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Chapter 01 – Cost Management and Strategy
Lecture Notes
A. The Uses of Cost Management Information. Cost management information is the information
managers need to effectively manage the firm or not-for-profit organization. By combining traditional
financial information with nonfinancial information, cost management seeks to avoid using only a short-
term focus; rather, it provides the manager with a strategic outlook on the firm’s competitive position.
The firm’s controller, who operates under the chief financial officer (CFO), is largely responsible for
obtaining cost management information for internal use. In addition, the controller is also in charge of
preparing the firm’s financial statements, primarily for external users. These dual roles can pose a
problem for the controller, since cost management information focuses on usefulness and timeliness,
while financial reporting is more concerned with accuracy and compliance. Underneath the controller are
management accountants, who have four different functions.
1. The Four Functions of Management. The cost accountant fills several different roles, as well as
provides a wealth of knowledge to the CFO and other company managers.
a. Strategic Management. Strategic Management is the development if a sustainable competitive
position in which the firm’s competitive advantage provides continued success. In order to
accomplish this goal, the management account must implement a strategy, or a set of goals and
specific actions plans that provide the desired competitive advantage.
b. Planning and Decision Making. The management accountant is also responsible for budgeting and
profit planning, cash flow management, and decisions relating to the firm’s operations.
c. Management and Operational Control. These responsibilities included managing and monitoring
the actions of employees. Specifically, management control refers to upper-level employees
evaluating mid-level employees, while operational control is used when operating-level employees
are monitored by mid-level employees.
d. Preparation of Financial Statements. The management accountant must also prepare financial
statements, which must comply with reporting requirements of different external groups and agencies.
Because of their relevant information, financial statements can also be used in any of the other
management functions.
2. Strategic Management and Strategic Cost Management. Overall, cost management’s traditional
role has changed to encompass a much more strategic emphasis. Changes is the business environment
have made cost management much more critical to the firm’s success, as well as more dynamic.
Therefore, this book focuses on the strategic aspects of cost management, such as anticipating change,
being more flexible, and thinking creatively. Along with this strategic focus has come a greater emphasis
on cross-functional teams and cooperation among different members of an organization.
3. Types of Organizations. Cost management information is useful in a wide range of organizations:
business firms, governmental units, and not-for-profit organizations. Business units are usually
categorized as a manufacturer (uses raw materials to produce goods), a wholesaler (a merchandising firm
that sells to other merchandisers), a retailer (a merchandiser that sells to final consumers), or a service
firm (a firm that appeals to consumers’ needs for speed and convenience by offering a service).
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Chapter 01 – Cost Management and Strategy
Governmental and not-for-profit organizations also provide services; however, they usually provide
public services and goods outside of established markets. These different organizations all use cost
management information, although in different ways. Specifically, while a manufacturer may use it to
manage production costs, a service firm could use cost management information to identify the firm’s
more profitable service lines. Its important to note that the firm’s strategy will often be the determining
factor in deciding how the information is used.
B. The Contemporary Business Environment. Many of the changes in the role of cost
management have been the result of changes in the current business environment.
1. The Global Business Environment. A key factor that drives the changes in the contemporary
business environment is the growth of international markets and trade. The growing number of
international organizations (NAFTA, EU, and WTO) as well as the increase in multinational alliances and
firms indicates that significant opportunities for growth and profitability lie in international markets. The
increasing competitiveness of the global business environment means that cost management information
will continue to be an important tool in the struggle to remain competitive.
2. Manufacturing and Information Technologies. As a result of the new global focus, several new
manufacturing and information technologies have been created (just-in-time, quality teams, statistical cost
control, and speed-to-market). Another recent change has been the gradual increase in facilities costs
relative to materials and labor costs; firms are now placing a greater emphasis of controlling large
facilities costs than they have in the past.
3. The New Economy: Use of Information Technology, the Internet, and E-Commerce. These
technologies have fostered the growing strategic focus of cost management by reducing the time required
for record keeping and expanding the individual manager’s access to information within the firm, the
industry, and the international business environment.
4. Focus on the Customer. As a result of an increased focus on consumer expectations regarding
product use and quality, product life cycles have begun to shorten. This shortened life cycle forces
companies to think in more strategic terms, as they begin to find their prior competitive advantages
slipping away. Today many firms’ critical success factors are all customer related. Cost management
information has also adapted by starting to provide more nonfinancial information regarding customer
satisfaction and preferences.
5. Management Organization. In order to address this changing business environment more quickly
and effectively, many firms have moved away from the traditional hierarchy of organization structure.
Many firms are now promoting a more flexible structure and more cross-functional interaction, in order to
meet consumers changing demands.
6. Social, Political, and Cultural Considerations. While changes in culture and politics vary between
countries, there have been some distinguishable trends. Specifically, they include a more diverse
workforce, a greater sense of ethical responsibility, and an increased deregulation. Overall, the changing
business environment has forced companies to think in broader terms, focusing beyond the production of
its product or service, and more on the global consumer and society as a whole.
