10/07/2025

Unit 2:
Strategic Cost
Management

Topics
Basic Review of Cost
Concepts of Accumulation
Strategic Cost Systems
Management • Job order costing
• Process costing
• Backflush costing

Activity-Based Environmental
Costing Cost
and Management Management
• Review: Activity-based Costing
• Activity-based management

1
 10/07/2025

Topics
Kaizen and Life Cycle Value-Chain
Cost Management Analysis
• Kaizen costing
• Target costing
• Life-cycle costing

Measuring and Managing

Management
Customer Relationships
Accounting
and Profitability
Gross profit variance analysis
& Control
Systems
•
• Sales price and sales volume variances
• Contribution margin variance
• Market share and market size
• variances

Strategic Cost Management

• Strategic cost management (SCM) is a cost management
technique that aims to reduce costs and boost the
strategic position of an organization.
• It’s the process of combining cost information with the
structure of decision-making to reinforce the overall
business strategy.
• Cost is measured and managed to align it with the
organization’s business strategy.
• In SCM, cost reduction is identifying and cutting
unnecessary expenses, thereby improving profitability
without compromising the quality of products or services

2
 10/07/2025

Elements of SCM
• Cost Reduction
• Value Chain Analysis
• Life Cycle Costing
• Target Costing
• Benchmarking

Strategic Cost Management Example

A Manufacturing Firm Decides To Offer Better
Turnaround And Quote Reduced Delivery Time
To Customers By Tightly Controlling Bottleneck
Production Operation
• To do so, the company incurs extra costs to keep
the bottleneck running 24x7. Expending extra
funds here directly contributes to the
profitability of the business.
• From a strategic perspective, the company
would do better to cut costs in non-bottleneck
areas that are downstream from the bottleneck
operation, since these cuts would have no
impact on the delivery times quoted to
customers.

3
 10/07/2025

Strategic Cost Management Example

Considering outsourcing
services
• When outsourcing, companies
take advantage of specialized
skills, cost efficiencies and labor
flexibility that the external
company can provide.

Basic Concepts of SCM

• Strategic planning and decision making requires a broad
set of information
 Information about customers, suppliers, different
product designs
• Information should
 Include information about the firm’s environment and
internal workings
 Must be prospective and should provide insight about
future periods and activities

4
 10/07/2025

Basic Concepts of SCM

• Strategic Decision Making: choosing among
alternative strategies with the goal of selecting a
strategy for long term growth and survival
• Strategic Cost Management: use of cost data to
develop and identify superior strategies that will
help produce a sustainable competitive
advantage

Basic Concepts of SCM

• Competitive Advantage: creating better customer
value for the same or lower cost than offered by
competitors or creating equivalent value for lower
cost than offered by competitors
• Customer Value: the difference between customer
realization (what a customer receives) and
customer sacrifice (what the customer gives up)

5
 10/07/2025

Porter’s Generic Strategies

• There are three general strategies to help

increase customer value to achieve a competitive
advantage:
1. Cost leadership
2. Differentiation
3. Focus

Cost Leadership
• The cost leadership advantage stems from the idea that a
company’s customers are better off because the firm has
been able to produce and sell its product for less than
that of its rivals.
• If the total cost of the firm are less than those of the rival
firms, the firm has a competitive market advantage.
• This advantage may be used by the firm in one of two
ways:
 Build market share
 Match the price of rivals

6
 10/07/2025

Cost Leadership

Cost Leadership
When Cost Leadership When Cost Leadership
Strategies Work Well Strategies Fail
• Where buyers have large amounts of • If firms focus too much on cutting
bargaining power and are able to costs of current processes, they may
switch between competitive products overlook technological advances that
without incurring significant cost could help lower costs or overlook the
• Markets with heavy price competition fact consumers may want
and where firms can influence buyers improvements to the product and are
to switch to their product willing to pay more for the product
they desire.

