A value-added activity increases the worth of a product or service to a customer and is one for which the customer is willing to pay. Dividing total value-added processing time by total cycle time results in a measurement referred to as manufacturing cycle efficiency (MCE). Alternatively, a non-value-added activity increases the time spent on a product or service but does not increase its worth. Manufacturing Cycle Efficiency = Total Value Added Time / Total Cycle Time Businesses can also engage in some activities that are essential (or appear to be essential) to business operations but for which customers would not willingly choose to pay. These activities are known as business-value-added activities. For instance, companies must prepare invoices for documenting sales and collections. Customers realize invoice preparation must occur, that it creates costs, and that its costs must be covered by product selling prices. However, because invoice preparation adds no direct value to products and services, customers would prefer not to pay for this activity through a higher selling price. In a retail environment, cycle time relates to time between ordering and selling an item. NVA activities in retail include shipping time from the supplier, delays spent counting merchandise in the Receiving Department, and any storage time between receipt and sale. In a service company, cycle time refers to the time between service order and service completion. All time spent on activities that are not actual service performance or are “nonactivities” (such as delays in beginning a job) are considered NVA activities for that job. A service company computes service cycle efficiency by dividing total actual service time by total cycle time. Service Cycle Efficiency = Total Actual Service Time / Total Cycle Time To reflect more complex environments,the accounting system must first recognize that costs are created and incurred because their drivers occur at different levels.3This realization necessitates using cost driver analysis, which investigates, quantifies, and explains the relationships of drivers to their related costs. Traditionally, cost drivers were viewed as existing only at the unit level: for example,labor hours or machine time expended to produce a product or render a service. These unit-level costs are caused by the production or acquisition of a single unit of product or the delivery of a single unit of service. From a management perspective, the cost of making products or performing services must be determined so that the company can charge a price for the items that is high enough to cover costs and produce profits. A process is a series of activities that, when performed together, satisfy a specific objective. Processes should be defined before a company tries to determine relationships among activities. Most processes occur horizontally across organizational functions and, thus, overlap multiple functional areas. For each distinct process, a process map (or detailed flowchart) should be prepared to indicate every step in every area that goes into making or doing something. Costs that are caused by a group of things being made, handled, or processed at a single time are referred to as batch-level costs, such as the cost of machine setup. After a process map has been developed, the time needed to perform the activities should be noted and classified in one of four ways: A cost caused by the development, production, or acquisition of diff erent items is called a product-level (process-level) cost. Processing (service) time: the actual time spent performing all necessary functions to manufacture the product or to perform the service; this time is VA. Certain costs, called organizational-level costs, are incurred for the sole purpose of sup porting facility operations. Inspection time: the time required to perform quality control other than what is internal to the process; this time is usually considered NVA unless the consumer would actually be willing to pay for it (such as in the pharmaceutical or food industries). Activity-based costing (ABC) is a cost accounting system that focuses on an organi zation’s activities and collects costs on the basis of the underlying nature and extent of those activities. Transfer time: the time consumed moving products or components from one place to another; this time is NVA. Two-Step Allocation An activity center is any part of the production or service process for which management wants a separate reporting of costs. In defining these centers, management should consider the fol lowing issues: Idle time: the time goods spend in storage or waiting at a production operation for processing; this time is NVA. The time from the receipt to completion of an order for a product or service is equal to value-added processing time plus non-value-added time. Th is total time is referred to as cycle (or lead) time. geographical proximity of equipment defined centers of managerial responsibility magnitude of product costs the need to keep the number of activity centers manageable Total Cycle (or Lead) Time = Value-Added Time +Non-Value-Added Time Understanding the NVA nature of these functions, however, should help managers strive to minimize such activities to the extent possible. Th us, companies should view VA and NVA activities as occurring on a continuum and strive to eliminate or minimize those activities that add the most time and cost and the least value. An activity driver measures the demands placed on activities and, thus, the resources consumed by products and services. An activity driver often indicates an activity’s output. Three significant cost drivers that have traditionally been disregarded are related to variety and complexity: Product variety refers to the number of diff erent types of products made Product complexity refers to the number of components included in a product Process complexity refers to the number of processes through which a product flows Combining the process map and the time assessments produces a value chart that traces a process from beginning to end. 1.Activity-based costing: a) Uses a plant-wide overhead rate to assign overhead b) Is not expensive to implement c) Typically applies overhead costs using direct labor-hours d) Uses multiple activity rates 2.Assigning overhead using ABC often: a) Shifts overhead costs from high-volume products to lowvolume products b) Shifts overhead costs from low-volume products to highvolume products c) Provides the same results as traditional costing d) Requires one predetermined overhead rate 3.Painting the product would be an example of which activity level groups a) Facility-level activity b) Product-level activity c) Unit-level activity d) Batch-level activity 4.X Company uses activity-based costing for Product B and Product D. The total estimated overhead cost for the parts administration activity pool was $550,000 and the expected activity was 2000 part types. If Product D requires 1200 part types, the amount of overhead allocated to product D for parts administration would be: a) $275,000 b) $300,000 c) $330,000 d) $345,000 5.Plant depreciation is an example of which activity-level group? a) Unit-level activity b) Facility-level activity c) Batch-level activity d) Product-level activity 6. Inspections are an example of which activity-level group? a) Unit-level activity b) Batch-level activity c) Product-level activity d) Facility-level activity 7. Which of the following characteristics would be an indicator that a company would benefit from switching to activity-based costing? a) Only one homogenous product is produced on a continuous basis b) The existing cost system is reliable and predictable c) Overhead costs are high and increasing with no apparent reason d) The costs of implementing ABC outweigh the benefits 8. Which of the following is a limitation of activity-based costing? a) Costs are accumulated by each major activity b) A variety of activity measures are used c) All costs in an activity cost pool pertain to a single activity d) Activity-based costing relies on the assumption that the cost in each cost pool is strictly proportional to its cost measure 9. An accounting system that collects financial and operating data on the basis of the underlying nature and extent of the cost drivers is a. Direct costing. c. Cycle-time costing. b. Activity-based costing. d. Variable costing. 10. The resource utilized by a given product divided by the total amount of the resource available is called the a. Activity driver. c. Cost object. b. Consumption ratio. d. Sustaining activity. 10. Which of the following statements is true? a. The traditional approach to costing uses many different cost drivers. b. Costs that are indirect to products are by definition traceable directly to products. c. Costs that are indirect to products are traceable to some activity. d. All of the above statements are true.
