Movement From Traditional to Modern Cost Accounting Methods in Manufacturing Companies

This paper discusses the movement from traditional to modern cost accounting methods in manufacturing companies. It explains the types of costing systems, cost allocation in traditional and activity-based costing systems, and the impact of these systems on product profitability evaluation. The paper concludes that modern cost accounting methods are more appropriate in current business conditions and should be used together with traditional methods.

155
Movement From Traditional to Modern
Cost Accounting Methods in
Manufacturing Companies (*)
Hrvoje Perčević
University of Zagreb, Croatia
Mirjana Hladika
University of Zagreb, Croatia
Abstract
Significant changes in business environment at the e
the beginning of 21st century enable the development and
cost accounting methods which main purpose is to give
management regarding the effectiveness of certain products,
consumers, responsibility centres etc. Traditional cost accounting
developed in the middle of 20th century due to the
focus of traditional cost accounting methods was on
of indirect manufacturing costs allocation to products or
development of technology, changes in consumer’s preferences, g
face modern manufacturing companies with permanent challenges
the global market. Traditional cost accounting methods are no l
modern business conditions, because cost accounting methods
potential areas in companies where are possible cost savings. Therefor
cost accounting methods are focused on cost rationalization
since modern manufacturing companies cannot effect on market prices
effect on their costs. In current business conditions, modern cost a
(*) Bu Araştırma, 19-22 Haziran 2013 tarihinde İstanbul’da yapılan 3rd
International Conference on Luca Pacioli in Accounting History’de ve 3rd Balkans
and Middle East Countries Conference on Accounting and Accounting History
(3 BMAC) Konferansı’nda bildiri olarak sunulmuştur.

156
are more appropriate while they are focused on the total
product life cycle. This paper deals with the modern cost accounti
their application in manufacturing companies. The results are s
cost accounting methods enables more confidential determination of t
profitability. But it is also important to state that r
cost accounting methods should be applied together with traditional c
methods. Traditional cost accounting methods give informat
short term, while modern methods are orientated on longer period (
product life cycle).
Key words: Traditional Cost AccountingMethods, Modern Cost Accounting
Methods, ABC, Target Costing, Life Cycle Costing, Product Profitability.
Jel Classificiation: M21, M4A, M51
1. Introduction
The basic purpose of costing systems is to
product or service by assigning manufacturing costs to products
that company produces or provides. Costing system
accounting methods used in order to define the cost
methods used in costing system enable the evaluation of p
from the manufacturing process. It is important to
costing systems differently affect the product evaluation.
costing system was based on the type of the production p
job order costing was used in job order production, while
was applied in process or mass production. Today, these two c
are considered as traditional costing systemswhich are no l
use in modern operating conditions. Business conditions a
becoming more and more complex. Manufacturing processes
production companies are almost fully automated and compute
process of manufacturing automation and computerization causes s
change in manufacturing cost structure. The most important c
modern manufacturing cost structure becomes indirect manufac

157
(manufacturing overheads). This change in manufacturing cost
found traditional costing systems inappropriate for product evaluation.
In order to avoid the inaccuracy of traditional costing
evaluation, the new costing system, based on activities, has b
This costing system is known as Activity based costing.
2. The Types of Costing Systems
Costing system can be defined as a system used
cost objects (products or services). The main purposeof c
enable cost assignment. Cost assignment is the process
and indirect costs to products or servicesin order to d
product or service.
Each costing system consists of five basic elements:1
1. cost object – anything for which a
desired. Usually, cost objects are products or services
manufactures or provides.
2. direct costs of a cost object – these are costs that c
a particular product or service
3. indirect costs of a cost object – these are costs that c
to a particular product or service. Indirect costs need to b
objects using a proper cost allocation method.
4. cost pool – a grouping of individual c
formed when company uses more cost allocation bases. In A
pools are identified activities to which indirect costs are a
5. cost allocation base – the factor that links in a
indirect cost (or group of indirect cost) to a particular c
1) Horngren, C.T., Datar, S.M., Foster, G. (2003), Cost Accounting – A
Managerial Emphasis, Prentice Hall, New Jersey, p. 96-97.

