Activity Based Costing and (ABC) Activity Based Management (ABM)

1. Activity Based Costing and (ABC) Activity Based Management (ABM) Management Level – Paper P2 Advanced Management Accounting Lecture - 02 Vidya Rajawasam ACMA CGMA MBA

2. ABC & ABM In the previous Lecture we will discuss • Activity Based Costing • Activity Based Management

3. ABC & ABM In this Lecture we will discuss • Implementation Problems with regard to ABC & ABM • Product/Customer/Distribution channel profitability

4. ABC & ABM Problems with implementation of ABC/ABM Although many academics, researchers and management theorists discuss about the ABC/ABM principles, the implementation of the same has met with some difficulties.

5. ABC & ABM Problems with implementation of ABC/ABM Some of the difficulties are; • General ledger financial information systems are too poor to provide reliable ABC information. The resulting figures are similar to traditional absorption costing methods.

6. ABC & ABM Problems with implementation of ABC/ABM Some of the difficulties are; • Lack of effort, dynamism among finance department staff to implement the ABC systems. Examples, difficulties in identification of more than 50 activities and costs attributed to them.

7. ABC & ABM Problems with implementation of ABC/ABM Some of the difficulties are; • Finance department staff unable to perceive the needs of the production staff. Some of the production procedures, processes, activities are complicated and difficult to interpret in accounting terms.

8. ABC & ABM Tips for implementation of ABC/ABM • Obtain the support of the senior management. • Recognize that the ABC/ABM requires a major investment related to time and resources.

9. ABC & ABM Tips for implementation of ABC/ABM • Be clear about what ABC/ABM can achieve and what information is required from the system. • Choose the model approach that emphasizes the operational understanding of all activities of the business.

10. ABC & ABM Tips for implementation of ABC/ABM • Involve people in the field, operations, technical staff etc… • Transfer ownership of cost management from the accounts department to departments that are responsible for carrying out operations/processes, where the costs are incurred.

11. ABC & ABM Tips for implementation of ABC/ABM • Do not underestimate the need to manage the change process. • Link ABC/ABM to corporate objectives in the form of increased product profitability and added customer value.

12. ABC & ABM Direct Product Profitability (DPP) DPP is used primarily in the retail industry. The traditional absorption costing generally uses labour hours as a basis for absorption of overheads and the method is rarely suitable for service and retail organizations.

13. ABC & ABM Direct Product Profitability (DPP) DPP involves the attribution of purchase cost and other indirect costs to each product line. Thus a net profit can be identified for each product as opposed to a gross profit.

14. ABC & ABM Direct Product Profitability (DPP) Therefore, It is important to understand that the cost attribution process utilizes variety of methods to reflect the resource consumption of individual products.

15. ABC & ABM Direct Product Profitability (DPP) The retail organizations traditionally use selling price less cost of bought in goods to calculate gross margins. The gross margin calculation is a useless measure in controlling costs. This calculation does not involve other indirect costs associated with the retail operation.

16. ABC & ABM Direct Product Profitability (DPP) Indirect costs related to retail operations are; storage costs, transport costs , warehouse costs, distribution costs. Warehouse costs include the labour,space occupied and insurance costs. Transport costs include, labour, fuel,vehicle maintenance costs.

17. ABC & ABM Direct Product Profitability (DPP) The traditional method is to spread these indirect costs across the different goods sold in relation to the volume of goods sold or area occupied. However, we can argue that it is better to spread insurance costs according to the value or risk profile of the goods.

18. ABC & ABM Direct Product Profitability (DPP) When arriving at DPP, bought in cost of goods and the indirect costs will be taken. Therefore, we can clearly observe the importance of DPP and ABC systems in identifying the costs and making strategic decisions regarding the product profitability.

19. ABC & ABM Direct Product Profitability (DPP) In 1985, the Food Marketing Institute in USA laid down the DPP as the standard approach. After 2 years, DPP was taken up by the Institute of Grocery Distribution in UK. The method has transformed over years with the development of ABC.

20. ABC & ABM Direct Product Profitability (DPP) Benefits • Provides better cost analysis • Better pricing decisions can be taken • Better management of store and warehouse space.

21. ABC & ABM Direct Product Profitability (DPP) Benefits • Better Merchandising decisions • Better rationalization of product ranges.

22. ABC & ABM Review MCQs The benefits of Direct Product Profitability are? • Provides better cost analysis • Provides in depth understanding of direct labour costs. • Supports traditional absorption costing. • Supports better pricing decisions

23. ABC & ABM Review MCQs The benefits of Direct Product Profitability are? • Provides better cost analysis • Provides in depth understanding of direct labour costs. • Supports traditional absorption costing. • Supports better pricing decisions

24. Competitor Analysis Review MCQs The implementation problems of Activity Based Costing systems are? • General ledger information too poor to provide reliable information for ABC • Difficulties in perceiving the needs of the production staff. • Too costly to implement • Does not require additional resources.

