Analysis of Cost Management System Maturity in Different Organisations

This report examines the maturity of cost management systems within organizations, analyzing the adoption and effectiveness of various techniques. It explores the different levels of maturity, from measurement to optimization, and considers the scale of operation. The report discusses both traditional and modern costing methods, including standard costing, absorption costing, activity-based costing (ABC), target costing, and lifecycle costing. It highlights the significance of ABC and Activity Based Management (ABM) in today's competitive business environment, particularly for customer profitability analysis and strategic cost management. The study also delves into the strategic implications of cost management, including cost leadership and differentiation strategies. Furthermore, it introduces the SMILE pattern (See, Measure, Improve, Learn, Evolve) for assessing maturity and emphasizes the importance of operationalization and technology integration in cost management. The report concludes by discussing Activity Based Planning (ABP) and its two parts: Activity Based Resource Planning and Activity Based Financial Planning.

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Practice Note
Maturity of Cost
Management Systems in
Organisations
Rajendra Patil*
Anil Kshatriya**
Abstract
Cost accounting is generally viewed as a
manufacturing industry specific function.
The service industry gives lesser
emphasis on the adoption of mature cost
management systems. Business
managers across industries tend to
assume that since the price is decided by
the market, there is little need for investing
time and resources in creating and
maintaining elaborate costing systems.
Irrespective of whether there is a statutory
requirement for statutory reporting of costs
(as in the case of India, Pakistan and
Bangladesh), very few organisations
undertake the study of maturity of their
prevailing cost management systems.
This study shows that Activity Based
Costing (ABC) and Activity Based
Management (ABM) are of greater
significance for organisations who aspire
to remain relevant and profitable in today’s
hyper competitive business environment.
Keywords
Activity Based Costing (ABC)
Activity Based Management (ABM)
Activity Based Planning (ABP)
Cost Management
Enterprise Performance Management
(EPM)
* ADI Strategies, India
**Institute of Management Technology, India
Introduction
There are various modern techniques that are
available in cost management, some of these
are customer profitability analysis, activity
based costing, strategic cost management,
target costing, lifecycle costing etc. For each
of these techniques, the level of maturity can
be very different within and across
organisations. The levels could be just
measuring, managing or optimising the use
over time. At each of this level the use of the
technique could be ‘one off’, process centric or
systematically adopted across the organisation.
Therefore, in trying to gauge the maturity of
cost management within an organisation, at
least across three different dimensions must be
recognised: (a) type of technique used (b) level
of maturity in the use of technique and (c)
scale of operation. The level of maturity would
be different in different organisations and
across different dimensions.
Type of Technique Used
There are various techniques that are available
for cost management (see Sharma and
Ratnatunga, 1997). Some are traditional
techniques like Standard Costing and
Absorption Costing which aim at calculating
the product costs and variances. While there
are modern techniques like Activity Based
Costing, Target Costing, Lifecycle Costing
which aim at strategic cost management. In the
manufacturing industry, the fundamental use
of costing is for inventory valuation.
For this, generally, the absorption costing
method is used, where the expenses booked in
the period are charged to the products as
manufacturing or administrative or sales
overheads. The method to charge the
overheads to the products is based on volume
drivers. In service industry on the other hand
there is no statutory requirement for inventory
valuation. Most of the time, the same
information is used in product profitability and
in business decision making. The lack of
sound costing practices therefore leads to
incorrect decisions making.
Activity based costing is used to calculate the
product cost for customer profitability
analysis. Here the cost of the cost objects is
calculated by calculating the cost of the

