Strategic Cost Management and Performance Evaluation
This domain tests your ability to select the right cost technique and to use performance measures that align divisional behaviour with firm value: activity-based costing, target and lifecycle costing, throughput accounting, transfer pricing, ROI/RI/EVA and the balanced scorecard.
Core rules
- ABC assigns overheads through activities and cost drivers; it reallocates product costs, not total overhead.
- Target cost = competitive price − required profit; close the gap through value engineering and design change, not across-the-board cuts.
- Throughput accounting ranks products by throughput per bottleneck minute; inventory is not value-added.
- Minimum transfer price = incremental cost + opportunity cost of the transferred unit. With spare capacity the opportunity cost is nil; at full capacity it is the lost contribution.
- EVA = NOPAT − (invested capital × WACC); RI = divisional profit − (capital × required return).
Worked example
Division A makes a component with variable cost ₹60. It can sell outside at ₹100, incurring ₹5 variable selling cost. Division B wants 10,000 units. With spare capacity, minimum transfer price = ₹60. At full capacity, each internal transfer sacrifices external contribution of ₹100 − ₹5 − ₹60 = ₹35, so minimum = ₹60 + ₹35 = ₹95. Any price between ₹95 and B's external purchase price is negotiable. Reasoning: a transfer price below ₹95 at full capacity makes A look profitable while destroying group profit.
Traps
Using full cost plus markup when spare capacity exists; ignoring capacity in transfer-pricing questions; comparing ROI with WACC when divisions have different asset bases; treating EVA as profit after tax without adjusting for accounting distortions; forgetting that the balanced scorecard needs both lead and lag measures across four perspectives.