7
 10/07/2025

Differentiation
• The differentiation advantage (product differentiation)
is when customers are better off because the
customer perceives the firm’s product to be superior in
some way to that of its rivals.
• Customers are willing to pay a higher price for the
product’s uniqueness.
• This advantage may be used by the firm in one of two
ways:
 Build market share
 Increase price

Differentiation

8
 10/07/2025

Differentiation

When Differentiation When Differentiation

Strategies Work Well Strategies Fail
• When customers are able to see value • When a firm attempts to differentiate in
in a product, when the product appeals an area without properly assessing the
to different people for different requirements of the consumer for desired
reasons, and when the firms that are features and preferences, or without
competing in the market choose creating value for the consumer
different features to differentiate their • Firms that focus too much on one area or
products wrong area
• If the firm is in a market where customers
do not care about differentiation

Focus / Niche Strategies

• Firms with cost leadership or differentiation strategies
may choose to focus their chosen strategy on a select,
small, group of consumers, or niche
• These firms are able to focus on market niches where
consumers have specialized needs and preferences

9
 10/07/2025

Focus / Niche Strategies

Focus / Niche Strategies

When Focus/ Niche When Focus/ Niche
Strategies Work Well Strategies Fail
• It works well provided the niche has • When other firms see that the niche
large enough demand to create a profit strategy has been successful, they may
for the firm and has the proper attempt to enter the market to take market
resources to adequately serve the share , likely reducing the firm’s profits and
needs of the niche group. its competitive advantage.
• This strategy also works well when • There is an additional risk that customers in
competitors cannot compete in price the current niche may actually prefer the
or are not addressing a particular features of products that the overall market
feature. desires rather than the features that made
up the market niche.

10
 10/07/2025

Porter’s Generic Strategies

Basic Concepts of SCM

• The industrial value chain is the linked set of value
creating activities from basic raw materials to the
disposal of the finished product by end use customers
 Internal linkages are relationships among activities
that are performed within a firm’s portion of the value
chain.
 External linkages describe the relationship of a firm’s
value chain activities that are performed with its
suppliers and customers. There are two types: supplier
linkages and customer linkages.

11
 10/07/2025

Basic Concepts of SCM

• Two types of organizational activities:
 Structural activities are activities that determine the
underlying economic structure of the organization.
 Executional activities are activities that define the
processes and capabilities of an organization and thus are
directly related to the ability of an organization to execute
successfully.

Basic Concepts of SCM

12
 10/07/2025

Basic Concepts of SCM

• Operational activities are day to day activities
performed as a result of the structure and processes
selected by the organization.
• Operational cost drivers are those factors that drive
the cost of operational activities.
• Operational activities and drivers are the focus of
activity-based costing

Basic Concepts of SCM

13
 10/07/2025

Cost Accumulation Systems

• Cost accumulation systems are used to assign costs to
products.
• The system used is driven by the cost object involved.
 If the cost object is a custom order, job costing is
used.
 If the cost object is a mass-produced, homogenous
product, process costing is used.

• Job order costing and process costing are the two cost
management systems have been used traditionally to
cost products and services

Job Order Costing

• Job order costing is the method of product costing that
identifies the job or individual units of batches as the
cost objective and is used when relatively few units are
produced and when each unit is unique or easily
identifiable
• Job-cost records are maintained for each product,
service, or batch of products, and they serve as the
primary records used to accumulate all costs for the job.

14
 10/07/2025

Job Order Costing

Job Order Costing

Benefits Limitations
• Useful for companies involved in • Time-consuming and costly because of the
customized products or services requirement to track at the individual job
• Provides costs and profitability of each level the cost of materials, labor, and
job separately overhead
• Helps management to keep track of, • Not suitable where similar processes are
and control costs at the job level repeated to produce a large volume of
products

15
 10/07/2025

Process Costing
• Process costing is a method of product costing that
averages costs and applies them to a large number of
homogenous items.
• Costs are incurred and accumulated by department for
a period of time.
• The total costs incurred are divided by the number of
units produced to determine a cost per unit.
• The allocation of costs of the product that remains in
process and transferred out to finished goods at the
end of the period is done by computing equivalent
units of production (EUP).

