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Cost Management Systems

Actual cost reporting is an effective method of cost reporting for small companies with low sales volume. However, it is not realistic for larger companies to use this form of cost reporting. As smaller companies grow they must recognize that a formal cost management system is necessary. In order to examine formal integrated cost management systems it is necessary to define cost management systems, understand the scope of these systems, recognize the goals of these systems, and consider the items that affect the design of these systems. Integrated Cost Management Systems A cost management system is a method that is used to plan and control the decisions an organization makes regarding cost generating activities, in order to lower product cost and increase product value for customers. Cost management systems provide information that helps management make short-term and long-term decisions regarding "amounts and kinds of materials being used, changes in plant processes, and changes in product design" (Horngren et al, 2006, p. 2-3). Ultimately, cost management systems are used to help make decisions that will increase short-term profit and improve the long-term position of the company. Three of the most common costing systems are job order costing, process costing, and activity-based costing (ABC). Job order costing is used by companies that produce products for specific orders. This type of system estimates the costs associated with producing goods for different jobs. Process costing is often used by companies that operate using continuous processing. This type of system applies the costs of production, labor, and support activities as the goods pass through the different process stages, ABC is a two-stage method of allocating costs. In the first stage, costs are allocated to pools and in the second stage the cost pools are allocated to products or services. Cost management systems cover a broad scope of activities and "should not be interpreted to mean only continuous reduction in costs".These systems separate product costs into three categories: direct material, direct labor, and overhead. However, cost management systems do more than that. They help management

the company must create measurements that can be used to determine throughout the year whether the company is likely to meet that goal at year end. manpower hours. . Items that Affect the Design of an Integrated Cost Management System Motivation . The company must decide how the information should be presented and then design the system so that the information is organized and displayed in the manner most beneficial to management. This increases costs initially. make decisions. requirements would include the ability to provide information on unit production. In order to design a system for this company. management might set a goal to increase net income by 50% from 2005 to 2006. Using the information provided by the cost management system. the company must provide training and motivation to managers in order to increase the likelihood of reaching the goal. In addition. but the goal is to ultimately improve profit later. The reporting feature of any system is of great importance. Reporting . and then create measurements to determine whether those goals are being reached. unit sales. Once this goal has been set.54% from 2004 to 2005. as well as train and motivate management to reach those goals. volume of material used. as well as apple juice costs and grape juice costs separately. management may choose to increase advertising costs. management may look at prior year income statements and note that net income increased by 42% from 2003 to 2004 and 45. For example. unit sales price.A company must first set organizational goals. production costs. total sales price.the system should be designed so that it provides reports with the necessary information in a manner that management can use in order to make decisions. a fruit juice company may decide that it wants to evaluate information regarding total juice costs.the system should be designed so that it provides information which helps management plan. sales volumes. such as production volume. Information . machine hours. Based on that information. etc. control. For example. and cost of goods sold. For example. and evaluate performance. management may make decisions that appear to increase costs.measure various cost activities.

the most efficient way of funding the growth profitability is to free up costs and capital and then re-invest these funds in the most promising growth opportunities. trade spend and innovation to drive growth. and then redirected much of the savings towards increased marketing. it does lead to temporary gains in efficiency however. Since the mid 1990’s they have significantly improved gross margins and overall operating efficiency. One of the best examples of a Company which has achieved this is Wrigley. controlling. There are three main reasons for this: 1)They are an excellent way to enhance profits in the short-term but can undermine efforts at more durable competitive improvements. however. They tend to be implemented at a time of ‘belt-tightening’ in hard times or as part of a turnaround. and decision-making. An integrated cost reporting system will be invaluable to the company. . selective cost cutting and improved organisational capabilities. some problems with cost-cutting programmes. There are four principles for achieving this involving the use of ambitious sales and earnings growth targets. tailored cost-reduction targets. Therefore: cost-cutting programmes rarely fortify or improve the company’s product and service offerings because benefits go straight to the bottom line or to customers in the form of lower prices. As a result they have been able to outperform competitors and provide good returns for shareholders. Cost management should be closely aligned with and made part of corporate growth strategies. whilst helping to meet earnings targets they rarely lead to sustained improvement in competitive position. Advantages/Importance of Cost Management System After the recent recessions many companies are looking for ways to boost sales and increase profits. since the 1980’s cost cutting programmes have become an integral part of corporate life in the search for increased profits. as it will assist management with planning. but as a company grows it will become more and more difficult to use that form of cost reporting. the challenge is not just to lower costs but also to ‘out invest’ competitors on growth. and their main aim is to protect or increase the bottom line.Conclusion Actual cost reporting may work for smaller companies. There are. the chewing gum manufacturer.

