Cost Accounting

Sixteenth Edition, Global Edition

Chapter 12
Strategy, Balanced
Scorecard
and,
Strategic Profitability
Analysis

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 Learning Objectives
12.1 Recognize which of two generic strategies a company
is using
12.2 Understand what comprises reengineering
12.3 Understand the four perspectives of the balanced
scorecard
12.4 Analyze changes in operating income to evaluate
strategy
12.5 Identify unused capacity and how to manage it

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 Strategy
• Strategy specifies how an organization matches its own
capabilities with the opportunities in the marketplace to
accomplish its objectives.
• Strategy describes how an organization can create value for
its customers while differentiating itself from its competitors.
• A thorough understanding of the industry is critical to
implementing a successful strategy. Industry analysis
focuses on five forces.

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 Industry Analysis Focuses on Five
Forces
1. Number and strength of competitors
2. Potential entrants to the market
3. Availability of equivalent products
4. Bargaining power of customers
5. Bargaining power of input suppliers

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 Two Basic Business Strategies
1. Product differentiation is an organization’s ability to offer
products or services perceived by its customers to be
superior and unique relative to the products or services
of its competitors.
– Competitive advantage: brand loyalty and the
willingness of customers to pay high prices.

2. Cost leadership is an organization’s ability to achieve

lower costs relative to competitors through productivity
and efficiency improvements, elimination of waste, and
tight cost control.
– Competitive advantage: lower selling prices.

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 Reengineering
• Reengineering is the fundamental rethinking and redesign
of business processes to achieve improvements in critical
measures of performance, such as cost, quality, service,
speed, and customer satisfaction.

• Stated another way, reengineering is the redesign of

business processes to improve performance by reducing
cost and improving quality.

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 Implementation of Strategy
Many companies have introduced a balanced scorecard to
track progress and manage the implementation of their
strategies.
A useful first step in designing a balanced scorecard is a
strategy map.
A strategy map is a diagram that describes how an organization
creates value by connecting strategic objectives in explicit
cause-and-effect relationships with each other in the financial,
customer, internal-business-process, and learning-and-growth
perspectives.

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 Structural Analysis of Strategy Maps
Before developing the balanced scorecard, it is prudent to assess and refine the strategy map.

Structural analysis is used to think carefully about the causal links in the strategy map.

There are five types of conditions to consider in a structural analysis:

1. Strength of ties—Ties are the causal links between strategic objectives and can
be qualified as strong, moderate, or weak.

2. Orphan objectives—An orphan objective is a strategic objective with only weak

ties leading out of it to other strategic objectives.

3. Focal points—A focal point is a strategic objective that has many other links
funneling INTO it.

4. Trigger points—A trigger point is a strategic objective where many ties spur OUT
from it, resulting in the achievement of many strategic objectives.

5. Distinctive objectives—Strategic objectives that distinguish an organization from

its competitors, based on the organization’s strategy, are distinctive objectives.

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 Strategy Map, Example
Exhibit 12.2 Strategy Map for Chipset, Inc., for 2017

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 The Balanced Scorecard
1. The balanced scorecard translates an organization’s
mission and strategy into a set of performance measures
that provides the framework for implementing its strategy.
2. Not only does the balanced scorecard focus on achieving
financial objectives, it also highlights the nonfinancial
objectives that an organization must achieve to meet and
sustain its financial objectives.
3. The scorecard measures an organization’s performance
from four perspectives.

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 The Four Perspectives of a Balanced
Scorecard (1 of 3)
1. Financial—profits and value created for shareholders
2. Customer—the success of the company in its target market
3. Internal business perspective—the internal operations
that create value for customers
4. Learning and growth—the people and systems capabilities
that support operations
The particular measure a company uses to track performance
will depend on its strategy.

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 The Four Perspectives of a Balanced
Scorecard ( 2 of 3)
FINANCIAL: Evaluates the profitability of the strategy and
the creation of shareholder value
Uses the most objective measures in the scorecard. The other three
perspectives eventually feed back into this dimension

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 The Four Perspectives of a Balanced
Scorecard ( 3 of 3)
CUSTOMER: Identifies targeted customer and market
segments and measures the company’s success in these segments
Here we see some measures that might be used including market share,
number of new customers and customer-satisfaction ratings.

