Debre Markos University
College Of Business and Economics
Department Of Accounting and Finance
A group assignment for the course of advanced cost accounting
for MSc PG. in accounting and finance
BY: Yesgat Lemma----------------GSE/92/13
Yismaw Alemayehu----------GSE/93/13
Yitayew Begashaw------------GSE/94/13
Email; yismaw09@gmail.com
Submitted To: Dr. Biruk Ayalew (PhD)
Debre Markos, Ethiopia
Augest, 2021
Advanced Cost Accounting Group Assignment
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Table of Contents
1
2
Defining of Cost Management System.................................................................................... 1
1.1
Designing a Cost Management System ........................................................................... 3
1.2
Elements of a Cost Management System ........................................................................ 3
1.3
Cost Management System (CMS) Implementation ......................................................... 4
1.4
Summary Cost Management System............................................................................... 5
Strategic Management Accounting ......................................................................................... 6
2.1
The Importance of Strategic Management Accounting ................................................... 7
2.1.1
Facts......................................................................................................................... 8
2.1.2
Features ................................................................................................................... 8
2.1.3
Considerations ......................................................................................................... 8
2.1.4
Benefits .................................................................................................................... 9
2.1.5
Warning ................................................................................................................... 9
2.2
Strategic Cost Management Techniques ......................................................................... 9
2.2.1
Activity Based Costing (ABC) .............................................................................. 10
2.2.2
Activity Based Management (ABM):.................................................................... 10
2.2.3
Target Costing (TC) .............................................................................................. 12
2.2.4
Total Quality Management (TQM) ....................................................................... 12
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1 Defining of Cost Management System
A cost management system (CMS) consists of a set of formal methods developed for
planning and controlling an organization’s cost-generating activities relative to its shortterm objectives and long-term strategies. Business entities face two major challenges:
achieving profitability in the short run and maintaining a competitive position in the long
run. An effective cost management system must provide managers the information
needed to meet both of these challenges.
Cost management system (CMS) summarizes the differences in the information
requirements for organizational success in the short run and long run. The short-run
requirement is that revenues exceed costs—the organization must make efficient use of
its resources relative to the revenues that are generated. Specific cost information is
needed and must be delivered in a timely fashion to an individual who is in a position to
influence the cost. Short-run information requirements are often described as relating to
operational management. Meeting the long-run objective, survival, depends on acquiring
the right inputs from the right suppliers, selling the right mix of products to the right
customers, and using the most appropriate channels of distribution. These decisions
require only periodic information that is reasonably accurate. Long-run information
requirements are often described as relating to strategic management. The information
generated from the CMS should benefit all functional areas of the entity.
Crossing all functional areas, a cost management system can be viewed as having six
primary goals:
1. Develop reasonably accurate product costs, especially through the use of cost
drivers (activities that have direct cause-and-effect relationships with costs);
2. Assess product/service life-cycle performance;
3. Improve understanding of processes and activities;
4. Control costs;
5. Measure performance; and
6. Allow the pursuit of organizational strategies.
First and foremost, a CMS should provide the means to develop accurate product or
service costs. This requires that the system be designed to use cost driver information to
trace costs to products and services. The system does not have to be the most accurate,
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but it should match benefits of additional accuracy with expenses of achieving additional
accuracy. Traceability has been made easier by improved information technology,
including bar coding.
The product/service costs generated by the cost management system are the input to
managerial processes. These costs are used to plan, prepare financial statements, assess
individual product/service profitability and period profitability, establish prices for costplus contracts, and create a basis for performance measurements. If the input costs
generated by the CMS are not reasonably accurate, the output of the preceding processes
will be inappropriate for control and decision-making purposes.
Although product/service profitability may be calculated periodically as a requirement for
external reporting, the financial accounting system does not reflect life-cycle information.
The cost management system should provide information about the life-cycle
performance of a product or service. Without life-cycle information, managers will not
have a basis to relate costs incurred in one stage of the life cycle to costs and profitability
of other stages. For example, managers may not recognize that strong investment in the
development and design stage could provide significant rewards in later stages by
minimizing costs of engineering changes and potential quality-related costs. Further, if
development/design cost is not traced to the related product or service, managers may not
be able to recognize organizational investment “disasters.”
