Fundamentals of Cost Management Chapter 10 Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Using Activity-Based Cost Management to Add Value Activity-based cost management uses activity analysis in decision making. Activity-based costing focuses on activities in allocating overhead costs to products. Activity-based management focuses on managing activities to reduce costs. L.O. 1 Explain the concept of activity-based cost management

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

Managing the Costs of Customers and Suppliers L.O. 3 Describe how the actions of customers and suppliers affect a firms costs. Information on customer profitability is important for managers, so they can make decisions that will improve firm performance

Using ABC Costing: Customers and Suppliers L.O. 4 Use activity-based costing methods to assess customer and supplier costs. Step 1:Identify the activities that consume resources. Step 2:Identify the cost driver associated with each activity. Step 3:Compute a cost rate per cost driver for each unit or transaction. Step 4:Assign costs to customers by multiplying the cost driver rate by the volume of cost driver units consumed by the activity or transaction that occurred. Use the same four-step ABC product costing process to assess customers and suppliers

Cost of Customers Step 1: Identify the Activities LO4 What activities consume resources for Reds delivering service? Process Flow of the Delivery Service – Red's Lumber Enter order Pick order Deliver order

Cost of Customers Step 2: Identify the Cost Drivers LO4 Cost Driver Number of orders entered Number of items picked Number of deliveries made Order value Activity Entering order Picking order Delivering order Delivery administration

Cost of Customers Step 3: Compute the Cost Driver Rates LO4 Computation of Cost Driver Rates – Red's Lumber Entering order Picking order Delivering order Delivery administration Activity $100,000 $150,000 $300,000 $250,000 10,000 orders 75,000 items 12,500 deliveries $5,000,000 order value $10 per order $ 2 per item $24 per delivery 5% of value Activity Cost Cost Driver Volume Cost Driver Rate ÷÷÷÷÷÷÷÷ ========

Cost of Customers Step 4: Assign Costs Using ABC LO4 Cost Driver Information by Customer – Red's Lumber Number of orders Number of items Number of deliveries Order value (total sales) $50, $50,000 JackJillCost Driver

Cost of Customers Step 4: Assign Costs Using ABC LO4 Entering order $10 per order Picking order $2 per item) Delivering order $24 per delivery Delivery administration Total delivery costs $ 1,500 1,500 4,800 2,500 $10,300 $ 500 1,500 1,200 2,500 $5,700 JackJillActivity Estimated Customer Delivery Costs – Red's Lumber

Using and Supplying Resources L.O. 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

Computing the Cost of Unused Capacity L.O. 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

Computing the Cost of Unused Capacity LO6 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

Managing the Cost of Quality L.O. 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

Cost of Quality L.O. 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

Cost of Quality LO8 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. – Warranty repairs – Product liability – Marketing costs – Lost sales

End of Chapter 10 Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin