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Chapter Five Activity-Based Costing
“Whatever you strive for, don’t dwell on constructing the perfect plan or search for the flawless solution, because perfect can be the enemy of progress. Have the confidence to forge ahead with a good enough plan, with imperfect knowledge. Then continually adjust, adapt, and learn.” Greg Brown, Motorola Solutions Chairman, Rutgers Commencement Spring 2013
Tri-Cities Community Bank A • The write-ups were all very good. One was a standout for the in-depth analysis and looking at the unobserved or unintended consequences. • Tips for future • Fully read question – strategy portion of question • Provide the right facts to set up the case. • Issues section should be brief and outline ‘issue(s)’ that will be solved through the recommendation. • Analysis should lead to the recommendations • Recommendation – outline alternates with detail for each one and then select the best alternate. Make sure that you are solving the issue. • Comments on unobserved or unintended consequences.
Tri-Cities Community Bank B • Analysis was very good based on the groups I reviewed. • Recommendations varied, but were supported through analysis. • Graphical presentations were all very good. • Make sure that you do not mix data types • Appropriate level of aggregation of data versus detail • Make sure the graph is helping to tell the story that is being presented • Labeling
Great Observations • Expected improvements in 2002 for ND if the same level of performance increases were duplicated through the BSC implementation. • Lack of information on profitability to really see if BSC is successful. • Graphical support for qualitative interviews.
Qualitative and Quantitative Data Great analysis of both the quantitative and qualitative information • How would the analysis have differed if only quantitative information was presented? • How would the analysis have differed if only qualitative information was presented?
Semi-Structured Interview Questions Semi-structured questionnaires build consistency into the interview, while allowing for the interviewer to deviate and delve deeper when new information is revealed. • Select participants to generate highest level of variation in answers. • High/low performers, managers, line, administrative • Will participants answer honestly • Questions - Implementation, performance measures, fairness of measures, incentives, cross-selling, strategy (objectives & goals), performance enhancing system or a monitoring system (panopticon), perceived management support.
TCCB - Questions • Did the BSC appear to have an effect? • Results? • Differences in implementation quality to explain performance differences. • Recommendation to SD managers who are considering implementation.
Implementation of BSC in TCCB ‘B’ • How was the BSC implemented in this case? • Did branches A-D achieve better results based on the method of implementation? • Who’s fault is the poor execution of the BSC in ‘E’? • Good implementation, poor execution? • Poor execution, even poorer execution? • Management buy-in? • What may preclude management buy-in? • Tied to Strategy – goals and objectives? • Different BSC – did this lead to differing results. • Participation in development of scorecards? • What happens after implemented and new employee joins? • Issues with allowing branches to create their own systems
How should a balanced scorecard system be implemented? Top down approach • Consistency of performance measures and language • Tie to strategy • Interactive management control system • Less buy in from managers and line employees depending upon implementation process • One incentive system • Everyone working in the same direction Bottom up approach • Different systems and performance measures • More buy in
How should BSC be Implemented in ND? • Top down with CEO involvement? • Bottom up
What really happened at TCCB? • The ND president asked Chris to help him implement the BSC in the ND branches. • Chris left the bank shortly thereafter to take a position with a larger bank. His new role consists entirely of implementing the BSC at the new bank. • At TCCB, the divisions were realigned when Chris left and the BSC program was most likely scrapped (formally) due to lack of leadership.
Big Takeaways • Measures influence behavior • Make sure you know what they are tied to and the perceived unintended consequences • Implementation is important • Consistency • Every initiative needs a ‘champion’
Learning Objectives • Describe ABC, the steps in developing an ABC system, and the benefits of an ABC system • Determine product costs under both the volume-based method and the ABC method • Explain activity-based management (ABM)
Four basic steps for computing overhead rates • Estimate the total manufacturing overhead costs (MOH) for the coming year • Select an allocation base and estimate the total amount that will be used during the year. • Calculate the predetermined overhead rate • Allocate some MOH cost to each job worked on during the year by multiplying the predetermined MOH rate by the actual amount of the allocation base used by the job.
