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Chapter 3 Activity-Based Management

Chapter 3 Activity-Based Management. Activity-based Costing & Management (ABCM) (Slide 1 of 4). ABCM rests on this premise: Products and services require/consume activities and activities consume resources To understand the cost of a product or service, one must:

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Chapter 3 Activity-Based Management

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  1. Chapter 3 Activity-Based Management

  2. Activity-based Costing & Management (ABCM)(Slide 1 of 4) • ABCM rests on this premise: • Products and services require/consume activities and activities consume resources • To understand the cost of a product or service, one must: • Identify activities required to make the product or provide the service

  3. Activity-based Costing & Management(ABCM)(Slide 2 of 4) • Identify resources used to provide for those activities • Determine the cost of those resources • To be competitive, managers must know both: • Activities involved in making the goods or providing the services, and • The cost of those activities

  4. Activity-based Costing & Management (ABCM) (Slide 3 of 4) • ABCM has 2 parts: What are they? • The costing part known as Activity-based Costing (ABC) • The management part known as Activity-Based Management (ABM)

  5. Activity-based Costing & Management (ABCM) (Slide 4 of 4) • ABC treats mostly indirect costs including: • Overhead costs related to the manufacture of a product or providing a service • Indirect costs of marketing a product • Indirect costs of managing a company

  6. Discuss Strategic Uses of ABCM • Managers use activity-based information in what 5 ways? • To add surcharges for particular customers • To “fire” some customers • To seek to serve more profitable customers • To raise or lower product prices • To drop products

  7. What are the 4 steps of activity analysis? • Chart the activities used to complete the product or service • Classify activities as value-added or non-value-added • Eliminate or reduce non-value-added activities • Continuously improve & reevaluate efficiency of activities or replace them with more efficient activities

  8. Define Cost Pools • Cost pools are groups of costs • List three major types of cost pools: • Plant (traditional) • Department (traditional) • Activity center (activity-based costing)

  9. Product Costing Allocation Methods Plantwide Overhead Rate P R O D U C T S Single Rate Multiple Department Rates Department Department Activity-Based Costing Activity Activity

  10. Discuss Traditional Allocation Methods • Plantwide allocation • Uses the entire plant as a cost pool • This approach is best for simple organizations with only a few departments and little variety in activities • Department allocation • Uses separate cost pools with different overhead allocation rates for each department

  11. Discuss Activity-Based Costing • Activity-based costing (ABC) • Assigns costs first to activities • Then to products or services based on the activities used to produce the product or provide the service

  12. Single Plantwide Factory Overhead Rate Total budgeted factory overhead costs Total budgeted plantwide allocation base $1,600,000 20,000 direct labor hours = $80 per hour Snowmobile: $80 x 10 direct labor hours = $800 Lawnmower: $80 x 10 direct labor hours = $800 What are the advantages of the single plantwide overhead rate method?

  13. Multiple Department Factory Overhead Rate Fabrication Department Overhead Rate: $1,030,000 10,000 direct labor hours = $103 per hour Assembly Department Overhead Rate: $570,000 10,000 direct labor hours = $57 per hour Snowmobile: Fabrication: $103 x 8 dlh $824 Assembly: $57 x 2 dlh 114 $938 Lawnmower: Fabrication: $103 x 2 dlh $206 Assembly: $57 x 8 dlh 456 $662

  14. Conditions for Product Cost Distortion Fabrication Department Assembly Department Condition 1: Different department overhead rates $103 per direct labor hour $57 per direct labor hour Snowmobile 8 direct 2 direct labor hours labor hours Condition 2: Different ratios of allocation-base usage Lawnmower 2 direct 8 direct labor hours labor hours

  15. What are the required steps of activity-based costing? • Identify activities that consume resources and assign costs to those activities • Identify cost drivers associated with each activity • A cost driver is a factor that causes or “drives” an activity’s costs • Compute a cost rate for each cost driver • Assign costs to products

  16. Cost Rates per Cost Driver Unit • Calculate predetermined cost rate for each cost driver as follows: Predetermined = Estimated indirect cost cost rate Est. volume of allocation base Multiply predetermined cost driver rate times volume of cost drivers consumed

  17. Activity-Based Costing Activity Amount Activity Rate Fabrication $ 530,000 / 10,000 dlh = $53 Assembly 70,000 / 10,000 dlh = $7 Setup 480,000 / 120 setups = $4,000 Quality control 312,000 / 104 insps. = $3,000 Engineering 208,000 / 16 changes = $13,000 Total $1,600,000

