ABC

Activity-Based Costing and Management
222545:Cost Management for Engineers
Activity Analysis
The process of combining activities into functions is aggregation. Aggregating activities to a function provide a basis for directing management attention to high-cost areas that might otherwise be obscured in numerous individual activities.
Assoc. Prof. Dr. Patcharaporn Yanpirat
Activity Analysis
The process of breaking down an activity into task is decomposition. To look inside the activity to model the detailed working of its internal tasks. It is suitable for performance improvement by decomposing activities into tasks and then restructuring the tasks.
Activity analysis seeks to provide the following information:
Activities
What the enterprise does specific tasks that make up the job assignment, their relative timing and importance in achieving corporate goal.
The transactions that trigger the activity (input) and the product of the activity (output).
Input/Output
Activity Analysis Methodology

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Determine activity analysis scope Determine activity analysis units Define activities Rationalize activities Classify as primary or secondary Create activity map Finalize and document activities
Activity Analysis Methodology: Determine activity analysis scope
To define the specific business decision to be analyzed to ensure the analysis is applied to an area of potential improvement. To limit the range of activities specified in the activity analysis so that the information can be efficiently gathered.
Activity Analysis Methodology: Determine activity analysis units
The activity units may correspond to organizational units, or they may cross organizational boundaries. The activity units is functionally homogeneous and large enough to warrant an analysis. Rule of thumb, they should consist of 5-20 people with a level of expenditure of $50,000 to $100,000.
Activity Analysis Methodology: Define activities
The primary techniques
Analysis of historical records Analysis of organizational units Analysis of business process Analysis of business functions Directed industrial engineering study Reconciliation of activity definition
A Structured Approach: Worksheet

No. Activity Duration Input Output
Define activities: Techniques
Analysis of historical records
The use of production statistics compiled over a period of time to determine what a department does and how long it has taken in the past to process the output of an activity.
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Define Activities
Activities Orders Employee 1 EH Employee 2 Check credit Type invoice Account adj. 20 Check credit 12 Type invoice 4 Address Change EH Employee 3 EH Employee 4 18 Check credit 13 Type invoice 8 Address Change Inventory control 1 Weekly Inventory report 6 Make new file 4 File invoice Pull files 15 File changes Pull changes 12 Inventory tickets 2 Search EH Totals 4 93 hrs. 8 59% 8 5 37 hrs. 5 24% 6 18 hrs. 11% 9 hrs. 3 6%
Adjustments Inventory
Miscellaneous Order supply File diaries
2 Weekly error 1 report
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Analysis of organizational units
By studying the organizational units that perform or manage a functional area to determine how each unit completes its specified objectives. To rely to a large extent on various peoples knowledge of the company operations. ---- Delphi method
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Delphi method
To identify current activities and the resources allocated to accomplish them. The activities and time allocations recorded are based on the judgment of the experts. Interviews, questionnaires, panels of experts, and observation.
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Analysis of business process
Study the business process and define them in terms of major activities. Product design, material procurement, production planning and control, and so on.
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Business Process of Procuring Material
It is composed of the following activities:

The The The The The The
issue of purchase specifications selection of bid vendors issue of purchase orders receiving of parts storage of parts payment of vendor account
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A business process analysis traces inputs to outputs
The procedure is to determine the sequence of activities by following the flow of information from one activity to another. The output of one activity becomes the input to another activity and being connected to emerge a business process.
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Advantage: being possible to graphically link all inputs and outputs among activities and identify interdepartmental communication routes. Disadvantage: general activities (supervising and secretarial support) may be missed. The important tool used to define business process is the PERT chart to portray the relationship between activities and their timing.
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Analyze Business Functions
To break down each major function (such as quality or security) into activities. It allows common activities (secretarial services) to be considered across the whole business.
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Directed industrial engineering study

Precise but expensive method Time observation It is appropriate for factory or clerical jobs that are repetitive, are of short duration, and have observable work cycles. Managerial and administration jobs are not suitable to this approach.
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Activity Analysis Methodology: Reconciliation of activity definition
The activity definition approaches are merely different methods of defining the same set of activities and therefore require reconciliation. To begin an activity analysis with an organizational review of each department followed by a business process or functional analysis.
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Step 4: Rationalize Activities
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Benefits and Limitations of an Activity-Based Costing System

