New Mexico State University Chapter 19 Activity-Based Systems: Activity-Based Management and Just-in-Time Belverd E. Needles, Jr. Marian Powers Sherry K. Mills Henry R. Anderson - - - - - - - - - - - Multimedia Slides by: Dr. Paul J. Robertson New Mexico State University Steve Leask

Activity-Based Management and Activity-Based Costing OBJECTIVE 2 Define activity-based management (ABM) and discuss its relationship with the supply chain and value chain.

Activity-Based Management Activity-based management (ABM) is an approach to management that includes: Identifying all major operating activities. Determining what resources are consumed by each activity. Categorizing the activities as either adding value to a product or service or not adding value.

Activity-Based Management ABM provides financial and operational performance information at the activity level that: Is helpful for making decisions about business segments. Helps managers eliminate waste and inefficiencies and redirect resources to activities that add value to the product or service.

Supply Chains and Value Chains Two tools of ABM, supply chains and value chains, help managers better understand their organization’s external and internal operations.

Supply Chain A supply chain is an interdependent collection of organizations that supplies materials, products, or services to a customer. A supply chain includes suppliers and suppliers’ suppliers as well as customers and customers’ customers.

Value Chain A value chain is a related sequence of value-creating activities within an organization. It helps managers better understand the interdependencies of those activities. A company’s value chain is part of its supply chain.

Value Chain When organizations work cooperatively with others in their supply chain or larger value chain, new processes can be introduced or existing processes redesigned to reduce the total cost of products or services.

Value-Adding and Nonvalue-Adding Activities and Process Value Analysis OBJECTIVE 3 Distinguish between value-adding and nonvalue-adding activities, and describe process value analysis.

Value-Adding Activities A value-adding activity is an activity that adds value to a product or service from the customer’s perspective. Examples include: Assembling a car. Painting a car. Installing brakes on a car.

Nonvalue-Adding Activities A nonvalue-adding activity is an activity that adds cost to a product or service but does not increase its market value. Examples include: Moving materials. Storing materials.

Process Value Analysis Process value analysis (PVA) is an analytical method of identifying all activities and relating them to events that cause or drive the need for the activities and the resources consumed.

Costs and Resources By identifying nonvalue-adding activities, organizations can reduce costs and redirect resources to value-adding activities.

Value-Adding Activities for a Service Organization Western Data Services, Inc. Value-Adding Activities for the Classic Letter Value-Adding Activities How the Activity Adds Value Design the letter Enhances the effectiveness of the communication Create a database of customer Increases the probability that the client names and addresses sorted in will efficiently and effectively reach the ZIP code order targeted customer group Verify the conformity of mailing Ensures that the client’s mailing will information with USPS receive the best postal rate requirements Process the job Creates the client mailing Deliver the letters to the post office Begins the delivery process

Implementing Activity-Based Costing OBJECTIVE 4 Define a cost hierarchy, describe its elements, and explain how a cost hierarchy and a bill of activities are used in activity-based costing.

Cost Hierarchy Many companies use a cost hierarchy to manage the assignment of activity-based costs. A cost hierarchy for a manufacturer typically has four levels: Unit level. Batch level. Product level. Facility level.

Unit-Level Activities Unit-level activities are performed each time a unit is produced: Insertion of a component during assembly.

Batch-Level Activities Batch-level activities are performed each time a batch of goods is produced: These activities vary with the number of batches prepared. Examples: setup, scheduling, and material handling.

Product-Level Activities Product-level activities are performed to support the diversity of products in a manufacturing plant. Examples include: Implementing engineering change notices. Redesigning the installation process.

Facility-Level Activities Facility-level activities are performed to support a facility’s general manufacturing process. Examples include: Lighting the manufacturing plant. Securing the manufacturing plant. Insuring the manufacturing plant.

Cost Hierarchy The frequency of activities varies across activity levels. The cost hierarchy includes both value-adding and nonvalue-adding activities.

Sample Activities in Cost Hierarchies Direct Mail Service: Car Manufacturer: Preparing Bank Activity Level Engine Installation Customer Mailing Unit level Install engine Print and fold letter Test engine Insert letter and other information into envelope Seal and meter envelope Batch level Set up installation process Retool machines Move engines Verify correct postage Inspect engines Bill client Product or Redesign installation Train employees service level process Develop and maintain computer systems and databases Facility or Provide facility management, Provide facility operations level maintenance, lighting, management, security, and space maintenance, lighting, security, and space

Bill of Activities A bill of activities is a list of activities and related costs that is used to compute the costs assigned to activities and the product unit cost.