158
These five elements are using to design an adequate
There are three basic costing systems used in
manufacturing companies in order to determine the cost of
a particular product or to evaluate product profitability:2
1. job order costing,
2. process costing,
3. activity based costing.
The first two costing systems are known as tradition
systems. While the appliance of traditional costing systems
type of a manufacturing process, activity based costing system c
regardless the type of manufacturing process. The main i
when is convenient to use traditional costing systemsand w
costing system should be applied? To answer on this question
conditions and the manufacturing cost structure should be c
2.1. Cost allocation in traditional costing systems
The basic distinction between job costing and process c
is in determination of cost object. In job costing cost
consistsof a unit or multiple units of distinct products
costing cost object is masses of identical or similar units o
Therefore, job costing can be applied in manufacturing which i
customer’s order, while process costing can be used in mass p
is continually performing and is not initiated by a
Cost allocation is similar in job costing and in
both costing systems direct manufacturing costs are traced to
services. These costs are directly assigned to particular p
which cause their appearance. Direct manufacturing costs include direct
material costs and direct labour costs. The main problem
system is indirect manufacturing costs allocation. Because these c
2) Lucey, T. (1996), Costing, DP Publications, London, p. 175-176.

159
be directly identified to particular product or service, indirect m
costs need to be allocated to products or serviceso
which correctly present the relationship between indirect
costs and certain product. This relationship is often very difficult to
express by a single allocation base. It is important
is no allocation base which can accurately provide
to products. Chosen cost allocation base can be more
but it can’t be 100% accurate. Indirect manufacturing
assigned to products or services using the followin3
1. direct labour hours,
2. machine hours,
3. direct material costs,
4. total direct costs,
5. quantity of production.
Indirect manufacturing costs are assigned to cost
overhead allocation rate which is computing on the c4
total indirect manufacturing costs
OAR = --------------------------------------------
cost allocation base
Companies can use either one or more overhead
assigning indirect manufacturing costs to products or services.
that the more overhead allocation rates are used the
accurate and the product profitability evaluation is
objective for decision making.
3) Engler, C. (1988), Managerial Accounting, Irwin, Homewood, Illinois,
p. 427
4) Lucey, T. (1996), Costing, DP Publications, London, p. 88

160
Figure 1. Cost allocation in traditional costing systems
In traditional costing systems the indirect manufac
allocated to cost objects on arbitrary bases which could
profitability evaluation. The impact of traditional costing systemsa
on product profitability evaluation depends on certain
which is manufacturing cost structure considered as the
indirect manufacturing costs participate significantly in total manufac
costs, traditional costing system may cause the wrong picture of
profitability evaluation. Otherwise, traditional costing system can
relatively objective product profitability evaluation.
2.2. Cost allocation in Activity Based Costing System
Activity Based Costing system (ABC system) was
order to correct the deficiencies of traditional costing
purpose of ABC system is to provide the fair and
Cost allocation base
Overhead allocation rate
COST OBJECT –
Direct material costs Direct labour costs
Manufacturing overheads

161
and therefore product profitability evaluation also. Accordin
system focuses attention on indirect manufacturing costs. The aim i
the most appropriate way for indirect manufacturing costs a
objects.
The main assumption
consume activities and activities consume resources.5 The more
activities are set up, the more complex is ABCsystem. An activity
is defined as any event, action, transaction
incurs cost when producing a product or providing a service.6
In ABCsystem direct manufacturing costs are also directly traced to
products or services, so the main attention is p
costs which are allocated to activities instead to departments or jobs
(like in traditional systems). Basically, the application
going through two main phases. In the first phase indirect
costs are allocated to activity cost pools. It is
correlation between particular indirect manufacturing cost
activity. Every indirect manufacturing cost must be assigned
activity which causes its occurrence. The second phase in ABC
is assigning indirect manufacturing costs from activity cost pools to
products using defined cost drivers. A cost driver
that has a direct cause – effect relationship with the7
ABC system uses multiple cost allocation bases to assign i
costs to products or services. The usage of multiple
provide a more accurate and objective product profitability e
5) Horngren, C.T., Datar, S.M., Foster, G. (2003), Cost Accounting – A
Managerial Emphasis, Prentice Hall, New Jersey, p. 141.
6) Horngren, C.T., Datar, S.M., Foster, G. (2003), Cost Accounting – A
Managerial Emphasis,Prentice Hall,New Jersey, p. 141 or Weygandt, J.J., Kieso,
D.E.,Kimmel, P.D. (2005), Managerial Accounting, John Wiley & Sons, USA, p. 144.
7) Weygandt, J.J., Kieso, D.E., Kimmel, P.D. (2005), Managerial Accounting,
John Wiley & Sons, USA, p. 144.

