Cost Accounting Foundations and Evolutions
Kinney, Prather, Raiborn
Chapter 5 Activity-Based Management and Activity-Based Costing
Learning Objectives (1 of 2)
Identify the focus of activity-based management Explain why non-value-added activities cause costs to increase unnecessarily Explain why cost drivers are designated in activity-based costing
Learning Objectives (2 of 2)
Contrast activity-based costing to the traditional cost accounting system Describe the types of information provided by an activity-based costing/management system Explain when it is appropriate to use activity-based costing
Activity-Based Management
Focuses on activities during production and performance process Improves the value received by customers Enhances profitability
Activity
An activity is a repetitive action performed in fulfillment of a business function
Activity-Based Management
Activity analysis Cost driver analysis Activity-based costing Continuous improvement
Operational control Quality management Business process improvement Performance measurement
ABM
Activity Based Management
External Benefits
Increased customer value Enhanced profitability
Internal Benefits
More efficient production More accurate cost determination More effective performance evaluation
ABM
Activity Analysis
Non-value-added activity Increases time spent on Value-added activity product or service but does Increases worth of not increase worth product or service to a Unnecessary from customer customer perspective Customer is willing to Can be reduced, redesigned pay for it or eliminated without affecting market value or quality Business-value-added activities are essential
Process
A process is a series of activities that, when performed together, satisfy a specific objective
Production Distribution Selling Administration
ABM
Activity Analysis
Create a Process Map (detailed flowchart) for each process
Identify each step
ABM
Activity Analysis
Create a Process Map (detailed flowchart) for each process
Identify each step
Create Value Chart
Identify stages and time spent in stages from beginning to end of process
Value-Added Processing Time Service Time Non-Value-Added Inspection Time Transfer Time Idle Time
Cycle Time
Cycle Time = ValueAdded + Activities NonValue-Added Activities
Eliminate or minimize activities that add the most time and cost and the least value
Manufacturing Cycle Efficiency
Manufacturing Cycle Efficiency (MCE)
Value-Added Processing Time Total Cycle Time
Manufacturing Cycle Efficiency
Manufacturing Cycle Efficiency (MCE)
Value-Added Processing Time Total Cycle Time
100% efficiency unrealistic Reducing non-value-added activities will increase Manufacturing Cycle Efficiency Value-added activity usually represents about 10% of total cycle time Just-in-time (JIT) increases MCE
Non-Value-Added Activities
Attributed to following factors
Systemic Physical Human
Eliminating or reducing non-value-added activities that create the most costs will
Increase product/service quality Decrease cycle time and cost
ABM
Cost Driver Analysis
Cost drivers are factors that have a direct cause-effect relationship to a cost
Limit the number of cost drivers Cost of measurement should not exceed benefit of using the cost driver Easy to understand Directly related to activity being performed Appropriate for measurement
A Management Tool
Combine Activity analysis
What activities are non-value-added?
Cost driver analysis
What causes costs to be incurred?
ABM
Cost Driver Analysis
Unit-level costs
direct material, direct labor
Batch-level costs
setup, inspection
Product/process-level costs
engineering changes, product development
Organizational or facility costs
building depreciation, plant managers salary
Product Cost Behavior
Unit-level costs are variable in relation to change in production volume Batch, product/process, and organizational level costs are variable for reasons other than changes in production volume
Product Cost
Unit-Level Costs Batch-Level Costs Allocate over number of units produced Allocate over number of units in batch Allocate over number of units produced in related product line Cost per unit
Cost per unit in batch
Product/ProcessLevel Costs
Cost per unit in product line
For each product line
Product and Company Profitability
Unit Batch Product
Total product revenue <Total product cost> Net product margin <Organizational/facility-level costs> Company profit or loss Not GAAP
ABM
Activity-Based Costing
Recognizes several levels of costs Accumulates costs into related cost pools Uses multiple cost drivers to assign costs to products and services
When to Use ABC
Companies use ABC when
They have a wide variety of products or services High overhead costs are not proportional to the unit volume of individual products Automation makes it difficult to assign overhead to products using direct labor or machine hours Profit margins are difficult to explain Hard-to-make products show big profits and easy-tomake products show losses
Two-Step Allocation
Collect costs in general ledger and subsidiary accounts Identify activity centers
Choosing an Activity Center
Geographical proximity of equipment Centers of managerial responsibility Magnitude of product costs Choose a manageable number of activity centers
Collect costs in general ledger and subsidiary accounts Identify activity centers Accumulate costs into activity center cost pools
Identify cost drivers
Two-Step Allocation
ABC Cost Pools
Assumptions about activity center cost pools Costs in each cost pool are
Driven by homogenous activities Strictly proportional to the activity
Collect costs in general ledger and subsidiary accounts Identify activity centers Accumulate costs into activity center cost pools cost drivers Allocate costs to products and services
activity driver measures demands placed on activities, thus, the resources consumed by products/services
Two-Step Allocation
Activity Drivers
Reports requested Job change actions Hiring actions Training hours Transactions processed Engineering changes Defects discovered Repair hours Material requisitions Purchase requisitions Space occupied Set-ups Moves Employees
Traditional vs. ABC Costing
When ABC implemented
Cost reduced for high volume, standard products Cost increased for low-volume, complex specialty products
Long-Term Variable Costs
Cost drivers
Product variety number of different types of products Product complexity number of processes through which a product flows
ABM
ABC Costing Considerations
Number and diversity of products/services produced Diversity and differential degree of support services used for different products Extent to which common processes are used Effectiveness of current cost allocation methods Rate of growth of period costs
ABM
Use ABC Costing when.
1. 2. 3. 4. Product Variety and Process Complexity Lack of Commonality in Overhead Costs Problems with Current Cost Allocations Changes in Business Environment
ABM
Use ABC Costing when.
1. Product Variety and Process Complexity
Caused by mass customization Too many choices, opportunity for errors Pareto Principle Commonality of parts Reduced by Simultaneous (or Concurrent) Engineering Design for Manufacturability
ABM
Use ABC Costing when.
2. Lack of Commonality in Overhead Costs
- Some products/services use substantially more overhead than others
1. Problems with Current Cost Allocations
- Significant changes in process with no change in cost allocations - Expense majority of period costs when incurred
ABM
Use ABC Costing when.
4. Changes in Business Environment
Increase in competition Change in management strategy
ABM
Continuous Improvement
Eliminates non-value-added activities to reduce cycle time Makes products/performs services with zero defects Reduces product costs on an ongoing basis Simplifies products and processes ABC Costing Supports Continuous Improvement
Criticisms of ABC
Significant amount of time and cost to implement Must overcome barriers to change Does not conform to GAAP May not promote total quality management
ABM
Advantages of ABC and ABM
Identify and monitor significant technology costs Trace technology costs directly to products Identify the cost drivers that create or influence cost Identify activities that do not contribute to perceived customer value
ABM
Advantages of ABC and ABM
Illustrate the impact of new technologies on all elements of performance Translate company goals into activity goals Analyze the performance of activities across business functions Analyze performance problems Promote standards of excellence
Questions
What are the differences between activitybased costing and traditional cost accounting? What are cost drivers and activity drivers? What are two advantages and two criticisms of activity-based costing?
