Chapter 4: Activity-Based Management and Activity-Based Costing

1. Chapter 4: Activity-Based Management and Activity-Based Costing Cost Accounting Principles, 9e Raiborn● Kinney

2. Learning Objectives • In an activity-based management system, what are value-added 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 cost 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?

3. Activity-Based Management • Focuses on activities during production and performance process • An activity is a repetitive action performed in fulfillment of a business function • Improves the value received by customers • Enhances profitability

4. Activity-Based Management • Activity analysis • Cost driver analysis • Activity-based costing • Continuous improvement Operational control Quality management Business process improvement Performance measurement

5. Activity-Based Management Benefits • External Benefits • Improved customer value • Enhanced profitability • Internal Benefits • More efficient production • More accurate cost determination • More effective performance evaluation

6. Value-added activity Increases worth of product or service to a customer Customer is willing to pay for it Non-value-added activity 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-addedactivities are essential Activity Analysis

7. Cost Driver Analysis • Cost drivers are factors that have a direct cause-and–effect relationship to a cost • Limit the number of cost drivers • Cost of measurement should not exceed benefit of using the cost driver • Easy to understand • Directly related to activity being performed • Appropriate for measurement

8. Cost Driver Analysis • Unit-level costs • direct material, direct labor • Batch-level costs • setup, inspection • Product/process-level costs • engineering changes, product development • Organizational or facility costs • building depreciation, plant manager’s salary

9. Activity-Based Costing • Recognizes several levels of costs • Accumulates costs into related cost pools • Uses multiple cost drivers to assign costs to products and services

10. Two-Step Allocation • Collect costs in general ledger and subsidiary accounts • Identify activity centers • Accumulate costs into activity center cost pools—cost drivers • Allocate costs to products and services • activity driver measures demands placed on activities, thus the resources consumed by products/services

11. Traditional vs. ABC Costing • When ABC is implemented • Cost is reduced for high volume, standard products • Cost is increased for low-volume, complex specialty products

12. Use ABC Costing for: Product Variety and Process Complexity • Caused by mass customization • Too many choices, opportunity for errors • Pareto Principle • Commonality of parts • Reduced by • Simultaneous (or Concurrent) Engineering • Design for Manufacturability

13. Use ABC Costing for: • Lack of Commonality in Overhead Costs • - Some products/services use substantially more overhead than others • Problems with Current Cost Allocations - Significant changes in process with no change in cost allocations • Expense majority of period costs when incurred • Changes in Business Environment • - Increase in competition or change in • management strategy

14. Criticisms of ABC • Significant amount of time and cost to implement • Must overcome barriers to change • Does not conform to GAAP

15. Continuous Improvement • 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

16. Advantages of ABC and ABM • 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

17. Advantages of ABC and ABM • 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

18. Questions • What are the differences between activity-based costing and traditional cost accounting? • What are cost drivers and activity drivers? • What are two advantages and two criticisms of activity-based costing?

19. Potential Ethical Issues • 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