162
Manufacturing overheads
Figure 2. Cost allocation in ABC system
Cost drivers should correctly show the relationship between
activity and cost objects. Otherwise, even this costing system
product cost distortion and unreliable product profitability
system is very complex and takes much more effort and r
than traditional systems. Its application is justified o
ABC system exceed costs of its implementation. So, when
a company decide to implement ABC system must be s
will provide the more useful cost information for business d
than traditional systems.
Activities
Cost drivers
COST OBJECT –
Direct material costs Direct labour costs

163
2.3. Traditional systems vs. ABC system – the impact on product
profitability evaluation
The main dilemma which many manufacturing companies
is the choice of costing system. Traditional costing systems
deficiencies in product profitability evaluation especially
allocation bases are not in direct correlation with indirect
costs. Today’s manufacturing environment characterizes automat
computerized manufacturing processes, technological innovations and g
competition.8 As a result of these changes, indirect
significantly increased, while direct labour costs are dramatically d
In these conditions, traditional costing systemscannot provide objective
accurate product profitability evaluation becausetypical cost allocatio
in traditional system (which are direct labour hours and machine
longer in correlation with indirect manufacturing costs appearance. T
the new approach for cost allocation needs to be
more appropriate costing system in modern manufacturing conditions. M
surveys conducted in modern manufacturing companies worldwide i
the factors which directs to ABC system application. These factors9
1. product lines differ greatly in volume and manufacturing
complexity;
2. product lines are numerous, diverse and require differing
of support services;
3. overhead costs constitute a significant portion o
4. the manufacturing process or the number of products
significantly – for example, from labour-intensive t
intensive due to automation;
8) Ibid.
9) Ibid, p. 154

164
5. production or marketing managers are ignoring
by the existingsystem and are instead using “bootleg” c
or other alternative data when pricing or making other p
decisions.
The existence of one or more of these factors w
that ABC system should be applied.
One of the most important factors that will be
clearly when deciding which costing system to apply is manufac
structure. Recent tremendous c
which are provoked by permanent manufacturing process automation,
significantly increased ABCsystem appliance in modern developed
manufacturing companies worldwide. As it is emphasised, t
process automation have increased indirect manufacturing costs which
became the most significant cost category in total manufacturing
costs. Simultaneously, direct labour costs have dramatically decreased
and today are considered as no longer an important cost category.
The portion of direct labour costs in total manufacturing cost in
modern automated manufacturing companies is between 5 - 15%,10
while the portion of indirect manufacturing costs is often
Manufacturing cost structure in modern developed manufacturing s
be shown as it follows:
Figure3. Manufacturing cost structure in modern automate
manufacturing sectors
10) Lucey, T. (1996), Management Accounting, Letts Educational, London,
p. 37.
Direct
manufacturing
costs
Indirect
manufacturing

165
When indirect manufacturing costs take the significant portion
of total manufacturing costs, more objective and more accurate
profitability evaluation can be achieved by using ABC s
manufacturing costs take the significant portion of total manufac
then even traditional costing systems can provide relativel
accurate product profitability evaluation. In these circumstances u
system wouldn’t contribute to more objective and more
profitability evaluation.
3. Dynamic Approach of Cost Management
Dynamic approach of cost management enables
product profitability through the entire product life cycle.
approach is oriented to the long run decisions r
forming the adequate product mix, eliminating the non-pro
introducing the new product line etc. But, in order to p
with relevant information regarding product profitability evaluation,
accounting function in companies need to combine
dynamic approach of cost management e.g. need t
product profitability in the short run and in the long r
of these two cost management approaches can give the o
picture regarding product profitability.
While static cost management approach is based on
cost accounting methods which are focused mainly on
towardsthe determination of the manufacturing cost per unit, d
management approach involves modern managerial account
focused on the total costs through the whole product
managerial accounting literature recognizes several costing methods
on the whole product life cycle. The most important methods
theory of constraints, life-cycle costing and long-term pricing11. These four
11) Blocher, E.J., Chen, K.H., Cokins, G., Lin, T.W. (2005), Cost Management
– A Strategic Emphasis, McGraw Hill – Irwin, New York.