A cost management system should help managers comprehend business processes and
organizational activities. Only by understanding how an activity is accomplished and the
reasons for cost incurrence can managers make cost-beneficial improvements in the
production and processing systems. Managers of a company desiring to implement new
technology or production systems must recognize what costs and benefits will flow from
such actions; these assessments can be made only if the managers understand how the
processes and activities will differ after the change.
The original purpose of a cost accounting system was to control costs. This is still an
important function of cost management systems given the current global competitive
environment. A cost can be controlled only when the related activity is monitored, the
cost driver is known, and the information is available. For example, if units are spoiled in
a process, the CMS should provide information on spoilage quantity and cost rather than
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“burying” that information in other cost categories. Additionally, the cost management
system should allow managers to understand the process so that the underlying causes of
the spoilage can be determined. Armed with this information, managers can compare the
costs of fixing the process with the benefits to be provided. The information generated
from a cost management system should help managers measure and evaluate
performance. The measurements may be used to evaluate human or equipment
performance or to evaluate future investment opportunities. As indicated in the
accompanying News Note, one of the critical decisions managers must make involves
trade-offs between long-run strategic benefits and short-run operational benefits.
1.1 Designing a Cost Management System
In designing and revising a cost management system, managers and accountants must be
attuned to the unique characteristics of their firms. A generic cost management system
cannot be “pulled off the shelf” and applied to any organization. Each firm warrants a
cost management system that is tailored to its situation. However, some overriding
factors are important in designing a cost management system.
1.2 Elements of a Cost Management System
A cost management system is composed of three primary elements: motivational
elements, information elements, and reporting elements. The elements as a whole must be
internally consistent, and the individually selected elements must be consistent with the
strategies and missions of the subunits. Different aspects of these elements may be used
for different purposes. For example, numerous measures of performance can be specified,
but only certain measures will be appropriate for specific purposes.
1. Motivational Elements Includes
 Performance measurements
 Reward structure
 Support of organizational mission and competitive strategy
2. Informational Elements Includes
 Support of budgeting process
 Emphasis on product life cycle
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 Differentiation of value–added and non–value–added activities
 Support of cost reduction initiatives
 Focus on cost control
 Assessment of core competencies and analysis of make–or–outsource
decisions
3. Reporting Elements Includes
 Preparation of financial statements
 Provision of details for responsibility accounting system
1.3 Cost Management System (CMS) Implementation
Once the organization and its subunits have been structured and the elements of the cost
management system determined, the current information system(s) should be evaluated.
A gap analysis is necessary to compare the information that is needed to the information
that is currently available, or to determine how well desired information outputs coincide
with current outputs. Any difference represents a “gap” to be overcome.
In many situations, it is impossible to eliminate all system gaps in the short term,
potentially because of software or hardware capability or availability. Methods of
reducing or eliminating the gaps, including all related technical requirements and changes
to existing feeder systems should be specified in detail. These details should be
expressed, qualitatively and quantitatively, in terms of costs and benefits.
As system implementation proceeds, management should assess the effectiveness of the
improvements and determine the need for other improvements. Once the CMS has been
established, previously identified gaps may become irrelevant or may rise in rank of
priority. Only through continuous improvement efforts can the cost management system
provide an ongoing, viable network of information to users.
Technology’s impact on cost management system design and implementation is
significant. With advancements in technology, it is becoming possible to link the feeder
systems of a company into a truly integrated cost management system. Enterprise
resource planning (ERP) systems are packaged business software systems that allow
companies to
1. Automate and integrate the majority of their business processes,
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2. Share common data and practices across the entire enterprise, and
3. Produce and access information in a real-time environment.
The ERP software often involves 30 separate modules that collect data from individual
processes in the firm (sales, shipping, distribution, etc.) and assemble that data in a form
accessible by all managers.
1.4 Summary Cost Management System
A cost management system is a subpart of a firm’s information and control systems. A
management information system is a structure that organizes and communicates data to
managers. Control systems exist to guide organizations in achieving their goals and
objectives. They have four primary components: detectors, assessors, effectors, and a
communications network.