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 Balanced Scorecard Implementation
A successful balanced scorecard implementation:
1. Must have commitment and leadership from top
management.
2. Must be communicated to all employees.
3. For the balanced scorecard to be effective, managers must
view it as a fair way to assess and reward all important
aspects of a manager’s performance and promotion
prospects.

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Common Balanced Scorecard Measures

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Different Strategies Lead to Different Scorecards
• A company that follows a cost-leadership strategy will likely have
designed their balanced scorecard to be different from a
company that follows a product-differentiation strategy.
• Companies are increasingly recognizing that they must
continually earn the right to operate in the communities and
countries in which they do business. Failure to perform
adequately on environmental and social outcomes puts at risk a
company’s ability to deliver future value to shareholders.
• Managers interested in measuring environmental and social
performance incorporate these factors into their balanced
scorecards to set priorities for initiatives, guide decisions and
actions and enhance discussions around strategies and
business models to improve performance.

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Features of a Good Balanced Scorecard
1. Tells the story of a firms strategy, articulating a sequence of
cause-and-effect relationships—the links among the various
perspectives that align implementation of the strategy.
2. Helps to communicate the strategy to all members of the
organization by translating the strategy into a coherent and linked
set of understandable and measurable operational targets.
3. Must motivate managers to take actions that eventually result in
improvements in financial performance.
Applies primarily to for-profit entities, but has some application to not-for-profit
entities as well.

4. Limits the number of measures, identifying only the most critical

ones.
5. Highlights less-than-optimal tradeoffs that managers may make
when they fail to consider operational and financial measures
together.
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 Pitfalls in Implementing a Balanced Scorecard
1. Managers should not assume the cause-and-effect linkages
are precise: they are merely hypotheses.
2. Managers should not seek improvements across all of the
measures all of the time.
3. Managers should not use only objective measures; subjective
measures are important as well.
4. Despite challenges of measurement, top management should
not ignore nonfinancial measures when evaluating managers
and other employees.

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Evaluating the Success of Strategy and
Implementation
• To evaluate how successful a company’s strategy and
implementation have been, its management must compare the
target and actual performance columns in the balanced scorecard.
• If a company does not meet its targets on the two perspectives that
are more internally focused (learning and growth, and internal
business processes), it would conclude that it did not implement its
strategy because it did not implement the activities that would give
it competitive advantage.
• If a company performs well in the internally focused perspectives
but not customer and financial measures, it may conclude that the
strategy was faulty because there was no effect on customers or
on long-run financial performance and value creation.

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End of chapter 12 part 1

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 Strategic Analysis of Operating Income
To evaluate the success of a strategy, managers and management
accountants need to link strategy to the sources of operating-income
increases. To do this evaluation, management accountants start by analyzing
three main factors:
1. The Growth component: measures the change in operating income
attributable solely to the change in quantity of output sold between years.
2. The Price-recovery component: measures the change in operating
income attributable solely to changes in prices of inputs and outputs
between years. This component measures the change in revenues as a
result of a change in output price compared with the change in costs as a
result of change in input prices.
3. The Productivity component: measures the change in costs attributable
to a change in the quantity of inputs used in current year relative to the
quantity of inputs that would have been used in the prior year to produce
the current year output. This component measures the amount by which
operating income increases by using inputs efficiently to lower costs.

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 Formulas Used for Strategic Analysis of
Income Summary (1 of 2)
Here are the formulas used in the strategic analysis of income:
1. Growth Component
• Revenue effect of growth (Slide #24)
• Cost effect of growth (Slide #25)
• Cost effect of growth for Fixed costs (Slide #26)
2. Price-Recovery Component
• Revenue effect of price recovery (Slide #27)
• Cost effect of price recovery (Slide #28)
• Cost effect of price recovery for Fixed costs (Slide #29)
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 Formulas Used for Strategic Analysis of
Income Summary (2 of 2)
Here are the formulas used in the strategic analysis of income:
3. Productivity Component
• Cost effect of productivity for variable costs (Slide #30)
• Cost effect of productivity for fixed costs (Slide #31)
Let’s review the formulas for each of these components on the
next slides:

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 Formulas Used for Strategic Analysis of
Income Details (1 of 8)
1.1 REVENUE EFFECT OF GROWTH
Revenue Actual Units of Actual Units of Prior
Effect = Output Sold in the _ Output Sold in the X Period
of Current Period Prior Period Selling
Growth Price

