C H A P T E R

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• C H A P T E R

Management Accounting Information In The New
Business Environment
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Learning Objective 1
Explain the fundamentals of activity-based
costing (ABC) and activity-based management (ABM).
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Activity-Based Costing (ABC)

• A method of attributing costs to products based
  on

• assigning costs of resources to activities
• assigning costs of activities to products

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Unit-Based Costing (UBC)
The traditional method of allocating costs
(manufacturing overhead) to products based on
number of units produced. If only three products
are produced (one of each), then
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Relationship BetweenUBC and ABC
Unit-Based Costing (UBC) Model of Costs
Activity-Based Costing (ABC) Hierarchical Product
Cost Model
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ABCAllocating Resource Costs to Activities
What is the hierarchical product cost model?
Common Costs
Product Costs
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ABCAllocating Resource Costs to Activities
Facility Support Activities
Product Line Activities
Batch-Level Activities
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ABCAllocating Resource Costs to Activities
Facility Support Activities
Product Line Activities
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ABCAllocating Resource Costs to Activities
Facility Support Activities

• Product Line Activities
• Engineering and design changes
• Warehousing of product line materials
• Production line dedicated supervisors
• Purchasing
• Receiving and shipping

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ABCAllocating Resource Costs to Activities

• Facility Support Activities
• Property taxes
• Plant security
• Landscaping
• Accounting and legal
• General administrative salaries

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Cross-Subsidization

• Does a hammer really cost THAT MUCH?

? Overhead per product

9,000 Overhead
If a UBC factory produces only three products (a
hammer, a clock, and a Ferrari) and a hammer
incurs 4 of direct labor and materials, how much
will the hammer cost if manufacturing overhead is
allocated evenly over finished products?
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Cross-Subsidization

• Does a hammer really cost THAT MUCH?

3,000 Overhead per product

9,000 Overhead
3 Products
3,004 !?
1 Hammer
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Cross-Subsidization

• Does a hammer really cost THAT MUCH?

? Overhead per product

9,000 Overhead
Under UBC (unit-based costing), some products may
be inappropriately assigned costs that actually
belong to another product line (in this case, the
hammer and clock are obviously cross-subsidizing
the Ferrari product line).
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What are the Hazards of Allocating Costs?
Product Cost Distortions

• When one product is cross-subsidizing
  another, it appears unprofitable to produce and
  is often mistakenly discontinued.
• When facility support (common) activity costs are
  allocated to individual product lines, they may
  appear unprofitable and are often mistakenly
  discontinued.

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Hazards of Allocating Costs

• Product profitability before overhead allocation

Hammer Clock Ferrari
8 20 100,000 2 10 70,000 2 5
25,000 4 5 5,000
Revenue Materials Labor Profit
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Hazards of Allocating Costs

• Product profitability after
• overhead allocation

In actuality, most of the 9,000 manufacturing
overhead is attributable to the Ferrari,
revealing it to be the real money loser.
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Hazards of Allocating Costs

• In actuality, most of the 9,000 manufacturing
  overhead is attributable to the Ferrari,
  revealing it to be the real money loser,
• BUT because the other products are
  cross-subsidizing, they appear unprofitable and
  will be discontinued from production.

Hammer Clock Ferrari
8 20 100,000 2 10
70,000 2 5 25,000 3,000 3,000
3,000 (2,996) (2,995) 2,000
Revenue Materials Labor Overhead Profit
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Hazards of Allocating Costs

• The result?

Hammer Clock Ferrari
100,000 70,000 25,000
8,990 (3,990)
Revenue Materials Labor Overhead Profit
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Activity-Based Management (ABM)

• Managing costs, quality, and timeliness of
  activities through the identification and use of
  Cost Drivers and Performance Measures.

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Learning Objective 2
Describe total quality management (TQM) and costs
of quality (COQ).
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What is Total Quality Management (TQM)?

• A management philosophy focused on increasing
  profitability by improving the quality of
  products and processes and increasing customer
  satisfaction, while promoting the well-being and
  growth of employees.

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Total QualityManagement (TQM)
The Secret to Success?
The Old Way
The New Way
Andrew Carnegie
W. Edward Deming
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Total Quality Management (TQM)

• Define SPCStatistical Process Control

A statistical technique for identifying and
measuring the quality status of a process by
evaluating its output to determine if serious
problems exist in the process.
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What are the Four Costs of Quality (COQ)?

• Prevention Costs
• Appraisal Costs
• Internal Failure Costs
• External Failure Costs

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Define Each Cost of Quality (COQ)
Prevention Costs Ensures that processes are
performed correctly the first time and that
products and services meet customers
expectations. Appraisal Costs Inspecting,
testing, and sampling activities performed in
order to identify and remove low-quality products
and services from the system. Internal Failure
Costs Expenses that occur when low-quality
products and services fail before production and
delivery to customers. External Failure Costs
Expenses that occur when low-quality products
and services fail after production and delivery
to customers.
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What is the Effect of Increasing Prevention and
Appraisal Costs of Quality (COQ)?
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Costs of Quality (COQ)
Cost in Millions
4 3 2 1
86 88 90 92 94 96
98
production within control limits
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Learning Objective 3
Describe how just-in-time (JIT) management
systems integrate with and extend ABC and TQM
using time-based performance measures.
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What is Just-In-Time (JIT)?

• A management philosophy that emphasizes removing
  all waste of effort, time, and inventory costs
  from the organization.
• Reduces or removes needless inventory in a
  production system.

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Just-In-Time (JIT)

• Define Value-Added Activities
• Necessary activities in a production or service
  process that customers identify as valuable and
  for which they are willing to pay.
• Define Non-Value-Added Activities
• Unnecessary activities in a production or
  service process that customers typically do not
  see or care about and for which they are
  unwilling to pay.

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The Point Is . . .