Benefits
It provides more accurate and informative product costs. It provides more accurate measurements of activitydriving costs. It helps managers identify and control the cost of unused capacity.
Limitations
Some costs may require allocations to departments and products based on arbitrary volume measures. Some costs that can be identified with specific products are omitted. Expensive to develop and implement; it is also very time-consuming.
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Learning Objective
Describe an activity-based management system and distinguish between highvalue-added and low-valueadded activities
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Activity-Based Management (ABM)

The management of activities to improve the value received by the customer and to increase the profit achieved by providing this value.
Management can pinpoint avenues for improving operations, reducing costs, or increasing values to customers. ABM improves managements focus on the firms critical success factors and enhances its competitive advantage.
Assoc. Prof. Dr. Patcharaporn Yanpirat Activity-Based Costing and Management
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ABM can be classified into two categories: Operational enhances operation efficiency and asset utilization and lowers costs Strategic attempts to alter the demand for activities and increase profitability at the current activity efficiency
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Cost driver analysis examines, quantifies, and explains the effects of the cost driver on the cost of an activity A cause-and-effect diagram maps out causes that affect an activity, process, stated problem, or outcome A Pareto analysis is a histogram of cost drivers that contribute to the total cost Performance measurement identifies the work performed and the results achieved by an activity, process, or organizational unit
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The Role of ABC/ABM Tools
Insert Exhibit 5.10
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Activity Analysis
To be competitive, a firm must assess each of its activities based on:

its need by the product or customer its efficiency, and its value content
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Activity Analysis
A firm performs an activity because it is: required to meet the specification of the product or service or satisfy customer demand required to sustain the organization, or deemed beneficiary to the firm A firm may or may not perform an activity at the highest level of efficiency
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Activity Analysis
Insert Exhibit 5.11 (Activity Analysis) Here

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Value-Added Activities
A value-added activity increases the value of the product or service to the customers A high-value-added activity increases significantly the value of the product or service to the customers A low-value-added activity consumes time, resources, or space, but adds little or does not contribute to satisfying customer needs
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Examples of High-Value-Added and Low-Value-Added Activities
Insert Exhibit 5.12
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Low-Value-Added Activities
Firms need to realize that low-valueadded activities decrease competitiveness and profitability Efforts to eliminate or reduce lowvalue-added activities are neverending tasks
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A Classification of High-Value-Added and Low-Value-Added Activities
Insert Exhibit 5.13
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Learning Objective
Describe how activity-based costing systems are used in the manufacturing industry
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Manufacturing Industry Applications
Activity-based costing started in the manufacturing industry Many manufacturing companies have successfully implemented activitybased costing and management systems ABC in manufacturing can focus on the costs of different activities at each production process
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Manufacturing Industry Applications
Insert Exhibit 5.14
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Learning Objective
Describe how activity-based costing systems are used in marketing and administrative activities
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ABC for Marketing and Administrative Activities
ABC can be used for marketing activities, such as sales calls, advertising, selling, order filling, shipping, etc. ABC can be used for administrative activities, such as accounting, data processing, personnel, quality assurance, etc. The procedures to apply ABC to marketing and administrative activities are similar to the steps for manufacturing applications
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Cost Drivers for Marketing Activities
Insert Exhibit 5.15
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Learning Objective
Demonstrate
how activitybased costing systems are used in service and not-forprofit organizations
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Service and Not-For-Profit Applications of ABC
Service and not-for profit organizations have many operating characteristics that make them different from manufacturing companies, such as:
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changeable outputs less predictability on service request activity ambiguous relations between overhead or indirect costs and products or service outputs
However, many service and not-for-profit organizations have developed and implemented ABC systems
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Learning Objective
Analyze factors affecting revenues and selling and administrative costs and determine customer profitability
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Customer Profitability Analysis
ABC/ABM product costing can be extended to customer profitability analysis to identify the best customers Customer profitability analysis focuses on selling, general, and administrative costs Customer profitability analysis analyzes activities, identifies proper cost drivers, and determines realized profits form customers
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Customer profitability analysis allows managers to: identify the most profitable customers manage each customers costs-to-serve to a lower level establish a surcharge for or re-pricing of expensive activities reduce services introduce new products and services raise prices for demanders abandon products, services, or customers
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Customer profitability analysis also allows managers to: improve their processes offer the customer profit-positives service level options shift the customers purchase mix toward richer, higher-margin products and service lines discount to gain more volume with low cost-toservecustomers select the customer mix choose various kinds of after-sale services to provide
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Insert Exhibit 5.16 (Profitability Matrix) Here