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activities first. The cause and effect
relationship is used. The cost objects consume
the activities and activities consume resources.
Based on this relationship the cost flows to
cost objects. This is a better way to arrive at
product and customer profitability.
Target costing is used by organisation when
developing a new product. Before doing this a
market survey is conducted to understand the
features that are desired by the target customer
segment and the price that they are ready to
pay. A study of competitors’ product features
and the corresponding prices are also done.
Based on this information the features of the
new product are defined. A target price is
decided with an expected profit. The cost is
the resultant factor. Target Price – Target
Profit = Target Cost. Once this is done, a
cross-functional team is formed to work on the
design of the product, material, processing,
marketing etc. Vendors are involved in this
process. With the help of this team the
organisation tries to achieve the target cost.
In Lifecycle costing, the organisation looks at
the costs of the product throughout the life of
the product from design, R&D, introduction,
enhancements to the phasing out of the
product. This helps the organisation to plan the
costs as well the price at various stages of the
lifecycle of the product. A company can plan
the overall profitability of the product and
manage the costs accordingly. The similar
concept is now being introduced for customers
also and called as Customer Lifecycle Value
(CLV).
Strategic Cost Management relates the
management of the costs based upon the
strategic direction of the organisation. It is the
management of the costs according to the
strategy of the organisation. This is similar to a
cost benefit ratio. Typically, it uses the
Porter’s concept of competitive strategy where
there are two ways of competing namely (a)
Cost Leadership (b) Differentiation.
In case of Cost Leadership, the organisation
has to manage the costs in such a way that
costs are at a minimum level without
compromising the value to the customer. For
this one can use cost driver analysis, waste
elimination etc. Activity based costing can
help the organisation to understand the non-
value adding consumption of resources. In
case of differentiation, the organisation looks
at capturing the market, beating competition
and making money by having a differentiation
in product features, customer services etc.
For this the Lifecycle costing concept, can be
useful, as it will help the organisation to make
money on overall life of the product and
pricing can be defined at various levels of the
life-stage of the product. Activity Based
Costing can help here to understand the future
resource requirement and costs. Another way
of defining strategy is by ‘target customer
segment’ management. In this, the
organisation defines its target customer
segment and tries to capture, retain and benefit
from the customer segment. In this case the
target costing can help the organisation to
manage the product costs.
Level of Maturity in the Use of
Technique
The maturity level can be classified in terms of
measurement, management and optimisation.
The level measurement is where the
organisation is collecting the data. For
example, in product costing, the organisation
is just calculating the cost of the product for
inventory valuation purposes. No other use of
the information is made. Here the typical
argument made is “the price is defined by the
market and we cannot do anything about it”.
Here the view is that an organisation can
neither manage the price nor the costs (which
at least is in their hands).
Some organisations do calculate the costs and
start managing those costs. For example, they
have budgets at expense level; they have
standard costs for products. They compare the
actual expense and product costs with the
standard periodically find the variance, the
reasons for the variance and take action plan to
improve upon the ‘unfavourable’ variances.
Executives who take the time to examine the
cost structure throughout their business and
embed cost discipline within their
organisation's culture will see gains that can be
sustained over the long term.
To do this, organisations need to look at costs
across whole processes, not just within
functions. Ultimately, this means rethinking

