Chapter 1 Strategic Management Accounting -An Introduction

Definitionof Strategic Management Accounting (SMA):

Today’s businesses operate in a dynamic, complex environment as they are affected by STEP
(Sociological, Technological, Economic and Political) factors, internal competition and the
increasing bargaining power of suppliers and customers.

In a changing business environments and conditions management must make sure that the
management accounting system changes too. Providing relevant data for guiding managerial
strategic decisions in changing situations is commonly known as Strategic Management
Accounting (SMA).
Strategic Management Accounting (SMA) is the process of identifying, gathering, choosing and
analysing accounting data for helping the management team to make strategic decisions and to
assess organizational effectiveness.

Organizational Strategy:
Strategy has been defined as a pattern or stream of decisions about an organization’s possible
future domains. Strategy is the determination of basic long term goals and objectives of the
enterprise and the adoption of courses of action and the allocation of resources necessary for
carrying out these goals.
Thus, strategy can be seen as an integrated set of actions aimed at securing a sustainable
competitive advantage.

Types of Strategy:
▪ Corporate strategy
▪ Competitive strategy
▪ Functional strategy
▪ Strategy as process
▪ Strategy as competitive position
▪ Business level strategy
▪ Defender type strategy: A defender strategy entails finding, and maintaining a secure
and relatively stable market. Rather than being on the cutting edge of technological
innovation, product development, and market dynamics; a defender tries to insulate
themselves from changes wherever possible.
▪ Analyzer or mixed strategy
▪ Reactor strategy: The reactor strategy is the least aggressive, and organizations
typically do not have any forward looking or predictive strategy. They are not pro-active
and react to events as and when they occur. Their strategies are enforced when they
are required to respond to changes in the market or other environmental factors.
▪ Lower cost strategy
▪ Differentiation strategy: A differentiation strategy is an approach businesses develop
by providing customers with something unique, different and distinct from items their
competitors may offer in the marketplace. The main objective of implementing
a differentiation strategy is to increase competitive advantage.
 What is life cycle costing?
Life cycle costing, or whole-life costing, is the process of estimating how much money you
will spend on an asset over the course of its useful life. Whole-life costing covers an asset’s
costs from the time you purchase it to the time you get rid of it.
Buying an asset is a cost commitment that extends beyond its price tag. For example, think of
a car. The car’s price tag is only part of the car’s overall life cycle cost. You also need to
consider expenses for car insurance, interest, gas, oil changes, and any other necessary
maintenance to keep the car running. Not planning for these additional costs can set you
back. The cost to buy, use, and maintain a business asset adds up. Whether you’re purchasing
a car, a copier, a computer, or inventory, you should consider and budget for the asset’s
future costs.
Life cycle costing process
Conducting a life cycle cost assessment helps you better predict how much your business will
pay when you acquire a new asset.
To calculate an asset’s life cycle cost, estimate the following expenses:
1. Purchase
2. Installation
3. Operating
4. Maintenance
5. Financing (e.g., interest)
6. Depreciation
7. Disposal

Purpose of the life cycle cost analysis

As mentioned, conducting a life cycle cost analysis helps you estimate how much an asset will
cost you over the course of its life.
Take a look at some of the reasons why knowing an asset’s total cost can guide your business
decisions.
1. Choose between two or more assets
Using life cycle costing helps you make purchasing decisions. If you only factor in the initial
cost of an asset, you could end up spending more in the long run. For example, buying a used
asset might have a lower price tag, but it could cost you more in repairs and utility bills than a
newer model.
Life cycle cost management depends on your ability to make a smart investment. When you are
deciding between two or more assets, consider their overall costs, not just the price tag in front of
you.
2. Determine the asset’s benefits
How do you know if you should buy an asset? Generally, you weigh the pros and cons of your
purchase. But if you only consider the initial, short-term cost, you won’t know if the asset will
benefit your business financially in the long run.
By using life cycle costing, you can more accurately predict if the asset’s return on investment
(ROI) is worth the expense. If you only look at the asset’s current purchase cost and don’t factor
in future costs, you will overestimate the ROI.
3. Create accurate budgets
When you know how much an asset’s total price is, you can create budgets that represent your
business’s actual expenses. That way, you won’t underestimate your business’s costs.
 A budget is made up of expenses, revenue, and profits. If you underestimate an asset’s cost on
your budget, you are overestimating your profits. Failing to account for expenses can result in
overspending and negative cash flow.
Looking for a simple way to track your business’s costs? Patriot’s online accounting software is
made for the non-accountant, making it easy to track your expenses. And, we offer free, U.S.-
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Lean Accounting
Lean Accounting is the management accounting system for a lean organization (Nike. The
famous shoe and clothing giant has also adopted lean manufacturing techniques. Much like other
businesses, Nike saw less waste and higher customer value, but also some unforeseen benefits.).
It provides the relevant financial and nonfinancial information necessary to execute
the lean strategy and drive financial success.
What are the key components of lean accounting?
The five principles are considered a recipe for improving workplace efficiency and include: 1)
defining value, 2) mapping the value stream, 3) creating flow, 4) using a pull system, and 5)
pursuing perfection.