A cost management system consists of a set of formal methods developed for planning
and controlling an organization’s cost-generating activities relative to its goals and
objectives. This system serves multiple purposes: to develop product costs, assess
product/service profitability, improve understanding of how processes affect costs,
facilitate cost control, measure performance, and implement organizational strategies.
It is not feasible to simply adopt a generic, “off-the-shelf” cost management system. As
in the design of any control system, managers must be sensitive to the unique aspects of
their organizations. Three factors that specifically should be taken into account in
designing a control system are the organizational form, structure, and culture;
organizational mission and critical success factors; and the competitive environment.
A cost management system’s design is based on elements from three groups of
management control tools. The selected elements of the system should be internally
consistent and be consistent with the missions of the individual subunits. The three
groups of control tools are motivational elements, informational elements, and reporting
elements.
The motivational elements exist to provide managers the incentive to take the actions that
are in the best interest of their subunits and the overall organization. Managers are
motivated to do the right thing when the rewards they receive for their efforts are linked
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to the quality of decisions they make on behalf of the organization and their specific
subunits.
The informational elements provide managers with relevant data. Accountants play a
primary role in information management and are charged with maintaining an
information system that is useful in performance measurement of managers and subunits
and in making managerial decisions. To compete in the global environment, firms are
developing new techniques to provide information relevant to assessing their competitive
positions.
The reporting elements exist to provide information regarding managerial performance.
For accounting, this is sometimes referred to as the “scorekeeping” role. A responsibility
accounting system provides information to top management about the performance of an
organizational subunit and its manager.
Gap analysis is the key to identifying differences (gaps) between the ideal cost
management system and the existing system. By prioritizing the order in which gaps are
to be closed, managers can proceed in an orderly manner with updating the cost
management system. Because business processes are constantly evolving, the cost
management system must be continuously evaluated and updated so that it provides the
information and motivation that managers currently require.
2 Strategic Management Accounting
Contemporary organizations face significant internal and external challenges that must be
addressed in order to operate and function effectively. It is essential for them to create
value for multiple stakeholders, including customers, employees, management, regulators
and their shareholders or owners. This must be achieved in a global environment that is
continuously changing and becoming more competitive. This subject focuses on the role
strategic management accounting plays in creating, managing and protecting value
For the purposes of this subject, strategic management accounting is defined as follows:
Creating sustainable value by:
• supporting the formation, selection, implementation and evaluation of organizational
strategy
• synthesizing information that captures financial and non-financial perspectives for both
the internal and external environments, to enable effective resource allocation.
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Strategic management accounting requires that management accountants embrace new
skills that extend beyond their traditional practices. They must collaborate with general
management (operational departments), corporate strategists (senior management team)
and product development, in creating, managing and protecting value. Fostering
organizational capabilities leads to value creation.
Value creation is essential in contemporary organizations. One way of thinking about
commercial organizations, government bodies and not-for-profit entities is as ‘linked
chains’ of resources and activities. These chains produce products and services of value
to consumers and end users. The essential requirements for successful performance are:
• To generate products and services with value that consumers are willing to pay for
• To constantly develop and improve the resources, activities and processes used to
generate that value (Anderson and Narus 1998)
This module first considers management accounting and its role in supporting
management. It then describes the key changes that have led to the development of
strategic management accounting. The module also identifies the challenges that
management accountants face and describes the skills required to perform their role, at
present and in the future. The ability to support managers at a strategic level has become
critically important for organizational survival, and management accountants must
broaden their role from traditional scorekeeping tasks to business advisory positions.
Advances in technology and information systems now help with capturing and processing
the routine events within an organization. This allows management accountants to spend
more time understanding the organization’s external environment and work on nonroutine, complex decisions. This module concludes with an examination of the various
analytical techniques available to management accountants that will assist them to
support management in their decisions about strategic direction.
2.1 The Importance of Strategic Management Accounting
Accounting is the business function of recording and reporting financial transactions in
a company’s accounting ledgers. Financial accounting is the preparation of
information to external users regarding the company’s financial health and business
operations. Management accounting is an internal accounting function used to allocate
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business costs to goods or services and prepare reports for internal management
business decisions. The management accounting function has slowly been
transforming into a critical strategic management function.