Process Costing

16
 10/07/2025

Process Costing

Benefits Limitations
• Widely used in industries where • Requires time and effort to calculate/
homogenous products are estimate percentage completion for work-
manufactured in-process
• Requires less tracking compared to job • Is not suitable for custom orders
order costing because individual unit • Does not always reflect true costs of
cost is not required products due to estimation of completion
• Used to estimate the cost of a product of work-in-process
to aid in determining price • Does not measure the productivity of
individual departments, processes, or
workers

Backflush Costing
• Backflush costing is a product costing system generally
used in a just-in-time (JIT) inventory system.
• It is an accounting method that records the costs
associated with producing a good or service only after
they are produced, completed, or sold.
• Backflush costing is used by companies who generally
have short production cycles, commoditized products,
and a low or constant inventory.
• It can be difficult to do and not every company meets the
criteria to conduct backflush costing.

17
 10/07/2025

Backflush Costing
• The total costs of a production run are recorded all at
once, at the end of the process.
• Companies using backflush costing, therefore,
primarily work backward, calculating the costs of
products after they're sold, finished, or shipped.
• “Flushing” costs to the end of the production run
eliminates the detailed tracking of expenses, such as
raw material and labor costs.

Backflush Costing
• Backflush costing has only two categories of costs:
Materials and Conversion
• There is no work in process account
• Trigger points:
 Stage A: Purchase of direct materials
 Stage B: Production resulting in work in process
 Stage C: Completion of good units of product
 Stage D: Sale of finished goods

18
 10/07/2025

Backflush Costing

Backflush Costing

19
 10/07/2025

Backflush Costing

Advantages Disadvantages
• It is a sensible way to avoid the many • It can also be challenging to implement
complexities associated with assigning • It should not be used for products that
costs to products and inventory. take a long time to produce
• Not logging costs during the various • It lacks a sequential audit trail and may
production stages enable companies to not always conform to generally accepted
save time and reduce their expenses. accounting principles (GAAP)

Cost Driver Rates

• All costs associated with a cost driver, such as setup
hours, are accumulated separately in a cost pool
• A cost pool is the collection of cost elements assigned to
other cost objects using a common basis of allocation
• Each cost pool has a separate cost driver rate
• Cost assignment is the process of assigning costs to cost
pools and then to cost objects.
• Costs can be assigned using direct tracing (for direct
costs) or allocation (indirect costs)

20
 10/07/2025

Cost Driver Rates

• The cost driver rate is the ratio of the cost of a support
activity accumulated in the cost pool to the level of the
cost driver for the activity.

Fluctuating Rates
• If the rate for machine costs is based on quarterly cost
driver levels instead of the normal levels:
 The rate increases as demand for machine activity falls
 The rate decreases as demand increases
• Determination of cost driver rates based on short-term
usage results in higher rates during periods of lower
demand
 Job costs appear to be higher during time periods when
demand is lower
 Bid prices based on estimated job costs are likely to be higher
during periods of low demand when they probably should be
lower
 The higher bid price can further decrease demand, which in
turn leads to higher cost driver rates and even higher prices

21
 10/07/2025

Activity-Based Costing (ABC)

Volume-Based Activity-Based
• Traditional costing systems assign • Activity-based costing (ABC) refines
overhead as a single cost pool with a traditional costing methods and assumes
single plant-wide overhead application that the resource-consuming activities
rate using a single allocation base with specific purposes cause costs
• Cost drivers: direct labor hours or • It assumes that the best way to assign
machine hours indirect costs to products is based on the
• It can distort the amount of costs product’s demand for resource-consuming
assigned to various product lines activities
because all overhead costs do not
fluctuate with volume.