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C. The Strategic Focus of Cost Management. Realizing, anticipating, and reacting to changes in the
business environment, the modern cost manager is now more concerned with strategic thinking, rather
than simply measuring a company’s financial information. Also, cost management has started to have a
greater focus on identifying costs and measures that a critical to the firm’s success. Generally speaking,
the role of management accounting can be seen as having traveled through different phases, from a simple
measurement and transaction-recording role, to more of a strategic business partner that helps identify and
monitor a firm’s critical success factors (aspects of a firm’s performance that are essential to its
competitive advantage and success).
D. Contemporary Management Techniques. Along with the changing business
environment, there are several new management styles and techniques that are designed
to help firms remain competitive.
1. The Balanced Scorecard and Strategy Map. Keeping with the renewed focus on both financial and
nonfinancial measurements, the balanced scorecard (BSC) is an accounting report that includes the
firm’s critical success factors in four areas: financial performance, customer satisfaction, internal
business processes, and innovation and training. The balanced scorecard provides a more well-
rounded assessment of the firm’s performance than just using financial measurements alone. The
Strategy Map is a method based on the BSC which links the BSC perspectives in a causal framework.
2. The Value Chain. The value chain is an analysis tool which identifies the specific steps required to
provide a product or service to the customer.
3. Activity Based Costing and Management. Activity-based costing (ABC) is used to improve the
accuracy of cost analysis by improving the tracing of costs to products and individual consumers. By
using an activity analysis, managers are able to gain a better understanding regarding the firm’s cost
structure, operations and management control.
4. Business Intelligence. Business Intelligence (also called business analytics or predictive analytics) is
an approach to strategy implementation in which the management accountant uses data to understand
and analyze business performance. Business Intelligence (BI) often uses statistical methods such as
regression or correlation analysis to predict consumer behavior, to measure customer satisfaction, or
to develop models for setting prices, among other uses. BI is best suited for companies that have a
distinctive capability which can be derived from measurable critical success factors. BI is similar to
the BSC because it focuses on critical success factors; the difference is that BI uses analytical tools to
develop predictive models of core business processes.
5. Target Costing. Target costing determines the desired cost for a product on the basis of a given
competitive price so that the product will earn a desired profit.
6. Life Cycle Costing. Life-cycle costing is a management technique used to identify and monitor the
costs of a product throughout its life cycle. Management accountants now manage the product’s full
life cycle of costs, including upstream and downstream costs, as well as manufacturing costs.
Particularly close attention is paid to product design, since design decisions affect most subsequent
life-cycle costs
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7. Benchmarking. Benchmarking is a process by which a firm identifies its critical success factors,
studies the best practices of other firms for achieving these factors, and then implements
improvements in the firm’s process to match or beat the performance of those competitors.
Cooperative networks of noncompeting firms that exchange benchmark information facilitate
benchmarking efforts.
8. Business Process Improvement. Based on the Japanese concept of kaizen, business process
improvement is a management technique in which managers and workers commit to a program of
continuous improvement in quality and other critical success factors. Continuous improvement is
often associated with benchmarking and TQM.
9. Total Quality Management (TQM). TQM is a technique by which management develops policies
and practices to ensure that the firm’s products and services exceed customers’ expectations. This
approach focuses on increased product functionality, reliability, durability, and serviceability. Cost
management is used when analyzing the cost consequences of a particular decision.
10. Lean Accounting. Lean accounting uses value streams to measure the financial benefits of a firm’s
progress in implementing lean manufacturing. Lean accounting places the firm’s product and
services into value streams, each of which is a group of related products or services. For example, a
company manufacturing consumer electronics might have two groups of products (and two value
stream) –digital cameras and video cameras – with several models in each group. Accounting for
value streams can help the firm to better understand the profitability of its process improvements and
product groups.
11. The Theory of Constraints (TOC). TOC is a strategic technique to help firms effectively improve
their cycle time (the rate at which raw materials are converted to finished goods). Specifically, TOC
helps identify and eliminate bottlenecks in the production process. Due to the increased importance
of speed-to-market, TOC has grown in popularity as an important new cost management technique.
12. Sustainability. Sustainability means the balancing of the organization’s short and long term
goals in all three dimensions of performance – social, environmental, and financial.
13. Enterprise Risk Management. Enterprise Risk Management is a framework and process that
organizations use to manage the risks that could negatively or positively affect the company’s
competitiveness and success. Risk is considered broadly, to include (1) hazards such as fire or
flood, (2) financial risks due to foreign currency fluctuations, commodity price fluctuations, and
changes in interest rates, (3) operating risk related to customers, products, or employees, and
(4) strategic risk related to top management decisions about the firm’s strategy and
implementation thereof.
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E. Developing a Competitive Strategy: Strategic Positioning. The concept of competitive strategy
developed by Michael Porter identifies two main types of competitive strategies: cost leadership and
differentiation. In developing a sustainable competitive position, each firm purposefully or as a result of
market forces arrives at one the two strategies.
