Chapter 1: Cost Management And Strategy

Chapter 01 – Cost Management and Strategy

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CHAPTER 1: COST MANAGEMENT AND STRATEGY

QUESTIONS

1-1 Firms Using Cost Management. Here are some examples; there are many

possible answers.

1. Walmart: to keep costs low by streamlining restocking and sales

2. Hewlett-Packard or Dell Computer: to keep costs low by improving

manufacturing performance and by using target costing and other management

techniques

3. Citicorp: to keep costs low by using activity analysis to identify key operations

and to find those that add little or no value

4. A municipality or public agency: to keep costs low in order to provide the best

possible service given available funds

5. Procter & Gamble or any similar large, diversified manufacturer: to assess the

profitability of its different products

6. A small machine shop: to determine whether it should repair or replace a

machine

7. A dance studio: to analyze and choose between different compensation plans

for its teachers; and to determine whether it should open a new studio

1-2 Firms that will likely use somewhat different types of cost management

information because of their unique competitive strategies include: :

1. Microsoft: here the focus is on forming strategic alliances, innovation and

competition; cost management is more important for other firms in the

information technology business, such as Hewlett-Packard, and Dell Computer

that compete in part on innovation but also on price

2. Versace: a high fashion firm competes on innovation and product leadership;

the development and communication of attractive new ideas is the key to

competitive success rather than cost management

3. Other firms in the fashion industry, such as Chanel, Coach, Gucci, and

Armani: for reasons similar to Versace

4. Major league sports: dependent primarily on the development of fan support,

good coaching and player acquisition

1-3 Cost management information is a broad concept. It is the information the

manager needs to implement the strategy of the firm or not-for-profit organization

— both financial information about costs and revenues and relevant non-financial

information about productivity, quality, and other key success factors for the firm.

Typically, cost management is the responsibility of the Chief Financial Officer

(CFO) who often delegates much of this responsibility to the Controller.

1-4 In the private sector, the Financial Accounting Standards Board, an independent

organization, and the American Institute of Certified Public Accountants (AICPA)

supply guidance regarding financial reporting practices. The Sarbanes-Oxley Act

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of 2002 also created the Public Company Accounting Oversight Board which

reports to the SEC to oversee auditing standards and practices. The AICPA also

provides educational opportunities. In the public sector, the Cost Accounting

Standards Board (CASB) sets cost accounting standards for those doing

business with the federal government, especially defense contractors. The

Institute of Management Accountants (IMA) is the principal organization devoted

primarily to management accountants in the United States. The IMA has

magazines, newsletters, research reports, management accounting practice

reports, professional development seminars, and monthly technical meetings that

serve the broad purpose of providing continuing educational opportunities for

management accountants. In Canada, the Society of Management Accountants

provides a similar role. Similar organizations are present in most other countries

around the world. The Financial Executives International (FEI) organization

provides services much like the IMA for financial managers, including controllers

and treasurers. Because of the nature of its membership, the FEI tends to focus

on management and operational control issues, and less on the product costing,

planning, and decision-making functions.

1-5 The Certificate in Management Accounting (CMA) is the most relevant

certification program for management accountants since it focuses on the types

of skills that are most in demand for management. Other relevant certificates

include the Certified Public Accountant (CPA) and the Chartered Global

Management Accountant (CGMA).

1-6 The four functions of management are:

1. Strategic Management — information is needed by management to make

sound strategic decisions regarding choice of products, manufacturing methods,

marketing techniques and channels, and other long term issues.

2. Planning and Decision Making — information is needed to support recurring

decisions regarding replacement of equipment, managing cash flow, budgeting

raw materials purchases, scheduling production, and pricing.

3. Management and Operational Control — information is needed to provide a fair

and effective basis for identifying inefficient operations, and to reward and

support the most effective managers.

4. Preparation of Financial Statements — information is needed to provide

accurate accounting for inventory and other assets, in compliance with reporting

requirements, for the preparation of financial reports and for use in the three

other management functions.

1-7 Strategic management is the most important management function since it most

directly relates to the overall success of the firm. In strategic management, top

managers determine how the firm is to compete and what specific goals it must

set and achieve to be successful. The determination of these strategies and

goals drives all other activities in the firm.

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1-8 Merchandising firms purchase goods for resale. Merchandisers that sell to other

merchandisers are called wholesalers, while those selling directly to consumers

are called retailers. Examples of merchandising firms include the large retailers,

such as Sears, Walmart, and Target. Merchandisers use cost management

information to control stocking, distribution, and customer service.

Manufacturing firms use raw materials, labor, and manufacturing facilities and

equipment to produce products. These products are sold to merchandising firms

or to other manufacturers as raw materials for additional products. Examples of

manufacturers include General Motors, IBM, and Samsung. These firms use

cost management information to control production costs.

Service firms provide a service to customers that offers convenience, freedom,

safety, or comfort. Common services include transportation, financial services

(banking, insurance, accounting), personal services (physical training, hair

styling), medical services, and legal services. These firms use cost management

information to identify profitable services and to control costs incurred in

providing services.