166
methods enable a comprehensive analysis of product
through the whole product life cycle. Target costing emphasizes the r
product design in reducing costs in the manufacturing and d
of the product life cycle.12 Theory of constraints includes methods used
identify and to manage (or eliminate if possible) bottlenec
process in order to reduce manufacturing costs and to increase
income13. Life-cycle costing tracks and accumulates all costs
the each product through its whole life cycle14 enabling a complete
of product profitability through its life cycle. Thus, long-term pricin
life-cycle costing in long-term pricing decisions.15
In further chapters of this paper, target costing and life-cycle
costing will be analysed, because these two methods
used by manufacturing companies, especially the ones where
development, manufacturing speed and efficiency are important.
3.1. The Characteristics and Implementation of Target Costing
3.1.1. The Characteristics and Reasons of Target Costing
Application
Target costing is a specific approach developed
combines market and accounting information. Target costing can b
as the process of determining the maximum allowab
product and then developing a prototype that can be p
12) Ibid.
13) Horngren, C.T., Datar, S.M., Foster, G. (2003), Cost Accounting – AHorngren, C.T., Datar, S.M., Foster, G. (2003), Cost Accounting – A
Managerial Emphasis, Prentice Hall, New Jersey.
14) Ibid.
15) Blocher, E.J., Chen, K.H., Cokins, G., Lin, T.W. (2005), Cost Management
– A Strategic Emphasis, McGraw Hill – Irwin, New York.

167
maximum target cost feature16. This approach is developed du
large number of companies operates on such marketsi
influence on market price. Market price is determined on
companies which operate on that market must adjust their costs t
price. Therefore, in order to sustain desired level of profitabi
such business conditions can affect only on costs. So, c
one of the most important areas of management interest.T
method of identifying target cost of a product at anticipat
desired profit per product:17
Target cost = Anticipated market price – Desired profit
Target cost, determined on the anticipated market price
profit pre product, must be met in the long run. T
is driven by the requirements of the market place.18 In order to obtain
reduction to a target cost level, companies have two o19
1. By integrating new manufacturing technology, using a
management techniques such as activity-based costing and seeking
profitability.
2. By redesigning the product or service.
Target costing as a specific costing method is employed i
option.Design phase is the most important phase in a
because in the design phase the number and types of
16) Garrison, R.H., Noreen, E.W. (2000), Managerial Accounting, Irwin –
McGraw Hill.
17) Ibid.
18) Lucey, T. (1996), Management Accounting, Letts Educational, London.
19) Blocher, E.J., Chen, K.H., Cokins, G., Lin, T.W. (2005), Cost Management
– A Strategic Emphasis, McGraw Hill – Irwin, New York.

168
determined using cost and market considerations.20 Therefore, the majorit
product costs are determined in the design phase.Once a p
and gone into manufacturing process,it is very difficultto f
costs.21
3.1.2. The Implementation of Target Costing
The implementation of target costing involves five steps:22
1. Determine the market price (MP);
2. Determine the desired profit (DP);
3. Calculate the target cost (TC) at market p
(TC = MP – DP);
4. Use value engineering to identify ways to r
5. Use kaizen costing and operational control to f
For many companies market prices are usually determined on
the market by the influence of supply and demand.
environment, companies have a little influence on market p
all. Therefore, they must adjust to the market prices instead o
In order to make that adjustment, companies define the d
and determined the target cost on the basis of market p
Once the target cost is defined, companies are seeking w
to reduce actual costs to target costs. In the process of r
to target costs, companies conduct value engineering (in
product) or kaizen costing and operational control (in the c
products).
20) Ibid.
21) Garrison, R.H., Noreen, E.W. (2000), Managerial Accounting, Irwin –Garrison, R.H., Noreen, E.W. (2000), Managerial Accounting, Irwin –Garrison, R.H., Noreen, E.W. (2000), Managerial Accounting, Irwin –
McGraw Hill.
22) Blocher, E.J., Chen, K.H., Cokins, G., Lin, T.W. (2005), Cost Management
– A Strategic Emphasis, McGraw Hill – Irwin, New York.

