The Difference between cost control and cost reduction?

cost control and cost reduction

To improve profits, two things are necessary – either an increase in revenue or a decrease in costs. But in today’s competitive world, it is not so easy to increase sales to improve profit position. That is why most businesses work hard to keep a check on their costs in order to maintain profitability. Thus, one of the primary goals of a good cost accounting system is to maintain discipline in expenditure. For this, two approaches are used – cost control and cost reduction.

Let us first see what cost control means.

What is cost control?

Cost control ensures that expenditures are within predetermined limits. Under this approach, managers and executives are held responsible for regulating the cost of operations. If there is a deviation from these established standards, it is noted and reported on a continuous basis.

The pre-requisites of an efficient cost control system are:

  • Establishment of authority and responsibility, i.e., each cost centre must be designated against the name of its responsible manager.
  • There should be clearly defined goals.
  • Individuals should be motivated to achieve targets, either through financial or non-financial incentives.
  • There should be efficient and timely reporting of results.
  • Comparison of actual performance with budgets should be followed by appropriate recommendations and actions.
  • Effective implementation of recommendations should be ensured through proper follow-up.

What steps are followed for cost control?

Normally, the following steps are followed to exercise control over cost:

1. Determination of pre-determined standards:

Before beginning any production or service activity, standard costs or performance targets are set for each cost object or cost centre. These then represent the desired costs or outcomes that must be met.

2. Assessment of actual performance:

Next, the actual cost or outcome of each cost object or cost centre is measured. But here, one thing must be taken care of. Performance must be measured in the same way in which targets are fixed. For example, if targets are set up operation-wise, then actual costs should also be collected and measured operation-wise to provide a common benchmark for comparison.

3. Comparison of actual performance with standards:

Once the actual performance is measured, it is compared against desired targets. Any deviation between the two is found out and conveyed to the appropriate person in charge.

4. Variance analysis and action:

Discrepancies noted in the previous step are analyzed thoroughly to locate their reasons. And accordingly, appropriate steps are taken to ensure their compliance in the future. If necessary, standards are revised to incorporate any developments.

Besides cost control, another approach that is equally beneficial is cost reduction.  Let us see how it works.

What is cost reduction?

Cost reduction is a management strategy in which the cost of an object is always thought to have room for further reduction. No cost is referred to as the lowest cost, and therefore, every possibility to cut costs is evaluated. But while looking for ways to achieve a real and permanent reduction in the unit cost of goods produced or services rendered, it is assured that the quality of products or suitability of services remains intact.

Thus, the term ‘cost reduction’ may be summarized in the following three points:

  • There is a saving in the unit cost of goods produced or services rendered.
  • Cost reduction is of permanent nature.
  • The quality of products or the utility of services remains unaffected, if not enhanced.

From the above points, it is clear that reductions due to unexpected transactions, fortunate collections, changes in government/tax policies, or temporary measures intended to overcome financial difficulties do not fall under the ambit of cost reduction. Cost reduction deals with savings in costs that are real and permanent. (source)

With such an approach, continuous efforts can be made to achieve genuine savings in the costs of manufacture, administration, selling, and distribution. This could be done by concentrating on areas such as product design (around 80% of production cost is committed at the design phase only), organizational structure, factory layout and equipment, production process, and more. For example, when examining a production process for any potential cost reduction, a business should check the following:

  • Whether wastage of manpower and materials is kept to the minimum
  • Whether there is any scope for reducing idle capacity
  • Whether there is any wastage of time and money owing to delay in the movement of resources from one production activity to another
  • Whether stores and maintenance services are efficient or not

What actions are taken for cost reduction?

To achieve cost reduction, a business entity usually resorts to the below-mentioned ways:

1. Value chain analysis:

All activities of a company are segmented to analyze and identify value-added activities and non-value-added activities. The activities that do not add any value to a company’s profit potential are eliminated without hampering the essential characteristics of a product or process. For this, many strategic tools are adopted, one of which is value chain analysis, developed by Michael Porter.

 2. Continual research:

Sometimes, companies also conduct regular research and study to find out the most optimal and cost-efficient way to produce a product or render a service. They keep on making improvements in their existing production processes so as to further reduce costs.

3. Other modern techniques:

For cost reduction, some of the other widely used techniques are Business Process Re-engineering (BPR), target costing, kaizen costing, standardization of products or components, inventory management tools like FSN analysis, Just in Time, backflush costing, etc.

Suppose a company uses the same type of component for more than one product or all products that it is manufacturing. With such standardization of products or components, the company might benefit in terms of economies of scale, ease in inventory control, and ease for the operator who uses that component for various purposes. This way it may achieve a reduction in overall cost.

Objective of cost control and reduction

The goal of cost control is to keep costs within the bounds of established standards. On the other hand, cost reduction is concerned with reducing costs. It challenges all standards and strives to improvise them on a continuous basis.

Approach of cost control and reduction

Cost control adopts the approach of standard costing and variance analysis to achieve the lowest possible cost under existing conditions. In contrast, cost reduction methodology assumes that no condition is permanent. It seeks to make changes in conditions so that a new and improvised method of production can be identified to lower costs. Therefore, rather than depending on existing conditions, the cost reduction technique believes in experimenting and tweaking the existing scenario.

Emphasis of cost control and reduction

While in the case of cost control, emphasis is placed on the past and present, cost reduction focuses on the present and future.

Nature of function

Cost control is a preventive function as it seeks to assure that costs do not exceed the set standards (or results do not fall behind the desired targets). But cost reduction is a corrective function. It operates even when an efficient cost control system already exists in a business.

Limit

When targets are met, cost control comes to an end. Cost reduction, on the other hand, has no visible endpoint and is a continuous process.

The table below will give a quick overview of the major differences between these two terms:

Comparison chart – Difference between cost control and cost reduction

Basis of differenceCost controlCost reduction
MeaningComparison of actual costs with budgeted figures to regulate costsAchievement of a real and permanent reduction in the unit cost of goods produced
AimTo maintain costs within established standardsTo make efforts to reduce costs on a continuous basis
ApproachStandard costing and variance analysisImprovisation in existing conditions of producing a product or rendering a service
EmphasisPast and presentPresent and future
NaturePreventive functionCorrective function
EndEnds when targets are achievedOngoing process
Savings in costCould be temporary savings in costRealistic and permanent savings in cost
Quality maintenanceQuality maintenance is not guaranteedQuality and utility of products is maintained
Setting of BudgetSets up targets, investigates variances, and takes remedial stepsDoes not use a budget as a yardstick
DynamicRelatively less dynamic approach than cost reductionFully dynamic
ApplicabilityApplicability is limited only to those items for which targets can be fixedUniversally applicable to all areas of operations
Conclusion

To conclude, it can be said that cost reduction differs from cost control in the sense that it believes in reducing costs to the most optimal level rather than any specified level such as a budget or target. It seeks to find out substitute means or new ways in production processes that can bring in waste reduction and increased production.


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Ruchi Gandhi

The author enjoys to write informational content in the domain of company law and allied laws. She takes interest in doing thorough and analytical research on legal topics. She is a CA along with MBA (Fin) and M. Com.

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