chapter 5 activity-based management. 1. how can reasonably accurate product and service cost...
TRANSCRIPT
Chapter 5
Activity-Based Management
1. How can reasonably accurate product and service
cost information be developed?
2. What are the differences among value-added, non-
value-added, and business value-added activities?
C5
Learning Objectives
3. What might cause decreased manufacturing
cycle efficiency?
4. How would the cost drivers in an activity-based
costing system be developed?
C5
Continuing . . . Learning Objectives
5. What distinguishes activity-based costing from
conventional overhead allocation methods?
6. When is the use of activity-based costing appropriate?
7. What are the benefits and limitations of using activity-
based costing?
C5
Continuing . . . Learning Objectives
Cost Distortions in a Machine-
Intensive Environment
Overhead costs per month,
primarily machine-related $600,000
Total direct labor hours (DLHs) 800
Overhead rate per DLH ($600,000 800) $750
Total machine hours (MHs) 2,450
Overhead rate per MH ($600,000 2,400) $250
Continuing . . . Cost Distortions in a
Machine-Intensive Environment
Product A (10,000 units per month)Total DLHs 600
OH assigned using DLHs $450,000
OH per unit $45
Total MHs 400
OH assigned using MHs $100,000
OH per unit $10
Continuing . . . Cost Distortions in a
Machine-Intensive Environment
Product B (10,000 units per month)Total DLHs 200
OH assigned using DLHs $150,000
OH per unit $15
Total MHs 2,000
OH assigned using MHs $500,000
OH per unit $50
Activity-Based Management
Managers can use activity-based management (ABM) to help enhance customer value and organizational profits by increasing organizational efficiency and effectiveness and producing more accurate costs.
The Activity-Based
Management Umbrella Activity-Based Management
•Process and activity analysis•Cost driver analysis•Activity-based costing•Strategic planning•Integration with cost management system
•Continuous improvement•Operational control•Performance evaluation•Business process reengineering
Activity-Based Management
• Analyze activities– Activity - a repetitive action, movement, or work sequence
performed to fulfill a business function
• Prepare a process map– Makes it possible to identify duplication, waste, and
unnecessary work– Value chart – indicates time spent in each activity and
assesses value of activity
Value-Added Activity
Increases the worth of a product
or service to customers for which
they are willing to pay
Non-Value-Added Activity
• Increases the time spent on a product or service but does not increase its worth to customers
• Inspection time, transfer time, idle time, NVA production or performance time
Business-Value-Added Activities
Business-value-added (BVA) activities are NVA activities that are essential to business operations, but for which customers would not willingly choose to pay.
Example: a publicly held company’s required audit at the end of its fiscal year.
Manufacturing Cycle Efficiency
In a manufacturing environment, the manu-facturing cycle time efficiency at most companies is 10%.
This means:
Value is added to the product only 10% of the time from receipt of the parts until shipment to the customer.
Ninety percent of the cycle time is waste.
Just-In-Time (JIT)
Under JIT, inventory is manufactured or purchased only as the need for it arises or in time to be sold or used.
JIT eliminates a significant portion of the idle time consumed in storage and transfer processes.
Activity-Based Costing
Activity-based costing (ABC) is an accounting information system that identifies organizational activities and collects costs by considering the underlying nature and extent of those activities.
Activity-Based Costing
• Recognizes that various activities and cost levels exist
• Gathers costs into related cost pools• Uses multiple cost drivers to assign costs to
products and services
Activity-Based Costing
Activity-based costing attaches costs to products and services based on the activities used to make, perform, distribute, or support products and services.
Level of Cost Incurrence
• Unit-level costs– Incurred by production or acquisition of a single unit of
product or the delivery of a single unit of service
• Batch-level costs– Incurred when a group of similar things are made,
handled, or processed at the same time
• Product- or process-level costs– Incurred in support of different products or processes
• Organizational- or facility-level costs– Incurred to support and sustain a business unit
Levels of Costs
Classification Levels Types of Costs Necessity of Cost
Unit-Level Costs
Direct materialDirect labor
Some machine costs,
if traceable
Once foreach unitproduced
Levels of Costs
Classification Levels Types of Costs Necessity of Cost
Batch-Level Costs
Purchase ordersSetup
InspectionMovement
Scrap, if related to the batch
Once foreach batchproduced
Levels of Costs
Classification Levels Types of Costs Necessity of Cost
Product- or Process-Level Costs
Engineering changeorders
Equipment maintenance
Product developmentScrap, if related to
product design
Supports aproducttype or aprocess
Levels of Costs
Classification Levels Types of Costs Necessity of Cost
Organizational- orFacility-Level
Costs
Building depreciation
Plant or division manager’s salaryOrganizational
advertising
Supports the overall
production of service process
Two-Step Allocation
Cost 1
Cost 5
Cost 2
Cost 3
Cost 4 Activity CostCenter 2
Product 1
Product 2
Product 3
Activity CostCenter 1
Activity Drivers
Accounting Reports requested; dollars expended
Personnel Job change actions; hiring actions; training hours; counseling hours
Data Processing Reports requested; transactions processed; programming hours; program change requests
Continuing . . . Activity Drivers
Production Engineering Hours spent in each shop; job specification changes requested; product change notices processed
Quality Control Hours spent in each shop; defects discovered;
samples analyzed
Continuing . . . Activity Drivers
Plant Services Preventive maintenance cycles; hours spent in each shop; repair maintenance actions
Material Services Dollar value of requisitions;number of
transactions processed; number of personnel in direct support
Continuing . . . Activity Drivers
Utilities Direct usage (metered to shop); space occupied
Production Shops Fixed per-job charge; setupsmade; direct
labor; machine hours; number of moves;material applied
Is ABC Information Better?
Consider:• The number and diversity of products or services
produced or provided• The diversity and differential degree of support
services used for different products• The extent to which common processes are used• The effectiveness of current cost allocation
methods• The rate of growth of period costs
Will ABC
Information Change Decisions?
Consider:• Management’s freedom to set prices• The ratio of period costs to total costs• Strategic factors• The climate and culture of cost reduction in the
company• The frequency of analysis that is desirable or
necessary
Product Variety
Creates Overhead Costs
Given differing product sets, which company would have more:
• Inventory carrying costs?
• Purchasing costs?
• Scheduling costs?
• Setup and change over costs?
• Expediting costs?
• Quality control costs?
• Scrap costs?
• Rework costs?
To which products do these increased costs relate?
Which product line would bear most of the costs?
Business Process Reengineering
• To find and implement radical changes in how things are made or how tasks are performed to achieve substantial cost, service, or time reductions
• Emphasizes continuous improvement• Ignores “the way it is”• Looks at “the way it should be”
Shortcomings of ABC
• Time and cost of implementing ABC– Need environment for change– Environment for change hindered by individual,
organizational, and environmental barriers
• Does not conform with GAAP– Most companies use ABC as a supplemental system– Additional clerical costs
• Some people question whether it promotes total quality management and continuous improvement
ABC Can Help Managers To:
• Identify and monitor significant technology costs• Trace many technology costs directly to products• Promote achievement of market share through
use of target costing• Identify the cost drivers that create or influence
cost• Identify activities that do not contribute to
perceived customer value
And To:
• Understand the impact of new technologies on all elements of performance
• Translate company goals into activity goals• Analyze the performance of activities across
business functions• Analyze performance problems• Promote standards of excellence