1 Activity-Based Management CHAPTER 3 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except.

1

Activity-Based Management

CHAPTER 3

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in

part, except for use as permitted in a license distributed with a certain product or service or

otherwise on a password-protected website for classroom use.

PowerPointPowerPoint Presentation by Presentation by

LuAnn BeanLuAnn BeanProfessor of AccountingProfessor of AccountingFlorida Institute of TechnologyFlorida Institute of Technology

Managerial Accounting 11E

Maher/Stickney/Weil

2

CHAPTER GOAL

This chapter shows how ABC and ABM rest on the premise that: Products require activities and activities consume resources. For products to be competitive, managers must knowActivities for producing goods, servicesCost of activities

ABC analyses ways to allocate indirect costs while ABM uses analysis to manage costs.

☼ ☼

3

How do ABC and ABM work?

ABC provides information about profitability in mix of activities, products

ABM encourages managers to use information to become low-cost producer or seller.

LO 1

4

ABM ACTIVITY ANALYSIS

Chart, start to finish, activities used to complete product or service

Classify activities as value-added or non-value-added

Eliminate non-value-added activitiesContinuously improve, reevaluate efficiency

of value-added activities or replace with more efficient activities

LO 1

5

Research and Development

Design Production Marketing Distribution Customer Service

Organization Strategy and Administration

Customer

Value Chain

EX

HIB

ITE

XH

IBIT

3.13.1

LO 1

6

Research and Development

Design Production Marketing Distribution Customer Service

Organization Strategy and Administration

Customer

ABM analyses and evaluates every

step of the Value Chain.

ABM analyses and evaluates every

step of the Value Chain.

Value Chain

EX

HIB

ITE

XH

IBIT

3.1

& 3

.23.

1 &

3.2

LO 1

7

NON-VALUE-ADDED COSTS: Definition

NON-VALUE-ADDED COSTS: Definition

Are costs of activities that the company can eliminate without reducing product

quality, performance, or value.

LO 1

8

Research and Development

Design Production Marketing Distribution Customer Service

Organization Strategy and Administration

Customer

ABM analyses and evaluates every

step of the Value Chain.

ABM analyses and evaluates every

step of the Value Chain.

Value Chain

EX

HIB

ITE

XH

IBIT

3.1

& 3

.23.

1 &

3.2

LO 1

Eliminate

9

ABC ANALYSIS

Potential candidates for elimination because they do not add value areStorageMoving: parts, materials, etc. around the factory

floorIdle timeOther production process components

LO 1

10

EXAMPLE

You and a friend go to dinner. You order tea ($2.50) and a salad ($8.00). Your friend orders appetizer, expensive entree, and dessert. The total bill is $60. Traditional cost allocation leads to splitting the bill, $30 apiece.

What does activity analysis suggest each of you should pay?

LO 2

YOU: $ 10.50 + tax & tip

FRIEND: $49.50 + tax & tip

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ABC COST-BENEFIT

Applying ABC has a cost of information gathering. Managers must take cost-benefit into account. Managers reject activity analysis, staying with traditional

methods that are simpler.Smaller companies don’t need sophisticated information systems

Managers use ABC because information helps them be competitiveComplex organizations facing heavy competition use ABC

Managers use ABC in special circumstances

LO 2

12

COST POOLS

Three major types of cost pools:The “plant” (traditional)

Sets one indirect cost allocation rate plantwide

The department (traditional)Sets indirect cost allocation rates for each department

The activity center (ABC)Determines cost pool for each activity

LO 2

13

ABC STEPS TO FOLLOW

Accountants required to follow four steps:1. Identify activities that consume resources; assign

costs to those activities. Example: purchasing materials

2. Identify cost drivers for each activity.Cost driver for purchasing materials: # of orders

3. Compute a cost rate per cost driver unit.Cost per order

4. Assign costs to products.(Cost per order) X (number of purchase orders)

LO 4

14

COST DRIVER: DefinitionCOST DRIVER: Definition

Is a factor that causes, “drives,” an activity’s

costs.

