Activity- and Strategy-Based Responsibility Accounting CHAPTER

After studying this chapter, you should be able to: Objectives 1. Compare and contrast functional-based, activity-based, and strategic-based responsibility accounting systems. 2. Explain process value analysis. 3. Describe activity performance measurement. 4. Discuss the basic features of the Balanced Scorecard. After studying this chapter, you should be able to:

Responsibility Accounting Model The responsibility accounting model is defined by four essential elements: Assigning responsibility Establishing performance measures or benchmarks Evaluating performance Assigning rewards

Types of Responsibility Accounting Management accounting offers the following three types of responsibility accounting systems. Functional-based Activity-based Strategic-based

Based Responsibility Accounting System Functional- Based Responsibility Accounting System A functional-based responsibility accounting system assigns responsibility to organizational units and expresses performance measures in financial terms. It is the responsibility accounting system that was developed when most firms were operating in relatively stable environments.

Elements of a Functional-Based Responsibility Accounting System

Responsibility Is Defined Individual in Charge Organizational Unit Responsibility Is Defined Operating Efficiency Financial Outcomes Performance Measures Are Established Unit Budgets Standard Costing Static Standards Currently Attainable Stds. Performance Is Measured Financial Efficiency Controllable Costs Actual vs. Standard Financial Measures Individuals Are Rewarded Based on Financial Performance Promotions Bonuses Profit Sharing Salary Increases

Based Responsibility Accounting System Activity- Based Responsibility Accounting System An activity-based responsibility accounting system assigns responsibility to processes and uses both financial and nonfinancial measures of performance. It is the responsibility accounting system developed for those firms operating in continuous improvement environments.

Elements of an Activity-Based Responsibility Accounting System

Responsibility Is Defined Process Responsibility Is Defined Team Value Chain Financial Performance Measures Are Established Optimal Dynamic Process Oriented Value-Added Performance Is Measured Time Reductions Quality Improvement Cost Reductions Trend Measures Individuals Are Rewarded Based on Multidimensional Performance Promotions Bonuses Gain- Sharing Salary Increases

Based Responsibility Accounting System Strategy- Based Responsibility Accounting System A strategic-based responsibility accounting system (Balanced Scorecard) translates the mission and strategy of an organization into operational objectives and measures for four different perspectives: The financial perspective The customer perspective The process perspective The infrastructure (learning and growth) perspective

Elements of a Strategy-Based Responsibility Accounting System

Responsibility Is Defined Customer Responsibility Is Defined Financial Process Infrastructure Performance Measures Are Established Communica-tion Strategy Balanced Measures Alignment of Objectives Link to Strategy Performance Is Measured Financial Measures Customer Measures Process Measures Infrastructure Measures Individuals Are Rewarded Based on Multidimensional Performance Promotions Bonuses Gain- Sharing Salary Increases

Activity-Based Management (ABM) Activity-based management (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. 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.

Activity-Based Management Model Cost Dimension Resources Process Dimension Driver Analysis Why? Activities What? Performance Analysis How well? Products and Customers

Process Value Analysis Process value analysis is fundamental to activity-based responsibility accounting, focuses on accountability for activities rather than costs, and emphasizes the maximization of systemwide performance instead of individual performance. Process value analysis is concerned with: Driver analysis Activity analysis Activity performance measurement

Activity analysis should produce four outcomes: Activity analysis is the process of identifying, describing, and evaluating the activities an organization performs. Activity analysis should produce four outcomes: What activities are done. 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.