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the entire business model around lower costs,
possibly taking out whole layers of the
organisation or supply chain, examining
customer interfaces, and considering
outsourcing, shared services, and off shoring.
The focus should be on creating a leaner, more
efficient organisation, with cost reduction as
the consequence, not necessarily the target.
The other way of looking at maturity level is
the ‘SMILE’ pattern. S – see M – measure I –
improve L – Learn E – Evolve.
Operationalisation
The third dimension that that was mentioned
earlier was the operationalisation of the use of
the technique. In here one must first have to
look at how frequently the techniques are used.
Sometimes techniques are used once in
lifetime, may be due to the influence by
someone at the top and then it ends there. The
word ‘used’ here means used in taking
business decisions including defining and
managing strategy. Often, various variance
reports are generated, but nobody looks at
them seriously.
In some cases, the information generated is
very useful, but it is given the status of
‘confidential’ and kept in the hands of few
people. What is meant by real
operationalisation is a technique that is used
regularly for creating information, used for
taking business decisions and used to provide
information to the people who are going to
take those decisions. In the current scenario,
the operationalisation can also be looked from
the angle of ‘use of technology’ for the cost
management techniques.
Spreadsheets are the minimum that people use
and they know it is not the best of the ways
always. There are various standalone software
solutions are available in the market and use of
those does help the organisation to make most
of the techniques. Going further, the results of
cost management techniques can be integrated
with other cost techniques or overall
performance management methodologies.
The maturity of the organisations can then be
plotted as shown in Figure 1.
Figure 1: Maturity of Cost Systems in
Organisations
Breadth of Techniques
A B
C
D
E
Maturity Level
The horizontal axis plots breadth of techniques
that the organisation is using. The vertical axis
plots overall maturity of various techniques.
The diameter of the circle shows the level of
overall operationalisation in the organisation.
What is meant by ‘overall’ is the combined
effect for all the techniques that are used.
Organisation ‘A’ is using only one technique
and at a very low level i.e. measurement and it
is still not operationalised. Organisation ‘B’ is
using many techniques but its overall maturity
of use is low but they have achieved some
progress in operationalisation. Organisation
‘C’ is using couple of techniques only but
achieved best of the overall maturity and
operationalisation. Organisation ‘D’ is using
few techniques with middle level of maturity
and operationalisation. Organisation ‘E’ is
using most of the techniques at a very high
maturity level but not operationalised it.
Companies can conduct such a study to
understand the cost maturity of the
organisation, industry, geography and help the
organisations to see which type of technique at
what level of maturity and operationalisation.
Activity Based Planning (ABP)
Activity Based Costing (ABC) is a cost
allocation model that links the activities that
resources perform to cost objects such as
products, services, customers and
organisational processors via cost drivers
(Kaplan and Cooper, 1998; Ratnatunga, Tse
and Balachandran, 2012). ABC has three

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major uses for a company adopting it as
system of costing. These benefits are as
follows; (1) To measure and understand
product, customer and channel profitability,
(2) To measure and understand cost of
processes by identifying cost drivers and (3)
To perform Activity Based Planning (ABP).
Several companies have streamlined the first
two uses of ABC. But Activity Based Planning
is not fully explored by companies using ABC.
Activity Based Planning can be divided into
two parts namely ;(a) Activity Based Resource
Planning and (b) Activity Based Financial
Planning.
Figure 2: Activity Based Planning
Start Strategic Plan
Demand
Forecast
Activities
Products & Services
Resource
Qty
Qty
Qty
Matches
Capacity?
Activity Based Resource Planning
Activity Based Resource Planning helps to
understand the requirement of resources based
on the forecast done. In Activity Based
Financial Planning, resources as well as costs
and revenues are included to understand the
complete profitability for the future period.
The various steps in this process will now be
discussed (Figure 2). The prerequisite for
creating the ABP model is that the
organisation should have a running ABC
model.
Once the strategic plan has been finalised for
the organisation (which may state what kind of
products to be provided to which customer
segments via which channels in the various
geographies), it will help the sales function to
convert it into the demand. This forecast will
be used as the starting point for creating the
ABP model. The cost objects as products,
customer and channel combination will have
the quantities from the sales forecast. These
quantities will in turn back-calculate the
volume of various activities to be performed to
fulfil the requirement of various customers.
The relation between the products, customer
and channels and the activities is used from the
ABC model in the organisation. In the same
manner, the resource requirements are
calculated from the activity volume. These
resource requirements generally consider the
volume of various skills required. For
example, 1200 hours of machining, 3000 hours
of sales executive time etc. One must compare
these resource requirements with the available
resources and see if it the plan can be carried
out, or if adjustments are required.
Figure 3: Activity Based Resource Planning
(Part 1)
Start Strategic Plan
Demand
Forecast
Activities
Products & Services
Resource
Qty
Qty
Qty
Matches
Capacity?
Capacity
Adjustments
Demand
Adjustments
Consumption
Rate
Adjustments
Adjust Operational
Data