Manufacturing Overhead (MOH) • Using a overhead rate to allocate indirect costs • Steps 1 – 3. Predetermined MOH rate = MOH Costs Allocation Base
Volume-Based vs. ABC (continued) The traditional volume-based costing system assigns factory overhead (OH) based on direct labor-hours (DLH). The firm has a total budgeted overhead of $2,000,000. Since the firm budgeted 100,000 DLHs for the year, the overhead rate per DLH is $20 ($2,000,000/100,000 DLH).
Volume-Based vs. ABC Example Haymarket BioTech, Inc. (HBT) produces and sells two secure communication systems, AW (Anywhere) and SZ (SecureZone). HBT has the following operating data for the two products:
Volume-Based vs. ABC (continued) Product profitability analysis per unit using volume-based costing:
Volume-Based Costing • Although it is often inadequate, volume-based costing may be a good strategic choice for some firms • This type of costing system is appropriate generally when direct costs are the major cost of the product or service and the activities supporting its production are relatively simple, low-cost, and homogeneous across different product lines • Volume-based costing is often used by paper product manufacturers, producers of agricultural products, other commodity firms, and professional service firms
Strategic Role of ABC Activity-based costing (ABC) vs. volume-based costing: • Volume-based costing is often inadequate because indirect costs do not always occur in proportion to output volume • Volume-based costing generally causes cross-subsidization of outputs (i.e., some products will be overcosted and others undercosted) • Activity-based costing uses detailed information about the activities that make up indirect costs so that outputs are charged only for resources consumed
Cost Assignment The two-stage cost assignment approach for indirect (support) costs: resource costs such as factory overhead are assigned to activity cost pools and then to cost objects (jobs, clients, products, patients, etc.) • Volume-based systems assign factory overhead to a single plant or departmental cost pool first and then to products or services using a volume-based rate • ABC systems assign factory overhead costs to activities or activity cost pools using resource consumption cost drivers and then assign these costs to cost objects using activity consumption cost drivers • The use of cost drivers in each stage makes ABC generally more accurate than volume-based costing
Activity-Based Costing (ABC) Activity-based costing (ABC) assigns resource costs to cost objects based on activities performed for the cost objects, using a two stage method. • In stage one, costs of resources are assigned to activities that consume resources (using resource consumption drivers), and in stage two costs of activities are assigned to cost objects that consume activities (using activity consumption cost drivers)
Developing an ABC System There are four steps in the development of an ABC system: Identify each activity that is performed during the manufacturing process. Estimate the total manufacturing overhead costs (MOH) for the coming year for each activity. Estimate the total amount of each activity that will be utilized during the year. Calculate the predetermined overhead rate for each activity. Allocate some MOH cost to each job worked on during the year by multiplying the activity cost allocation rate by the actual amount of activities used by the job.
Volume-Based vs. ABC (continued) In an attempt to use an ABC system, HBT has identified the following activities, budgeted costs, and activity consumption cost drivers:
Volume-Based vs. ABC (continued) HBT also has gathered the following operating data pertaining to each of its products:
Volume-Based vs. ABC (continued) Using the operating data, the activity rate for each activity consumption cost driver is calculated as follows:
Volume-Based vs. ABC (continued) Factory overhead costs for AW @ 5,000 units of production:
Volume-Based vs. ABC (continued) Factory overhead costs for SZ @ 20,000 units of production:
Volume-Based vs. ABC Example (continued) Product profitability analysis per unit using ABC:
Volume-Based vs. ABC (continued) The following chart compares the results of the two costing systems: Can you guess which is the high-volume and which is the low-volume product? Keep in mind that volume-based costing tends to undercost low-volume products and overcost high-volume products, a situation often referred to as product costcross-subsidization
Five Steps of Strategic Decision Making in the HBT Example • Determine the Strategic Issues Surrounding the Problem: HBT competes on differentiation • Identify the Alternative Actions: focus on AW or SZ? • Obtain Information and Conduct Analyses of the Alternatives: cost analysis based on ABC costing • Based on Strategy and Analysis, Choose and Implement the Desired Alternative: do not promote AW over SZ, but instead focus on AW to improve overall profitability • Provide an On-going Evaluation of the Effectiveness of implementation in Step 4.