  18. Activity-Based Costing Activity Amount Activity Rate Fabrication $ 530,000 / 10,000 dlh = $53 Assembly 70,000 / 10,000 dlh = $7 Setup 480,000 / 120 setups = $4,000 Quality control 312,000 / 104 insps. = $3,000 Engineering 208,000 / 16 changes = $13,000 Total $1,600,000 Fabrication: DL Hours Rate Total Snowmobile 8,000 $53 $424,000 Lawnmower 2,000 53 106,000 Total 10,000 $530,000

  19. Activity-Based Costing Activity Amount Activity Rate Fabrication $ 530,000 / 10,000 dlh = $53 Assembly 70,000 / 10,000 dlh = $7 Setup 480,000 / 120 setups = $4,000 Quality control 312,000 / 104 insps. = $3,000 Engineering 208,000 / 16 changes = $13,000 Total $1,600,000 Assembly: DL Hours Rate Total Snowmobile 2,000 $7 $14,000 Lawnmower 8,000 7 56,000 Total 10,000 $70,000

  20. Activity-Based Costing Activity Amount Activity Rate Fabrication $ 530,000 / 10,000 dlh = $53 Assembly 70,000 / 10,000 dlh = $7 Setup 480,000 / 120 setups = $4,000 Quality control 312,000 / 104 insps. = $3,000 Engineering 208,000 / 16 changes = $13,000 Total $1,600,000 Setup: Setups Rate Total Snowmobile 100 $4,000 $400,000 Lawnmower 20 4,000 80,000 Total 120 $480,000

  21. Activity-Based Costing Activity Amount Activity Rate Fabrication $ 530,000 / 10,000 dlh = $53 Assembly 70,000 / 10,000 dlh = $7 Setup 480,000 / 120 setups = $4,000 Quality control 312,000 / 104 insps. = $3,000 Engineering 208,000 / 16 changes = $13,000 Total $1,600,000 Quality Control: Insps. Rate Total Snowmobile 100 $3,000 $300,000 Lawnmower 4 3,000 12,000 Total 104 $312,000

  22. Activity-Based Costing Activity Amount Activity Rate Fabrication $ 530,000 / 10,000 dlh = $53 Assembly 70,000 / 10,000 dlh = $7 Setup 480,000 / 120 setups = $4,000 Quality control 312,000 / 104 insps. = $3,000 Engineering 208,000 / 16 changes = $13,000 Total $1,600,000 Engineering: Changes Rate Total Snowmobile 12 $13,000 $156,000 Lawnmower 4 13,000 52,000 Total 16 $208,000

  23. Activity-Based Costing Cost Allocation Summary: Activity Snowmobile Mower Total Fabrication $ 424,000 $106,000 $ 530,000 Assembly 14,000 56,000 70,000 Setup 400,000 80,000 480,000 Quality control 300,000 12,000 312,000 Engineering 156,000 52,000 208,000 Total $1,294,000 $306,000 $1,600,000 Budgeted units 1,000 1,000 Cost per unit $1,294 $306

  24. Distortion in Product Costs Factory Overhead Cost per Unit: Snowmobile Lawnmower Single plantwide rate $ 800 $ 800 Multiple department rates 938 662 Activity-based costing 1,294 306

  25. Selling and Administrative Activities Selling and administrative activities may include: 1. Post-sale technical support 2. Order writing 3. Promotional support 4. Order entry 5. Customer return processing 6. Shipping document preparation 7. Shipping and handling 8. Field service

  26. Activity-Based Costing in Service Businesses Hopewell Hospital—Activity-Based Costing $180 per admission P A T I E N T S Admitting Radiological Testing $320 per image Operating Room $200 per hour Pathological Testing $120 per specimen Dietary and Laundry $150 per day

  27. Activity Costs Allocated to a Patient Patient Name: Mary Wilson Activity-Base Activity Activity Activity Usage Rate Cost Admitting 1 admission $180 $ 180 Radiology testing 2 images 320 640 Operating room 4 hours 200 800 Pathological testing 1 specimen 120 120 Dietary and laundry 7 days 150 1,050 Total $2,790

  28. Activity Category Capacity Customer Product Batch Unit Examples Plant Mgmt & Depr Mkt Research Product Specs & Testing Machine Setups Direct Materials Cost Hierarchies

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