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If the resource requirement does not match
with the availability of the resources, then a
need arises to perform some operational
adjustments. These could be of multiple types
(Figure 3).
Capacity Adjustments: If the required
resources are more than the available then an
organisation may hire more or transfer skills
from other functions where there is excess
capacity and the cross-functional transfer is
possible. If the available resources are more
than those required, then one has to see if there
is scarcity in other functions and if the
resources can be transferred there. One has to
also consider the seasonality of the business,
before taking any drastic steps with respect to
the excess resources.
Consumption Rate Adjustments: This is
nothing but the driver quantities as in ABC. In
simple terms, how much time is taken for
various activities or how many times an
activity is performed to provide a service to a
customer. With respect to time taken by
activities, internal benchmarking is very
useful.
A company can compare the timing in other
plants, branches, location etc. It can also look
at the ‘non-value adding’ activities and try to
eliminate them. Sometimes few of the
customers are making a organisation perform
certain activities or their recurrence which is
not adding any value to it. In that case a
discussion with the customer to make them
understand this situation is useful. It is also
seen that a ‘menu based’ pricing method can
be adopted. The company has to understand
that even if the customer is ready to pay for the
activities, a company may face the resource
crunch; until it gets paid by the customer.
Demand Adjustments: Once both the above-
mentioned adjustments are done then an
organisation can consider adjusting the
demand. This could by taking certain strategic
actions to either increase or decrease the
demand for its products or services. Increasing
the demand means getting more market share
or creating more market segments (by adding
customers, regions or products).
This has to be seen in conjunction with
competition. Reduction of demand because of
scarcity of the resources also has to be seen in
multiple ways. It may be that the demand in
the market is temporary. If it is a sustaining
requirement then investment in the machinery,
people etc. can be considered.
Companies have to also consider various other
strategic possibilities and a SWOT analysis
should be performed. Also, it is not the case
that the adjustments have to be done in this
sequence only. Practically it would be various
steps with a combination of adjustments
(Figure 4).
Figure 4: Activity Based Resource Planning
(Part 2)
Start Strategic Plan
Demand
Forecast
Activities
Products & Services
Resource
Qty
Qty
Qty
Amount
Amount
Amount
Predicted
Profitability
Met
Target?
Once the operational adjustments are
competed, one starts by entering the financial
information like the rates for products or total
revenue and the costs of the resources.
Once this information is entered one will get
the predicted profitability of the organisation.
This is a combination of product and customer
profitability. The value calculated is the result
of the strategic initiatives being put into action.
A company may find that the best of the
strategies at any point in time may not be
giving it the best of the returns.
If the target for the profitability is not
achieved, then financial adjustments can be
undertaken, like reducing the resource costs or
increasing the price (Figure 5). Both of these

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could be very difficult to achieve. A practical
combination of these two adjustments has to
be performed.
Figure 5: Activity Based Resource Planning
with Price Adjustments
Start Strategic Plan
Demand
Forecast
Activities
Products & Services
Resource
Qty
Qty
Qty Amount
Amount
Amount
Predicted
Profitability
Met
Target?
Resource
Cost
Adjustments
Price
Adjustments
Adjust Financial
Data
Figure 6: Activity Based Capacity Planning
Start Strategic Plan
Demand
Forecast
Activities
Products & Services
Resource
Qty
Qty
Qty Amount
Amount
Amount
Predicted
Profitabilit
y
Met
Target?
Resource
Cost
Adjustments
Price
Adjustments
Adjust Financial
Data
Adjust Operational data
Matches
Capacity?
Finalize Plan Execute
This is an iterative process of adjustments
(Figure 6). The various steps of adjustments or
combination of the same can be saves as
scenarios. The final accepted model is used as
the planned model and the actual results are
compared.
In the usual financial budget, the comparison
of the actual expenses against the plan is
undertaken, GL account by account. With this
comparison, the manager is provided with
information of favourable or unfavourable
variance. With this information, the manager
can be happy or unhappy with the result; but
still not have a deeper understanding as to he
has utilised the resources of the company. The
comparison of the ABP model with ABC
model gives the variance of price, cost as well
as resource utilisation, activity variance etc.
This helps the organisation to revisit the
strategic initiative to reach to the expected
returns from the business.
Enterprise Performance
Management (EPM)
Nowadays one hears the term Enterprise
Performance Management (EPM) in different
ways. Sometimes it is also used
interchangeably with the individual
performance and organisational performance.
There are also various definitions for EPM.
Cokins (2001), states that performance
management is the process of managing the
execution of an organisation’s strategy. It
integrates the business improvement
methodologies with technology. It is neither
the methodology only, nor the technology only
in isolation. Activity Based Management
(ABM) is the way to manage a business by
managing the activities to provide improved
value to the customer or organisational
performance. EPM starts with the definition of
the objectives and strategy of the organisation.
Defining the objectives and strategy for an
organisation, preparing business plan
according to the strategy and then measuring
the performance and analysing the variances
with reasons to modify the internal processes
or strategy is a cyclic process. ABM fits into
the ‘measure and analyse’ part of the cycle.
Here, the ABM model is based on the business
plan, and can provide the information on the
resource requirement in the future as well
measure the actual performance. Once a
company analyses the actual performance
against the planned one; the results can be
further analysed using various techniques like
root cause analysis, continuous improvement
etc. The analysis will tell whether a company
has to manage the processes to improve the
customer value or organisational performance.
The performance management is also seen as

