1 Developments in the

Business Environment
Basic Concepts
A Bottleneck A Bottleneck is an activity within the organisation where the
demand for that resource is more than its capacity to supply.
A Constraint A Constraint is a situational factor which makes the
achievement of objectives / throughput more difficult than it
would otherwise be. Constraints may take several forms such
as lack of skilled employees, lack of customer orders or the
need to achieve a high level of quality product output.
Activity Based Activity Based Budgeting (ABB) is a process of planning and
Budgeting controlling the expected activities for the organisation to
derive a cost-effective budget that meets forecasted workload
and agreed strategic goals.
An activity-based budget is a quantitative expression of the
expected activities of the firm, reflecting management’s
forecast of workload and financial and non-financial
requirements to meet agreed strategic goals and planned
changes to improve performance. Thus, the key elements of
ABB are:
– Type of work / activity to be performed;
– Quantity of work / activity to be performed; and
– Cost of work / activity to be performed.
Activity Based Activity Based Costing is an accounting methodology that
Costing assigns costs to activities rather than products or services.
This enables resources & overhead costs to be more
accurately assigned to products & services that consume
them.
CIMA defines ‘Activity Based Costing’ as an approach to the
costing and monitoring of activities which involves tracing
resource consumption and costing final outputs. Resources
are assigned to activities, and activities to cost objects based

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 1.2 Advanced Management Accounting

on consumption estimates. The latter utilise cost drivers to

attach activity costs to outputs.
Activity Based The term Activity Based Management (ABM) is used to
Cost Management describe the cost management application of Activity Based
Costing (ABC).
CAM-1 defines ABM as ‘A discipline that focuses on the
management of activities as the route to improving the value
received by the customer and the profit achieved by
providing this value. This discipline includes cost driver
analysis, activity analysis, and performance measurement.
Activity-Based Management draws on Activity-Based Costing
as its major source of information’.
Activity Cost Pool* Aggregation of all costs related to a specific activity.
Activity Driver* Transaction that causes an activity.
Activity Driver Identification and evaluation of the activity drivers used to
Analysis* trace the cost of activities to cost objects.
Activities, Classification of activities by level of organisation, for
Hierarchy* example unit, batch, product sustaining and facility
sustaining.
Benchmarking Benchmarking is the process of identifying and learning from
the best practices anywhere in the world. It is a powerful tool
for continuous improvement.
Back-flushing Back-flushing requires no data entry of any kind until a
finished product is completed. At that time the total amount
finished is entered into the computer system, which
multiplies it by all the components listed in the bill of
materials for each item produced. This yields a lengthy list of
components that should have been used in the production
process and which are subtracted from the beginning
inventory balance to arrive at the amount of inventory that
should now be left on hand. Given the large transaction
volumes associated with JIT, this is an ideal solution to the
problem.
Batch Level Activity (such as setting up machines) where volume varies
Activities* directly with the number of batches of output but is
independent of the number of units in a batch.
Business Process Business Process Re-Engineering involves examining
Re-Engineering business processes and making substantial changes in the day
to day operation of the organisation. It involves the redesign
of work by changing the activities. A business process

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 Developments in the Business Environment 1.3

consists of a collection of activities that are linked together in

a coordinated & Sequential manner to achieve goal &
objective.
Cost Control Cost Control implies guidance a reputation of cost by
executive action. For this purpose, the executives are
provided with some yard stick such as standards or budgets
with which the actual costs and performances are compared
to ascertain the degree of achievement made. Therefore Cost
Control involves continuous comparisons of actual with the
standards or budgets to regulate the former. Standards or
budgets once set up are not attended during the period or
until some mistakes are discovered in standards.
Committed Cost* Cost arising from prior decisions, which cannot, in the short
run, be changed. Committed cost incurrence often stems
from strategic decisions concerning capacity with resulting
expenditure on plant and facilities. Initial control of
committed costs at the decision point is through investment
appraisal techniques.
Cost Driver* Factor influencing the level of cost. Often used in the context
of ABC to denote the factor which links activity resource
consumption to product outputs, for example the number of
purchase orders would be a cost driver for procurement cost.
Cost Application of management accounting concepts, methods of
Management* data collection, analysis and presentation in order to provide
the information needed to plan, monitor and control costs.
Cost Reduction Cost Reduction is the achievement of real and permanent
reduction in unit cost of products manufactured. It,
therefore, continuously attempts to achieve genuine savings
in cost of production distributing, selling and administration.
It does not accept a standard or budget as or fined. It rather
challenges the standards/budgets continuously to make
improvement in them. It attempts to excavate, the potential
savings buried in the standards by continuous and planned
efforts.
Cost of Appraisal* Costs incurred in order to ensure that outputs produced meet
required quality standards.
Cost of Cost of achieving specified quality standards.
Conformance*
Cost of External Cost arising from inadequate quality discovered after the
Failure* transfer of ownership from supplier to purchaser.

