Chapter 4 ActivityBased Management and ActivityBased Costing Cost

Chapter 4: Activity-Based Management and Activity-Based Costing Cost Accounting: Foundations and Evolutions, 9 e Kinney ● Raiborn © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Learning Objectives n n n In an activity-based management system, what are valueadded and non-value-added activities? How do value-added and non-value-added activities affect manufacturing cycle efficiency? Why must cost drivers be designated in an activity-based costing system? How are product and service costs computed using an activity-based costing system? Under what conditions is activity-based costing useful in an organization and what information do activity-based costing systems provide to management? What criticisms have been directed at activity-based costing? © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Activity-Based Management n Focuses on activities during production and performance process q An activity is a repetitive action performed in fulfillment of a business function Improves the value received by customers n Enhances profitability n © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Activity-Based Management n n Activity analysis Cost driver analysis Activity-based costing Continuous improvement § § Operational control Quality management Business process improvement Performance measurement © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Benefits of Activity-Based Management n External benefits q q Improved customer value Enhanced profitability n Internal benefits q q q More efficient production More accurate cost determination More effective performance evaluation © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Activity Analysis Value-added activity n n Increases worth of product or service to a customer Customer is willing to pay for it Non-value-added activity n n Increases time spent on product or service but does not increase worth Unnecessary from customer perspective Can be reduced, redesigned or eliminated without affecting market value or quality Business-value-added activities are essential © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Process n A process is a series of activities that, when performed together, satisfy a specific objective q Production q Distribution q Selling q Administration © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Activity Analysis n Create a Process Map (detailed flowchart) for each process q n Identify each step Create Value Chart q Identify stages and time spent in stages from beginning to end of process Value-Added Processing Time Service Time Non-Value-Added Inspection Time Transfer Time Idle Time © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Cycle Time n Eliminate or minimize activities that add the most time and cost and the least value Cycle Time = Value. Added Time + Non. Value-Added Time © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Manufacturing Cycle Efficiency (MCE) n n = Value-Added Processing Time Total Cycle Time 100% efficiency unrealistic Reducing non-value-added activities will increase MCE Value-added activity usually represents about 10% of total cycle time Just-in-time (JIT) increases MCE © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Non-Value-Added Activities n n Attributed to following factors q Systemic q Physical q Human Eliminating or reducing non-value-added activities that create the most costs will Increase product/service quality q Decrease cycle time and cost q © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

A Management Tool n Combine: q q Activity analysis n What activities are non-value-added? Cost driver analysis n What causes costs to be incurred? © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Cost Driver Analysis n Cost drivers are factors that have a direct cause–and-effect relationship to a cost q q q Limit the number of cost drivers Cost of measurement should not exceed benefit of using the cost driver Easy to understand Directly related to the activity being performed Appropriate for measurement © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Cost Drivers n Unit-level costs q n Batch-level costs q n setup, inspection Product/process-level costs q n direct material, direct labor engineering changes, product development Organizational or facility costs q building depreciation, plant manager’s salary © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Product Cost Behavior Unit-level costs are variable in relation to change in production volume n Batch, product/process, and organizational level costs are variable for reasons other than changes in production volume n © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Product Cost Unit-Level Costs Allocate over number of units produced Cost per unit Batch-Level Costs Allocate over number of units in batch Cost per unit in batch Allocate over number Product/Processof units produced in Level Costs related product line Cost per unit in product line © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Product and Company Profitability Unit Batch Product Total product revenue <Total product cost> Net product margin +/– All other net product margins Total margin provided by products <Organizational/facility-level costs> Company profit or loss Not GAAP © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Activity-Based Costing Recognizes several levels of costs n Accumulates costs into related cost pools n Uses multiple cost drivers to assign costs to products and services n © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

When to Use ABC n Companies use ABC when: q q q They have a wide variety of products or services High overhead costs are not proportional to the unit volume of individual products Automation makes it difficult to assign overhead to products using direct labor or machine hours Profit margins are difficult to explain Hard-to-make products show big profits and easy-tomake products show losses © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Two-Step Allocation n n Collect costs in general ledger and subsidiary accounts Identify activity centers q Choosing an activity center n n n q n Choose a manageable number of activity centers Accumulate costs into activity center cost pools q q Identify cost drivers Costs in each cost pool are n n n Geographical proximity of equipment Centers of managerial responsibility Magnitude of product costs Driven by homogenous activities Strictly proportional to the activity Allocate costs to products and services q Activity driver measures demands placed on activities, thus, the resources consumed by products/services © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Activity Drivers n n n n Reports requested Job change actions Hiring actions Training hours Transactions processed Engineering changes Defects discovered n n n n Repair hours Material requisitions Purchase requisitions Space occupied Set-ups Moves Employees © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Activity-Based Costing Record Costs in GL Cost Driver Activity Driver Accumulate in Activity Center Cost Pools Cost Objects © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Traditional vs. ABC Costing n When ABC is implemented q Cost is reduced for high-volume, standard products q Cost is increased for low-volume, complex specialty products © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Long-Term Variable Costs n Cost drivers q Product variety—number of different types of products q Product complexity—number of processes through which a product flows © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

ABC Costing Considerations n n n Number and diversity of products/services produced Diversity and differential degree of support services used for different products Extent to which common processes are used Effectiveness of current cost allocation methods Rate of growth of period costs © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Use ABC Costing for… 1. Product Variety and Process Complexity 2. Lack of Commonality in Overhead Costs 3. Problems with Current Cost Allocations 4. Changes in Business Environment © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Use ABC Costing for… 1. Product Variety and Process Complexity Caused by mass customization q n n n Too many choices, opportunity for errors Pareto Principle Commonality of parts Reduced by q n n Simultaneous (or Concurrent) Engineering Design for Manufacturability © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Use ABC Costing when… 2. Lack of Commonality in Overhead Costs q Some products/services use substantially more overhead than others 3. Problems with Current Cost Allocations q q Significant changes in process with no change in cost allocations Expense majority of period costs when incurred 4. Changes in Business Environment q Increase in competition or change in management strategy © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Continuous Improvement n n Eliminates non-value-added activities to reduce cycle time Makes products/performs services with zero defects Reduces product costs on an ongoing basis Simplifies products and processes ABC Costing Supports Continuous Improvement © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Criticisms of ABC Significant amount of time and cost to implement n Must overcome barriers to change n Does not conform to GAAP n © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Advantages of ABC and ABM n n n Identify and monitor significant technology costs Trace technology costs directly to products Increase market share Identify the cost drivers that create or influence cost Identify activities that do not contribute to perceived customer value n n n 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 © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Questions n n n What are the differences between activitybased costing and traditional cost accounting? What are cost drivers and activity drivers? What are two advantages and two criticisms of activity-based costing? © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Potential Ethical Issues n n n n Ignoring non-value-added activities Using non-value label to eliminate jobs Misclassifying activities to allocate costs away from lower volume products to justify lower selling prices Selecting an inappropriate cost driver to distort cost calculations Using ABC to eliminate a vendor or customer Using ABC to eliminate funding of social or environmental causes Using ABC to transfer cost from fixed price contracts to cost-plus contracts © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.