Cost Management I (W6)

What is a value added acitivity?

Any activity that increases the worth of a product or service to customers

• Increases customer value

• Not a simple yes/no- e.g. high value or low value activity

• Different perceptions- Value depends on what customers think is important

• Some activities are essential for the company’s existence

• Important for long term success

What is a value chain?

A chain of activities within the business that add value to it.

What is the purpose of value chain analysis?

• Breaking down a business into activities to identify the activities that add value and those that add costs

• To reduce those costs

• To improve efficiency, differentiation and gain a competitive advantage

How can a business achieve competitive advantage?

• Improve individual activities- analysis of each individual activity

• identify linkages between activities

• Improving How activities work together

What are the key elements of traditional cost control and production practices

• Concentrates on the manufacturing stage

• Cost containment rather than reduction

• Push rather than pull system

• Concentrates on expense items rather than processes, leads to undesirable decisions and reduction of discretionary expenses

What is the push system?

Where organisations produce what they wish and hope customers will purchase.

it is supply driven

Does value chain analysis extend beyond organisational boundaries?

YES, to cover the value chain of suppliers and customers.

What are the 3 steps for value chain analysis?

1. Costs and assets assigned to each activity

2. Determine cost drivers (factors that influence the levels of costs in a business)

3. Identify opportunities for cost reduction and/or enhanced differentiation ( e.g. by improving control of the cost drivers or reconfiguring the value chain)

What are the 2 cost drivers?

• Structural

• Executional - increasing these drivers will always result in decreased costs

Do value added activities increase or decrease the worth of products or services?

Increase

According to value chain analysis are activities interlinked or non interlinked?

Interlinked, as changes in one activity may affect other activities

Does value chain analysis consist of primary and support activities?

Yes

How can we create value?

• Reconfigure the value chain

• Improving the control of cost drivers

With traditional absorption based costing how are overheads allocated?

• To departments cost centres using volume based allocators

• Then cost objects

With activity based costing how are overheads allocated?

• Allocated to activity cost centres ( no longer defined as departments)

• Then allocated to cost objects using activity cost drives)

What are the 2 key differences between the absorption costing and ABC costing?

• Cost centres are defined by activities in an activity based costing system compared to by departments in a traditional absorption costing system

• Activity costs are allocated to cost objects using activity cost drivers as opposed to volume based allocators in a traditional absorption costing system.

What are the differences between traditional analysis and activity based management analysis?

• Traditional analysis reports by departments VS ABM analysis reports by activities ( crosses departmental boundaries so better cost management)

• Traditional analysis reports by expense categories VS ABM analysis reports by sub activities

What is operational Activity based management?

Efficiency.

1. Identification of activities

2. Assign costs to activity cost centres

3. Determine the cost driver for each activity and the cost driver rate

What is strategic activity based management?

Effectiveness. Doing the right things

E.g. selling the right products, to the right clients, in the right mix, at the right prices.

Requires all 4 steps for activity based costing. The 4th step is to assign activity costs to cost objects (products)

With operational activity based management which activities should you focus on?

• Activities with the largest costs

• Activities with no or little value added (ranking of 1)

• Activities currently highly inefficient ( ranking of 5)

combination of the above criteria

What is the next step after priority for analysis has been determined, operational ABM?

Analyse the efficiency of activities.

• Compare the cost driver rate to that of industry average, competitor or prior year

What are the advantages of activity based management?

• Provides visibility of activity cost, a key for effective cost management, as it highlights issues for management action

• Knowing cost of activities may trigger action necessary to become competitive

• Facilitates the identification of the highest cost activities to be prioritised for detailed studies

What is more accurate activity based costing or traditional absorption costing?

Activity based costing as cost centres are activity cost centres and not departments.

What is life cycle costing?

A contemporary cost management model that focuses on costs over the products entire life cycle.

• Profits earned during the manufacturing stage will need to cover costs incurred during the pre and post manufacturing stages

What are the strategic implications?

1. Declining mature products are replaced with a new version

2. to prevent competitors from gaining market share

What are the benefits of life cycle costing?

• Better information for decision making

• Product profitability more fully understood

• Inform strategic decisions such as product replacement

• More accurate feedback on the success of product development or whether development should be continued or undertaken

Explain the difference between traditional cost control and production practices and contemporary cost management?

• Concentrates on the manufacturing stage as opposed to costs incurred over the entire life cycle of a product

• Concentrates on cost containment rather than reduction

• Cost reduction with no understanding of the impact of such an exercise on processes

• Push rather than pull system