Activity-Based Costing and Management

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Activity-Based Costingand Management
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The Just-in-Time System

• Eliminating waste
• Reducing inventories
• Developing a strong supplier relationship
• Increasing employee involvement
• Developing customer focus programs

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What is Kanban?

• A set of control cards that are used to signal
  the need for materials and products to move from
  one operation to the next in an assembly line.

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Work Cells

• Major Characteristics
• Related manufacturing equipment are organized in
  clusters
• Operations are moved together
• All production activities from raw materials to
  finished stage are in the same cell
• Visual control is easy

• Small groups of related manufacturing equipment
  organized in clusters to assemble production
  units that produce finished products.

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Automation

• Robots
• Computer-aided design (CAD)
• Computer-aided manufacturing (CAM)

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Limitations of TraditionalCosting Systems
Departmental Rate
Activity Based Costing
Volume-BasedPlantwide Rate
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Limitations of TraditionalCosting Systems
Plantwide allocation is simple but
omits allocation of service department costs.
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Limitations of TraditionalCosting Systems
A departmental rate provides more detailed
cost measures, particularly if the departments
perform quite different activities.
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Limitations of TraditionalCosting Systems
I need to know more about activity-based costing
before I make my decision. It looks like my
decision will be based on a careful cost-benefit
analysis.
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Activity-Based Costing
Direct labor hours

• ABC is a costing approach that assigns costs to
  products or services based on their consumption
  of the resource caused by the activities.

Machine hours
Lot size
Number of setups
Number of engineering hours
Number of layers
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Single Plant-wide Overhead Rate
Dole Company has two factories Alpha and Beta.
Alpha is a highly automated factory while Beta is
a labor-intensive factory.The company uses a
single plant-wide overhead rate based upon labor
hours.
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Single Plant-wide Overhead Rate
During the first month of operations the company
has the following information for it two products
Widget and Gidget
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Single Plant-wide Overhead Rate
Using the plant-wide rate, factory overhead is
applied to the two products as shown below.
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Departmental Overhead Rates
To obtain more accurate product costing the
company decided to use departmental overhead
rates. The overhead in Alpha is to based on
machine hours, and Beta will use labor hours.
Alphas DepartmentalOverhead Rate
400,000 20,000
20 per machine hour

Betas DepartmentalOverhead Rate
200,000 50,000
4 per labor hour

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Departmental Overhead Rates
Using the new departmental overhead rates,
overhead would be allocated to the two products
as shown below.
Applied overhead will be 13,000 lower for Widget
and 13,000 higher for Gidget as a result of
using departmental rates rather than a plant-wide
rate.
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Two-Stage AllocationProcedures
Traditional
Activity-Based
Resource Costs
Resource Costs
First stage
First stage
Cost Pools Plants or Departments
Cost Pools Activities or Activity Centers
Second stage
Second stage
Cost Objects
Cost Objects
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When Is an Activity-Based Costing System Needed?

• ABC should be implemented when . . .
• the cost of measuring the activities and their
  costs is reduced, perhaps because of computerized
  scheduling systems on the production floor.
• stronger competition increases the cost of errors
  caused by erroneous pricing.
• product diversity is high in volume, size, or
  complexity.

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Steps in Designing anActivity-Based Costing
System

• Identify resource costs and activities
• Assign resource costs to activities
• Assign activity costs to cost objects

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Categories of Activities

• Unit-level activity An activity that is
  performed for each unit of production (direct
  materials, direct labor hours, inserting a
  component)
• Batch-level activity An activity that is
  performed for each batch of products rather than
  for each unit of production (machine setup,
  purchase ordering, production scheduling)

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Categories of Activities

• Product-sustaining activity An activity that is
  performed to support the production of a given
  product (product design, parts administration,
  issuance of engineering change orders,
  expediting)
• Facility-sustaining activity An activity that
  is performed to sustain the production of
  products in general (security, safety,
  maintenance, plant management)

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Sample Activity Drivers at John Deere
Slide 4-12
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Activity-Based Costing and Management
Materials purchasing Direct labor support Machine
operation Setup Production order Materials
handling Parts administration General and admin-
istrative
Identify these activities as unit, batch, product
or facility.
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Sample Activity Drivers at John Deere
Slide 4-12
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Activity-Based Costing and Management
Materials purchasing Direct labor support Machine
operation Setup Production order Materials
handling Parts administration General and admin-
istrative

