JIT
Transaction 5: Application of overhead.
Traditional Journal Entry
Work-in-Process Inventory
Overhead Control
210,000
210,000
Back-Flush Journal Entry
No entry.
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Cost Flows:
Traditional Compared with JIT
Transaction 6: Completion of goods.
Traditional Journal Entry
Finished Goods Inventory
Work-in-Process Inventory
395,000
395,000
Back-Flush Journal Entry
Finished Goods Inventory
395,000
Raw Materials and in-Process Inventory
Conversion Cost Control
160,000
235,000
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Cost Flows:
Traditional Compared with JIT
Transaction 7: Goods are sold.
Traditional Journal Entry
Cost of Goods Sold
Finished Goods Inventory
395,000
395,000
Back-Flush Journal Entry
Cost of Goods Sold
Finished Goods Inventory
395,000
395,000
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Cost Flows:
Traditional Compared with JIT
Transaction 8: Variance is recognized.
Traditional Journal Entry
Cost of Goods Sold
Overhead Control
15,000
15,000
Back-Flush Journal Entry
Cost of Goods Sold
Conversion Cost Control
15,000
15,000
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COST MANAGEMENT
Accounting & Control
Hansen▪Mowen▪Guan
End Chapter 11
COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning.
Cengage Learning and South-Western are trademarks used herein under license.
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