Value Chain, ActivityBased Costing, and ActivityBased Management

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Chapter 5

• Value Chain, Activity-Based Costing, and
  Activity-Based Management

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Learning Objectives
1. Describe strategic cost management. 2. Explain
the importance of the value chain analysis to
assess decision alternatives. 3. Analyze an
organizations internal value chain, dividing it
into processes and activities. 4. Explain how
process management can improve organizational
performance.
After studying this chapter, you should be able
to
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Learning Objectives Contd

• Determine the costs of individual activities and
  the activity costs associated with various cost
  objectives.
• Explain how activity-based costing is used for
  activity-based management.

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Strategic Cost Management
Strategic cost management is defined as making
decisions concerning specific cost drivers within
the context of an organizations business
strategy, its internal value chain, and its place
in a larger value chain stretching from the
development and use of resources to the final
consumers.
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Elements of a Value-Chain for a
Beverage-Packaging Plant
First level Business entities
Timber Farm
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Second level Processes
Procurement
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Usefulness of the Value Chain Perspective
The goal of maximizing final customer value while
minimizing final customer cost leads
organizations to examine internal and external
links in the value chain.
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The Value Chain Perspective Fosters
Supplier-Buyer Partnerships
Value Chain Perspective Focuses on Processes, Not
Departments
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The Value-Chain Perspective

• Comprehensive
• Focused on the final customers
• Strategic
• Basic for partnerships between vendors and
  customers

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Structural Cost Drivers
Making fundamental choices about the size and
scope of operations and technologies involved.
Structural Cost Drivers
Making choices concerning the organization of
processes and activities
Organizational Cost Drivers
Performing specific units of work (activities) to
serve customer needs.
Activity Cost Drivers
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Structural Cost Drivers
Structural cost drivers include decisions
affecting--

• Goals
• Location
• Scale
• Scope
• Technology
• Complexity

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Structural Cost Drivers
Organizational cost drivers include decisions
affecting--

• Organization of processes
• Layout efficiency
• Product configuration
• Exploitation of linkages in the value chain
• Work force involvement
• Attitudes toward total quality management

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Measures of Activity
Preparing purchase order
Number of orders
Number of orders
Number of units in order
Units in order
Number of orders
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Generic Internal Processes
Supporting Processes Accounting, Design,
Finance, Human Resources, Maintenance, and so
forth.
Source The basic idea for this exhibit is based
on concepts contained in Michael E. Porter,
Competitive Advantage (New York The Free Press,
1985), p. 37.
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Representative Activities
Accounting

• Processing employee paychecks
• Developing budgets
• Determining activity costs
• Verifying the existence of recorded assets

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Representative Activities
Design

• Developing specifications for products or
  services delivered to customers
• Developing specifications for procedures to
  produce products or services

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Representative Activities
Finance

• Signing checks
• Obtaining financial resources

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Representative Activities
Human Resources

• Hiring employees
• Training employees

Maintenance

• Repairing equipment
• Cleaning buildings

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Process Map
It is a schematic overview of all the activities
within a process.
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Process Map
Is there an existing order?
Accept shipment
Reject shipment
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Process Map
Activity Placing a Purchase Order
Go to file cabinet
Open drawer containing blank purchase orders
Remove one purchase order
Close drawer
Return to desk
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In continuous improvement, an organizations
employees constantly evaluate products, services,
and processes seeking ways to do better.
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Activity-Based Costing
Activity-based costing (ABC) involves determining
the cost of activities and tracing their costs to
cost objectives on the basis of the cost
objectives utilization of units of activity.
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Activity-Based Costing
Activity-based costing is used to develop cost
information for the following (and other)
purposes in which management might be interested

• The cost of processing a purchase order to assist
  in continuous improvement.
• The cost of a product or service to determine the
  profitability of the product or service.
• The cost of alternative long-distance telephone
  carriers to identify the carrier with the best
  combination of quality, service, and cost.

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Activity-Based Costing
Activities performed to fill customer needs
consume resources that cost money.
Customer
Activities
Resources
Costs
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Activity-Based Costing
The cost of resources consumed by activities
should be assigned to cost objectives.
Costs
Resources
Activities Pools
Cost Objectives
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Activity-Based Costing
Operationalizing the two-stage model requires the
following

• Identifying activities.
• Assigning costs to activities.
• Determining the basis (activity cost driver) for
  assigning the cost of activities to cost
  objectives.
• Determining the cost per unit of activity.
• Reassigning costs from the activity to the cost
  objective in the basis of the cost objectives
  volume of consumption of activities.

