STRATEGIC MANAGEMENT
ACCOUNTING
(BB315009S)
Prepared by:
MISS NURAZRIN BINTI JUPRI
Chapter 4:
Changes in business structures and
management accounting:
Linking value chain, BPR,ABC,ABM,TQM
Cost management and the value chain
• The value chain is the linked set of value-creating activities from supplier to
customer.
• Objective is to perform value chain activities more efficiently and at a lower cost
than the competitors.
• Focus should be on each link in the chain from the customer ’s perspective.
• Critics claim that traditional management accounting starts too late and finishes
too soon in terms of the value chain.
Figure 1: The value chain
A comparison of traditional and ABC systems
• Both systems use the two-stage allocation process.
• In the first stage traditional systems tend to allocate costs to departments whereas
ABC systems allocate costs to activities: (ABC systems tend to have more cost
centres/cost pools)
• In the second stage traditional systems rely on a small number of volume-based
cost drivers (typically direct labour or machine hours) whereas ABC systems use
many second stage cost drivers.
• ABC systems seek to use only cause-and-effect cost drivers whereas traditional
systems often rely on arbitrary allocation bases.
• ABC systems tend to establish separate cost driver rates for support departments
whereas traditional systems merge support and production centre costs.
A two-stage allocation process (traditional costing system)
The two-stage allocation process (ABC System)
The emergence of ABC systems
• Traditional systems were appropriate when:
1.
Direct costs were the dominant costs
2. Indirect costs were relatively small
3. Information costs were high
4. There was a lack of intense global competition
5. A limited range of products was produced.
Errors from relying on misleading product costs
• Traditional costing systems use volume-based (e.g.direct labour and machine
hours) second stage drivers but if volume bases are not the cause of indirect costs
reported costs will be misleading.
Example
Products HV (a high volume product)and LV (a low volume product)are two of
several products produced by a company. HV is made in large batches and LV is
made in small batches. HV consumes 30%of DLH ’s and LV consumes 5% but each
product consumes 15%of the batch-related indirect costs.The traditional system
uses DLH ’s as the cost driver and the ABC system uses the number of batches
processed. All overheads (total =£1m)are batch-related .
• Reported product costs:
• Traditional system reports misleading information —In the longer term
overheads will not decline by £300 000 if HV is discontinued.
• ABC allocates on a cause-and-effect basis and shows high level of resources
consumed by LV —The 2 costing systems report different messages (Traditional
=Drop HV ABC =Drop LV).
•Traditional system motivates the wrong strategy.
Designing ABC systems
1. Identify the major activities that take place in an organization:
• The activities chosen should be at a reasonable level of aggregation
based on cost/benefit criteria.
• Choice of activities influenced by the total cost of theactivity centre and
the ability of a single cost driver to provide a satisfactory determinant of
the cost of the activity.
Designing ABC systems (contd.)
2. Assign costs to cost pools /cost centre for each activity:
• Costs assigned to activity cost pools will include direct and indirect costs.
• Resource cost drivers used to assign indirect costs.
• Reliability of cost information will be reduced if arbitrary allocations are
used to assign a significant proportion of costs to activities.
Designing ABC systems (contd.)
3. Determine the cost driver for each major activity:
• Drivers at this stage called activity drivers.They should:
(a) provide a good explanation of costs of each
activity pool.
(b) be easily measurable
(c) the data should be easy to obtain and identifiable with
the product.
• Activity cost drivers consist of three types (Transaction, duration and intensity
drivers).
4. Assign the cost of activities to products:
• The cost driver must be measurable so that it can be identified with individual
products.
Classification of activities
• Unit-level activities:
1.
2.
3.
Performed each time a unit of the product or service is produced.
Resources are consumed in proportion to the number of units produced or
sold.
Examples —Direct materials and labour,energy costs and expenses consumed
in proportion to machine processing time.
• Batch-related activities:
1.
2.
3.
Performed each time a batch of goods is produced.
Costs vary with the number of batches made.
Examples include set-ups, purchase ordering and first-item inspection
activities.
Classification of activities contd.
• Product/service sustaining activities:
1.
2.
Performed to enable the production of individual products or services.
Examples include activities related to maintaining an accurate bill of materials,
preparing engineering change notices.
• Facility-sustaining (or business-sustaining) activities:
1.
2.
3.
Performed to support the organization as a whole.
Examples include plant management,property costs and salaries of general
administrative staff.
Common to all products and services –.not allocated to products/services.
Activity-based profitability analysis
• Applies ABC hierarchical activity classification to profitability analysis.
• Used for attention directing —claimed provides more accurate information.
• Hierarchical approach can be applied to different cost objects (e.g.
products/services, customers, locations.)
• See sheet 11 for an illustration of the ABC hierarchical profitability analysis.
• Aim is to assign all organizational expenses to a particular hierarchical level
where cause-and-effect cost assignments can be established.
• The approach helps to identify the impact of resource consumption of adding or
dropping items at each level of the hierarchy.
(Fig 10.2) An illustration of hierarchical profitability analysis)
Resource consumption models
• ABC systems measure the cost of using resources and not the cost of supplying
resources:
Cost of resources
=
Cost of resources +
Cost of unused
Supplied
used
capacity
• Periodic financial statements measure the cost of resources supplied (i.e.15 000
orders at a cost of £300 000 in Example10.2).
• ABC systems measure the cost of resources used (i.e.13 000 orders at a cost of
£20 per order in Example 10.2).
