Cost control and cost reduction are two terms that are sometimes used interchangeably; however, they have different meanings. These two represent an integral part in cost accounting, gaining constant attention of management. The key difference between cost control and cost reduction is that cost control is the process of maintaining costs at estimated levels while cost reduction aims to lower unit cost of production without compromising on the quality.
CONTENTS
1. Overview and Key Difference
2. What is Cost Control
3. What is Cost Reduction
4. Side by Side Comparison – Cost Control and Cost Reduction
5. Summary
What is Cost Control?
Cost control is a practice of identifying costs and managing them. This starts with the budgeting exercise at the beginning of the year where costs and revenues are estimated for the coming year. During the year, these will be recorded and results will be compared at the end of the year. Thus cost control is closely related to aspects such as budgeting, comparing budgeted results with actual results and variance analysis.
Cost control is an important outcome of these processes since the incurred costs over the accounting period should be compared against expected results and the variations should be identified in order to take future decisions. Therefore, cost control is an important decision taken by the management. Cost control is primarily concerned with costs that exceed the expected costs. Such situations cause adverse variances and these will be taken into the attention of managers by the cost accountant, so that the managers can make necessary decisions to implement corrective actions.
Cost control does not solely mean cost reduction; maintaining the costs at the prevailing level is also an important part of cost control. Cost control should pay equal attention to both favorable and adverse variances. For instance, if a particular cost has an exceptionally high favorable variance, this means that the targeted cost during budgeting is too high. In such situations, the budget should be revised, even though no action should be taken regarding the incurred cost.
What is Cost Reduction?
This is a process aimed at reducing the cost per unit of production without compromising on the quality. Higher costs reduce profits; therefore, regular evaluations of costs should take place to minimize its negative impact.
E.g. ABC is a car manufacturing company that purchases many components from a number of suppliers, including a single supplier of tyres. At the beginning of the year, ABC budgeted to purchase 2,500 tyres at $750 per tyre for the year. However, half way through the year the supplier increased the price of a tyre to $1,250. ABC purchased 1,800 tyres following this increase in price. Therefore, the resulting variance will be,
Expected total cost for 2,500 tyres = $ 1,875,000
Actual cost for 25,500 tyres (700* $750) + (1,800* $1,250) =$ 2,775,000
Variance = ($ 900,000)
Management can take the following actions to ensure that the variance is minimized for the next year by,
- Negotiations with the supplier to reduce the price
- Terminate business with the supplier and acquire a new supplier who sells tyres at a lower price
In this type of a situation, management must be very careful and not be tempted to make decisions solely based on financial indicators, but also consider qualitative factors. In the above example, ABC Company may be a well-reputed world class car manufacturer and had been purchasing tyres solely from the said supplier for a number of years for the proven quality. A similar real-life company example is Toyota purchasing tyres for their automobiles from Goodyear. If the supplier produces a quality product compared to other suppliers and has the capacity to cater to all the needs of the company, it will not be a wise decision to terminate a business relationship based on an increase in price. Thus, is it essential to carry out both cost control and cost reduction after a detail consideration of their effects on costs.
Image 1: Cost Reduction is an important business construct
What is the difference between Cost Control and Cost Reduction?
Cost Control vs Cost Reduction |
|
| Cost control is the system of maintaining costs at estimated levels. | Cost reduction aims to lower unit cost of production without negatively affecting the quality. |
| Cost Focus | |
| Cost control is implemented for the total cost. | Cost reduction is focused on unit cost. |
| Type of Measure | |
| Cost control is a preventive measure. | Cost reduction is a corrective measure. |
| Oucome | |
| Outcome of cost control may be cost reduction or amending a previously set standard. | Outcome of cost reduction is lower costs. |
Summary – Cost Control vs Cost Reduction
The main difference between cost control and cost reduction depends on whether costs are maintained at a particular level or lowered with the intention of achieving higher profits. Both these exercises should be carried out after considering its impact on quality and the market conditions. Cost reduction can also challenge pre-set standards; however, excessive cost focus may be detrimental at many organizational levels and lead to dissatisfaction among customers, employees, and suppliers.
Reference:
1. “Difference between Cost Control and Cost Reduction.” Learn Accounting: Notes, Procedures, Problems and Solutions. N.p., 18 June 2016. Web. 15 Mar. 2017.
2. “Cost Control.” Investopedia. N.p., 04 Sept. 2015. Web. 15 Mar. 2017.
3. “Toyota Chooses Goodyear Wrangler Tires Exclusively for 2016 Tacoma TRD Off-Road Grade.” Goodyear Corporate. N.p., n.d. Web. 15 Mar. 2017.
Image Courtesy:
1. “How to Survive and Thrive in the Recession with Web 2.0” by Dion Hinchcliffe (CC BY-SA 2.0) via Flickr