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 1.4 Advanced Management Accounting

Cost of Internal Costs arising from inadequate quality which are identified
Failure* before the transfer of ownership from supplier to purchaser.
Cost of Non- Cost of failure to deliver the required standard of quality.
Conformance*
Cost of Costs incurred prior to or during production in order to
Prevention* prevent substandard or defective products or services from
being produced.
Computer-Aided The manufacturing process is carried out by a range of
Manufacturing machinery that, together with its concomitant software,
comes under the collective heading of computer–aided
manufacturing (CAM).
Maximum elements of CAM are computer numerical control
(CNC) and robotics.
CNC machines are programmable machine tools. These are
capable of performing a number of machining tasks, e.g.
cutting, grinding, moulding, bending etc.
A program stores all the existing manufacturing activities and
set-up instructions for a particular machine or bank of
machines, providing facility of changing its configuration in a
matter of seconds via the keyboard; changes to existing
configurations and new configurations are easily
accommodated. CNC therefore offers great flexibility, and
reduces set-up times.
Human operators will tire and are error prone. CNC
machines are able to repeat the same operation continuously
in identical manner, with high accuracy level.
Differentiation It occurs when customers perceive that a business unit’s
Advantage product offering (defined to include all attributes relevant to
the buying decision) is of higher quality, involves fewer risks
and/or outperforms competing product offerings. For
example, differentiation may include a firm’s ability to deliver
goods and services in a timely manner, to produce better
quality, to offer the customer a wider range of goods and
services, and other factors that provide unique customer
value.
Executional Cost These drivers capture a firm’s operational decisions on how
Drivers best to employ its resources to achieve its goals and
objectives. These cost drivers are determined by management
policy, style and culture. How well a firm executes its use of
human and physical resources will determine its level of
success or failure.

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 Developments in the Business Environment 1.5

Industry Value Industry Value Chain refers to the series of activities, which
Chain add value to the product supplied to the industry. The
industry value chain starts with the value-creating processes
of suppliers, who provide the basic raw materials and
components. It continues with the value creating processes of
different classes of buyers or end-use consumers, and
culminates in the disposal and recycling of materials.
Just-in-Time (JIT) System whose objective is to produce or to procure products
* or components as they are required by a customer or for use,
rather than for stock.
Just-in-Time Production system which is driven by demand for finished
Production* products, whereby each component on a production line is
produced only when needed for the next stage.
Just-in-Time Purchasing system in which material purchases are contracted
Purchasing* so that the receipt and usage of material, to the maximum
extent possible, coincide.
Just-in-Time Pull system, which responds to demand, in contrast to a push
System* system, in which stocks act as buffers between the different
elements of the system such as purchasing, production and
sales.
Kaizen Costing It focuses on the reduction of waste in the production
process, thereby further lowering costs below the initial
targets specified during the design phase.
Kaizen Costing is a Japanese term for a number of cost
reduction steps that can be used subsequent to issuing a new
product design to the factory floor. Some of the activities in
the Kaizen Costing methodology include the elimination of
waste in the production, assembly, and distribution processes,
as well as the elimination of work steps in any of these areas.
Low-Cost A firm enjoys a relative cost advantage if its total costs are
Advantage lower than the market average. This relative cost advantage
enables a business to do one of the two things; price its
product or services lower than its competitors in order to
gain market share and still maintain current profitability; or
match with the price of competing products or services and
increase its profitability.
Life Cycle Costing Life Cycle Costing is different to traditional cost accounting
system which report cost object profitability on a calendar
basis i.e. monthly, quarterly and annually.
Life Cycle Costing involves tracing cost and revenues on a
product by product basis over several calendar periods. Costs
and revenue can be analysed by time period, but the emphasis