• The difference between the cost of resources supplied and the cost of resources
used represents the cost of unused capacity (i.e.2 000 orders at £20 per order
=£40 000)
• Unused capacity arises with committed resources because they must be
acquired in discrete amounts in advance of usage.
• With flexible resources supply can be continually adjusted to match exactly the
usage of resources.
• Managers make decisions that will result in a change of activity usage
(e.g.discontinuation decisions reduce cost of resources used and increase the
cost of unused capacity).
• Cash flow consequences will only arise if action is taken to remove unused
capacity by reducing spending on the supply of resources.
• The periodic reporting of unused capacity signals the need for a change in the
spending on the supply of resources.
Example 10.2
(1) Resources supplied
10 staff at £30 000 per year
Cost driver
Annual quantity of cost driver
supplied:
(1 500 orders per employee)
Estimated cost driver rate
(2) Resources used
Estimated annual number of
orders to be processed
Estimated cost of resources
used assigned to parts/
materials
(3) Cost of unused capacity
Resources supplied (15 000)
–Resources used (13 000)
at £20 per order
= £300 000 annual activity cost
= Number of orders processed
= 15 000 purchase orders
= £20 per purchase order
(£300 000/15 000 orders)
= 13 000
= £260 000 (13 000*£20)
= £40 000 (2 000*£20)
Selecting the cost driver denominator level
• The correct denominator activity level to use is the level of capacity supplied
(practical capacity)and not the anticipated usage.
• Using anticipated usage in Example 10.2 would result in a cost driver rate of
£23.08 (£300 000/13 000)so that the cost of unused capacity will be hidden in the
cost driver rate rather than being separately reported.
• Using anticipated usage would result in high cost driver rates in periods of low
sales demand.
The ABC data base
• Ideally maintained at estimated standard costs and periodically reviewed.
• In addition a cost and profitability audit of a firm’s products,customers and sales
outlets should be periodically undertaken.
ABC cost management applications
• ABC can be used for a range of cost management applications besides
product costing.
Criticisms of ABC
• ABC unit costs must be used with care —They can suggest an
inappropriate degree of variability.
• The concept of unused capacity within the resource consumption model
is questionable for physical resources.
• Reported costs may not significantly differ from a less costly traditional
system if indirect costs are a low proportion of total costs.
Activity-based management (ABM)
•
Involves the following stages:
1. Identifying the major activities that take place in an organization.
2. Assigning costs to cost pools/cost centres for each activity.
3. Determining the cost driver for each activity.
•
Omits the fourth stage required for product costing ABC.
•
ABM focuses on managing the business on the basis of the activities that make
up the organization — by managing the activities costs are managed in the
long term.
•
Traditional control reports analyze costs by types of expenses for each
responsibility centre whereas ABM analyses costs by activities (See sheet 22.6
for an illustration).
•
Knowing the cost of activities is a catalyst for triggering action to become
competitive.
Activity-based management (ABM) - contd.
•
1.
2.
Activity cost information is useful for prioritizing thos activities that need to
be studied more closely. Activities can be classified:
As value-added or non-value-added.
According to a scale similar to that advocated by Kaplan and Cooper.
•
Activity-based systems can also be used to manage costs at the design stage
using behavioural drivers.
•
Surveys also suggest that many organizations use cost driver rates as measures
of cost efficiency
Example
Cost of purchasing activity = £100,000 Orders processed =10,000
Cost per order = £10 (Used for relative, trend and budget comparisons).
Example
Customer order processing activity
Traditional analysis (customer order processing
department)
Salaries
Stationery
Travel
Telephone
Depreciation of equipment
£000 ’s
320
40
140
40
40
580
ABM analysis
Preparing quotations
Receiving customer orders
Assessing the credit-worthiness of customers
Expediting
Resolving customer problems
120
190
100
80
90
580
Business process re-engineering (BPR)
•
A business process consists of a collection of activities that are linked together
in a co-ordinated manner to achieve a specific objective.
•
BPR involves examining business processes and making substantial changes to
how the organization operates by focusing on:
1.
2.
3.
Cost reduction
Simplification
Improved quality and enhanced customer satisfaction.
•
Stages in a BPR exercise:
1. Identify the process for innovation
a) The process of production or operations
b) The ordering cycle
2.
Identify the change levers
a) Development in information needs
b) Competition
c) Innovation in IS & IT
d) Changes in the culture and management of the firm
3.
Develop the process vision
a) What should the speed of service be?
b) What role will there be for suppliers and customers?
c) What amount of staffing will be involved?
4.
Understand the existing processes
a) The way data is captured
b) The interfaces between the firm and outsiders
c) The interfaces within the organization
5.
Design and prototype the new process
Total Quality Management (TQM)
•
Quality is now one of the key competitive variables.
•
Customer’s view – a product that meets their requirements is a ‘quality
product’:
•
Time & quality
•
Performance & quality
•
Management accountants are now placing greater emphasis on the provision of
information relating to the cost of quality.
•
Cost of quality reports prepared periodically:
1. Prevention costs
2. Appraisal costs
3. Internal failure costs
4. External failure costs
•
The aim of TQM- to completely eliminate the internal failure costs by
working towards a goal of zero defects.
•
Improve employee skills and efficiencies by training (inside & outside).
•
Non-financial measures and statistical quality control tools also play a key
role in improving quality and reducing internal and external failure costs.
Cost of quality report
Cost of quality report (contd.)
Questions