Throughout these slides, we’ll use values from the textbook example to
illustrate the formulas:
actual units of output sold in the current period are 1,150,000
Actual units of output sold in the prior period are 1,000,000
the selling price in the prior period was $23/unit,
therefore:

(1,150,000 – 1,000,000) x $23 = $3,450,000

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 Formulas Used for Strategic Analysis of
Income Details (2 of 8)
1.2 COST EFFECT OF GROWTH
Cost Effect Units of Input Required Actual Units of Prior
of Growth = to Produce Current _ Input Used to X Period
for Variable Output in the Prior Produce Prior Input
Costs Period Period Output Price

The cost effect of growth measures how much costs would have
changed in the prior year if production would have been at current year
levels.
This is done separately for Variable and Fixed costs.

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 Formulas Used for Strategic Analysis of
Income Details (3 of 8)
1.3 COST EFFECT OF GROWTH FOR FIXED COSTS

Cost
Effect Actual Units of Actual Units Prior
Of capacity in of Capacity Period
Growth = Prior Period to in the X Price
For Produce Current Prior per unit
Fixed Period Output Period of
Costs capacity

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Formulas Used for Strategic Analysis of
Income Details (4 of 8)
2.1 REVENUE EFFECT OF PRICE RECOVERY

Revenue
Effect Current
Current Period Prior Period Period
Of = X
Selling Price Selling Price Units
Price-
Recovery Sold

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Formulas Used for Strategic Analysis of
Income Details (5 of 8)
2.2 COST EFFECT OF PRICE RECOVERY
Cost Units of
Effect Input
Of required to
Price- Current Period Prior Period produce
= X Current
Recovery Input Price Input Price
for Period’s
Variable Output in
Costs the Prior
Period

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 Formulas Used for Strategic Analysis of
Income Details (6 of 8)
2.3 COST EFFECT OF PRICE RECOVERY FOR FIXED
COSTS

Cost
Effect Actual Units of
Of Current Period Prior Period Capacity on
Price- = Price per Unit Price per Unit X Prior Period to
Recovery of Capacity of Capacity Produce
for Fixed Current
Costs Period’s Output

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Formulas Used for Strategic Analysis of
Income Details (7 of 8)
3.1 COST EFFECT OF PRODUCTIVITY FOR VARIABLE
COSTS

Cost
Actual Units of Units of Input
Effect
Input used to Required to
Of Input Price in
= Produce Produce Current X
Productivity Current Period
Current Period Period’s Output
for Variable
Output in Prior Period
Costs

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 Formulas Used for Strategic Analysis of
Income Details (8 of 8)
3.2 COST EFFECT OF PRODUCTIVITY FOR FIXED COSTS
Assuming adequate current capacity:
Cost
Actual Actual Units of
Effect
Units of Capacity in Prior Price Per Unit of
Of
= Capacity in Period to X Capacity in
Productivity
Current Produce Current Current Period
for Fixed
Period Period’s Output
Costs

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 Further Analysis of Growth, Price-
Recovery and Productivity Components
EXHIBIT 12.6 Strategic Analysis of Profitability

• Consistent with a cost-leadership strategy, the productivity gains of $1,912,500 in 2017

were a big part of the increase in operating income for prior year to current year.
• Under different assumptions about the change in selling price, the analysis will attribute
different amounts to the different strategies.
 Downsizing and the Management of
Processing Capacity
• Managers can reduce capacity-based fixed costs by
measuring and managing unused capacity.
• Unused capacity is the amount of productive capacity
available over and above the productive capacity employed to
meet consumer demand in the current period.
• To better understand this concept of unused capacity, it is
necessary to distinguish engineered costs from discretionary
costs.

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 Analysis of Unused Capacity:
Engineered and Discretionary Costs
1. Engineered costs result from a cause-and-effect
relationship between the cost driver (output) and the
(direct or indirect) resources used to produce that output.
Engineered costs have a detailed, physically observable
and repetitive relationship with output.
2. Discretionary costs have two important features:
1. They arise from periodic (usually annual) decisions
regarding the maximum amount to be incurred.
2. They have no measurable cause-and-effect
relationship between output and resources used.

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 Managing Unused Capacity
• Downsizing (rightsizing) is an integrated approach of
configuring processes, products, and people to match costs
to the activities that need to be performed to operate
effectively and efficiently in the present and future.
• Downsizing often means eliminating jobs, which can
adversely affect employee morale and the culture of a
company.

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