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 1.6 Advanced Management Accounting

is on cost revenue accumulation over the entire life cycle of

each product.
MRP- II When the scope of MRP-1 is developed further that includes
– Planning of Raw Material;
– Planning of Component & Sub- Assemblies;
– Compute the Other Resources e.g. Machine or Labour
Capacity;
– To create a fully integrated Plan for Management
then it is known as Manufacturing resources planning (MRP
– 2).
MRP-II (also written MRP-2) adds the MRP schedule into a
capacity planning system and then builds the information into
a production schedule. It is also seen as a link between
strategic planning and manufacturing control.
Management Management accounting is the application of the principles of
Accounting* accounting and financial management to create, protect,
preserve and increase value for the stakeholders of for-profit
and not-for-profit enterprises in the public and private
sectors. Management accounting is an integral part of
management. It requires the identification, generation,
presentation, interpretation and use of relevant information
to:
– Inform strategic decisions and formulate business
strategy
– Plan long, medium and short-run operations
– Determine capital structure and fund that structure
– Design reward strategies for executives and
shareholders
– Inform operational decisions
– Control operations and ensure the efficient use of
resources
– Measure and report financial and nonfinancial
performance to management and other stakeholders
– Safeguard tangible and intangible assets
– Implement corporate governance procedures, risk
management and internal controls.
Material System that converts a production schedule into a listing of
Requirements the materials and components required to meet that schedule,
Planning (MRP) * so that adequate stock levels are maintained and items are
available when needed.

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 Developments in the Business Environment 1.7

Non-Value-Added The Non-Value-Added Activities (NVA) represents work that

Activities (NVA) is not valued by the external or internal customer. NVA
activities do not improve the quality or function of a product
or service, but they can adversely affect costs and prices.
Non-value added activities create waste, result in delay of
some sort, add costs to the products or services and for
which the customer is not willing to pay. Moving materials
and machine set up for a production run are examples of
NVA activities.
Product Life Cycle Each product has a life cycle. The life cycle of a product vary
from a few months to several years. Product life cycle is thus
a pattern of expenditure, sales level, revenue and profit over
the period from new idea generation to the deletion of
product from product range.
The life cycle of a product consists of four phases viz.,
Introduction; Growth; Maturity; Saturation and Decline.
Penetration Penetration Pricing is the strategy of entering the market with
Pricing Strategy a low initial price so that a greater share of the market can be
captured. The penetration strategy is used when an elite
market does not exist and demand seems to be elastic over
the entire demand curve, even during early stages of product
introduction. High price elasticity of demand is probably the
most important reason for adopting a penetration strategy.
The penetration strategy is also used to discourage
competitors from entering the market.
Quality It is a measure of goodness to understand how a product
meets its specifications. ISO standard defines quality as ‘the
totality of features and characteristics of a product or service
that bears its ability to satisfy stated or implied needs’.
When the expression ‘quality’ is used, we usually think terms
of an excellent product or service that fulfills or exceeds our
expectations. These expectations are based on the intended
use and the selling price. When a product surpasses our
expectations we consider that quality. Thus, it is somewhat of
an intangible based on perception.
Quality Assurance It deals with the present, and concerns the putting in place of
systems to prevent defects from occurring.
Quality Control It is concerned with the past, and deals with data obtained
from previous production which allow action to be taken to
stop the production of defective units.
Quality Cost Cost of performing the activities to check failure in meeting

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 1.8 Advanced Management Accounting

the quality specification. The ‘cost of quality’ isn’t the price of

creating a quality product or service. It’s the cost of not
creating a quality product or service. Every time work is
redone, the cost of quality increases.
Quality It is concerned with the future, and manages people in a
Management process of continuous improvement to the products and
services offered by the organisation.
Synchronous ‘Synchronous Manufacturing’ has been defined as ‘an all-
Manufacturing encompassing manufacturing management philosophy that
includes a consistent set of principles, procedures, and
techniques where every action is evaluated in terms of the
common global goal of the organisation.
Structural Cost Structural Cost Drivers consist of organisational factors that
Drivers determine the economic structure driving the cost of a firm’s
products. These cost drivers reflect a firm’s long-term
decisions, which position the firm in its industry and
marketplace.
Skimming Pricing Skimming Pricing is the strategy of establishing a high initial
Strategy price for a product with a view to ‘skimming the cream off
the market’ at the upper end of the demand curve. It is
accompanied by heavy expenditure on promotion. A
skimming strategy may be recommended when the nature of
demand is uncertain, when a company has expended large
sums of money on research and development for a new
product, when the competition is expected to develop and
market a similar product in the near future, or when the
product is so innovative that the market is expected to
mature very slowly.
Six-Sigma The sigma accuracy means the process is 99.999998%
Accuracy accurate. That is the process will / can produce only 0.002
defects per million. This is the structural meaning of six-
sigma. In quality practice, six-sigma means 3.4 parts per
million.
Throughput* Throughput term defined, in work by Goldratt, ‘as sales
minus material and component costs. Similar to contribution
except material is considered the only variable cost’. Goldratt
argues that labour costs should be treated as fixed’. In
Goldratt’s analysis ‘operating expense is all non-material
costs’ and ‘inventory cost is defined as the cost of assets
employed’.
Throughput Variable cost accounting presentation based on the definition

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 Developments in the Business Environment 1.9

Accounting (TA) * of throughput (sales minus material and component costs).