Governmental and not-for-profit organizations provide services, much like the

firms in service industries. However, the service provided by these organizations

is such that there is often no direct relationship between the amount paid and the

services provided. Instead, both the nature of the services to be provided and

the customers who receive the services are determined by government or

philanthropic organizations. These organizations use cost management

information to determine and control the costs of the services they provide.

1-9 The answers here can vary from large manufacturers such as Boeing to small

retail stores. If the class has trouble getting started, the instructor might use

some of the firms mentioned in question 1-1 or from the instructor’s own

experience and understanding. Again, if the students have a hard time, the

instructor might ask them to think of firms close to their homes, or to think of firms

in a given industry, etc.

1-10 For some firms, a popular web site can be an important differentiating factor.

Firms such as Amazon.com, Etrade, eBay and many retailers have achieved

powerful competitive advantage through their web sites, offering fast delivery and

enhanced customer service. Other firms such as Walmart use the Internet to

achieve cost advantage by using Internet based systems for transactions

processing, production scheduling, purchasing, employee recruiting, etc.

1-11 The management accountant is a full business partner with management in

Stage 4 of cost system development. At this stage, the highest level, the

management accountant has an integral role with management to implement the

organization’s strategy.

1-12 The factors in the contemporary business environment that affect business firms

and cost management are:

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1. Increased global competition, which means an increasingly competitive

environment for all firms and thus the need for cost management information

to become more competitive; the need for competitive non-financial

information in addition to financial information in cost management reports;

2. Lean manufacturing, in which companies reduce costs by using flexible

manufacturing methods, statistical quality control, and many of the techniques

developed by Japanese manufacturers; lean manufacturers adopt lean

accounting to measure and sustain the improvements made from lean

manufacturing.

3. Use of information technology; cost management information is used to

facilitate the introduction of new manufacturing and product technologies

(e.g., determining which technologies will most contribute to profitability), to

develop new ways to manage customer and supplier relationships using the

Internet; and to use enterprise resource management to develop and report

cost management information in a lower cost, more comprehensive, and

timely way;

4. A focus on the customer, which requires cost management reports to include

critical information about customer satisfaction, changing customer

preferences, etc.;

5. Changes in management organizations which require new reporting practices

to recognize the new focus on cross-functional teams in which employees

from all areas of the firm work together to make the firm successful;

6. Changes in the social, political, and cultural environment of business, which

requires an expansion of cost management reporting to include critical

success factors related to the expectations of those beyond the ownership of

the firm including employees, local government officials, and community

leaders.

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1-13 Refer to Exhibit 1-3 in the text, reproduced here.

Comparison of Prior and Contemporary Business Environments

Prior Business

Environment

Contemporary Business

Environment

MANUFACTURING

Basis of Competition

Economies of scale,

standardization

Quality, functionality,

customer satisfaction

Manufacturing Process

High volume, long

production runs,

significant levels of in–

process and finished

inventory

Low volume, short

production run, focus on

reducing inventory levels and

other non-value-added

activities and costs

Manufacturing

Technology

Assembly line

automation, isolated

technology applications

Robotics, flexible

manufacturing systems,

integrated technology

applications connected by

network

Required Labor Skills

Machine paced, low-

level skills

Individual and team paced,

high-level skills

Emphasis on Quality

Acceptance of a normal

or usual amount of

waste

Strive for zero defects

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Question 1-13 (continued)

Prior Business

Environment

Contemporary Business

Environment

MARKETING

Products

Relatively few

variations, long product

life cycles

Large number of variations,

short product life cycles

Markets

Largely domestic

Global

MANAGEMENT

ORGANIZATION

Types of Cost

Management

Information Needed

Almost exclusively

financial data

Financial and operating data,

the firm’s strategic success

factors

Management

Organizational

Structure

Hierarchical; command

and control

Network-based organization

forms; teamwork focus —

employee has more

responsibility and control;

coaching rather than

command and control

Management Focus

Short term: short term

performance measures

and compensation;

concern for sustaining

stock price; short tenure

and high mobility of top

managers

Long term; focus on critical

success factors, commitment

to the long term success of

the firm, including adding

shareholder value

Chapter 01 – Cost Management and Strategy

1-14 The thirteen contemporary management techniques are:

1. The Balanced Scorecard (BSC) and the Strategy Map. The BSC is an

accounting report that includes the firm’s critical success factors in four areas:

financial performance, customer satisfaction, internal processes, and learning

and growth. The Strategy Map is a method, based on the balanced scorecard,

which links the four perspectives in a cause-and-effect diagram.

2. Value-Chain Analysis is a tool that helps the firm identify the specific steps

required to provide a product or service.

3. Activity-based Costing and Management: Activity-based costing is used to

improve the tracing of manufacturing costs to products and therefore the

accuracy of product costs. Activity-based management (ABM) uses activity

analysis to help managers improve the value of products and services and to

increase the firm’s competitiveness.

4. Business Analytics is an approach to strategy implementation in which the

management accountant uses data to understand and analyze business

performance.

5. Target Costing is a management method that determines the desired cost for

a product upon the basis of a given competitive price, such that the product will