Cost Accounting Cost Reduction - Accounting Basics

What is Cost Reduction in Cost Accounting?

The profit of an organization can be maximized in two ways – either by increasing the sale price of the unit or by decreasing the cost of that unit. The first case of increasing the sales price is only possible when the business deals with the monopoly items. And reduction of cost should not be effect the product quality.

Reduction of cost is done in the following way:

  • For the same volume of production, the expenditure cost must be reduced.
  • Production should increase without changing the level of production.

What is Cost Reduction Program?

Some of the essential points for cost reduction program are as follows:

  • The Cost reduction program should be designed as the company requirements.
  • Cost reduction program is a continuous program and is not treated as a one time activity. Continuous improvements of the efforts results in the success of the cost reduction program.
  • Cost reduction program should be real and permanent.
  • The Success of the cost reduction program depends on the co-operation of all the employees and departments of the organization.
  • The employee participation in cost reduction program need to be rewarded and the innovative ideas related to the program need to be encouraged.

What are the different fields covered under the Cost Reduction Program?

The scope of cost reduction program covers a number of fields such as:

Design

Design of the product is the first step in the manufacturing process. Investment is required either for improving the design of the old product or designing the new product. The investment may lead to reduction in product cost in terms of:

Material Cost

The product design enables to identify the possibility of the cheaper raw material such as a substitute, maximum production, less quantity etc.

Labour Cost

The product design reduces the operation time, after-sale service cost etc.

Organization

Employees should always be encouraged for the cost reduction scheme. Proper care should be taken and ensure that there is no communication gap between the departments and the levels of management and the responsibilities should be properly delegated by defining the area of the organization functions.

Factory Layout and Equipment

The material, manpower machines that remain unused should be studied properly such that these should be utilized to maximum reducing the cost of the product effectively.

Administration

The cost of the administrative expenses should be reduced. For the following expenses, the costs can be reduced but not the efficiency:

  • Telephone expenses
  • Travelling expenses
  • Salary by reducing staff
  • Reduction in cost of stationery
  • Postage and Telegrams

Marketing

The cost reduction program should cover the following areas:

  • Advertisement
  • Warehouse
  • Sales Promotion
  • Distribution Expenses
  • Research & Development Program

When the cost reduction program is focused on the Marketing segment, the cost accountant should think about the following points:

  • The distribution system of the organization should be checked for its overall efficiency and economical working.
  • Identify the efficiency of the sales promotion system
  • Identify whether cost can be reduced from the sales and distribution system and identify whether the research and development system is sufficient.
  • The ABC analysis of the customer need to be performed by the cost accountant by dividing the customers into :
ABC ANALYSIS OF CUSTOMERS
Category
Number of Dispatches
Volume of Sale Covered
Customer...A
About 10%
60% to 80%
Customer...B
About 20%
20% to 30%
Customer...C
About 70%
5% to 10%

Once the analysis is performed, the customers covering majority of the sales volume need to be focused. The cost reduction program will be more efficient for Category B and C.

Financial Management

In the following areas of financial management, more attention should be given:

  • If there is any over-investment.
  • How much economical is the cost of capital received?
  • If the organization is getting maximum returns for the capital employed.
  • If there is any over-investment that should be sold and similarly, unutilized fixed assets should be eliminated.

Personal Management

By using the staff welfare measures and by improving the labour relation, cost reduction program can be performed. An efficient cost reduction program can be run by introducing incentive schemes and providing better working conditions.

Material Control

Purchase of economic and useful material may also run the cost reduction program and the technique used for the same is Economic Order Quantity (EOQ) technique. Inward material should be properly checked, warehouse should be properly controlled and material should be properly issued and the material yield should be done effectively.

Production

A better cost reduction program can be run by using effective control over material, labour and machinery.

What are the tools and techniques of Cost Reduction Program?

The tools and techniques used for reducing the cost are as follows:

  • Budgetary Control
  • Standard Costing
  • Simplification and Variety Reduction
  • Planning and Control of Finance
  • Cost Benefit Analysis
  • Value Analysis
  • Contribution Analysis
  • Job Evaluation and Merit Rating
  • Improvement in Design
  • Material Control
  • Labor Control
  • Overhead Control
  • Market Research

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