2.1.1 Facts
Strategic management accounting is a form of management accounting focusing on
information relating to external business situations, non-financial information or other
internal information relating to various business decisions. This transformation takes
accounting into the strategic financial planning environment, which requires
accountants to include a variety of business scenarios when planning and preparing
financial information for business use. Companies may specifically employ certified
public accountants or certified management accountants to advance its strategic
management accounting function.
2.1.2 Features
Strategic management accounting includes external economic information when
analyzing and preparing financial information. Traditional management accounting
typically uses the company’s internal information when aiding business management
decisions. Including external economic information can help companies plan for
changes in the business marketplace outside of the company’s control, such as
competitors entering the market or the threat of substitute goods and services
competing for the company’s market share.
2.1.3 Considerations
Companies can also use strategic management accounting to develop and implement
cost leadership strategies in its business operations. Common cost leadership strategies
include lean accounting or manufacturing, six sigma or total quality management.
These strategies help companies develop the lowest operating or production costs in its
industry, giving the company an opportunity to pass these savings on to consumers.
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While cost leadership strategies can be difficult to implement, strategic management
accounting can usually estimate the future profits against the implementation costs.
2.1.4 Benefits
Using strategic management accounting to develop cost leadership strategies and strong
economic forecasts can help companies improve its market share in the economic
marketplace. Companies may also be able to create a distinct competitive advantage
over competitors in its business industry or sector. This advantage means more profits
for the company and the opportunity to expand its operations or enter new business
markets. Strategic management accounting can also determine if a company needs to
drop certain business lines to improve its profit margin and cut wasteful operations.
2.1.5 Warning
Implementing strategic management accounting can be an arduous and expensive
process for companies. Accountants are usually trained to simply collect financial
information, input the information into the accounting software and prepare financial
reports. Strategic management accounting attempts to change this mentality by
including management accountants in the strategic planning and decision-making
process of the company. This change goes against decades of traditional accounting
training, requiring companies to develop new business thought processes in their
accountants.
2.2 Strategic Cost Management Techniques
1. Activity Based Costing (ABC)
2. Activity Based Management (ABM):
3. Target Costing (TC)
4. Total Quality Management (TQM)
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2.2.1 Activity Based Costing (ABC)
Activity-based costing (ABC) is a costing method that is designed to provide managers
with cost information for strategic and other decisions that potentially affect capacity and
therefore “fixed” as well as variable costs. Activity-based costing is ordinarily used as a
supplement to, rather than as a replacement for, a company’s usual costing system. Most
organizations that use activity-based costing have two costing systems—the official
costing system that is used for preparing external financial reports and the activity-based
costing system that is used for internal decision making and for managing activities.
ABC is a natural outgrowth of today’s competitive and complex environment. ABC
provides a closer approximation of the cost of a product than that provided by the
traditional volume based costing method. The main principle of ABC states that activities
cause costs and to control costs, the activities must be controlled.
Under ABC system, the activities are identified, the expenses related to each activity are
clubbed together to get activity-wise expenses, a cost driver for each activity is selected
and finally the cost of the product is worked out.
Traditional cost accounting measures what it costs to do a task whereas ABC records the
cost of not doing also. The system monitors activities more closely, relates costs to
activities and bring in cost effectiveness. This system of costing makes a great impact in
the service sector also.
ABC is a primary source of information for Activity Based Management (ABM). ABM is
basically a top down approach wherein the top management exploits information derived
from ABC and passes the decision to the operational level towards continuous
improvement and excellence.
2.2.2 Activity Based Management (ABM):
The adopters of activity based costing (ABC) used it is produce more accurate product or
service costs but it soon became apparent to the users that it could be extended beyond
purely product costing to a range of cost management applications.
The term activity based management (ABM) or activity based costing management
(ABCM) are used to describe the cost management applications. To complement an
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ABM system only first three stages of the five stages for designing an activity-based
product costing system are required.
They are:
 Identifying the major activities that take place in the organisation;
 Assigning costs to cost pools/cost centers for each activity;
 Determining the cost driver for each major activity.
