Strategic management accounting fundamentals and cost management
Domain 1 - Strategic management accounting fundamentals and cost management - tests whether you can classify costs for decisions, trace overhead to cost drivers, and choose cost-management techniques that support strategy. Expect contrasts between absorption costing and activity-based costing (ABC), and questions on target, life-cycle, Kaizen and throughput methods.
Cost classification and the value chain
- Cost object: any item for which costs are measured. Direct costs trace economically; indirect costs are allocated.
- Variable vs fixed; product vs period; relevant vs irrelevant; controllable vs uncontrollable.
- Porter's value chain: primary activities are inbound logistics, operations, outbound logistics, marketing and sales, and service; support activities are firm infrastructure, human resource management, technology development and procurement. Advantage comes from linkages and cost drivers, not blanket cost cuts.
- Strategic cost drivers include scale, scope, experience, technology and complexity.
Cost-management techniques
- ABC assigns resource costs to activities, then to products using cost drivers. It is most useful when overhead is high, products are diverse and volume alone misleads.
- Activity-based management uses ABC for value-added analysis, cost-driver analysis and improvement.
- Target costing: target cost = target selling price - target profit. It is design-led and uses value engineering before production.
- Life-cycle costing includes R&D, design, production, distribution and disposal, avoiding a production-only focus.
- Kaizen costing seeks incremental reduction during production.
- Theory of constraints: throughput = sales - direct material cost. The bottleneck sets output; throughput accounting ratio = throughput per bottleneck hour / operating cost per bottleneck hour. Subordinate non-bottlenecks.
Worked example
Overhead is $300,000: setups $120,000 for 600 setups, machining $180,000 for 30,000 hours. Product A uses 200 setups and 20,000 hours; B uses 400 setups and 10,000 hours. Traditional rate = $300,000 / 30,000 = $10 per hour, so A absorbs $200,000 and B $100,000. ABC rates: setup $200, machining $6. A = 200 x $200 + 20,000 x $6 = $160,000. B = 400 x $200 + 10,000 x $6 = $140,000. A was overcosted by $40,000; B undercosted by $40,000. B's setup intensity is hidden by volume-based absorption, so pricing and process redesign should focus on B.
Traps
Treating all overhead as volume-driven; using ABC for external reporting without checking accounting standards; confusing target costing with cost-plus pricing; deducting labour from throughput; ignoring idle capacity; treating committed fixed costs as avoidable.