169
Value engineering is used in target costing to reduce
by analyzing the trade-offs between different types o
(different types of product features) and total product cost23. The initial step
in value engineering is to conductconsumer analysisduring t
of the new or revised product in order to identify product f
preferred and desired by the consumers. Basically, value e
the most preferable product functions by its consumers a
reduce product costs but maintain the required level of p
is all done in the design phase of a product, w
can be changed. Therefore, in the design phase value
purpose to identify value-added and non-value-added costs. A
cost is a cost that, if eliminated, would reduce the a
or utility consumers obtain from using the product24. On the other hand,
value-added cost is a cost that, if eliminated, would n
perceived value or utility consumers obtain from using the p
that the consumer is unwilling to pay for25. In the value engineering
companies are trying to reduce both the value-added and
cost.
While value engineering is oriented to product cost reduction
during the design phase, kaizen costing and operational control are f
on product cost reduction during the manufacturing product
costing means continuous improvement in order to reduce cost
improve manufacturing processes and the quality of a
i.e. to improve productivity and eliminate waste26. If the majority
23) Ibid.
24) Horngren, C.T., Datar, S.M., Foster, G. (2003), Cost Accounting – A
Managerial Emphasis, Prentice Hall, New Jersey.
25) Ibid.
26) Horngren, C.T., Datar, S.M., Foster, G. (2003), Cost Accounting – AHorngren, C.T., Datar, S.M., Foster, G. (2003), Cost Accounting – AHorngren, C.T., Datar, S.M., Foster, G. (2003), Cost Accounting – A
Managerial Emphasis, Prentice Hall, New Jersey.

170
costs (approximately 85%) are locked in after the design phase,
the product costs can be changed during the manufacturing p
product phases. Kaizen costing is the ongoing search for new w
costs in the manufacturing process of a product
functionality.27 Cost reduction at the manufacturing phase c
with the development of new manufacturing methods and
of new management techniques such as operational control,
management and theory of constraints.28 Target costing and kaizen costing
are two complementary methods whose basic aim is to
cost by keeping the desired level of product quality
major difference between these two methods is the
the method is oriented; target costing is oriented on t
costing is focused primarily on manufacturing processes.
Target costing enable dynamic product profitability evaluation, s
it is oriented to the future. In the design phase, t
are defined. After the design phase, it is very difficultt
Kaizen costing can influence on approximately 15% of total
Target costing is the crucial method for product cost determination, b
determines the product costs for all subsequent product phases. T
represents the form of feed forwardcontrol29.
3.2. The Purpose and Application of Life-Cycle Costing
3.2.1. The Concept and Purpose of Life-Cycle Costing
While traditional costing methods are focused on manufac
and allocation of indirect manufacturing costs on products, l
considers all costs associate with the product during its l
of life-cycle costing is to identify the „real“costs of a
27) Blocher, E.J., Chen, K.H., Cokins, G., Lin, T.W. (2005), Cost Management
– A Strategic Emphasis, McGraw Hill – Irwin, New York.
28) Ibid.
29) Lucey, T. (1996), Management Accounting, Letts Educational, London.

