Cost Accounting
Foundations and Evolutions
Kinney and Raiborn
Seventh Edition
Chapter 4
Activity-Based Management and
Activity-Based Costing
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.
Learning Objectives (1 of 2)
• Identify value-added versus non-valueadded activities
• Explain how value-added and non-valueadded activities effect manufacturing cycle
efficiency
• Explain why cost drivers are designated in
activity-based costing
Learning Objectives (2 of 2)
• Explain how costs are computed using
activity-based costing
• Describe the types of management
information provided by an activity-based
costing/management system
• Explain when it is appropriate to use
activity-based costing
Activity-Based Management
• Focuses on activities during production
and performance process
• Improves the value received by
customers
• Enhances profitability
Activity
An activity is a repetitive action
performed in fulfillment of a business
function
Activity-Based Management
Activity analysis
Cost driver analysis
Activity-based costing
Continuous
improvement
Operational control
Quality management
Business process
improvement
Performance
measurement
Activity Based Management
• External Benefits
– Increased customer value
– Enhanced profitability
• Internal Benefits
– More efficient production
– More accurate cost determination
– More effective performance evaluation
Activity Analysis
Non-value-added activity
• Increases time spent on
Value-added activity
product or service but does
• Increases worth of
not increase worth
product or service to a
• Unnecessary from customer
customer
perspective
• Customer is willing to
• Can be reduced, redesigned
pay for it
or eliminated without
affecting market value or
quality
• Business-value-added
activities are essential
Cost Driver Analysis
• Cost drivers are factors that have a direct
cause-effect relationship to a cost
– Limit the number of cost drivers
– Cost of measurement should not exceed
benefit of using the cost driver
– Easy to understand
– Directly related to activity being performed
– Appropriate for measurement
Cost Driver Analysis
• Unit-level costs
– direct material, direct labor
• Batch-level costs
– setup, inspection
• Product/process-level costs
– engineering changes, product development
• Organizational or facility costs
– building depreciation, plant manager’s salary
Activity-Based Costing
• Recognizes several levels of costs
• Accumulates costs into related cost pools
• Uses multiple cost drivers to assign costs
to products and services
Two-Step Allocation
• Collect costs in general ledger and subsidiary
accounts
• Identify activity centers
• Accumulate costs into activity center cost
pools – cost drivers
• Allocate costs to products and services
– activity driver measures demands placed on
activities, thus, the resources consumed by
products/services
Traditional vs. ABC Costing
• When ABC is implemented
– Cost is reduced for high volume,
standard products
– Cost is increased for low-volume,
complex specialty products
Use ABC Costing for.
1. Product Variety and Process Complexity
– Caused by mass customization
• Too many choices, opportunity for errors
• Pareto Principle
• Commonality of parts
– Reduced by
• Simultaneous (or Concurrent) Engineering
• Design for Manufacturability
Use ABC Costing when….
2. Lack of Commonality in Overhead Costs
-
Some products/services use substantially more
overhead than others
3. Problems with Current Cost Allocations
-
-
Significant changes in process with no change in
cost allocations
Expense majority of period costs when incurred
Use ABC Costing when….
4. Changes in Business Environment
– Increase in competition
– Change in management strategy
Continuous Improvement
• Eliminates non-value-added activities to reduce
cycle time
• Makes products/performs services with zero defects
• Reduces product costs on an ongoing basis
• Simplifies products and processes
ABC Costing Supports
Continuous Improvement
Criticisms of ABC
• Significant amount of time and cost
to implement
• Must overcome barriers to change
• Does not conform to GAAP
Advantages of ABC and ABM
• Identify and monitor significant technology
costs
• Trace technology costs directly to products
• Increase market share
• Identify the cost drivers that create or
influence cost
• Identify activities that do not contribute to
perceived customer value
Advantages of ABC and ABM
• Illustrate the impact of new technologies on
all elements of performance
• Translate company goals into activity goals
• Analyze the performance of activities across
business functions
• Analyze performance problems
• Promote standards of excellence
Questions
• What are the differences between activitybased costing and traditional cost
accounting?
• What are cost drivers and activity drivers?
• What are two advantages and two criticisms
of activity-based costing?
Potential Ethical Issues
• Ignoring non-value added activities
• Using non-value label to eliminate jobs
• Misclassifying activities to allocate costs
away from lower volume products to justify
lower selling prices
• Selecting an inappropriate cost driver to
distort cost calculations
Potential Ethical Issues
• Using ABC to eliminate a vendor or
customer
• Using ABC to eliminate funding of social or
environmental causes
• Using ABC to transfer cost from fixed price
contracts to cost-plus contracts