• Unit
• Unit
• Unit
• Batch
• Batch
• Batch
• Product
• Facility

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Steps in Designing anActivity-Based Costing
System

• Identify resource costs and activities
• Assign resource costs to activities
• Assign activity costs to cost objects

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Typical Resource Drivers

• Meters for utilities
• Number of employees for payroll-related
  activities
• Number of setups for the machine setup activity
• Number of moves for the material handling
  activity
• Machine hours for machine power running activities

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Steps in Designing anActivity-Based Costing
System

• Identify resource costs and activities
• Assign resource costs to activities
• Assign activity costs to cost objects

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Activity Drivers at John Deere
Activity
Driver Materials purchasing Material
cost Direct labor support Direct labor
cost Machine operation Machine hours Setup Setup
hours Production hour Number of orders Material
handling Number of loads Part administration Numbe
r of parts General and administrative Amount of
value-added
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Activity-Based Costing
Limitations
Benefits

• Some costs may require allocations to departments
  and products.
• Some costs that can be identified with specific
  products are omitted.
• Expensive to develop and implement it is also
  very time-consuming.

• It provides more accurate and informative product
  costs.
• It provides more accurate measurements of
  activity driving costs.
• It provides managers with easier access to
  relevant costs.

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Comparison of Traditional and Activity-Based
Systems
Northern High-Tech, Inc.
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Comparison of Traditional and Activity-Based
Systems
Northern High-Tech provides the following
information about the two products it sells.
Overhead Rate
2,000,000 100,000
20 DLH
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Comparison of Traditional and Activity-Based
Systems
Northern High-Tech provides the following
information about the two products it sells.
Deluxe Model 20 25,000 500,00 total
overhead 500,000 5,000 units 100 per unit
Regular Model 20 75,000 1,500,000 total
overhead 1,500,000 15,000 units 100 per unit
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Comparison of Traditional and Activity-Based
Systems
Here are the actual activity units or
transactions for both products
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Comparison of Traditional and Activity-Based
Systems
Calculate the activity rate for each activity
cost driver.
125,000 12,500 10 per engineering hour
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Comparison of Traditional and Activity-Based
Systems
50,000 5,000 10 per unit
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Comparison of Traditional and Activity-Based
Systems
75,000 15,000 5.00 per unit
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Product ProfitabilityTraditional Costing Systems
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Product ProfitabilityActivity-Based Systems
Total overhead of 275,000 would be shifted from
the Regular to the Deluxe Model when using
activity-based costs in this case. This shifting
accounts for the change in product margins.
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Activity-Based Management

• The management of activities to improve the
  value received by the customer and to increase
  the profit achieved by providing this value.
• Measures the effectiveness of the key business
  processes and activities and identifies how they
  can be improved to reduce costs and to increase
  value to customers.
• Improves management focus by allocating resources
  to key value-added activities, key customers, key
  products, and continuous-improvement methods.

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Value-Added andNon-Value-Added Activities
Value-added activity is an activity that is
judged to contribute to (1) customer value and
satisfaction or (2) satisfy an organizational
need.
Non-value-added activity is an activity that is
considered not to contribute to customer value or
to the organizations needs.
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Non-Valued-Added Costs
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Non-Valued-Added Costs
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Value-Added Costs
Inspection time
Moving time
Processing time
Storage time
Waiting time
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Which of These Are Value-Added Costs?
Designing product
Waiting
Setting up
Moving
Repairing
Processing
Storing
Reworking
Inspecting
Delivering product
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Which of These Are Value-Added Costs?
Designing product
Waiting
Setting up
Moving
Repairing
Processing
Storing
Reworking
Inspecting
Delivering product
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Adding Value Using Activity-Based Costing

• Better information about product costs.
• Better product costs information helps managers
  make pricing decisions.

• Better information about the cost of activities
  and processes.
• By identifying the costs of various activities,
  managers gain a lot of information that was
  previously buried in the accounting system.

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Activity-Based Costing and Strategic Cost
Management

• How do the cost structures and profits of a firm
  measure up to its competition?
• What are the potential impacts on pricing,
  product design, process design, and product-line
  decision when a firm switches from the
  traditional to activity-based costing?
• Has a firm adopted the most profitable
  distribution system in its product market?
• How would changes in activities and components
  affect the suppliers and customer in the value
  chain?

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End of Chapter 4