Types of Operational Cost Drivers

Activity-Based Costing (ABC)

Characteristics of ABC:

 ABC applies a more focused and detailed approach than the

use of a department or plant as the level for gathering costs.
 The cost of activities is used to more accurately determine the
cost of products using increased cost pools and allocations.
 ABC can be part of a job order system or a process cost system.
 ABC can be used for manufacturing or service business
 ABC takes a long-term viewpoint and treats production costs as
variable.

22
 10/07/2025

Activity-Based Costing (ABC)

Characteristics of ABC:

 The cost driver is often a nonfinancial variable.

 ABC may be used for internal purposes but not for external
purposes
 ABC estimates normal/ abnormal spoilage at activity levels.
 ABC is also referred to as transaction-based costing.
 ABC focuses management on the cost/ benefit of activities. Value-
added activities increase the product value or service.

Activity-Based Costing (ABC)

Levels of activity:

 Unit-level activities- performed for each individual unit of a product or

service (direct material, direct labor)
 Batch-level activities- performed on a group or batch of units of
products and services (scheduling production, purchase orders,
inspections by batch)
 Product-level activities- performed at a product or service level
(research, development, and design of product)
 Facility-sustaining activities- performed to support either the
production or the provision of service at the entire facility (insurance,
maintenance)
 Customer-level activities- performed for customers (customer service
and orders)

23
 10/07/2025

Activity-Based Costing (ABC)

Activity-Based Costing (ABC)

24
 10/07/2025

Activity-Based Costing (ABC)

Activity-Based Costing (ABC)

Benefits Limitations
• It produces superior information for • Difficult to establish a cost/ benefit
decision making because overhead relationship in some cases
allocation is based on activities and • Difficult to implement when a large
resource consumption. number of cost drivers exist
• Produces more accurate cost information • Time consuming and costly to implement
• Allows better identification and elimination and maintain because ABC requires more
of non-value-added activities information
• Highlights the interrelationship between • Cannot identify the correct cost driver in
activities some cases (e.g. factory rent expense)
• Contributes to process improvement and • Ignores nonquantifiable factors such as
continuous quality improvement quality

25
 10/07/2025

Activity-Based Management
• A term that includes activity management, activity costing
and activity-based product costing
• Also includes concepts associated with just-in-time and the
theory of constraints
• Represents an attempt to integrate all of the new
accounting and management concepts into one effective
system
• In other words, ABM is used to analyze the cost of an activity
in relation to the value added by the activity, with the goal
of operational and/or strategic improvement.

Activity-Based Management
The Relationship of Activity-Based Costing and Management

• Continuous Improvement is a process of improving

performance by constantly searching for ways to eliminate
waste.
• Activity-based management (ABM) is a system-wide, integrated
approach that focuses management’s attention on activities
with the objectives of improving customer value and the profit
achieved by providing this value.
• Activity-Based costing (ABC) is the major source of information
for activity-based management.
• ABC covers the accounting side of the process that aims to
provide more reliable cost information, and ABM focuses on
using information generated by ABC to manage activities and
improve results.

26
 10/07/2025

Activity-Based Management
How to implement activity-based management:
1. Identify primary business activities
 This process involves identifying the factors that cause
variation in the cost of an activity, or the activity's cost drivers.
2. Conduct activity-based costing
 Use activity-based costing to evaluate all costs of activities.
3. Complete value chain analysis
 A value chain analysis is a way to assess the worth of each
activity. This computes the overall cost of production and
whether the value adds additional profits.
4. Identify opportunities for improvement
 Leaders who are implementing operational ABM scrutinize
activity costs to improve the overall efficiency of an
organization's processes. Those applying strategic ABM are
looking to improve the company's profitability.

Process Value Analysis

• Process value analysis is focused on accountability
for activities rather than costs, and emphasizes the
maximization of system wide performance instead
of individual performance.
• It is concerned with:
1. Driver analysis
2. Activity analysis
3. Performance measurement

27
 10/07/2025

Process Value Analysis

• Driver analysis is the effort expended to identify the factors
that are the root causes of activity costs. Root causes are
identified by asking ‘why’ questions.