171
the long term evaluation of product profitability. Therefore, l
creates a basis for dynamic product profitability evaluation.
Life-cycle costing identifies main activities associated with the
certain product and traces all costs associated with that products
performance of each activity. The helpful tool in determin
activity is Activity-Based Costing. The appliance of ABC i
has the purposeto connect each cost associated with the p
activity involved in product realization. Thereat, ABC
on indirect manufacturing costs, but on all costs, manufac
nonmanufacturing costs.
In today’s business environment, managers are more interested
in the total costs over the entire life cycle of a30, rather than only
in manufacturing product costs. Life-cycle costing provides
cost information regarding products that traditional costing
it considers all cost during the entire product life
information of life-cycle costing provides the qualitative b
decision making regarding product pricing, evaluati
formingthe product mix, eliminating the non-profit product etc.
3.2.2. The Application of Life-Cycle Costing in Evaluating
Product Profitability
Life-cycle costing provides the information of costs
during the each phase in the product life cycle. But, in o
product profitability, revenues are also must be traced over
cycle. So, when evaluating product profitability, two importa
different views of the product life cycle must be31 the cost li
cycle and sales life cycle. The cost life cycle gives informa
of a product during its life cycle. The sales life
regarding sales and revenues earned from selling the product o
30) Blocher, E.J., Chen, K.H., Cokins, G., Lin, T.W. (2005), Cost Management
– A Strategic Emphasis, McGraw Hill – Irwin, New York.
31) Ibid.

172
Therefore, the sales life cycle is the sequence of p
in the market from the introduction of the product to t
in sales and finally maturity, decline and withdrawal from t32. The
sales life cycle is focused only on market phases over the p
and thus recognizes the following phases:33 introduction, growth, matu
decline and withdrawal from the market.
Since the sales life cycle includes only market phases o
life cycle and cost life cycle all product phases, the product l
the viewpoint of cost life cycle and from the viewpoin
differedi.e. the product life cycle is longer from the viewpoin
cycle becauseit includes into consideration product phases prior t
phase.
The evaluation of product profitability
the market phases of the product life cycle, becausei
earns revenues. In all phases prior to the market phases,
only costs and therefore creates loss. But these costs, occurred
of research and development as well as in the d
by the revenues during the market phases of the product
very important to combine cost and sales life cycle o
determine the appropriate long term product pricing policy.
to cover all costs associated with the certain products.
and development costs and design costs occurred in the p
to the market phase should be covered by revenue
product during its market phases. Product profitability should be e
dynamically, during the whole product life cycle. Dynamical product
profitability evaluation enables the identification of the
of a certain product to the company’s income and
set up the appropriate price of a product in
corresponding costs need to be considered as well as
product market. Usual pricing policy in the appropriate product
shown in the following table.
32) Ibid.
33) Ibid.

173
Table 1. Pricing Policy According to the Sales Life C
Sales Life
Cycle Phase
Market
Situation
Costs of a
Product Pricing Policy
Introduction
Little
competition,
Sales increase
High costs (due
to R&D costs,
manufacturing
costs and
marketing costs
High price
(because of
demandand
differentiation)
Growth
Rapid sales
increase,
competition
increases
High costs
(due to
differentiation,
innovation and
performance)
High price
(because of
demandand
differentiation)
Maturity
Slower sales
increase,
competition
declines,
required
quality and
functionality of
a product
Cost control,
quality costs
occurs
Price falls
and is set by
a competitive
market
Decline
Sales decline,
competition
declines
Cost control,
cost reductionLow price
Source: Blocher, E.J., Chen, K.H., Cokins, G., Lin, T
Management – A Strategic Emphasis, McGraw Hill –
Strategic (long term) pricing policy changes over the
cycle. In the first phase, price is set at the relativel
recover high research and development costs as well as
of product differentiation and the new demand for34 In the
34) Blocher, E.J., Chen, K.H., Cokins, G., Lin, T.W. (2005), Cost Management
– A Strategic Emphasis, McGraw Hill – Irwin, New York.

174
second phase, price is still set at high level because
to increase income and profitability with the new product
market. In the third phase, price begins to fall and is s
In this phase company conducts cost control in order
level of profitability without jeopardising product quality.
fourth phase, price is set at the relatively low level.
is trying to extend product life. The key point for product s
reduction as well as the effective distribu
life cycle costing are used in the third and fourth p
reduction since the company has no longer influenc35
4. The Integration of Static and Dynamic Approach of Cost
Management
In order to obtain fair and objective evaluation o
both static and dynamic cost management approaches need t
Traditional cost accounting methods (such as job order c
costing) were developed in the time of industrial revoluti
desirable information by the managers was information
that time, the majority of total costs were direct manufac
the other costs (indirect manufacturing costs, sale and adminis
did not take the high portion in total costs. So, tradition
methods were, and still are, focused primarily on manufac
way that indirect manufacturing costs are allocated on
(cost object). Since indirect manufacturing costs were not
allocation of indirect manufacturing costs were based on certain c
base that links indirect manufacturing costs with manufacturing
(such as direct labour hours, machine hours etc.). But, business
environment have significantly changed due to the innovati
automation of production processes, globalization as well a
consumer’s preferences and desires. Today’s business conditio
35) Ibid.