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the operational performance management or
strategic performance management, as was
mentioned in the earlier.
Operational Performance Management is
looking at the processes to improve
organisational performance and Strategic
Performance Management is looking at the
processes to improve the value to the
customer. The ABM model can be designed to
manage the performance at both the levels. It
can also be used for some tactical purposes as
managing a customer segment or a product
group etc.
In typical strategic management methodology,
a strategy map is created, the corresponding
action plans and Key Performance Indicators
(KPIs) are then developed. Based on the
strategic plan the budgeting and planning
solution can create the business plan. It can
also use Activity Based Management (ABM)
to create a driver based planning. ABM can
also provide the actual values for various KPIs
defined.
Activity analysis using the cost drivers and
performance measures can provide
information the performance of the
organisation vis-à-vis the planned one. ABM
fits into Enterprise Performance Management
(EPM) conceptually as well as technologically
and helps the organisation to manage the
performance at the strategic level as well as
operational level (including the tactical one).
Using ABC in a Profitable Company
Should an organisation use Activity Based
Costing (ABC) when it is already making
profits?It is a common notion that an
organisation should seriously look at the costs
when it is in serious trouble. This trouble
could be that they are making losses or a
competitor has come with a similar product
with lower price or a possibility of losing an
order because of pricing. Cost is also seen as
something that has to be reduced in any case.
Generally, because of this view, it appears that
an organisation is serious about understanding
costs only when it seems to be making losses.
The management accountants have been
trained professionally to take each and every
unit of expense to the product. This is not true
with any kind of business. There are some
costs that caused by the products/services,
some are caused by customers, some are
caused by running the business and not related
to any product or customer are some caused by
the installed capacity. A company should be
able to segregate costs according these causes
and relate them to the profit/loss the
organisation is making.
ABC is based on the concept of ‘cause-and-
effect’; hence it separates the costs that related
product, customer, business and unutilised
capacity. Even within the product and
customer related costs, they are apportioned
based on the consumption. With this
calculation the organisation can understand the
costs related to the products, customers,
channels etc. and take proper decisions based
on the information. To explain this, let us see
Figure 7.
The horizontal dotted line in the diagram
represents the cost of products according to the
traditional way of costing and the ‘S’ curves
represents the cost of products using ABC. It
is generally seen that few products are grossly
‘overcosted’ and more than that products are
grossly ‘undercosted’. The products that are
overcosted have more cost up to 50% and the
products that are undercosted have costs less
up to 500%.
Figure 7: Relationship Between Cost of
Products with Traditional Costing and ABC
Under-costed
500%
Grossly
Over-costed
Highest volume
Low complexity
Simple / Problem
free
0% 0%
50% Low volume
Diverse and Complex
Specialty /Niche
Source: Turney (2005)
The primary reason for this incorrect cost
calculation is that generally the overheads
are taken based on the volume produced.
The complexity of product is not