Value-Added Activities Those activities necessary to remain in business are called value-added activities. Value-Added Activities

Value-Added Activities Activities needed to comply with the reporting requirements, such as the SEC, are value-added by a mandate. Value-Added Activities

Value-Added Activities A discretionary activity is classified as value-added provided it simultaneously satisfies three 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. Value-Added Activities

Nonvalue-Added Activities All activities other than those essential to remain in business are referred to as nonvalue-added activities. Nonvalue-Added Activities

Nonvalue-Added Activities Scheduling Moving Waiting Inspecting Storing Nonvalue-Added Activities

Activity Analysis Can Reduce Costs in Four Ways: Activity elimination Activity selection Activity reduction Activity sharing

Efficiency Quality Time Measures of Activity Performance Efficiency Quality Time

Measures of Activity Performance Financial measures of activity efficiency include: Value and nonvalue-added activity cost reports Trends in activity cost reports Kaizen standard setting Benchmarking Life-cycle costing

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

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

Formulas Value-added costs = SQ x SP Nonvalue-added costs = (AQ – SQ)SP Where SQ = The value-added output level of an activity SQ = The standard price per unit of activity output measure AQ = The actual quantity used of flexible resources or the practical activity capacity acquired for committed resources

Value- and Nonvalue-Added Cost Report Value-Added Nonvalue- Actual Activity Costs Added Costs Costs Welding $400,000 $ - 80,000 $320,000 Rework 0 90,000 90,000 Setups 0 360,000 360,000 Inspection 0 60,000 60,000 Total $400,000 $430,000 $830,000

Trend Report: Nonvalue-Added Costs Activity 2003 2004 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 $430,000 $355,000 $235,000

The Role of Kaizen Standards Kaizen costing is concerned with reducing the costs of existing products and processes. Controlling this cost reduction process is accomplished through the repetitive use of two major subcycles: (1) the kaizen or continuous improvement cycle, and (2) the maintenance cycle.

Kaizen Cost Reduction Process Check Check Act Act Do Do Plan Search Lock in Standard Kaizen Subcycle Maintenance Subcycle

Benchmarking uses best practices as the standard for evaluating activity performance.

Activity Capacity Management Activity capacity is the number of times an activity can be performed.

Activity Capacity Variance AQ = Activity capacity acquired (practical capacity) SQ = Activity capacity that should be used AU = Actual usage of the activity SP = Fixed activity rate SP x SQ $2,000 x 0 $0 SP x AQ $2,000 x 60 $120,000 SP x AU $2000 x 40 $80,000 Activity Volume Variance $120,000 U Unused Capacity Variance $40,000 F

Life-Cycle Cost Commitment Curve 100 90 80 70 60 50 40 30 20 10 Cost Commitment Curve 90 percent of life-cycle costs are committed at this point Planning Design Testing Production Logistics

Target Costing A target cost is the difference between the sales price needed to capture a predetermined market share and the desired per-unit profit. Example: Current product specifications and the targeted market share call for a sales price of $250,000. The required profit is $50,000 per unit. The target cost is computed as follows: $250,000 – $50,000 = $200,000

Target-Costing Model Target Price Market Share Objective Product Functionality Target Profit Target-Costing Model Target Cost Product and Process Design NO Target Cost Met? Produce Profit YES

Unit Cost and Price Information for New Product Life-Cycle Costing: Budgeted Costs and Income Unit Cost and Price Information for New Product Unit production cost $ 6 Unit life-cycle cost 10 Unit whole-life cost 12 Budgeted unit selling price 15

Development costs $200,000 ---- ---- $ 200,000 Budgeted Costs Item 2003 2004 2005 Item Total Development costs $200,000 ---- ---- $ 200,000 Production costs ---- $240,000 $360,000 600,000 Logistic costs ---- 80,000 120,000 200,000 Annual subtotal $200,000 $320,000 $480,000 $1,000,000 Postpurchase costs --- 80,000 120,000 200,000 Annual total $200,000 $400,000 $600,000 $1,200,000 Units produced 40,000 60,000 Note: The post purchase costs are costs incurred by the customer and are not included in the budgeted income e statement.

Budgeted Product Income Statements Annual Cumulative Year Revenues Costs Income Income Budgeted Product Income Statements 2003 ---- -$200,000 -$200,000 -$200,000 2004 $600,000 -320,000 280,000 80,000 2005 900,000 -480,000 420,000 500,000

Performance Report for Life-Cycle Costs Year Item Actual Costs Budgeted Costs Variance 2003 Development $190,000 $200,000 $10,000 F 2004 Production 300,000 240,000 60,000 U Logistics 75,000 80,000 5,000 F 2005 Production 435,000 360,000 75,000 U Logistics 110,000 120,000 10,000 F Analysis: Production costs were higher than expected because insertions of diodes and integrated circuits also drive costs (both production and postpurchase costs). Conclusion: The design of future products should try to minimize total insertions.

The Balanced Scorecard The Balanced Scorecard translates an organization’s mission and strategy into operational objectives and performance measures for four different perspectives: The Balanced Scorecard The financial perspective The customer perspective The internal business process perspective The learning and growth perspective

Strategy, according to Robert Kaplan and David Norton, is defined as “. . . choosing the market and customer segments the business unit intends to serve, identifying the critical internal and business processes that the unit must excel at to deliver the value propositions to customers in the targeted market segments, and selecting the individual and organizational capabilities required for the internal, customer, and financial objectives.”

Strategy-Translation Process Vision and Strategy Financial Infrastructure Customer Process Objectives Measures Strategy-Translation Process Targets Initiatives

Testable Strategy Illustrated Increase Sales Increase Profits Financial Increase Customer Satisfaction Increase Market Share Customer Reduce Defective Units Redesign Products Process Testable Strategy Illustrated Quality Training Infra-structure

Summary of Objectives and Measures: Financial Perspective Objectives Measures Revenue Growth: Increase the number of new Percentage of revenue products from new products Create new applications Percentage of repeat customers Develop new customers and Percentage of revenue from markets new sources Adopt a new pricing strategy Product and customer profitability

Objectives Measures Cost Reduction: Reduce unit product cost Unit product cost Reduce unit customer cost Unit customer cost Reduce distribution channel cost Cost per distribution channel Asset Utilization: Improve asset utilization Return on investment Economic value added

Summary of Objectives and Measures: Customer Perspective Objectives Measures Core: Increase market share Market share (percentage of market) Increase customer retention Percentage of repeat customers Increase customer acquisition Number of new customers Increase customer satisfaction Ratings from customer surveys Increase customer profitability Customer profitability

Objectives Measures Performance Value: Decrease price Price Decrease postpurchase costs Postpurchase costs Improve product functionality Ratings from customer surveys Improve product quality Percentage of returns Increase delivery reliability On-time delivery percentage Aging schedule Improve product image and Ratings from customer reputation surveys

Actual Conversion Cost per Unit Theoretical Conversion Cost per Unit Standard costs per minute = $1,600,000/400,000 = $4 per minute Actual cycle time = 60 minutes/10 units = 6 minutes per unit Actual conversion costs = $4 x 6 = $24 per unit Theoretical Conversion Cost per Unit Theoretical cycle time = 60 minutes/12 units = 5 minutes per unit Theoretical conversion costs = $4 x 5 = $20 per unit

Summary of Objectives and Measures: Process Perspective Objectives Measures Innovation: Increase the number of new Number of new products vs. products planned Increase proprietary products Percentage of revenue from proprietary products Decrease new product Time to market (from start development time to finish)

Objectives Measures Operations: Increase product quality Quality costs Output yields Percentage of defective units Increase process efficiency Unit cost trends Output/input(s) Decrease process time Cycle time and velocity MCE Postsales Service: Increase service quality First-pass yields Increase service efficiency Cost trends Decrease service time Cycle time

Summary of Objectives and Measures: Learning and Growth Perspective Objectives Measures Increase employee capabilities Employee satisfaction ratings Employee turnover percentage Employee productivity (revenue/employee) Hours of training Strategic job coverage ratio (percentage of critical job requirements filled)

Objectives Measures Increase motivation and Suggestions per employee alignment Suggestions implemented per employee Increase information systems Percentage of processes with capabilities real-time feedback capabilities Percentage of customer-facing employees with on-line access to customer and product information

Chapter Ten The End