175
and turbulent. Companies don’t have any or have a
on market prices and are permanently under pressure of
keepingthe desirable level of product quality in order to s
preferences. These new business conditions changed the m
information which led to the development and implementation o
methods. Traditional cost accounting methods can provide t
profitability evaluation i.e. they can provide the information r
of a product in a certain accounting period. This informat
managers in static business environment and for short-ter
But, in modern business environment, this information is i
to obtain cost optimization and maintain the desirable l
managers require information about total costs not only manufac
Traditional costing methods, which are focused on manufac
and determination of cost of a product, couldn’t
information in modern business environment. The first significa
costing systems was done by the implementation of A
Costing). Due to the automation of manufacturing processes, the cost
structure of manufacturing companies has dramatically changed
labour costs have significantly decreased36 or eliminated at all,
time the portion of indirect manufacturing costs have significantly i
The problem that occurred was the following: how
allocation of indirect manufacturing costs to products or s
came up with ABC method. ABC requiresthat indirect manufac
need to be allocated on activities in the manufac
from the activities to product on the basis of product c
activity.37 The allocation of costs from activities to
through the appropriate cost driver which linked the activity
product i.e. which indicated the product usage of certain
36) Lucey, T. (1996), Management Accounting, Letts Educational, London.
37)) Horngren, C.T., Datar, S.M., Foster, G. (2003), Cost Accounting – A
Managerial Emphasis, Prentice Hall, New Jersey.

176
method, indirect manufacturing costs are allocated to
through large number of cost drivers, not by one cost allocatio
traditional costing systems. That enabled the more reliable determin
product costs and brought back manager’s confidence in company
system. Evaluation of product profitability with the applianc
more accurate and reliable than with traditional costing methods
certain revolution in cost and managerial accounting (and i
of companies as well) and it was a link between
of cost management and product profitability evaluation.
The implementation of ABCwas a first step to modern cost
management and to dynamic evaluation of product
firstly focused on manufacturing process and had the purposeto p
objective allocation of indirect manufacturing costs to p
apply ABC at the level of the whole company, all r
the company should be determined and every cost that o
should be linked or allocated to certain activity (or activities
applying ABC to whole company is to identify the c
i.e. to identify which activities generate the high
activity costs is very useful for managers trying to reduce o
Tracing costs to activities enabled ABM (Activity Based Managem
to the information about the cost of a certain activity,
which activity should be maintained within the company and w
be outsourced. ABC i.e. ABM enables the implementation of m
methods such as Target costing and Life-Cycle Costing.
methods (cost management methods) are focused on
product or services, not only on manufacturing costs. Due
business conditions, managers are now interested in t
manufacturing and nonmanufacturing. Static product profitability evaluatio
obtained with traditional costing methods, can be relevant
decision making, not for long term. Managers require
product profitability through the whole product life, because
can evaluate which products have the greatest contribu

income. Static product profitability evaluation doesn’t provide
picture about the product’s contribution to company’s income
oriented to one specific accounting period (usually
side, dynamic product profitability evaluation considers
with product from research and development to withdrawal f
and all revenues product earns through its life,
clearer and more reliable picture of product profitability
company’s income. But, static and dynamic product
combined.
Figure 4. Static vs. Dynamic Cost Management Approac
Although static product profitability evaluation is focused on
manufacturing products, it can indicatethe phase of a p
a certain product is. Besides, static approach of
exist because of external financial reporting. Dynami
evaluation provide management with the information of product p
through its whole life enabling the useful basis for long t
177
Static Cost
Management
Approach
Job Order Costing
Process Costing
Activity Based
Costing
Static Product
Profitability
Evaluation
Dynamic Cost
Management
Approach
Activity Based
Costing / Activity
Based Management
Target Costing
Life Cycle Costing
Dynamic Product
Profitability
Evaluation