The seven Lean principles are:

• Eliminate waste.
• Build quality in.
• Create knowledge.
• Defer commitment: Deferring commitment means waiting until the last responsible moment to
make a decision. It might be easier if we rephrase it this way: Defer critical
decisions. Deferring all decisions is not practical or useful..
• Deliver fast.
• Respect people.
• Optimize the whole.

Lean Tools and Their Applications

• Bottleneck Analysis. How many times have your projects gotten stuck somewhere between
development and delivery? ...
• Just-in-Time (JIT) ...
• Value Stream Mapping. ...
• Overall Equipment Effectiveness (OEE) ...
• Plan-Do-Check-Act (PDCA) ...
• Error Proofing.

Value chain analysis is the process of looking at the activities that go into changing the inputs
for a product or service into an output that is valued by the customer.

The primary activities of Michael Porter's value chain are inbound logistics, operations,
outbound logistics, marketing and sales, and service. The goal of the five sets of activities is
to create value that exceeds the cost of conducting that activity, therefore generating a higher
profit.

Five steps to developing a value chain analysis

Step 1: Identify all value chain activities. ...
Step 2: Calculate each value chain activity's cost. ...
Step 3: Look at what your customers perceive as value. ...
Step 4: Look at your competitors' value chains. ...
Step 5: Decide on a competitive advantage.

Cost & Management Accounting Concepts, Classifications and Statements

Classifications of Costs:

Basis of classification Cost classifications

A. The product 1.Manufacturing costs

-Direct materials

-Direct labor

-Factory overhead

2.Non-manufacturing costs

-Marketing or selling costs

-Administrative costs

B. Volume of production 3.Variable costs

4. Fixed costs

5.Semivariable costs

C. Assigning costs to cost objects 6.Production and service departments costs

7.Direct and indirect departmental costs

8.Common costs and joint costs

D. Costs in the financial statements 9.Product costs

 10.Period costs

E. Making decisions 11.Differential cost

12.Sunk cost

13.Opportunity cost

1. Manufacturing costs: Manufacturing costs, often called production cost or factory cost, is
the some of the three cost elements: direct materials, direct labor, and factory overhead.
i. Direct materials: Materials that can be physically and conveniently traced to a
product are called direct materials. Example: wood in a table.
ii. Direct labor: Labor cost that can be physically and conveniently traced to a
product is called direct labor. Example: the labor cost of carpenters.
iii. Factory overhead: All costs of manufacturing a product other than direct
materials and direct labor are called factory overhead. Example: factory heat
and light, depreciation, insurance, property taxes on manufacturing facilities.
2. Non manufacturing costs:
i. Marketing and selling costs: All costs necessary to secure customer orders and
get the finished products and services into the hand of the customer are
marketing and selling costs. Example: sales commission, advertising.
ii. Administrative costs: All costs associated with the general management of the
company as a whole are administrative costs. Example: executive travel costs,
secretarial salaries, depreciation of office building.
3. Variable costs: A variable cost is a cost that varies, in total, in direct proportion to
changes in the volume of production.
4. Fixed costs: A fixed cost is a cost that remains constant, in total, regardless in changes in
the volume of production.
5. Semi variable costs: The cost contains a portion fixed and a portion variable is called
semi variable cost. Example: telephone bill.
6. Production and service department costs: Production department cost is manual and
machine operations, such as forming and assembling. Service department cost is for
service rendered for the benefit of other departments.
7. Direct and indirect departmental costs: If the cost is readily identifiable with the
department in which it originates, it is referred to as direct departmental cost. Example:
the salary of the departmental supervisor. On the other hand, if the cost is shared by
several departments that benefit from its incurrence, it is referred to as indirect
departmental cost. Example: building rent and building depreciation.
8. Common costs and joint costs: Common costs are cost of facilities or services employed
by two or more operations. Joint costs occur when the production of one product may be
possible only if one or more other products are manufactured at the same time.
9. Product costs: Product costs include all the costs that are involved in acquiring or making
product that is direct material, direct labor and factory overhead costs. Initially, product
costs are assigned to an inventory account on the balance sheet. When the goods are sold,
the costs are released from inventory as expenses. So these costs are also known as
inventoriable costs.
10. Period costs: Product costs are all the costs that are not included in product costs. For
example sales commission and office rent are not included as part of the cost of
purchased or manufactured goods. Rather, they are treated as expenses on the income
statement in the period in which they are incurred.
11. Differential cost: A difference in costs between any two alternatives is known as a
differential cost. This cost is also called relevant cost.
12. Sunk cost: A sunk cost is a cost that has already been incurred and that cannot be
changed by any decision made now or in the future. This is also called irrelevant cost.
13. Opportunity cost: Opportunity cost is the potential benefit that is given up when one
alternative is selected over another.