Sometimes referred to as super variable costing because only
material costs are treated as variable.
Target Costing Target Costing has been described as a process that occurs in
a competitive environment, in which cost minimization is an
important component of profitability. This newer approach
of product costing may take into account initial design and
engineering costs, as well as manufacturing costs, plus the
costs of distribution, sales and services.
It can be defined as ‘a structured approach to determining the
cost at which a proposed product with specified functionality
and quality must be produced, to generate a desired level of
profitability at its anticipated selling price’.
Throughput Several ratios were defined by Galloway and Waldron based
Ratios* on the definition of throughput. The TA (throughput
accounting) ratio is:
Throughput Per Bottleneck Minute
Factory Cost Per Bottleneck Minute
[Note: Galloway and Waldron define factory cost in the same
way that Goldratt defines operating expense. See throughput]
If the TA ratio is greater than 1 the product in question is
“profitable” because, if all capacity were devoted to that
product, the throughput generated would exceed the total
factory cost. If there was a bottleneck products could be
ranked by a variant of the TA ratio (although the ranking is
the same as that derived by the use of throughput per
bottleneck minute). Other performance ratios suggested
include:
Throughput Throughput
and
Labour Cost Material Cost
Theory of Procedure based on identifying bottlenecks (constraints),
Constraints (TOC) maximising their use, subordinating other facilities to the
* demands of the bottleneck facilities, alleviating bottlenecks
and re-evaluating the whole system.

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 1.10 Advanced Management Accounting

Total Quality TQM is a management approach for an organization,

Management centered on quality, based on the participation of all its
(TQM) members and aiming at long-term success through customer
satisfaction, and benefits to all members of the organization
and to society.
CIMA defines ‘Total Quality Management’ as integrated and
comprehensive system of planning and controlling all
business functions so that products or services are produced
which meet or exceed customer expectations. TQM is a
philosophy of business behaviour, embracing principles such
as employee involvement, continuous improvement at all
levels and customer focus, as well as being a collection of
related techniques aimed at improving quality such as full
documentation of activities, clear goal-setting and
performance measurement from the customer perspective.
Throughput per Method of ranking products that share the same (bottleneck)
Bottleneck facility. Very similar to the use of contribution per unit of
Minute* limiting factor.
The Plan–Do– The ‘Plan – Do – Study – Act’ Cycle describes the activities a
Study–Act Cycle company needs to perform in order to incorporate
continuous improvement in its operation. This cycle, is also
referred to as the Shewhart Cycle or the Deming Wheel. The
circular nature of this cycle shows that continuous
improvement is a never-ending process.
Value Analysis* Value Analysis is a systematic interdisciplinary examination of
factors affecting the cost of a product or service in order to
devise means of achieving the specified purpose at the
required standard of quality and reliability at the target cost.
Value Chain Porter described the Value Chain as ‘internal processes or
activities a company performs to design, produce, market,
deliver and support its product’. He further stated that ‘a
firm’s value chain and the way it performs individual activities
are a reflection of its history, its strategy, its approach of
implementing its strategy, and the underlying economics of
the activities themselves’.
John Shank and V. Govindarajan described the value chain in
broader terms. According to them ‘the value chain for any
firm is the value-creating activities all the way from basic raw
material sources from component suppliers through to the
ultimate end-use product delivered into the final consumer’s
hands’. This description views the firm as part of an overall
chain of value-creating processes.

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 Developments in the Business Environment 1.11

Value Engineering Value Engineering involves searching for opportunities to

(VE) modify the design of each component or part of a product to
reduce cost, but without reducing functionality or quality of
the product.
Value-Added The Value-Added Activities are those activities which are
Activities (VA) indispensible in order to complete the process. The
customers are usually willing to pay (in some way) for these
services. For example polishing furniture by a manufacturer
dealing in furniture is a value added activity.

(*)Source - CIMA’s Official Terminology

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