Chapter 6 Activity-Based Management

1. IDIS 364 – Spring 2007 Chapter 6 Activity-Based Management

2. Activity-based Costing and Management (ABCM) • ABCM rests on this premise: • Products require activities • Activities consume resources

3. Activity-based Costing and Management (ABCM) • To understand a product’s costs, one must: • Identify activities required to make the product • Identify resources used to provide for those activities • Figure the cost of those resources

4. Activity-based Costing and Management (ABCM) • To be competitive, managers must know both: • Activities involved in making the goods or providing the services, and • The cost of those activities

5. Activity-based Costing and Management (ABCM) • ABCM has 2 parts: • The costing part known as Activity-based Costing (ABC) • The management part known as Activity-Based management (ABM)

6. Activity-based Costing and Management (ABCM) • 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

7. Strategic Use of ABCM • Managers use activity-based information in 2 ways: • To shift the mix of activities and products away from less profitable to more profitable operations • To help them become a low-cost producer or seller

8. Activity Analysis • Involves 4 steps: • Chart activities used to complete the product or service • Classify activities as value-added or non-value-added • Eliminate non-value-added activities • Continuously improve & reevaluate efficiency of activities or replace them with more efficient activities

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

10. Traditional Allocation Methods • Plantwide allocation • Uses the entire plant as a cost pool • Simple organizations with only a few departments and little variety in activities might use this method • Department allocation • Uses separate cost pools with different overhead allocation rates for each department

11. Activity-Based Costing • Activity-based costing (ABC) • Assigns costs first to activities • Then to products based on each product’s use of activities

12. Activity-Based Costing Methods • Requires the following steps: 1. Identify activities that consume resources and assign costs to those activities 2. Identify cost drivers associated with each activity A cost driver is a factor that causes or “drives” an activity’s costs 3. Compute a cost rate for each cost driver 4. Assign costs to products

13. 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

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

15. Resources Used Vs. Resources Supplied • ABC estimates cost of resources used by an activity as: Cost driver rate X cost driver volume • Cost of Resources supplied = amount spent on the activity • Difference between resources used and supplied is unused capacity

16. End of Chapter 6