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Detroit Metal Shop produces custom metal parts in
response to customer job orders. Inbound
logistics and operations for the firm is as
follows
Perform activities
Place purchase order
Receive materials
Setup each job
Continued
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Polish
Pack
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Monthly Costs Purchasing Dept.
Placing Purchase Receiving Orders
Materials
Purchasing agent salaries (4,000 x
3) 12,000 Receiving room employees (3,000 x
5) 15,000 Supervisor (6,000 x .38 time
with purchasing agent) 2,250 (6,000 x .63 of
time with receiving agent) 3,750 Other
costs (12,000 x 0.15 purchasing
space) 1,800 (12,000 x 0.85 receiving
space) 10,200
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Refining into Three Activities
Placing Verifying Unloading/
Purchase Purchase Unpacking Orders
Orders Inspecting
Purchasing agent salaries (4,000 x
3) 12,000 Receiving room employees (3,000
x 5 x 0.20 verifying time)
3,000 (3,000 x 5 x 0.80 unloading/
unpacking/inspect time) 12,000
Continued
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Placing Verifying Unloading/
Purchase Purchase Unpacking Orders
Orders Inspecting
Carried forward 12,000 3,000 12,000 Superviso
r (6,000 x .38 of time with purchasing
agents) 2,250 (6,000 x .63 of time with
receiving employees x 0.20 employees
verifying time) 750 (6,000 x .63 of time
with receiving employees x 0.80
employees unloading/ unpacking/inspecting
time) 3,000
Continued
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Placing Verifying Unloading/
Purchase Purchase Unpacking Orders
Orders Inspecting
Carried forward 14,250 3,750 15,000 Other
costs (12,000 x 0.15 purchasing
space) 1,800 (12,000 x 0.85 receiving
space) 10,200
Because the purchase order is verified before
delivery trucks are unloaded, the space devoted
to this activity is assumed to be insignificant.
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Cost per Unit of Activity
Placing Purchasing Orders
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Cost per Unit of Activity
Verifying Purchasing Orders
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Cost per Unit of Activity
Unloading/Unpacking/Inspecting
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Assigning Activity Costs
Purchase Purchase Order 1 Order 2
Total
Direct materials costs 5,000.00 3,500.00 8,500.
00 Activity costs Placing purchase order
80.25 80.25 160.50 Verifying purchase
order 18.75 18.75 37.50 Unloading/unpacking/inspe
cting (5,000 x 0.0315) 157.50 (3,500 x
0.0315) 110.25 267.75 Total 256.50
209.25 465.75 Total costs assigned to
cost objective 5,256.50 3,709.25 8,965.75
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Purchasing Department 45,000
Resource Costs
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Detroit Metal Shop Example
The following activity costs were determined in
the Machining and Finishing Departments
Machining Department Setup 250 Conversion
(100 x 35MH) 3,500 Finishing Department Polish
(50 x 20 labor hours) 1,000 Pack (5 x 450
kilograms) 2,250 Total cost assigned to cost
object 7,000
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Detroit Metal Shop Example
Machining Department
Finishing Department
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Detroit Metal Shop Example
Direct materials Order 1 5,000.00 Order
2 3,500.00 8,500.00 Inbound logistics Placing
purchase order 160.50 Verifying purchase
order 37.50 Unloading/unpacking/inspecting
267.75 465.75 Operations Setup
250.00 Conversion 3,500.00 Polish 1,000.00 Pack
2,250.00 7,000.00 Total cost assigned to Job
102 15,965.75
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Two-Stage Activity Based Costing Method
Direct Resource Costs
Costs of resources directly traceable to cost
objectives
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Two-Stage Activity Based Costing Method
Stage 1 Indirect resources costs are assigned
to activity pools.
Continued
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Two-Stage Activity Based Costing Method
Stage 2 Activity costs are reassigned to cost
objectives using an activity drivers.
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Additional Considerations
Because activity-based costing is not guided by
financial accounting requirements, there is wide
variation in the components of ABC systems.
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Reducing Non-Value-Added Activities

• Movement
• Waiting
• Setup
• Inspection

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Reducing Non-Value-Added Activities
Continuous improvement and process reengineering
seek to minimize non-value-added activities.
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The ABC/ABM Cross
Cost Assignment View (ABC)
Process View (ABM)
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