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The Importance of Cost Efficiency and Reduction in Production

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According to Drury (2004), Cost efficiency focuses on cost reduction and continuous improvement and change rather than cost containment. The term cost reduction could be used instead of cost efficiency. Whereas traditional cost control systems are routinely applied on a continuous basis, cost efficiency tends to be applied on an ad hoc basis when an opportunity for cost reduction is identified. Also, many of the approaches that are incorporated within the area of cost efficiency do not necessarily involve the use of accounting techniques. In contrast, cost control relies heavily on accounting techniques. Cost efficiency consists of those actions that are taken by managers to reduce costs, some of which are prioritized on the basis of information extracted from the accounting system. Although cost efficiency seeks to reduce costs, it should not be at the expense of customer satisfaction. Ideally, the aim is to take actions that will both reduce costs and enhance customer satisfaction.

Cost efficiency has become an essential emphasis in today’s highly competitive business environment. This study was aimed at defining cost efficiency and discussing the philosophies that underpins efficiency. Over the past 25 years, we have seen a significant shift in the cost accounting and management accounting (Maher and Deakin, 1994, Günther 1997 and Götze, 2004). This shift is the result of an increasing competitive environment due to the introduction of new manufacturing and information technologies, the focus on the customer, the growth of worldwide markets, and the introduction of new forms of management organization (Blocher et al, 1999).

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Productivity and quality are the watchwords of today’s business competitions. Companies are not only measuring productivity and insisting on improvements but also insisting that quality means to bring to market products that satisfy customers, improve sales and boosts profits. With greater competition the banking environment defined by cost, quality and time issues, there exists a prevalent conviction that conventional accounting-based measures of organizational performance are outdated (Nixon, 1998). Hence, there are moves to adopt newer techniques due to greater needs to be more responsive to investor and customer needs. It is urged that the traditional approaches of the managerial accounting have limited evidence of technical development in response to the major changes in manufacturing technology. Management accounting was confined to financial reporting. Consequently, there was a need for developing a management accounting project oriented towards the strategic accounting rather than the management control process. The idea of cost efficiency of a production unit was first introduced by Farell (1957), under the concept of “input oriented measure”.

According to Farell, a technical efficiency measure is defined by one minus the maximum proportionate reduction in all inputs that still allows continuous production of given outputs. Technical efficiency is linked to the possibility of avoiding wasting by producing as much outputs as the use of input allows it (output-oriented measure), or by using as less as input that the production objective plans it (input-oriented measure). This efficiency is measured by comparing observed and optimal values of production, costs, revenue, profit or all that the production system can follow as objective and which is under appropriate quantities and prices constraints. Efficiency measurement is one aspect of investigating a firm’s performance. Efficiency can be measured in three ways; maximisation of output, minimisation of cost, and maximisation of profits. In general, efficiency is divided into two components (Kumbhakar and Lovell, 2003).

A firm is regarded as technically efficient if it is able to obtain maximum outputs from given inputs or minimise inputs used in producing given outputs. The objective of producers here is to avoid waste. According to Koopmans (1951), a producer is considered technically efficient if, and only if, it is impossible to produce more of any output without producing less of some other output or using more of some inputs. ‟On the other hand, allocative efficiency relates to the optimal combination of inputs and outputs at a given price. The objective of producers might entail the following: to produce given outputs at minimum costs; to utilise given inputs so as to maximise revenue; and to allocate inputs and outputs so as to maximise profit. This technique of production is widely known as economic efficiency where the objective of producers becomes one of attaining a high degree of economic efficiency (cost, revenue or profit efficiency).

Theoretically, competition is good because it ensures that the costs of production are minimised and at the same time it promotes efficiency (Nickell, 1996). Increased competition could force firms to operate more efficiently in order to survive. It forces the banks to produce products and provide services that are most demanded by the customers. If they can provide services demanded efficiently and with the least cost, there is no reason why they cannot make more profits. Otherwise, they will make losses and possibly go out of business.


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