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Education.
Fundamentals of
Cost Management
Chapter 10
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the prior written consent of McGraw-Hill Education.
10-2
Learning Objectives
LO 10-1
LO 10-2
LO 10-3
LO 10-4
LO 10-5
LO 10-6
LO 10-7
LO 10-8
Describe how activity-based cost management can be
used to improve operations.
Use the hierarchy of costs to manage costs.
Describe how the actions of customers and suppliers
affect a firm’s costs.
Use activity-based costing methods to assess customer
and supplier costs.
Distinguish between resources used and resources
supplied.
Design cost management systems to assign capacity costs.
Describe how activities that influence quality affect costs
and profitability.
Compare the costs of quality control to the costs of failing
to control quality.
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the prior written consent of McGraw-Hill Education.
10-3
LO 1
Using Activity-Based Cost Management
to Add Value
LO 10-1
•
Describe how activity-based cost management
can be used to improve operations.
Activity-based costing (ABC) is a system used to assign costs to products
based on the products’ use of activities, which are the discrete tasks an
organization undertakes to make or deliver the product.
• The value chain is the set of activities that transforms raw resources into
products for customers. Activities in the value chain are the things that
customers will pay for.
• Activity-based management focuses on managing activities to reduce
costs.
• Activity-based costing focuses on activities in allocating overhead costs
to products.
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10-4
LO 1
Using Activity-Based Cost Information
to Improve Processes
The first step in ABCM is activity analysis. We begin by analyzing the costs of
key activities. Activity analysis has six steps:
1. Identify what the customer wants or expects from the firm’s products or
services, including key features, price, and quality.
2. Chart, from start to finish, the company’s activities for completing the product.
3. Develop activity-based costing data for each activity, based on the resources
used in each activity.
4. Classify all activities as value-added or non-value-added.
5. Compare the costs of each activity with the value that customers assign to it.
(The value of non-value-added activities would be zero.)
6. Continuously improve the efficiency of all value-added activities. Eliminate or
reduce non-value-added activities.
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10-5
LO 2
Using Cost Hierarchies
LO 10-2
Hierarchy Level
Use the hierarchy of costs to manage costs.
Cost Example
Cost Driver Example
Volume related
Supplies
Lubricating oil
Machine repair
Direct labor cost
Machine-hours
Number of units
Batch related
Setup costs
Material handling
Shipping costs
Setup hours
Production runs
Number of shipments
Product related
Compliance costs
Design and
specification costs
Number of products
Facility related
General plant costs
Plant admin. costs
Direct costs
Value added
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10-6
LO 3
Managing the Costs of Customers
and Suppliers
LO 10-3
Describe how the actions of customers and
suppliers affect a firm’s costs.
Customers affect our profitability by both their buying
behavior and their effect on our costs. Information on
customer profitability is important for managers, so they
can make decisions that will improve firm performance.
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10-7
LO 3
Managing the Costs of Customers
and Suppliers (2)
• Customers (and suppliers) use resources.
• Some customers use more resources than others.
Think about the last time you stood in line to purchase a ticket, check
in for a flight, or make a transaction in a bank. Many people ahead of
you are purchasing the same service (a ticket, a flight, or a deposit),
but some take longer (sometimes much longer) to complete the
transaction. The additional time those customers take adds cost to
the company.
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10-8
LO 4
Using ABC to Determine the Cost of
Customers and Suppliers
LO 10-4
Use activity-based costing methods to assess
customer and supplier costs.
Use the same four-step ABC product costing process to assess
customers and suppliers.
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.
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10-9
LO 4
Cost of Customers
Operating Data – Lygon Food Distributors
Process Flow of the Delivery Service
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10-10
LO 4
Cost of Customers
Step 1: Identify the Activities
What activities consume resources
for LFD’s delivering service?
Process Flow of the Delivery Service –
Lygon Food Distributors
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10-11
LO 4
Cost of Customers
Step 2: Identify the Cost Drivers
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10-12
LO 4
Cost of Customers
Step 3: Compute the Cost Driver Rates
Computation of Cost Driver Rates – Lygon Food Distributors
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the prior written consent of McGraw-Hill Education.
10-13
LO 4
Cost of Customers
Step 4: Assign Costs Using ABC
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10-14
LO 4
Cost of Customers
Step 4: Assign Costs Using ABC (2)
Cost Driver Information by Customer – Lygon Food Distributors
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10-15
LO 4
Cost of Customers
Step 4: Assign Costs Using ABC (3)
Estimated Customer Delivery Costs – Lygon Food Distributors
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10-16
LO 4
Determining the Cost of Suppliers
The analysis of customers cost also can be
applied to suppliers.
Annual Data on Food and Restaurant Supply Deliveries –
Lygon Food Distributors
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10-17
LO 4
Determining the Cost of Suppliers
(2)
Effective Purchase Price of Products
When Late Deliveries Are Considered
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10-18
LO 5
Using and Supplying Resources
LO 10-5
Distinguish between resources used and
resources supplied.
Resources Used
Cost driver rate multiplied by the cost
driver volume
Resources Supplied
Expenditures or the amounts spent on a
specific activity
Unused Resource Capacity
Difference between resources used and resources
supplied
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10-19
LO 5
Using and Supplying Resources (2)
Traditional Income Statement
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10-20
LO 5
Using and Supplying Resources (3)
Activity-Based Income Statement
Lygon Food Distributors
Year 2
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10-21
LO 6
Computing the Cost of Unused Capacity
LO 10-6
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
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10-22
LO 6
Computing the Cost of Unused
Capacity (2)
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
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10-23
LO 6
Computing the Cost of Unused
Capacity (3)
Fixed Operating Cost Rate for Northern Air Charter
Capacity and Cost Drivers Rates at Different Capacities
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10-24
LO 6
Computing the Cost of Unused
Capacity (4)
Seasonality of the Cost of Unused Capacity –
Northern Air Charter
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10-25
LO 6
Computing the Cost of Unused
Capacity (5)
Reported Cost
per Passenger:
Assigning Cost
of Capacity for
Northern Air
Charter
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10-26
LO 7
Managing the Cost of Quality
LO 10-7
Describe how activities that influence quality
affect costs and profitability.
• Quality as defined by the customer
• Organization is managed to excel on all dimensions
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10-27
LO 7
What Is Quality?
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10-28
LO 7
External View of Quality: Customer
Expectations
• Tangible:
– Performance
– Taste
– Functionality
• Intangible:
– Customer service
– Delivery time
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10-29
LO 7
Internal View of Quality:
Conformance to Specifications
Conformance to Specifications
Degree to which a good or service
meets specifications
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10-30
LO 8
Cost of Quality
LO 10-8
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
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10-31
LO 8
Cost of Quality (2)
• 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
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10-32
LO 8
Cost of Quality (3)
Trade-Off Between Conformance and Nonconformance Costs
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10-33
LO 8
Cost of Quality Report
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the prior written consent of McGraw-Hill Education.
10-34
End of Chapter 10
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10-35