An understanding of cost behavior not only helps cost management as such but also supports strategic and tactical decision-making across the entire spectrum of business operations. Projects, processes and regular operations can all benefit from cost management, leading to overall business performance improvement.
Cost Analysis for Decision Support Information
When cost accounting started during the industrialization era, the emphasis was on finding the direct costs of making a product or providing a service to help in setting prices. Establishment costs such as rent and administrative expenses tended to be ignored and had to be recovered through the high margins in the selling prices.
Emphasis then turned to ascertaining the "full" cost of producing something. Complex and labor-intensive methods were developed to allocate costs that could not be identified to specific products in a multi-product environment. An idea of full costs can help in better price-setting in a seller's market.
The increasingly competitive business environment required that cost behavior be analyzed in a way that can help business decisions in such areas as market-oriented pricing and alternative use of production resources. New approaches were developed to provide better decision support information. Cost accounting itself came to be known as management accounting to reflect the new emphasis.
Standard costing involved establishing standards for all cost elements and analyzing the specific reasons for actual costs deviating from these standards. The analysis helped pinpoint such specific performance factors such as:
- Inefficient use of materials or equipment,
- Higher than budgeted material prices or labor compensation, and
- Lower productivity of operations causing an under-recovery of fixed overhead costs.
Activity based costing involved analyzing costs of all activities involved in operations, including such overhead activities as waiting for clear instructions or talking to customers on different issues. With a clear idea about the costs being incurred by different activities, it becomes easier to select areas for focused cost-reduction attempts.
Modern approaches such as lean, throughput and resource consumption accounting seek to identify all factors that affect cost and profit behavior and provide more sophisticated decision support information. In fact, lean accounting seeks to support the operational strategy of lean manufacturing, an approach where all tasks that do not contribute to customer value are sought to be eliminated.
The latest in these developments is the Resource Consumption Accounting discussed in a separate article on management accounting.
Cost Management Implications
Cost management involves using the cost analysis information in different areas such as project, inventory cost, operations, process and overall business performance management. Total cost management (TCM) is an approach to managing cost over the entire life cycle of an enterprise, project, program, facility, product or service. Cost management focus starts from project selection, planning and initiation stage. Costs are then managed through all stages till retirement through:
- Cost estimating
- Economic analysis
- Cost engineering
- Program/project management
- Planning and scheduling
- Monitoring cost and schedule performance and
- Change control
Using costs for decision support becomes more meaningful when costs are viewed from different perspectives as outlined below:
- Cost Elements: Material, Labor, Expenses
- Functional Costs: Production, Selling, Distribution, Administrative, Financial, R&D, Product Development
- Cost Identification: Direct costs identifiable with specific products etc, Indirect costs
- Cost Variability: Costs that vary with level of operations, Fixed costs, Semi-fixed
- Controllability: Controllable costs, Costs uncontrollable within specific time-frames
- Cost Alerts: Normal costs, Abnormal costs
Cost management is a key business management function. An understanding of cost behavior can also support decision-making across the full range of business operations, from project selection through pricing, alternative use of resources to retirement of products at the end of their life cycles. New and highly sophisticated approaches are being developed to enhance the decision-support value of cost analysis.
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