ABM rules business as a set of linked activities that ultimately add value to the customer.
It focuses on managing the business on the basis of activities that make up the
organisation. ABM is based on the premise that activates consume costs.
Therefore, by managing activities costs will be managed in the long-term. The goal of
ABM is to enable customer needs to be satisfied while making fewer demands on
organisational resources.
ABC also provides information on the cost of activities why activities are taken and how
will they are performed. ABM is much broader concept than ABC. It refers to the
management philosophy that focuses on the planning execution and measurement of the
activities as the key to competitive advantage.
From the above we can conclude that Strategic Cost Management helps to find lower cost
solutions but this also requires proper supply chain management. Globalized market place
and consumer’s increased demands on availability put higher pressure on companies
supply chain.
If supply chain is efficient, then end consumers will be better served. If supply chain is on
top, it not only helps to gain new consumers but also helps to retain old ones.
The major responsibility of purchasing is to ensure that the price paid for an item is fair
and reasonable because price has a direct-impact on the end consumer’s perception of
value provided by the organisation.
So evaluation of supplier’s cost to provide the product and services is an ongoing
challenge within all industries. Price analysis focuses simply on a seller’s price
perspective, giving less consideration to actual cost of production.
On the other hand cost analysis, lays emphasis on each individual cost element (i.e.
material, labour, overhead, other administrative costs and profits) and final cost of
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product. This analysis determines a fair and reasonable price and develop plan to achieve
future cost reduction.
So price and cost management should be considered from total supply chain perspective.
Strategic cost management requires that purchasing and logistics system should adopt a
series of new initiatives that can deliver results of the bottom line.
2.2.3 Target Costing (TC)
As customers become more demanding and seek great value, importance of effective cost
management becomes even more. Much of the Indian manufacturing in the past was
occurring in a cost plus environment, aided by extensive government regulations. The
operating practice was to fix a price as: Price = Cost + Profit. But in the global market the
customer will dictate the price and features that he will be looking for.
Target costing is a new attempt in which cost is the difference between the price
expectation of the customers and margin expectations of the corporation entities. Cost =
Price – Target Profit. Management Accountant will have to work closely with design and
engineering personnel to achieve this target.
2.2.4 Total Quality Management (TQM)
Total Quality Management is a term first coined by the U.S. Naval Air Systems
Command to describe its Japanese-style management approach to quality improvement.
TQM is a set of management practices throughout the organisation, geared to ensure that
the organisation consistently meets or exceeds customer requirements. TQM places
strong focus on process measurement and controls as means of continuous improvement.
Total Quality is a people-focused management system that aims at continual increase in
customer satisfaction at continually lower real cost. In a TQM effort, all members of an
organisation participate in improving processes, products, services and the culture in
which they work.
The OPT philosophy therefore, advocates that non-bottleneck resources should not be
utilized to 100% of their capacity, since this would merely result in an increase in
inventory. Thus, idle time in non-bottleneck is not considered detrimental to the
efficiency of the organisation.
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If it were utilized, it would result in increased inventory without a corresponding increase
in throughput for the plant. The process of maximising profit when faced with bottleneck
and non-bottleneck operations is known as theory of constraint (TOC).
The process involves five steps:
i.
Identify the system’s bottleneck;
ii.
Decide how to exploit the bottlenecks;
iii.
Subordinate everything else to the decision in step (ii);
iv.
Elevate the system’s bottlenecks;
v.
If, in the previous steps a bottleneck has been broken go back to
step (i).
Total quality management (TQM) is the continual process of detecting and reducing or
eliminating errors in manufacturing, streamlining supply chain management, improving
the customer experience, and ensuring that employees are up to speed with training.
Total quality management aims to hold all parties involved in the production process
accountable for the overall quality of the final product or service.
TQM was developed by William Deming, a management consultant whose work had a
great impact on Japanese manufacturing. While TQM shares much in common with the
Six Sigma improvement process, it is not the same as Six Sigma. TQM focuses on
ensuring that internal guidelines and process standards reduce errors, while Six Sigma
looks to reduce defects.
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