Cost Drivers
The Third Key to Strategic
Cost Management
Basic Definitions on Cost
A cost is incurred when a firm uses a resource for some purpose
Costs are assembled into meaningful groups called cost pools
(e.g., by type of cost or source)
Any factor that has the effect of changing the level of total cost
is called a cost driver
A cost object is any product, service, customer, activity, or
organizational unit to which costs are assigned for some
management purpose
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Blocher,Stout,Cokins,Chen, Cost Management 4e
The McGraw-Hill Companies 2008
Cost Assignment: General Principles
Costs
Electric Motor
Materials
Handling
Cost Drivers and Cost Assignment
Cost Pools
Cost Objects
Assembly
Dishwasher
Packing
Washing
Machine
Supervision
Packing
Materials
Final
Inspection
Blocher,Stout,Cokins,Chen, Cost Management 4e
The McGraw-Hill Companies 2008
Basic Purposes of Cost
For product and service costing
For strategic decision-making (cost-driver analysis)
For planning and decision-making
For control/feedback
Blocher,Stout,Cokins,Chen, Cost Management 4e
The McGraw-Hill Companies 2008
Product/Service Costing
The process of assigning costs to cost pools or from cost
pools to cost objects
Direct
costs can be conveniently and economically traced to
a cost pool or a cost object
Indirect
costs cannot be traced conveniently or economically
to a cost pool or a cost object
Because
indirect costs cannot be traced, assignment is made
through the use of cost drivers (cost allocation)
These
cost drivers are often called allocation bases
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Blocher,Stout,Cokins,Chen, Cost Management 4e
The McGraw-Hill Companies 2008
Product and Service Costing Concepts
Product
costs include only the costs necessary to
complete the product at the manufacturing step in the
value chain (manufacturing) or to purchase and
transport the product to the location of sale
(merchandising)
Period
costs include all other costs incurred by the firm
in managing or selling the product (indirect costs
outside the manufacturing step of the value chain)
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Blocher,Stout,Cokins,Chen, Cost Management 4e
The McGraw-Hill Companies 2008
Costs for Strategic Decision-Making Cost driver
Analysis
Cost drivers provide two roles for the management
accountant
Assigning
costs to cost objects
Explaining
cost behavior, i.e., how total cost changes as the cost
driver changes
Blocher,Stout,Cokins,Chen, Cost Management 4e
The McGraw-Hill Companies 2008
Types of Cost Drivers
The
four types of cost drivers:
Volume-based
cost drivers,
Activity-based
cost drivers,
Structural
cost drivers, and
Executional
cost drivers.
Blocher,Stout,Cokins,Chen, Cost Management 4e
The McGraw-Hill Companies 2008
Activity-based
drivers are developed at a detailed level of operations
and are associated with a given manufacturing activity. Activity-based
cost drivers are identified by using activity analysis, a detailed
description of the specific activities performed in the firms operations.
Volume-based
cost drivers are developed at an aggregate level. The
relationship between the cost driver and total cost is approximately
linear within the relevant range.
Cost
concept relating to the volume based:
Fixed
Vs. Variable, Average cost Vs. Marginal cost, CVP analysis, Break even
Analysis etc.
Volume
based cost drivers capture very little of richness of cost
behavior.
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Blocher,Stout,Cokins,Chen, Cost Management 4e
The McGraw-Hill Companies 2008
Drawbacks of volume based cost drivers
Ignores the fact that different products make different demands on factory support
services. It not relate to unique manufacturing characteristics in different
operations
As absorption costing emphasized on total cost namely both variable and fixed, it is
not so useful for management to use to make decision, planning and control.
It only uses a common plant wide or departmental cost driver and ignores
differences in activities for different products or productions runs with in the plant.
Employs
common
activity
volume
of
all
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Blocher,Stout,Cokins,Chen, Cost Management 4e
The McGraw-Hill Companies 2008
products
Structural and executional drivers
Structural
and executional drivers involve strategic and
operational decisions that affect the relationship between these
cost drivers and total cost.
Structural
cost drivers facilitate strategic decision making
because they involve plans and decisions that have long-term
effects.
It
involves choices by the firm that drive product cost
Scale,
experience, technology, and complexity are considered in
hopes of improving competitive position
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Blocher,Stout,Cokins,Chen, Cost Management 4e
The McGraw-Hill Companies 2008
Executional cost drivers facilitate operational decision making
by focusing on short-term effects.
Those determinants of a firms cost position that hinge on its
ability to execute successfully. (Related to organizational skills)
Workforce involvement, design of the production process, and supplier
relationships are considered in an attempt to reduce costs
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Blocher,Stout,Cokins,Chen, Cost Management 4e
The McGraw-Hill Companies 2008
Structural Cost Drivers
Scale:
Investment size in manufacturing, R&D, and
marketing
Scope: Degree of vertical integration
Experience: Previous repetitions of current work
Technology: Process technologies used at each step in
value chain
Complexity: Broadness of product line
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Blocher,Stout,Cokins,Chen, Cost Management 4e
The McGraw-Hill Companies 2008
Executional Cost Drivers
Work
Force Involvement: participation; empowerment;
commitment to continuous improvement
Capacity Utilization: given scale choices on plant
construction
Plant Layout Efficiency: compared to current norms
Product Configuration: design or formulation effectiveness
Exploiting Linkages with Suppliers/Customers: in relation
to the value chain
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Blocher,Stout,Cokins,Chen, Cost Management 4e
The McGraw-Hill Companies 2008
Cost Driver Analysis Some Key Ideas
Volume is usually not the best way to explain cost behavior
More useful to explain cost position in terms of structural choices and
executional skills
Not all strategic cost drivers applicable or equally important all the time but
some are probably very important in every instance.
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Blocher,Stout,Cokins,Chen, Cost Management 4e
The McGraw-Hill Companies 2008
Cost Driver Analysis
Management Accounting
Strategic Cost management
What is the most
useful way to analyze
costs?
In terms of products, customers,
functions
In terms of various stages of the overall
value chain of which the firm is a part
Strongly internal focus
Strongly external focus
What is the objective
of cost analysis?
Not regard to the strategic
context
Design of cost management system
changes dramatically depending on the
basic strategic positioning of the firm
Score keeping, Problem solving,
attention direction
How should we try to
understand cost
behavior?
Cost is primarily a function of
output volume
Cost is a function of strategic choices
about the structure of how to compete
and managerial skill in executing the
strategic choices.
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Blocher,Stout,Cokins,Chen, Cost Management 4e
The McGraw-Hill Companies 2008
Linkages Among Value Chain Analysis, Strategic
Positioning Analysis and Cost Driver Analysis
Understanding the value chain helps define the optimal
positioning strategy
Understanding the value chain and positioning strategy helps
identify the relevant cost drivers
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Blocher,Stout,Cokins,Chen, Cost Management 4e
The McGraw-Hill Companies 2008
