C H A P T E R

1. C H A P T E R 7 Management Accounting Information In The New Business Environment

2. Learning Objective 1 Explain the fundamentals of activity-based costing (ABC) and activity-based management (ABM).

3. Costs Products Activities Activity-Based Costing (ABC) • A method of attributing costs to products based on: • assigning costs of resources to activities • assigning costs of activities to products

4. = $3,000 Overhead per product $9,000 Overhead Production Departments Costs Products Unit-Based Costing (UBC) The traditional method of allocating costs (manufacturing overhead) to products based on number of units produced. If only three products are produced (one of each), then:

5. Costs of Direct Materials Costs of Unit-Level Activities Costs of Direct Labor Costs of Batch-Level Activities Variable Manufacturing Overhead Costs Costs of Product Line Activities Fixed Manufacturing Overhead Costs Costs of Facility Support Activities Relationship BetweenUBC and ABC Unit-Based Costing (UBC) Model of Costs Activity-Based Costing (ABC) Hierarchical Product Cost Model

6. Facility Support Activities Product Line Activities Batch-Level Activities Unit-Level Activities ABC—Allocating Resource Costs to Activities What is the hierarchical product cost model? CommonCosts Product Costs

7. Unit-Level Activities • Take place each time a unit is produced • Packing • Assembly • Depreciation • Maintenance ABC—Allocating Resource Costs to Activities Facility Support Activities Product Line Activities Batch-Level Activities

8. Batch-Level Activities • Number of setups • Setup hours • Movements of materials • Orders for nonstocked items • Inspections Unit-Level Activities ABC—Allocating Resource Costs to Activities Facility Support Activities Product Line Activities

9. Batch-Level Activities Unit-Level Activities ABC—Allocating Resource Costs to Activities Facility Support Activities • Product Line Activities • Engineering and design changes • Warehousing of product line materials • Production line dedicated supervisors • Purchasing • Receiving and shipping

10. Product Line Activities Batch-Level Activities Unit-Level Activities ABC—Allocating Resource Costs to Activities • Facility Support Activities • Property taxes • Plant security • Landscaping • Accounting and legal • General administrative salaries

11. Cross-Subsidization • Does a hammer really cost THAT MUCH? ? Overhead per product = $9,000 Overhead If a UBC factory produces only three products (a hammer, a clock, and a Ferrari) and a hammer incurs $4 of direct labor and materials, how much will the hammer cost if manufacturing overhead is allocated evenly over finished products?

12. Cross-Subsidization • Does a hammer really cost THAT MUCH? $3,000 Overhead per product = $9,000 Overhead 3 Products $3,004 !? 1 Hammer =

13. Cross-Subsidization • Does a hammer really cost THAT MUCH? = ? Overhead per product $9,000 Overhead Under UBC (unit-based costing), some products may be inappropriately assigned costs that actually belong to another product line(in this case, the hammer and clock are obviously cross-subsidizing the Ferrari product line).

14. What are the Hazards of Allocating Costs? • When one product is cross-subsidizing another, it appears unprofitable to produce and is often mistakenly discontinued. • When facility support (common) activity costs are allocated to individual product lines, they may appear unprofitable and are often mistakenly discontinued. Product Cost Distortions

15. Hazards of Allocating Costs • Product profitability before overhead allocation: Hammer Clock Ferrari Revenue Materials Labor Profit $8 $20 $100,000 2 10 70,000 2 5 25,000 $4$ 5$ 5,000

16. Hammer Clock Ferrari Revenue Materials Labor Overhead Profit $ 8 $ 20 $100,000 2 10 70,000 2 5 25,000 3,000 3,000 3,000 $(2,996) $(2,995)$ 2,000 Hazards of Allocating Costs • Product profitability after • overhead allocation: In actuality, most of the $9,000 manufacturing overhead is attributable to the Ferrari, revealing it to be the real money loser.

17. Hazards of Allocating Costs • In actuality, most of the $9,000 manufacturing overhead is attributable to the Ferrari, revealing it to be the real money loser, • BUT because the other products are cross-subsidizing, they appear unprofitable and will be discontinued from production. Hammer Clock Ferrari Revenue Materials Labor Overhead Profit $ 8 $ 20 $100,000 2 10 70,000 2 5 25,000 3,000 3,000 3,000 $(2,996) $(2,995)$ 2,000

18. Hazards of Allocating Costs • The result? Hammer Clock Ferrari Revenue Materials Labor Overhead Profit $100,000 70,000 25,000 8,990 $ (3,990)

19. Cost Drivers Costs Products Activities Performance Measures Activity-Based Management (ABM) • Managing costs, quality, and timeliness of activities through the identification and use of Cost DriversandPerformance Measures.

20. Learning Objective 2 Describe total quality management (TQM) and costs of quality (COQ).

21. TQM What is Total Quality Management (TQM)? A management philosophy focused on increasing profitability by improving the quality of products and processes and increasing customer satisfaction, while promoting the well-being and growth of employees.

22. “Watch the costs and the profits will take care of themselves.” “Watch the Quality and the profits will take care of themselves.” Total QualityManagement (TQM) The Secret to Success? The Old Way The New Way Andrew Carnegie W. Edward Deming

23. Total Quality Management (TQM) A statistical technique for identifying and measuring the quality status of a process by evaluating its output to determine if serious problems exist in the process. Define SPC—Statistical Process Control

24. What are the Four Costs of Quality (COQ)? $ • Prevention Costs • Appraisal Costs • Internal Failure Costs • External Failure Costs

25. Define Each Cost of Quality (COQ) Prevention Costs: Ensures that processes are performed correctly the first time and that products and services meet customers’ expectations. Appraisal Costs: Inspecting, testing, and sampling activities performed in order to identify and remove low-quality products and services from the system. Internal FailureCosts: Expenses that occur when low-quality products and services fail before production and delivery to customers. External FailureCosts: Expenses that occur when low-quality products and services fail after production and delivery to customers.

26. Prevention & Appraisal Internal Failure & External Failure = What is the Effect of Increasing Prevention and Appraisal Costs of Quality (COQ)?

27. Total Costs of Quality Internal/External Failure Costs Appraisal & Prevention Costs Costs of Quality (COQ) Cost in Millions 4 3 2 1 86% 88% 90% 92% 94% 96% 98% % production within control limits

28. Learning Objective 3 Describe how just-in-time (JIT) management systems integrate with and extend ABC and TQM using time-based performance measures.

29. What is Just-In-Time (JIT)? • A management philosophy that emphasizes removing all waste of effort, time, and inventory costs from the organization. • Reduces or removes needless inventory in a production system.

30. Just-In-Time (JIT) • Define Value-Added Activities • Necessary activities in a production or service process that customers identify as valuable and for which they are willing to pay. • Define Non-Value-Added Activities Unnecessary activities in a production or service process that customers typically do not see or care about and for which they are unwilling to pay.

31. The Point Is . . .