25. Competitor Analysis Review MCQs The implementation problems of Activity Based Costing systems are? • General ledger information too poor to provide reliable information for ABC • Difficulties in perceiving the needs of the production staff. • Too costly to implement • Does not require additional resources.

26. ABC & ABM Customer Profitability Analysis Many organizations have realized the importance of customer profitability analysis. This is a new technique made possible through ABC, which identify the customer profitability to through cost pools and activities.

27. ABC & ABM Customer Profitability Analysis Different customers have different profitability contribution levels. Some customers use certain activities only and all customers will not use all related the activities. Basically, the customers have different activity profiles.

28. ABC & ABM Customer Profitability Analysis Definition, the analysis of revenue streams and service costs associated with specific customers or customer groups. The method is useful for service organizations such as Banks , hotels etc..

29. ABC & ABM Customer Profitability Analysis Example of customer service activities for a bank; • Depositing of cash • Withdrawal of cash • Unauthorized overdraft • Request for a statement • Returning a chequedue to insufficient funds

30. ABC & ABM Customer Profitability Analysis Out of the facilities indicated for a bank, some customers will only request certain facilities and some customers may request all the facilities. The customers can be charged for the each different activity used and thus arriving at revenue from the customer.

31. ABC & ABM Customer Profitability Analysis Example of customer service activities for a Hotel; • Well laid out gardens • Swimming pool • Restaurant • Bar

32. ABC & ABM Customer Profitability Analysis Out of the services provided by the hotel, older guests and guests with families may use swimming pool and garden facilities. Business Guests may use bar or restaurant facilities . Based on the services provided for the guests, we can calculate the profitability for each customer.

33. ABC & ABM • Customer Profitability Curve Manufacturing organizations can also benefit from costing their customers. All customers cannot be charged with similar charges. Some customers may require additional transport facilities due to distance from the factory.

34. ABC & ABM • Customer Profitability Curve Some customers may have urgent production requirements. Some may require technical assistance from the factory after the delivery of products etc.. When organizations analyze their customer profitability, they can observe that 20% of the customers provide 80% of the profit.

35. ABC & ABM • Customer Profitability Curve This scenario is known as Pareto analysis. As per the analysis and the diagram 50% of the customers reduce the profitability generated by the other customers.

36. ABC & ABM • Customer Profitability Curve Some theorists argue that there is no point serving these customers. What is important is to make them profitable. Usually small volume/order customers become unprofitable due to high production batch costs.

37. ABC & ABM • Distribution Channel Profitability The distribution channel of an organization refers to a chain of businesses or intermediaries through which good/service channeled until it reaches the end customer. This can include wholesalers, retailers, distributors and the internet .

38. ABC & ABM • Distribution Channel Profitability The customers will look for ease of access to its suppliers, continuous supply of products for their needs, reciprocal communication, prompt delivery, after sales support etc.. Therefore, the distribution channel which a firm selects is a critical driver of business profitability.

39. ABC & ABM • Distribution Channel Profitability It is important to be aware of channel costs similar to products costs and customer costs. Different channels will have different profitability levels and ABC system supports this analysis through creating cost pools for channel activities.

40. ABC & ABM • Distribution Channel Profitability Therefore, by having a detail understanding of distribution channel activities and costs through ABC system, the firm can reduce the channel costs and improve the channel profitability.

41. Competitor Analysis Review MCQs What is the true statement related to customer profitability analysis ? • Identifies the costs related to the activities performed for servicing each customer. • Provides information related to discounts • Provides information related to products. • Provides after sales service.

42. Competitor Analysis Review MCQs What is the true statement related to customer profitability analysis ? • Identifies the costs related to the activities performed for servicing each customer. • Provides information related to discounts • Provides information related to products. • Provides after sales service.

43. Competitor Analysis Review MCQs What is true related to Distribution Channel Profitability? • Supports decisions concerning marginal costing. • Supports quality assurance programs . • Identifies the activities and costs related to distribution channels. • Non of the above

44. Competitor Analysis Review MCQs What is true related to Distribution Channel Profitability? • Supports decisions concerning marginal costing. • Supports quality assurance programs . • Identifies the activities and costs related to distribution channels. • Non of the above

45. Competitive Advantage Lecture Summary We have discussed the • Implementation Problems with regard to ABC & ABM • Product/Customer/Distribution channel profitability

46. Activity Based Costing and Activity Based Management Management Level – Paper P2 Advanced Management Accounting Lecture - 02 Vidya Rajawasam ACMA CGMA MBA