LO 4

15

EXAMPLE: Cost Drivers

LO 4

Machine hours

Computer time

Labor hours, cost

Items produced, sold

Pounds of material handled

Clients served

Pages typed

Flight hours

Machine setups

Number of surgeries

Purchase orders

Scrap/rework orders

Quality inspections

Hours of testing time

# of parts in product

# of different clients

Miles driven

Which cost drivers listed below would a law firm use?

EX

HIB

ITE

XH

IBIT

3.33.3

16

EXAMPLE: Cost Drivers

LO 4

Machine hours

Computer time

Labor hours, cost

Items produced, sold

Pounds of material handled

Clients served

Pages typed

Flight hours

Machine setups

Number of surgeries

Purchase orders

Scrap/rework orders

Quality inspections

Hours of testing time

# of parts in product

# of different clients

Miles driven

Which cost drivers listed below would a law firm use?

EX

HIB

ITE

XH

IBIT

3.33.3

17

How do managers decide which cost driver to use?

Typically, managers choose a cost driver that causes the

cost.

LO 4

18

COST RATE EQUATION

LO 4

Predetermined indirect cost rate =

Estimated Indirect Cost

÷ Estimated Volume of Allocation Base

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EXAMPLE: Traditional Costing

LO 4

Ciudad Juarez factory makes 2 products: mountain bikes and racing bikes. 1,000 mountain bikes and 200 racing bikes will be produced. Direct materials include

Frames: $100 per mountain bikes and $200 per racing bike

Direct labor: $30 per mountain bike and $60 per racing bike

Overhead, allocated at 5 times direct labor

What would be the cost of each bike under traditional costing?

Continued

20

EXAMPLE: Traditional Costing

LO 4

Continued

Mountain Bikes Racing Bikes

Direct materials $100 $200

Direct Labor 30 60

Manufacturing overhead1,2 150 300

Total cost per bike $280 $560

1 5 * DL

2 ($150 * 1,000 + $300 * 200) = $210,000

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EXAMPLE: ABC Costing

LO 4

Ciudad Juarez factory makes 2 products: mountain bikes and racing bikes. 1,000 mountain bikes and 200 racing bikes will be produced. Direct materials include

Frames: $100 per mountain bikes and $200 per racing bike

Direct labor: $30 per mountain bike and $60 per racing bike

Overhead, allocated by activity costs

What would be the cost of each bike under ABC costing?

Continued

22

EXAMPLE: ABC Costing

LO 4

Activity Rate Cost driver units

Cost Allocated

Cost driver units

Cost Allocated

Purchasing $20/frame 1,000 frames $ 20,000 1,000 frames $ 4,000

Setups $2,000/setup 13 setups 26,000 13 setups 60,000

Inspections $100/inspect hr 200 hours 20,000 200 hours 20,000

Running machines

$30/hour 1,500 hrs 45,000 1,500 hrs 15,000

Total $111,000 $99,000

Mountain Bike Racing Bike

Mountain Bike = $111,000 / 1,000 = $111

Racing Bike = $99,000 / 200 = $495 EXHIBITEXHIBIT 3.53.5

23

COST HIERARCHY: DefinitionCOST HIERARCHY: Definition

Categorizes costs so changes in one cost can be examined for its effects on

other cost categories.

LO 6

24

Activity Category Example

Capacity Size limitations Aircraft depreciation

Customer Needs Special promotions

Product Production needs Route schedules

Batch Batch Fuel, baggage handling

Unit Variable costs Credit card fees

EXAMPLE: Hierarchy of Costs

LO 6

25

RESOURCES USED: DefinitionRESOURCES USED: Definition

Are measured by ABC.

LO 7

26

UNUSED RESOURCES

Knowing the difference between resources used and supplied helps managers to identify unused capacity. Finding unused capacity helps managers reduce or use it.

Knowing the difference between resources used and supplied helps managers to identify unused capacity. Finding unused capacity helps managers reduce or use it.

LO 7

27

LO 7

Imprinting a hierarchy of costs

on ABM statements helps managers understand what

costs can be reduced or better used.

Imprinting a hierarchy of costs

on ABM statements helps managers understand what

costs can be reduced or better used.

EXHIBITEXHIBIT 3.93.9

Capacity-sustaining costs will have

unused resources unless operating at

full capacity.

Capacity-sustaining costs will have

unused resources unless operating at

full capacity.

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End of CHAPTER 3