ACCA Applied Knowledge · Management Accounting

Cost reductions and value enhancement: formula sheet

Full chapter guide

Key formulas

Cost control: Variance = Standard (or budget) cost − Actual cost; Used to spot deviations from a set standard. A positive result is favourable when it compares costs. Action is aimed at returning to the standard.
Cost reduction: Cost saving per unit = Old unit cost − New unit cost; Only a true reduction if quality and fitness for purpose are maintained. The standard cost is then revised.
Target cost gap: Cost gap = Current expected cost − Target cost; Target cost = Target selling price − Target profit. The gap is the amount cost reduction must achieve.
Value (concept): Value = Function (benefit to customer) ÷ Cost; A conceptual ratio, not a number you calculate. Value rises if function is kept and cost falls, or if function rises at the same cost.
Target cost gap: Cost gap = Estimated cost − Target cost; Value engineering aims to close this gap before production. Target cost = target selling price − required profit margin.
Saving from a change: Saving per unit = Old cost per unit − New cost per unit; total saving = saving per unit × units; Use this to test whether a proposed change is worthwhile. Include any extra costs the change creates.
Timing rule: Value engineering = before production (design stage); value analysis = existing product; This is the usual exam distinction between the two.
Economy: Economy = actual cost of inputs compared with planned or benchmark cost of inputs; Spending less for the same quality. Example: a lower price per kg of material of the same grade.
Efficiency: Efficiency = output ÷ input; Compare with a standard or earlier period. Example: units per labour hour or cost per unit of output.
Effectiveness: Effectiveness = actual outcome achieved compared with the objective or target; Example: percentage of patients treated within the target waiting time.
Value for money: VFM = economy + efficiency + effectiveness (all three together); Not a numeric formula. Good VFM needs all three, not just one.
Target cost: Target cost = Target selling price − Target profit; If profit is given as a margin on selling price, target profit = price × margin %. If it is a mark-up on cost, work from cost instead: cost = price ÷ (1 + mark-up).
Cost gap: Cost gap = Estimated cost − Target cost; A positive gap means the product is too expensive and savings are needed. Zero or negative means the target is met.
Kaizen cost target: New target cost = Previous cost × (1 − reduction %); Applied each period. Reductions compound, so two 2% cuts are not a 4% cut.
Target costing vs kaizen: Target costing: design stage. Kaizen: production stage.; Learn this contrast, as it is the most common exam point.

Quick revision

Cost control keeps costs within a set standard or budget.
Cost reduction lowers unit costs permanently without harming quality or suitability for the purpose.
Value analysis reviews an existing product to remove cost that adds no value.
Value engineering does the same at the design stage, before production.
Both techniques aim to keep or improve the product's function while lowering cost.
Target cost = target selling price − required profit.
Cost gap = estimated cost − target cost. A positive gap means cost must come down.
Target costing starts with the market price, not with the cost of production.
Kaizen means small, continuous improvements made by all employees.
Value for money combines economy, efficiency and effectiveness.
Economy is spending less, efficiency is getting more output per input, and effectiveness is achieving the objectives.

Common mistakes

Treating the two terms as the same thing. Fix: Control keeps costs at the standard. Reduction lowers the standard. Write that one line at the start of your notes.
Calling any cost cut a cost reduction. Fix: A true cost reduction keeps fitness for purpose. Cheaper materials that make the product worse are a cut that may harm sales.
Treating value engineering as plain cost cutting. Fix: Remember that function and quality must be kept. Any option that harms what the customer needs is not value engineering.
Swapping the definitions of value analysis and value engineering. Fix: Link engineering with design (before production) and analysis with reviewing what exists. Use the timing test.
Treating economy and efficiency as the same thing. Fix: Economy is the price of inputs. Efficiency is the output you get from inputs. Look for a ratio of output to input.
Calling a cost cut effective. Fix: Effectiveness means meeting objectives. A cost cut with no link to the objective is economy or efficiency.
Adding profit to cost to get the price. Fix: In target costing the price comes first. Always compute price − profit.
Treating a mark-up on cost as a margin on price. Fix: Read the wording. Margin is on selling price. Mark-up is on cost, so divide price by (1 + mark-up).

Exam tips

Watch the key verbs. Words like monitor, compare with standard and take corrective action point to control. Words like redesign, eliminate and lower the standard point to reduction.
Always check the quality condition when an option mentions cheaper inputs.
In number entry questions, work out target cost first, then the gap. Enter the figure in the unit asked for, per unit or in total.
In multiple response questions, read how many answers to select and rank each option as control or reduction before choosing.
Link the topic to target costing, value analysis and kaizen, since these are the usual reduction examples.
Decide first whether the product exists yet. This answers most definition questions.
Check every option for the phrase function or quality being kept. Options that reduce quality are usually wrong.
In number questions, include extra costs from the change, then scale to the volume asked.