LECTURE 11 – INTRODUCTION TO STRATEGIC MANAGEMENT ACCOUNTING
Deficiencies of Traditional Management Accounting
Thus far covered cost accounting – referred to as traditional management accounting techniques.
Commonly acknowledged limitations of traditional management accounting and the ‘new’ techniques that have
o Traditional systems were set up in a direct-labour-intensive manufacturing environment. Consequently,
using overhead allocations based on direct-labour (or other volume-related bases) in a highly
automated environment leads to inaccurate, non-representative product costs, and potentially bad
business decisions. The problem is exacerbated because in an automated environment overhead is
typically a higher percentage of manufacturing cost than in a traditional environment. (Activity based
costing and management)
o Product costs have included manufacturing costs only. A wider view recognises that much of the
product's cost occurs in the design and development stage, and further that additional expense here
can lead to savings in other areas. (Activity based costing, life-cycle costing, value-chain analysis)
o The requirements of external reporting have dominated management accounting in the past. While it is
still necessary to provide information for inventory valuation, in addition relevant information for
decision-making is needed. (Cost concepts such as opportunity costs, relevant costs, marginal costs)
o Management accounting in the past has been reactive. A firm made a decision to produce a product,
and the management accountant was then called on to provide the costing for that product. In today's
competitive environment, it is necessary for management accounting to take a more proactive role.
Consequently, the strategic role of the management accountant is becoming increasingly important as
the accountant provides management with information to enable the firm gain a sustainable
competitive advantage. (Target costing, strategic cost management focus, marketing issues)
o In the past, management accounting systems have focused on cost control (as evidenced by the
emphasis placed on variance analysis). Today's systems still include cost control via traditional
measures such as variance analysis, but also emphasise the reduction and elimination of non-value
adding costs. (Value added, customer profitability analysis, total quality management, continuous
improvement, business process re-engineering, just-in-time inventory)
o Traditionally performance evaluation has focused on accounting measures, e.g. return on investment;
achieving favourable variances etc. These accounting measures are primarily of interest to the principal
stakeholder, viz. the owners/shareholders. While bottom-line profit is still important, it is recognised
that there is a need to focus on other critical success factors for the firm (such as quality, customer
satisfaction etc.) Consequently for certain decisions, non-financial indicators are required in addition to
financial measures. (Non-financial performance indicators, balanced scorecards, benchmarking, best
o Past management accounting information systems have focused on accumulating data internal to the
firm. The challenge in today's global market and highly competitive environment is to be able to
supplement internal data with data from external sources (market-related information, customer
information, competitor information).
o Almost exclusive focus on manufacturing firms. The majority of accountants will be working in non-
manufacturing firms, and consequently techniques need to be adapted to the service industry.
Value engineering includes value chain analysis, and involves analysing products, processes and costs with the
objective of changing the way firms do things, and therefore reducing cost while at the same time maintaining
o It is important that any changes should not remove activities (and therefore costs) resulting from what
customers value, therefore value engineering revolves around the concept of value-added and non-
value added activities and costs.
A feature of the “target costing” technique.
Value Chain Analysis
An analysis of the firm's value chain provides potential for cost reduction. A firm gains competitive advantage is
by performing all value chain functions (not just the production function, which has been the focus of most
weeks of the course) more efficiently than its competitors.
Furthermore, analysis of the value chain also yields cost reduction opportunities relating to: o Linkages in the chain. For example, spending more in the design stage may mean savings greater than
that amount in later stages.
o The extended value chain. Strategies can be extended back to suppliers (e.g. setting contracts for
supply of materials), or forward to customers (not just customer service, which is part of the value
chain, but consulting customers in advance of production to find out what they value).
o Re-engineering the way things are done. For example, instead of transporting A to B, move B to A.
(Business process re-engineering)
Value-added and non-value added
A value added activity is an activity which, if eliminated, would reduce the worth of a product or service to the
customer. The activity adds value for the customer, and the customer is willing to pay for the activity.