Process Value Analysis

• Activity analysis is the process of identifying, describing,
and evaluating the activities an organization performs.
• Activity analysis should produce four outcomes:
1. What activities are performed
2. How many people perform the activities
3. The time and resources required to perform the activities
4. An assessment of value of the activities to the organization
• Activities can be Value Added or Non Value Added.

28
 10/07/2025

Process Value Analysis

Value-Added Activities Non-Value-Added Activities

• Activities necessary to remain in • All activities other than those
business essential to remain in business
• Activities that contribute to • These activities fail to produce a
customer value and/or help meet change in the product’s state or
an organization’s needs those activities that replicate work
• The activity produces a change of because it was not done correctly the
state first time
• The activity enables other • Examples: scheduling, moving,
activities to be performed waiting, inspecting, storing
• Activities that are necessary to • Not required by the customer, but
meet customer requirements. occurs because of mistakes, errors,
omissions, and process failures.

Process Value Analysis

• Activity management can reduce costs in four ways:

1. Activity elimination
2. Activity selection
3. Activity reduction
4. Activity sharing

29
 10/07/2025

Activity-Based Budgeting (ABB)

• Applying ABC concepts to the budgeting process
• Uses ABC information for budgeting various overhead
items
• Steps:
1. Specify the products to be produced and the customers
to be served.
2. Determine the activities that are necessary to produce
these products.
3. Quantify the resources necessary to perform the
specified activities.

Activity-Based Budgeting (ABB)

Benefits of ABB

• Provides solid reasoning for budgeting costs at

particular levels
• More useful budget for the management
 Reveals how cost levels will change
 More actionable and understandable

30
 10/07/2025

Activity-Based Budgeting (ABB)

Why ABM implementations fail:

• Lack of support of higher-level management

• Failure to maintain support from higher level
management
• Resistance to change
• Failure to integrate the new system

Financial-Based Versus Activity-

Based Responsibility Accounting
• Financial–based responsibility accounting system
 Assigns responsibility to organizational units and
expresses performance measures in financial terms.

• Activity-based responsibility accounting system

 Assigns responsibility to processes and uses both
financial and nonfinancial measures of performance

31
 10/07/2025

Financial-Based Versus Activity-

Based Responsibility Accounting

Environmental Cost Management

• Ecoefficiency is the ability to produce competitively

priced goods and services that satisfy needs while
simultaneously reducing negative environmental
impacts, resource consumption and costs.
• Sustainable development is defined as
development that meets the needs of the present
without compromising the ability of future
generations to meet their own needs.

32
 10/07/2025

Environmental Cost Management

• Producing more goods and services using less
materials, energy, water, and land, while at the same
time, minimizing air emissions, water discharges,
waste disposal and the dispersion of toxic
substances.
• Complementary and supportive to sustainable
development – development that meets the needs of
the present without compromising the ability of
future generations to meet their own needs.

Environmental Cost Management

• The Ecoefficiency Paradigm

1. Reduce the consumption of resources

2. Reduce the environmental impact
3. Increase product value
4. Reduce environmental liability

33
 10/07/2025

Environmental Cost Management

• Environmental costs: costs that are incurred because
poor environmental quality exists or may exist
• Environmental costs can be classified in four
categories
 Prevention costs
 Detection costs
 Internal failure costs
 External failure costs

Environmental Cost Management

34
 10/07/2025

Environmental Cost Management

Environmental Cost Management

An Environmental Financial Report

• Three types of Benefits:
1. Additional revenues: revenues that flow into the
organization due to environmental actions
2. Cost avoidance (ongoing savings): refer to ongoing
savings of costs that had been paid in prior years
3. Current savings: refer to reductions in
environmental costs achieved in the current year

35
 10/07/2025

Environmental Cost Management

Environmental Cost Management

• Full environmental costing: the assignment of all

environmental costs, both private and societal, to
products.
• Full private costing: the assignment of only private
costs to individual products

36