1. 1 PowerPointPresentation by PowerPoint Presentation by Gail B. Wright Professor Emeritus of Accounting Bryant University MANAGERIAL ACCOUNTING 10 TH EDITION BY MAHER, STICKNEY & WEIL ACTIVITY-BASED MANAGEMENT STUDENT CHAPTER 3 © Copyright 2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star Logo, and South- Western are trademarks used herein under license.

2. Overview & Basic Concepts 2 CHAPTER GOAL This chapter shows how ABC & ABM rest on premise that: Products require activities & activities consume resources. For products to be competitive, managers must know  Activities for producing goods, services  Cost of activities ABC analyses ways to allocate indirect costs while ABM uses analysis to manage costs. ☼☼

3. Overview & Basic Concepts 3 How do ABC & ABM work?  ABC provides information about profitability in mix of activities, products  ABM encourages managers to use information to become low-cost producer or seller. LO 1

4. Overview & Basic Concepts 4 ABM ACTIVITY ANALYSIS  Chart, start to finish, activities used to complete product or service  Classify activities as value-added or non- value-added  Eliminate non-value-added activities  Continuously improve, reevaluate efficiency of value-added activities or replace with more efficient activities LO 1

5. Overview & Basic Concepts 5 NON-VALUE-ADDED COSTS: Definition Are costs of activities that the company can eliminate without reducing product quality, performance, or value. LO 1

6. Overview & Basic Concepts 6 ABC ANALYSIS Potential candidates for elimination because they do not add value are  Storage  Moving: parts, materials, etc. around the factory floor  Idle time  Other production process components LO 1

7. Overview & Basic Concepts 7 ABC COST-BENEFIT Applying ABC has a cost of information gathering. Managers must take cost-benefit into account.  Managers reject activity analysis, staying with traditional methods that are simpler.  Smaller companies don’t need sophisticated information systems  Managers use ABC because information helps them be competitive  Complex organizations facing heavy competition use ABC  Managers use ABC in special circumstances LO 2

8. Overview & Basic Concepts 8 COST POOLS: Definition Are ways of grouping costs for analysis. LO 2

9. Overview & Basic Concepts 9 COST POOLS 3 Major types of cost pools  The “plant” (traditional)  Sets 1 indirect cost allocation rate plantwide  The department (traditional)  Sets indirect cost allocation rates for each department  The activity center (ABC)  Determines cost pool for each activity LO 2

10. Overview & Basic Concepts 10 ACTIVITY-BASED COSTING (ABC): Definition Assigns costs first to activities then to products based on each product’s use of the activity. LO 3

11. Overview & Basic Concepts 11 ABC STEPS TO FOLLOW Accountants required to follow 4 steps: 1.Identify activities that consume resources; assign costs to those activities. Example: purchasing materials 2.Identify cost drivers for each activity. Cost driver for purchasing materials: # of orders 3.Compute a cost rate per cost driver unit. Cost per order 4.Assign costs to products. Cost per order x number of purchase orders LO 4

12. Overview & Basic Concepts 12 COST DRIVER: Definition Is a factor that causes, “drives,” an activity’s costs. LO 4

13. Overview & Basic Concepts 13 How do managers decide which cost driver to use? Typically, managers choose a cost driver that causes the cost. LO 4

14. Overview & Basic Concepts 14 COST RATE EQUATION LO 4 Predetermined indirect cost rate = Estimated Indirect Cost ÷ Estimated Volume of Allocation Base

15. Overview & Basic Concepts 15 When Hewlett-Packard outsourced overhead costs identified under ABC, what was the result? Product costs rose when overhead costs dropped & managerial emphasis shifted to managing suppliers. LO 4 MANAGERIAL APPLICATION

16. Overview & Basic Concepts 16 How can ABC analysis be applied to marketing? In marketing it is still important to a) identify activities, e.g., selling, advertising, etc. and b) identify cost drivers to reduce, eliminate non-value-added costs. LO 5

17. Overview & Basic Concepts 17 COST HIERARCHY: Definition Categorizes costs so changes in one cost can be examined for its effects on other cost categories. LO 6

18. Overview & Basic Concepts 18 Activity Category Example CapacitySize limitationsAircraft depreciation CustomerNeedsSpecial promotions ProductProduction needsRoute schedules Batch Fuel, baggage handling UnitVariable costsCredit card fees EXAMPLE: Hierarchy of Costs LO 6

19. Overview & Basic Concepts 19 RESOURCES USED: Definition Are measured by ABC. LO 7

20. Overview & Basic Concepts 20 UNUSED RESOURCES Knowing the difference between resources used and supplied helps managers to identify unused capacity. Finding unused capacity helps managers reduce or use it. LO 7

21. Overview & Basic Concepts 21 What is the difference between capacity-sustaining & unit level costs? Capacity-sustaining costs are fixed & indirect. Unit level costs are variable, direct costs. LO 7

22. Overview & Basic Concepts 22 LO 7 Imprinting a hierarchy of costs on ABM statements helps managers understand what costs can be reduced or better used. EXHIBIT 3.5 Capacity-sustaining costs will have unused resources unless operating at full capacity.

23. Overview & Basic Concepts 23 Do the benefits of ABC go beyond managing costs? YES! Research shows that companies adopting ABC have superior financial performance because of better cost controls & asset utilization. LO 8 MANAGERIAL APPLICATION

24. Overview & Basic Concepts 24 CHAPTER 3 THE END