A non-value-added activity increases the time spent producing the product, creates additional cost, but does
not increase the worth of the product to the customer.
o Elimination of the activity means that costs would decrease without affecting the market value or the
quality of the product.
Determine whether the following activities from the clothes-dryer assembly product line are value-added or non-value
(a) Time-consuming moving of component parts from warehouse to assembly line.
(b) Assembling the tumbler unit.
(c) Expediting materials to the door-assembly area because of stock-balance error.
(d) Assembling the dial-presentation component.
(e) Inserting the owner's manual and instruction guide in the dryer package.
(f) Reworking faulty latches on doors.
(g) Testing the operating capabilities of the assembled unit.
(h) Packaging the clothes dryer in a breakage-resistant box.
Costs of Quality
Measurement of quality in traditional systems has focused on items such as:
o the planning and control of production costs (variance analysis)
o accounting for spoilage (which assumes that some level of spoiled product is acceptable and consistent
with efficient production, and aims to control abnormal spoilage).
Some of today's firms strive for total quality management (TQM) production, which says that the only
acceptable level of spoilage is zero.
Costs of Quality
There are four costs of quality for a firm:
(1) prevention costs
(2) appraisal costs
(3) internal failure costs
(4) external failure costs
A cost advantage is sought by a TQM firm based on the principle that prevention costs are less than correction
costs. In other words, costs incurred in the prevention stage will be more than compensated for by savings in
the costs of failure.
o TQM firms will be hoping to see the amounts spent in the four areas above decreasing as the firm
moves from (1) to (4) to the ultimate stage when the only cost incurred is (1).
The employment of quality as a strategic tool for competitive advantage involves recognition of issues such as
o Expenditure on prevention costs has not been attractive in the past because of the short-term focus of
traditional systems. Cost-savings lag cost-increases sometimes by lengthy periods.
o Actual costs of poor quality in the past are probably higher than is recognised because of the multiplier
effect on external failure costs. The firm may know the amount of goods that had to be replaced, but
do not know how much lost custom has resulted because dis-satisfied customers
o Firms may be slow to change because of the funds already committed to "fixing" the problem (eg.
inspection systems, reworking etc.). Short-term profitability can be improved by incurring costs in the
wrong area, ie. by continuing to "fix" rather than "prevent". Continuous Improvement
A TQM environment is characterised by "continuous improvement".
o For example, a firm may start its quality improvement by focusing on problem areas - "on time
delivery". Initially the firm will select performance measures to address that problem. The measure
may be "percentage of on-time deliveries", and the target may be "70%". As things improve, the target
moves higher (now "95%").
o Once on-time delivery is improved, we change our focus.
Classify the following costs as prevention, appraisal, internal failure or external failure.
a) Line inspection
b) Normal spoilage identified
c) Design engineering
d) Returned goods
e) Product testing equipment
f) Customer problems and complaints
g) Rework of faulty products prior to sale
h) Preventive maintenance
i) Product liability claims
j) Incoming materials inspection
k) Breakdown maintenance
l) Product testing labour
n) Warranty repair
o) Supplier evaluations
Reduction Inventory – Just in Time Inventory Systems
With the new focus on cost leadership and value-adding, firms are realising that holding inventory is frequently
a "non-value-added" activity and cost. Therefore cost can be reduced by reducing inventory, or in the extreme
case, as under JIT, eliminating it altogether.
A JIT system implies that physical material moves along the production line only in response to customer orders,
rather than being pushed into production only to be stored in warehouses. It is sometimes called a "demand
Firms sit somewhere on a continuum from “just in case” to 100% “just in time”, with various number of
o “Just in case” firms will have Materials, WIP and FG. Others will combine their Materials and WIP into a
“RIP account” (raw materials in process). Others will have a FG account, and still others at the extreme
may have “none of the above”, i.e. only produce to order, so the job can be immediately expensed.
Life Cycle Costing
Better decision-making will occur, resulting in potential cost reduction, by considering the life-cycle costs of the