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PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Fundamentals of Cost Management Chapter 10

10-3 Using Activity-Based Cost Management to Add Value LO 10-1 Describe how activity-based cost management can be used to improve operations. LO 10-1 Describe how activity-based cost management can be used to improve operations.  Activity-based costing (ABC) is a system used to assign costs to products based on the products’ use of activities, which are the discrete tasks an organization undertakes to make or deliver the product.  The value chain is the set of activities that transforms raw resources into products for customers. Activities in the value chain are the things that customers will pay for.  Activity-based costing focuses on activities in allocating overhead costs to products.  Activity-based management focuses on managing activities to reduce costs. LO 1

10-4 Using Activity-Based Cost Information to Improve Processes The first step in ABCM is activity analysis. We begin by analyzing the costs of key activities. Activity analysis has six steps: 1.Identify what the customer wants or expects from the firm’s products or services, including key features, price, and quality. 2.Chart, from start to finish, the company’s activities for completing the product. 3.Develop activity-based costing data for each activity, based on the resources used in each activity. 4.Classify all activities as value-added or non-value-added. 5.Compare the costs of each activity with the value that customers assign to it. (The value of non-value-added activities would be zero.) 6.Continuously improve the efficiency of all value-added activities. Eliminate or reduce non-value-added activities. The first step in ABCM is activity analysis. We begin by analyzing the costs of key activities. Activity analysis has six steps: 1.Identify what the customer wants or expects from the firm’s products or services, including key features, price, and quality. 2.Chart, from start to finish, the company’s activities for completing the product. 3.Develop activity-based costing data for each activity, based on the resources used in each activity. 4.Classify all activities as value-added or non-value-added. 5.Compare the costs of each activity with the value that customers assign to it. (The value of non-value-added activities would be zero.) 6.Continuously improve the efficiency of all value-added activities. Eliminate or reduce non-value-added activities. LO 1

10-5 Using Cost Hierarchies LO 10-2 Use the hierarchy of costs to manage costs. Cost Example Supplies Lubricating oil Machine repair Supplies Lubricating oil Machine repair Hierarchy Level Volume related Cost Driver Example Direct labor cost Machine-hours Number of units Direct labor cost Machine-hours Number of units Setup costs Material handling Shipping costs Setup costs Material handling Shipping costs Batch related Setup hours Production runs Number of shipments Setup hours Production runs Number of shipments Compliance costs Design and specification costs Compliance costs Design and specification costs Product related Number of products General plant costs Plant admin. costs General plant costs Plant admin. costs Facility related Direct costs Value added Direct costs Value added LO 2

10-6 Managing the Costs of Customers and Suppliers Customers (and suppliers) use resources. Some customers use more resources than others. Think about the last time you stood in line to purchase a ticket, check in for a flight, or make a transaction in a bank. Many people ahead of you are purchasing the same service (a ticket, a flight, or a deposit), but some take longer (sometimes much longer) to complete the transaction. The additional time those customers take adds cost to the company. LO 3

10-7 Cost of Customers Step 1: Identify the Activities What activities consume resources for Red’s delivering service? Process Flow of the Delivery Service – Red's Lumber LO 4

10-8 Cost of Customers Step 2: Identify the Cost Drivers LO 4

10-9 Using and Supplying Resources LO 10-5 Distinguish between resources used and resources supplied. LO 10-5 Distinguish between resources used and resources supplied. Resources used: Cost driver rate multiplied by the cost driver volume Resources supplies: Expenditures or the amounts spent on a specific activity Unused capacity: Difference between resources used and resources supplied LO 5

10-10 Computing the Cost of Unused Capacity LO 10-6 Design cost management systems to assign capacity costs. Actual activity: Actual volume for the period Theoretical capacity: Amount of production possible under ideal conditions with no time for maintenance, breakdowns, or absenteeism. LO 6

10-11 Computing the Cost of Unused Capacity Practical capacity: Amount of production possible assuming only the expected downtime for scheduled maintenance and normal breaks and vacations. Normal activity: Long-run expected volume LO 6

10-12 Managing the Cost of Quality LO 10-7 Describe how activities that influence quality affect costs and profitability. Quality as defined by the customer Organization is managed to excel on all dimensions LO 7

10-13 External View of Quality: Customer Expectations Tangible: – Performance – Taste – Functionality Intangible: – Customer service – Delivery time LO 7

10-14 Cost of Quality LO 10-8 Compare the costs of quality control to the costs of failing to control quality. Prevention:Costs incurred to prevent defects in the products or services being produced – Materials inspection – Process control – Quality training – Machine inspection – Product design Appraisal:Costs incurred to detect individual units of products that do not conform to specifications – End-of-process sampling – Field testing LO 8

10-15 Cost of Quality Internal failure:Costs incurred when nonconforming products and services are detected before being delivered to customers. – Scrap – Rework – Reinspection/Retesting External failure:Costs incurred when nonconforming products and services are detected after being delivered to customers. – Warrant repairs – Product liability – Marketing costs – Lost sales LO 8

10-16 End of Chapter 10