regarding the product prices, production quantity, product
methods used for dynamic product profitability evaluati
ABC which can be used for both, static and dynamic e
profitability. In static cost management approach, ABC is
determine the appropriate cost of a product. In
approach ABC (or ABM) is used in order to determin
activity within a company which afterwards can be used
as well as in life-cycle costing. Target costing determi
a product which includes the target material cost,
indirect manufacturing cost, target sale and distribution cost. Target i
manufacturing and nonmanufacturing costs can be determine
to activities and in such determination ABC/ABM has
comparison of actual activity cost (determined by ABC/A
activity cost indicatewhetherthe cost of activity is within the t
ABC/ABM can be used in life-cycle costing as well. S
considers all cost associated with products within the w
method requires the identification of all activities associat
through its life and tracing cost according to identified p
the product life. ABC is a useful tool for identification o
and for tracing costs associated with certain product activity. T
enables the more qualitative implementation of life-cycle costing.
Static and dynamic cost management approach is l
compatible. Dynamic product profitability evaluation can
if static product profitability evaluation is based on
methods. For the purposeof decision making process regardin
prices, product mix, eliminating the product line, managers must c
both, static and dynamic evaluation of product profitability. A
the company should have implemented and integrated static a
management approach.
Static cost management approach (represented by job o
process costing and ABC) is focused primarily on manufac
costing as one method of dynamic cost management
178

primarily on design, because in this activity the
determined and therefore locked in38. Life cycle costing combined with
ABM is focused on all activities associated with a p
5. Conclusion
This paper is dealing with static and dynamic cost
approaches and their impact on product profitability evaluati
management approach is based on traditional cost account
and ABC whose focus was on manufacturing costs and ways
manufacturing costs allocation to products or services.
of traditional cost accounting methods is the determi
product and evaluation of product profitability. When business
and environment have changed due to automation, innovati
globalization and changesin consumer’s preferences which led t
of indirect manufacturing costs, traditional cost accounting methods
inappropriate for product cost determination and therefore for product
profitability evaluation. In order to achieve more reliable
ABC is introduced. ABC traces indirect manufacturing costs to a
then allocates these costs from activities to products a
cost drivers. ABC method accomplished its purposeof reliable product c
determination. Afterwards this method is used for determi
costs within the whole company, which enables the implem
dynamic cost management approach. Dynamic cost managem
represented by target costing and life cycle costing. Target costing d
the target cost of a product based on anticipated
costing is focused on all costs associated with a
product life.
In order to obtain the qualitative evaluation of
both, static and dynamic evaluation of product profitability should be
38) Horngren, C.T., Datar, S.M., Foster, G. (2003), Cost Accounting – A
Managerial Emphasis, Prentice Hall, New Jersey.
179

considered. Dynamic evaluation of product profitability
associated with certain product, manufacturing and nonmanufacturin
evaluation of product profitability considers only manufac
modern business environment, managers are interested in
product (manufacturing and nonmanufacturing costs). Dynamic evaluati
of product profitability enables the identification of
greatest contribution to company’s income.Managers require informat
product costs and revenues through the whole product life. Therefor
determine the real product profitability. Although static evaluatio
profitability refers to the particular accounting period, it
to determine the phase in which a certain product
regarding product profitability evaluation can be achieve only b
of static and dynamic cost management approach i.e. b
and dynamic evaluation of product profitability.
References
• Blocher, E.J., Chen, K.H., Cokins, G., Lin, T.W
Management – A Strategic Emphasis, McGraw Hill – Irwin
York.
• Engler C. (1988), Managerial Accounting, Irwin, Homewood,
Illinois.
• Garrison, R.H., Noreen, E.W. (2000), Managerial Accoun
Irwin – McGraw Hill.
• Horngren C.T., Datar S.M., Foster G. (2003), Cost Accoun
A Managerial Emphasis, Prentice Hall, New Jersey.
• Lucey T., (1996a), Costing, DP Publications, Lond
• Lucey, T. (1996b), Management Accounting, Letts Educ
London.
• Weygandt, J.J., Kieso, D.E., Kimmel, P.D. (2005), Man
Accounting, John Wiley & Sons, USA.
180