Activity-Based Management

1. Activity-Based Management Chapter 12

2. CHAPTER 12 Objectives Describe how activity-based management and activity-based costing differ Define process value analysis Describe activity-based financial performance measurement Discuss the implementation issues associated with an activity-based management system

3. CHAPTER 12 Objectives Explain how activity-based management is a form of responsibility accounting, and tell how it differs from financial-based responsibility accounting

4. The Relationship of Activity-Based Costing and Activity-Based Management Activity-based management (ABM): a systemwide, integrated approach that focuses management’s attention on activities with the objectives of improving customer value and the profit achieved by providing this value Activity-based costing (ABC): major source of information for activity based management LO-1

5. EXHIBIT 12.1—The Two-Dimensional Activity-Based Management Model LO-1

6. Process Value Analysis Fundamental to activity-based responsibility accounting, focuses on accountability for activities rather than costs, and emphasizes the maximization of system wide performance instead of individual performance Is concerned with (1) driver analysis, (2) activity analysis, and (3) performance measurement LO-2

7. Process Value Analysis Driver Analysis: Defining Root Causes Effort expended to identify the factors that are the root causes of activity costs Root Causes are identified by asking ‘why’ questions • Once the root cause is known, then action can be taken to improve the activity LO-2

8. Process Value Analysis Activity Analysis: Identifying and Assessing Value Content Process of identifying, describing, and evaluating the activities an organization performs Activity analysis should produce four outcomes • What activities are performed • How many people perform the activities • The time and resources are required to perform the activities • An assessment of the value of the activities to the organization LO-2

9. Process Value Analysis Value Added Activities Necessary to remain in business Contribute to customer value and/or help meet an organization’s needs Comply with legal mandates LO-2

10. Process Value Analysis Value Added Activities If the following conditions are simultaneously met, a discretionary activity is classified as value-added • The activity produces a change of state • The change of state was not achievable by preceding activities • The activity enables other activities to be performed Value added costs are the costs to perform value added activities with perfect efficiency LO-2

11. Process Value Analysis Non-Value Added Activities Unnecessary and are not valued by internal or external customers Fail to produce a change in the product’s state or replicate work because it wasn’t done correctly the first time Non-value-added costs are costs that are caused either by non-value-added activities or the inefficient performance of value-added activities LO-2

12. Process Value Analysis Non-Value Added Activities In manufacturing, five major activities are considered wasteful and unnecessary • Scheduling • Moving • Waiting • Inspecting • Storing LO-2

13. Process Value Analysis Cost Reduction through Activity Management Kaizen costing: characterized by constant, incremental improvements to existing processes and products Activity management can reduce costs in four ways • Activity elimination • Activity selection • Activity reduction • Activity sharing LO-2

14. Process Value Analysis Assessing Activity Performance Measures of activity performance are both financial and nonfinancial and center on three major dimensions • Efficiency: concerned with the relationship of activity outputs to activity inputs • Quality: concerned with doing the activity right the first time it is performed • Time: time required to perform an activity is critical Time measures of performance tend to be nonfinancial, whereas efficiency and quality measures are both financial and nonfinancial LO-2

15. Financial Measures of Activity Efficiency Value-added and non-value-added activity costs Trends in activity costs Kaizen standard setting Benchmarking Activity flexible budgeting Activity capacity management LO-3

16. Financial Measures of Activity Efficiency Reporting Value-Added and Non-Value-Added Costs A firm should identify and formally report the value- and non-value-added costs of each activity A cost-reporting system is an important ingredient in an activity-based responsibility accounting system The value added standard calls for the complete elimination of non-value-added activities • A value-added standard identifies the optimal activity output LO-3

17. EXHIBIT 12.2—FOrmulas for Value- and Non-Value-Added Costs LO-3

18. Financial Measures of Activity Efficiency Drivers and Behavioral Effects Activity output measures are needed to compute and track non-value-added costs If a team’s performance is affected by its ability to reduce non-value-added costs, then the selection of activity drivers and the way the drivers are used can affect behavior LO-3

