Lecture 4: Activity Based Management IFAP - 2010

Objectives Describe Activity-based management and explain its relationship to ABC Explain process value analysis Explain activity performance measurement IFAP - 2010

Activity Based Management Once product costs are obtained using ABC, info can be used in decision making Called Activity Based Management IFAP - 2010

The Definition: ABM ABM is a systemwide, integrated approach that focuses management’s attention on activities with the objective of improving customer value and the profit achieved by providing this value. Improving process means improving the way activities perform Management activities, not costs, is the key to succesfull control of a firm ABC is the major source of information for activity-based management. Activity-based management encompasses both product costing and process value analysis. The activity-based management model has two dimension: a cost dimension and a process dimension. IFAP - 2010

The Two-Dimensional Activity-Based Management Model IFAP - 2010

The Objectives: ABM Improving decision making Reducing costs by continuous improvement IFAP - 2010

Process Dimension Processes are the way things are done to change process has to change the way things done Methods of changing processes: Process improvement Process innovation Process creation IFAP - 2010

Process Value Analysis Process value analysis is fundamental to activity-based responsibility accounting Focuses on accountability for activities rather than costs emphasizes the maximization of systemwide performance instead of individual performance. Process value analysis is concerned with: (1) Driver analysis (2) Activity analysis (3) Performance measurement IFAP - 2010

Process Value Analysis Driver analysis is the effort expended to identify the factors that are the root causes of activity costs. Activity analysis is the 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. IFAP - 2010

Driver Analysis Process of identifying the factors that are the root causes for costs of an activity (searching for root causes) Activity input : resources consumed by the activity in producing output Activity output: result or product of an activity IFAP - 2010

Process Value Analysis Value-Added Activities: are those activities necessary to remain in business. Mandatory-value added activities Discretionary-value added activities It has to meet all 3 conditions: 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. IFAP - 2010

Process Value Analysis Non-value-added activities : are the unnecessary activities. These activities should be eliminanated. Five major non-value added activities: scheduling, moving waiting inspecting storing IFAP - 2010

Activity Analysis 1. Activity elimination 2. Activity selection Activity management can reduce costs in four ways: 1. Activity elimination 2. Activity selection 3. Activity reduction 4. Activity sharing IFAP - 2010

Value-Added Activities Non-Value-Added Activities Cost Reduction Activity Selection Activity Sharing Value-Added Activities Activity Reduction Activity Elimination Non-Value-Added Activities IFAP - 2010

Measures of Activity Performance To assess how well an activity was performed and the result achieved Covered both financial and non-financial forms 3 major dimensions: Efficiency,Quality and Time Financial measures of activity efficiency include: Value-added and nonvalue-added activity costs Trends in activity costs Kaizen standard setting Benchmarking Life cycle costing IFAP - 2010

Formulas for Value- and Non-Value-Added Costs IFAP - 2010

Value- and Nonvalue-Added Cost Reporting Activity Activity Driver SQ AQ SP Welding Welding hours 10,000 8,000 $40 Rework Rework hours 0 10,000 9 Setups Setup hours 0 6,000 60 Inspection Number of inspections 0 4,000 15 Value-added standards call for their elimination IFAP - 2010

Value- and Nonvalue-Added Cost Report Value-Added Nonvalue- Net Activity Costs Added Costs Costs Welding $400,000 $80,000 $480,000 Rework 0 90,000 90,000 Setups 0 360,000 360,000 Inspection 0 60,000 60,000 Total $400,000 $590,000 $990,000 IFAP - 2010

Trend Report: Nonvalue-Added Costs Activity 2006 2007 Change Welding $80,000 $ 50,000 $ 30,000 Rework 90,000 70,000 20,000 Setups 360,000 200,000 160,000 Inspection 60,000 35,000 25,000 Total $590,000 $355,000 $235,000 IFAP - 2010

BENCHMARKING Use the best practices as the standard for evaluating activity performance Internal benchmarking External Benchmarking competitive Functional  Generic IFAP - 2010

Why ABM Implementations Fail Implementing Activity-Based Management Why ABM Implementations Fail Lack of support of higher-level management. Failure to maintain support from higher-level management. Resistance to change. Failure to integrate the new system. IFAP - 2010