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considered. It is seen that the change in the
overheads of the organisation is related to
the additional complexity of the business.
This complexity could be added due to
more products, more customers, more
channels etc. It can also be introduced due
to the complexity of the product features.
This is complexity is generalised in the
traditional costing and the same is
converted into a logic for apportioning the
overheads in ABC.
It is generally seen after the ABC
modelling that the organisation is almost
shocked after looking at the results. This is
due to the fact that the products those were
‘dear ones’ earlier start looking loss
making and vice-a-versa. Figure 8 shows
another diagram, which is called with
different names like profit cliff, whale
diagram, profit umbrella etc. This diagram
depicts the products or customers on the
horizontal axis and the cumulative profit
percentage on the vertical axis. This
diagram can be plotted for products as well
as customers.
Figure 8: Relationship Between
Products and Profits.
Source: Cokins (2004)
In Figure 8, the horizontal axis represents
the products and the vertical axis
represents the cumulative profit in USD
millions. The current profit shown in the
financial records is $2 million. When
analysing the diagram, one can see that the
same $ 2 million is achieved by first 13%
of the products; i.e. from the products that
are making most of the profits, the top
13% gives a company the current profit of
$ 2million. The story does not end there.
The top 65% of the product by profitability
provide the organisation a profit of $ 8
million (400% of current $ 2 million).
Then there are some products are neither
profit making nor loss making. And almost
15% of the products which are actually
making loss, bring the profits from $ 8
million back $ 2 million. Therefore,
apparently the organisation is making a
profit of $ 2 million. It might be satisfied
with that profit, but then it is not realising
that the potential of the organisation is $ 8
million and not merely $ 2 million. With
the use of ABC, plotting this graph the
organisation can realise its full operational
potential. It can also understand the loss in
profit it is subject to. It will also
understand which products are bringing
the profit and which are eating into profit.
A similar diagram for customer
profitability shows which customers are
profitable and which are taking away the
profits. This is where Activity Based
Costing ends and Activity Based
Management (ABM) starts. In ABM the
organisation looks at the costs analyses
them and takes appropriate actions. For
doing so, organisation can use various
techniques like root cause analysis,
benchmarking, cost driver analysis etc. to
understand the reason behind the profits or
losses.
Therefore, managers not only understand
‘what’ leads to higher profit or loss but can
also know why that happens. Based on this
information organisation can take series of
actions in order to optimise the profits by
selling its best products to the best
customers. It can also decide to give
greater emphasis on loss making products
and customers to drive change in
organisational results.

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Conclusion
Maturity of cost systems in an organisation
can have significant impact on short-term
and long-term business planning.
Inaccurate cost information leads to
incorrect decisions. Also there is a strong
bias among business managers in service
industry to perform an in-depth cost
analysis before arriving at critical
decisions. This phenomenon therefore
impacts operational controls in business
processes.
Even within the manufacturing industry,
several large companies have not fully
adopted ABC and ABM. With increasing
sophistication in enterprise management
systems, companies have not invested
proportional amount of resources to
measure, manage and control costs. Lack
of awareness, high cost of implementation,
low motivation and difficulty of timely
updating cost driver data are some of the
factors behind non-adoption of ABC and
ABM practices. There remains huge
opportunity for professional accountants in
discussing, debating and leading in this
area for an impactful contribution in
business process excellence.
References
Cokins, G. (2001). Activity-Based Cost
Management: An Executive's Guide, Wiley,
Hoboken, New Jersey, USA.
Cokins, G. (2004). How to Measure and
Manage Customer Value and Customer
Profitability, SAS White Paper, Cary, NC,
USA.
Turney, P. (2005), Common Cents (2nd
Edition), McGraw-Hill, New York, USA.
Kaplan, R. S. and Cooper, R. (1998). Cost and
Effect: Using Integrated Cost Systems to Drive
Profitability and Performance, Harvard
Business School Press, Boston, USA.
Ratnatunga, J. Tse, M.S.C. and Balachandran,
K.R(2012). Cost management in Sri Lanka: A
case study on volume, activity and time as cost
drivers, International Journal of Accounting,
47(3): 281-301.
Sharma, R. and Ratnatunga, J. (1997).
Traditional and activity based costing systems,
Accounting Education, 6(4): 337-345.

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