ADVANCED MANAGEMENT ACCOUNTING

Activity Based Management

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.

Activity-Based Management Model Cost Dimension Resources Process Dimension Driver Analysis Activities Performance Measures Why? What? 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 Performance measurement

Activity Analysis Activity analysis should produce four outcomes: What activities are performed? How many people perform the activities? The time and resources required to perform the activities. An assessment of the value of the activities to the organization, including a recommendation to select and keep only those that add value.

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.

Nonvalue-Added Activities Nonvalue-Added Activities are activities that add cost and impede performance. Scheduling Moving Waiting Inspecting Storing Examples

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

Activity Performance Measurement Three Dimensions 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

Value- and Nonvalue-Added Cost Reporting Consider the following data: 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 # of inspections 0 4,000 15

Value- and Nonvalue-Added Cost Report (continued) Value- Nonvalue- Activity Added Costs Added Costs Actual Costs Welding $400,000 $ 80,000 $480,000 Rework ---- 90,000 90,000 Setups ---- 360,000 360,000 Inspection ---- 60,000 60,000 Total $400,000 $590,000 $990,000 ======== ======== ========

Trend Report: Nonvalue-Added Costs Activity 2000 2001 Change Welding $ 80,000 $ 50,000 $ 30,000 Rework 360,000 200,000 160,000 Setups 90,000 70,000 20,000 Inspections 60,000 35,000 25,000 Total $590,000 $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.

Improving Performance Through Benchmarking Organization A Share Information Organization B Cost of Processing a Purchase Order is $20 Cost of Processing a Purchase Order is $15 How do we improve?

Activity-Based Budgeting Activity flexible budgeting is the prediction of what activity costs will be as activity output changes.

Flexible Budget: Direct Labor Hours Cost Formula Direct Labor Hours Fixed Variable 10,000 20,000 Direct materials --- $10 $100,000 $200,000 Direct labor --- 8 80,000 160,000 Maintenance $ 20,000 3 50,000 80,000 Machining 15,000 1 25,000 35,000 Inspections 120,000 --- 120,000 120,000 Setups 50,000 --- 50,000 50,000 Purchasing 220,000 --- 220,000 220,000 Total $425,000 $22 $645,000 $865,000 ======= === ======= =======

Activity Flexible Budget Driver: Direct Labor Hours Formula Level of Activity Fixed Variable 10,000 20,000 Direct materials --- $10 $100,000 $200,000 Direct labor --- 8 80,000 160,000 Subtotal $0 $18 $180,000 $360,000 == === Driver: Machine Hours Fixed Variable 8,000 16,000 Maintenance $20,000 $5.50 $64,000 $108,000 Machining 15,000 2.00 31,000 47,000 Subtotal $35,000 $7.50 $95,000 $155,000 ====== ====

Activity Flexible Budget (continued) Driver: Number of Setups Fixed Variable 25 30 Inspections $80,000 $2,100 $132,500 $143,000 Setups --- 1,800 45,000 54,000 Subtotal $80,000 $3,900 $177,500 $197,000 ====== ===== Driver: Number of Orders Fixed Variable 15,000 25,000 Purchasing $211,000 $1 $226,000 $236,000 ======= == Total $678,000 $948,000 ======= =======

Activity-Based Performance Report Actual Costs Budgeted Costs Budget Variance Direct materials $101,000 $100,000 $1,000 U Direct labor 80,000 80,000 --- Maintenance 55,000 64,000 9,000 F Machining 29,000 31,000 2,000 F Inspections 125,500 132,500 7,000 F Setups 46,500 45,000 1,500 U Purchasing 220,000 226,000 6,000 F Total $657,000 $678,500 $21,500 F ======= ======= ======

Variances for the Inspection Activity Activity Actual Cost Budgeted Cost Variance Inspection: Fixed $ 82,000 $ 80,000 $2,000 U Variable 43,500 52,500 9,000 F Total $125,500 $132,500 $7,000 F ======= ======= =====