Bill of Activities More complex bills of activities include cost pool rates and cost driver levels used to assign costs to cost objects. A bill of activities may be used as the primary document or a supporting schedule to calculate the product unit cost in job order or process costing.

Discussion Q. What are the four cost hierarchy levels common to a manufacturer? A. 1. Unit level. 2. Batch level. 3. Product level. 4. Facility level.

The New Manufacturing Environment and JIT Operations OBJECTIVE 5 Define the just-in-time (JIT) operating philosophy and identify the elements of a JIT operating environment.

Traditional Operating Environment In a traditional operating environment, a company usually: 1. Maintains large amounts of inventory. 2. Uses push-through production methods. 3. Purchases materials in larger lot sizes with fewer deliveries. 4. Performs infrequent setups. 5. Manufactures products in batches. 6. Uses a work force skilled in only one area.

The New Environment The new manufacturing environment emphasizes streamlined and improved manufacturing. 1. Waste in materials, labor, space, and production time are reduced. 2. Recordkeeping is reduced. 3. Resources that tie up working capital are reduced.

JIT: Basic Concepts Underlying the new methods are several basic concepts. 1. Simple is better. 2. The quality of the product or service is critical. 3. The work environment must emphasize continuous improvement. 4. Any activity or function that does not add value should be reduced. 5. Goods should be produced only when needed.

JIT Operating Environment The elements of a JIT operating environment are: 1. Maintain minimum inventory levels. 2. Develop pull-through production planning and scheduling. 3. Purchase materials and produce as needed, in smaller lot sizes. 4. Perform quick, inexpensive machine setups.

JIT Operating Environment 5. Create flexible manufacturing work cells. 6. Develop a multiskilled work force. 7. Maintain high levels of product quality. 8. Enforce a system of effective preventive maintenance. 9. Encourage continuous improvement for the work environment.

Accounting for Product Costs in the New Manufacturing Environment OBJECTIVE 6 Identify the changes in product costing that result when a firm adopts a JIT operating environment.

Traditional Operating Environment The traditional operating environment divides the production into five parts: 1. Processing time. 2. Inspection time. 3. Moving time. 4. Queue time. 5. Storage time.

JIT Operating Environment In product costing under JIT, costs associated with processing time are grouped as either materials costs or conversion costs. Conversion costs include the total of direct labor costs and manufacturing overhead costs incurred by a production department, JIT/FMS work cell, or other work center.

Assigning Costs In the JIT operating environment, indirect costs have little correlation with direct labor hours. Since automation has replaced direct labor hours with machine hours, machine hours become more important with JIT.

Indirect Costs Several costs that were treated as indirect costs in a traditional production environment are directly traceable to a JIT production cell. Only costs associated with building occupancy, insurance, and property taxes remain indirect costs of work cells.

Throughput Time The key measure in a JIT operating environment is throughput time. Throughput time is the time it takes to move a product through the entire production process.

Comparison of ABM and JIT OBJECTIVE 8 Compare ABM and JIT as activity-based systems.

Similarities of ABM and JIT ABM and JIT are similar in that both analyze processes and identify value-adding and nonvalue-adding activities. Both seek to eliminate or reduce nonvalue-adding activities. Both seek to improve the allocation of resources.

System Differences The two systems differ in their primary goals. The primary goal of ABM is to calculate the most accurate product cost by using activity-based costing (ABC). The primary goal of JIT is to simplify and standardize production and purchasing activities.

Comparison of ABM and JIT Approaches to Activity-Based Systems ABM JIT Purpose Reduce or eliminate Reduce complexity using work nonvalue-adding cells, standardizing parts, and activities reducing or eliminating inventories and nonvalue-adding production activities Cost Use ABC to assign Reorganize service activities so assignment manufacturing over- that they are performed within head costs to the work cells and manufacturing product cost by overhead costs incurred in the using appropriate work cell become direct costs of cost drivers the products made in the work cell Costing Integrate ABC with Use backflush costing to calculate method either job order or product costs when the products process costing to are completed calculate product costs