19. Financial Measures of Activity Efficiency The Role of Kaizen Standards Kaizen costing is concerned with reducing costs by identifying small, continuous improvements for existing products and processes Controlling this cost reduction process is accomplished through the repetitive use of two major subcycles: (1) the kaizen or continuous improvement cycle, and (2) the maintenance cycle The kaizen subcycle is defined by a Plan-Do-Check-Act sequence LO-3

20. EXHIBIT 12.3—Kaizen Cost Reduction Process LO-3

21. Financial Measures of Activity Efficiency Benchmarking Complementary to kaizen costing and activity-based management Uses best practices found within and outside the organization as the standard for evaluating and improving activity performance LO-3

22. Financial Measures of Activity Efficiency Benchmarking Internal benchmarking: benchmarking against internal operations External benchmarking: benchmarking that involves comparison with others outside the organization LO-3

23. Financial Measures of Activity Efficiency Activity Flexible Budgeting The prediction of what activity costs will be as activity output changes LO-3

24. EXHIBIT 12.4—Flexible Budget: Direct Labor Hours LO-3

25. EXHIBIT 12.5—ACTIVITY Flexible Budget LO-3

26. EXHIBIT 12.6—ACTIVITY-BASED PERFORMANCE REPORT LO-3

27. Financial Measures of Activity Efficiency Activity Capacity Management Activity capacity is the number of times an activity can be performed Activity drivers measure activity capacity Capacity variances: to determine the potential for improvement and the progress made in the objective of eliminating waste, two capacity variances are defined and calculated: the activity volume variance and the unused capacity variance LO-3

28. Financial Measures of Activity Efficiency Activity Capacity Management Capacity Variances • The activity volume variance is the difference between the actual activity level acquired (practical capacity, AQ) and the value-added standard quantity of activity that should be used (SQ), multiplied by the budgeted activity rate (SP) • The unused capacity variance is defined as the difference between activity availability (AQ) and activity usage (AU), multiplied by the budgeted activity rate (SP) LO-3

29. Implementing Activity-Based Management Objectives of activity-based management (ABM) • Improving decision making by providing accurate cost information • Reducing costs by encouraging and supporting continuous improvement efforts LO-4

30. EXHIBIT 12.7—ABM Implementation Model LO-4

31. Implementing Activity-Based Management Systems planning provides the justification for implementing ABM and addresses the following issues • The purpose and objectives of the ABM system • The organization’s current and desired competitive position • The organization’s business processes and product mix • The timeline, assigned responsibilities, and resources required for implementation • The ability of the organization to implement, learn, and use new information LO-4

32. Implementing Activity-Based Management Why ABM Implementations Fail Lack of support of higher-level management Operating and sales managers do not have the expertise to use the new activity information Resistance to change Failure to integrate the new system LO-4

33. Financial-Based Versus Activity-Based Responsibility Accounting Responsibility accounting is a fundamental tool of managerial control • Objective isto influence behavior in such a way that individual and organizational initiatives are aligned to achieve a common goal or goals LO-5

34. Financial-Based Versus Activity-Based Responsibility Accounting Responsibility accounting is defined by four essential elements • Assigning responsibility • Establishing performance measures or benchmarks • Evaluating performance • Assigning rewards LO-5

35. EXHIBIT 12.8—The Responsibility Accounting Model LO-5

36. Financial-Based Versus Activity-Based Responsibility Accounting Three types of responsibility accounting systems have evolved over time • Financial-based • Activity-based • Strategic-based LO-5

37. Financial-Based Versus Activity-Based Responsibility Accounting Financial–based responsibility accounting system: assigns responsibility to organizational units and expresses performance measures in financial terms Activity-based responsibility accounting system: Assigns responsibility to processes and uses both financial and nonfinancial measures of performance LO-5

38. EXHIBIT 12.9—Responsibility Assignments Compared LO-5

39. EXHIBIT 12.10—performance measures compared LO-5

40. EXHIBIT 12.11— performance evaluation compared LO-5

41. EXHIBIT 12.12—rewards compared LO-5

42. End of Chapter 12