May 2, 2016

Costing for Strategic Profitability Analysis

Strategic management accounting is a recently developed branch in management accounting. It helps management in developing required estimates for various proposed strategies based on accounting information. The main job of management accountant is to provide accounting statements that have the relevant information of use in developing estimates of the results.

Company can pursue cost leadership strategy or  differentiation strategy in the product and target markets it is operating. The accounts of two years can be compared and the growth, product differentiation and cost leadership components of the increase in operating income can be determined.

Growth component

The growth component measures change in revenue and costs based on changes in units sold or produced, with all other variables being the same as the previous year. By isolating the change in units, the analysis looks at the impact of the change in growth on revenue.


Revenue effect of growth


Revenue effect of
growth component = (Actual units of output sold in the current period – Actual units of output
sold in the last period) × Selling price in the last period.

Maintaining the selling price of the last period isolates the increase in revenue resulting from the change in units sold.

Cost effect of growth

Cost effect of growthcomponent  = (Actual units of input or capacity that would have
used to produce current period output assuming the same input-output relationship that existed in the last period  – Actual units of input or capacity to produce the last period output)  × Input prices
in the last period


Maintaining the input-output relationship in the last period input prices isolates the increase in cost resulting from the growth in sales between the last period and the current period. Since fixed costs do not change, variable direct-material costs are isolated from fixed costs (including conversion and R&D costs). This approach assumes that the company is still operating within its relevant range.


Price-recovery component

The price-recovery component of operating income measures the change in revenues and the change in costs to produce the given level of current output resulting from the change, assuming the relationship of input output remains constant. This isolates the change in revenue due solely to the change in selling price.

Revenue effect of price recovery

Revenue effect of product
differentiation component = (Selling price in the current period – Selling price in the last period) ×
Actual units of output sold in the current period

Cost effect of price recovery

This component focuses on the effect of changes in prices of input and also incorporates changes in fixed costs or conversion costs.
Cost effect of  product differentiation component
 = (Input prices in the current period  – Input prices in the last period)  ×
(Actual units of inputs or capacity that would have been used to produce in the current period output
assuming the same input-output relationship that existed in the last period)

Productivity component

The productivity component analysis uses current-year prices to isolate the change in costs between the current and past year caused solely by the changes in quantities, mix, and capacity of inputs.

Productivity/cost leadership component =
(Actual units of input or capacity to produce the current period input
 – Actual units of inputs or capacity that would have been used to produce the current period output assuming the same input-output relationship that existed in the last period)
 × (Current period prices)

Conclusion
Companies that have chosen a cost-leadership strategy would be more likely to focus on productivity and growth components, while companies following a differentiation strategy would see more changes in price recovery and growth components.


Strategic Analysis of Operating Income - Part 1
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Startup Tech Asia

Strategic Analysis of Operating Income - Part 2
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Startup Tech Asia


Updated  2 May 2016, 8 Dec 2011

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