instead of continuous processes. growth oriented cost management.How do the cost levels compare with those for competitors? .What level of costs will be necessary to support projected growth rates and ensure that the business is not ‘out-invested’ on growth by competitors? Principle Three – Differentiate between ‘good’ and ‘bad’ costs.g. so any gained advantage is temporary. improved and continuous cost management must become part of the ethos of the organisation. this may be achieved by setting challenging top. 3) Cost-reduction programmes are often treated as finite projects. and commitment to. This requires the growth targets for managers across businesses to reflect the characteristics of that business. The challenge is to differentiate between ‘good costs’ which add to profitability and ‘bad costs’ which may be eliminated without affecting profits. and none should take precedence: . but will also be able to invest more in marketing and innovation. Ultimately consistent under investment in growth compared to competitors and maintaining rather than lowering operating costs will lead to a limit of top-line growth and erosion of the business position over time. In addition to the earning growth targets set by senior mangers three other factors should be taken into account when setting cost-reduction targets for any business. Even after a successful cost-cutting exercise companies will find that their competitors follow suit. a company with solid historical earnings growth but with only modest sales growth requires a change in performance.How do the cost levels compare to those of other businesses in the company? . growth oriented cost management. not just the use of aggressive cost-cutting. E. – Differentiate between ‘good’ and ‘bad’ costs. To prevent this. and commitment to. There are four principles for aligning cost management and top line growth: Principle One – Use ambitious sales and earnings growth targets to motivate the need for. they should be balanced. this will affect what percentage of the increased earnings will come from cost-cutting and what from top-line growth across different businesses. or as a platform for growth. – Use ambitious sales and earnings growth targets to motivate the need for. The most important part of this approach of growth orientated cost management . Continuous cost management will provide more permanent gains and it limits the need for large scale efficiency initiatives.2) Most cost-cutting programmes take a single target and apply measures across all of the different businesses in a company without regard for the peculiarities of each business. or costs creep up perhaps in a different area. Most companies do not see cost management as linked to corporate strategy. – Tailor cost-reduction targets to the existing cost position and strategy of each business.and bottom-line targets so that the businesses need to cost cut and increase sales to achieve the desired earning growth. Principle Two – Tailor cost-reduction targets to the existing cost position and strategy of each business. If their competitor has a more efficient cost base they will achieve similar levels of profitability.

by assessing costs across selling. The challenge is to reduce costs but not lose the critical capabilities that maintain competitiveness. growth oriented cost management. and making sure that cost-cutting in one area is not going to drive up costs in another. – Create the right conditions for ongoing cost management . E. – Create the right conditions for ongoing cost management. and bottom-up initiatives. – Tailor cost-reduction targets to the existing cost position and strategy of each business. Senior management provide the rallying cry. but it is line management who perform the task of checking the details of the business. – Use ambitious sales and earnings growth targets to motivate the need for.and bottom-line performance. organisation and capabilities is often a pre-requisite for continuous cost management. and the trade-offs between different costreduction options. and commitment to.g.begins once the earning and cost-reductions targets have been set. This may be achieved by improving the way in which financial reporting is made on specific cost areas of each business. The most essential element in getting cost management to be effective is the link with growth. Principle Four – Create the right conditions for ongoing cost management. Also by sharing and coordinating the best practice from each business within a company the whole group will benefit from each others experience. cost-reduction must be given a clear and agreed role on the growth agenda so that it drives both top. – Differentiate between ‘good’ and ‘bad’ costs. Balancing Top and Bottom Managing costs for increased growth means having to find the right balance between top-down directions. and create funds for re-investment in growth. general and administration areas of a business cost-cutting initiatives may bring business costs in line with those of competitors. Making changes to management processes. finding good and bad costs.

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