1. Cost Leadership. Cost leadership is a strategy in which a firm outperforms competitors in producing
products or services at the lowest cost. The cost leader makes sustainable profits a lower price, thereby
limiting the growth of competition in the industry. The cost leader normally has a relatively large market
share and tends to market segments by using the price advantage to attract a large portion of the broad
market. Cost advantages usually result from productivity in the manufacturing process, in distribution, or
in overall administration. A potential weakness of the cost leadership strategy is the tendency to cut costs
in a way that undermines demand for the product or service. The cost leader remains competitive only so
long as the consumer sees that the product or service is nearly equivalent to competing products that cost
more.
2. Differentiation. The differentiation strategy is implemented by creating a perception among
consumers that the product or service is unique in some important way, usually by being higher quality.
This perception allows firms to charge higher prices and outperform the competition in profits without
reducing costs significantly. The appeal of differentiation is especially strong for product lines for which
to perception of quality and image is important. A weakness of the differentiation strategy is the firm’s
tendency to undermine its strength by attempting to lower cost or by ignoring the necessity to have a
continual and aggressive marketing plan to reinforce the perceived difference.
3. Other Strategic Issues. While most firms will have a dominant strategy, recognize that many firms
are likely to employee both of the strategies at the same time. However, a firm following both strategies
is likely to succeed only if it achieves one of them significantly; otherwise, it could face the problem of
“getting stuck in the middle.” A firm stuck in the middle is not able to sustain a competitive advantage. A
common way for a firm to get stuck in the middle arises from its normal progression from one type of
strategy to another.
F. The Professional Environment of Cost Management. Management accountants must continually
improve their technical skills and maintain a constant high level of professionalism, integrity, and
objectivity about their work. Many professional organizations encourage their members to earn relevant
professional certifications, participate in professional development programs, and continually reflect on
the professional ethics they bring to their work.
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1. Professional Organizations. The professional environment of the management accountant is
influenced by two types of organizations: one that sets guidelines and regulations regarding management
accounting practices and one that promotes the professionalism and competence of management
accountants.
a. Federal Agencies. The first group or organizations include several federal agencies, such as the
Internal Revenue Service (IRS), which sets product costing guidelines for tax purposes, and the
Federal Trade Commission (FTC), which restricts pricing practices and requires that prices be
justified on the basis of cost. Also, the Securities and Exchange Commission (SEC) provides
guidance, rules, and regulations regarding financial reporting. The Cost Accounting Standards
Board’s (CASB) objective is to reduce fraud in government contracts through continual efforts at
consistent documentation.
b. Private Agencies. The Financial Accounting Standards Board (FASB) and the American Institute
of Certified Public Accountants (AICPA) supply additional guidance regarding financial reporting.
The AICPA also provides educational opportunities, such as newsletters, magazines, seminars, and
technical meetings. The Institute of Management Accountants (IMA) supports the growth and
professionalism of management accountants. The IMA also provides magazines, newsletters,
research reports, and seminars. Several different countries, including U.K., Spain, and India, also
have separate accounting organizations.
2. Professional Certifications. The role of professional certifications is to provide a distinct measure of
experience, training, and performance capability. There are three types of certifications relevant to the
management accountant.
a. The Certified Management Accountant (CMA). The CMA is administered by the IMA, and
requires passing an exam and satisfying other experience requirements. The test covers four areas of
knowledge: economic, financial, and management; financial accounting and reporting; management
analysis and reporting; and decision analysis and information systems.
b. The Certified Public Accountant (CPA). The certification, prepared by the AICPA, is only
administered in the United States. Although it is necessary for those accountants who intend to
practice auditing, the CMA is widely viewed as the most relevant certification when dealing with cost
management issues.
3. Professional Ethics. Professional ethics can be summed up as the commitment of the management
accountant to provide a useful service for management. This commitment means that the management
accountant has the competence, integrity, confidentiality, and objectivity to serve effectively.
The IMA Code of Ethics. The IMA Code of Ethics specifies minimum standards of behavior that
are intended to guide the management accountant and to inspire professionalism. The IMA Code
has four sections: competence, confidentiality, integrity, and credibility.
The Sarbanes-Oxley Act. Passed in July 2002, this Act of the U.S. Congress created a new
oversight board for the accounting profession – the Public Company Accounting Oversight Board
(PCAOB). The PCAOB is now the source of auditing standards for the accounting profession, in
contrast to the American Institute of CPAs, as was the case prior to July 2002.
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How to Apply the Code of Ethics.
First, the management accountant must consider the ethical principles that apply to the
situation. Also, the management accountant should consider how the resolution would affect
a manager’s trust and reliance.
Second, the management accountant should discuss the situation with a superior who is not
involved with the ethical problem. Also, the accountant should refrain from communicating
the situation to anyone outside the firm.
Third, the management accountant may have to resign if the situation is significant and the
conflict cannot be resolved.
Fourth, if resigning, the accountant should consider his or her responsibility to communicate
the matter to the appropriate regulatory authorities.
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