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Customer profitability analysis traces and reports customer revenues and customer costs Customer profitability analysis can provide many benefits, such as: providing better services to highly profitable customers securing highly profitable customers from competitors setting prices based on the cost to serve negotiating with customers to reach mutually beneficial levels of services conceding permanent loss customers to competitors
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Customer Revenue Analysis
Customer revenue analysis considers all activities that affect the net amount received from the customers Customer revenue analysis traces prices and discounts (including sales and cash discounts) to customers and identifies financing costs associated with customer revenues
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Illustration of RevenueRelated Activities
Insert Exhibit 5.17
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Example of Customer Revenue Analysis
Insert Exhibit 5.18
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Learning Objective
Describe customer cost categories and identify the costs to serve a customer
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Customer Cost Analysis
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Not all customers require the same type of activities. Examples of customer-specific activities include: order processing costs billing, collection,and payment processing costs accounts receivable and carrying costs customer service costs return or allowance processing costs restocking costs selling and marketing costs
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Customer cost analysis identifies activities and cost drivers to service customers Traditionally, these costs are hidden in the customer support, marketing, and sales function ABC/ABM can help managers to grasp activities and their costs to serve customers
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Customer cost can be classified into the following categories:

customer unit-level cost customer batch-level cost customer-sustaining cost distribution-channel cost sales-sustaining costs
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Customer-Related Activity
Insert Exhibit 5.19 (Customer-Related Activity) Here

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Customer-Related Activity
Insert Exhibit 5.20
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Insert Exhibit 5.21
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Learning Objective
Conduct customer profitability analysis and determine customer value
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A
customer profitability analysis combines customer revenue and customer cost analyses to assess customer profitability and helps identify actions to improve customer profitability
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Insert Exhibit 5.22
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Customer Value Assessment
Customer profitability analysis provides valuable information to the assessment of customer values However, firms must also weigh other relevant factors, such as: Growth potential of the customer Possible reactions of the customer to changes Importance of having the firm as a customer for future sales references
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Learning Objective
Relate activity-based costing to strategic cost management
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Strategic Cost Management

Activity-based costing facilitates strategic cost management ABC provides information for mangers to manage activities to improve competitiveness and achieve strategic goals Successful firms use their resources on activities that lead to the greatest strategic benefit ABC/ABM helps managers to understand the relationship between the firms strategy and the activities and resources needed to implement the strategy
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Strategic Cost Management
For firms following a cost
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leadership strategy, ABC/ABM identifies key activities, cost drivers, and ways to improve processes to reduce cost For firms following a differentiation strategy, ABC/ABM can help to: identify value-enhancement opportunities develop a customer strategy support a technological leadership strategy establish a pricing strategy
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Learning Objective
Identify key factors for a successful ABC/M implementation
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Successful ABC/ABM Implementation
A successful ABC/ABM implementation requires close cooperation among management accountants, engineers, and manufacturing and operating managers According to a recent survey, a main reason for unsuccessful implementations was that many companies overemphasized the architectural and software design of ABC systems and failed to pay adequate attention to other issues
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Successful ABC/ABM Implementation
Key factors for a successful ABC/ABM implementation include: involve management and employees in creating an ABC system maintain a parallel system use ABC/ABM on a job that will succeed keep the initial ABC/ABM design simple create desired incentives educate management
1. 2. 3. 4. 5. 6.
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End
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Activity-Based Costing and Management

222545:Cost Management for Engineers

Assoc. Prof. Dr. Patcharaporn Yanpirat

Assoc. Prof. Dr. Patcharaporn Yanpirat

Activity analysis seeks to provide the following information:

Assoc. Prof. Dr. Patcharaporn Yanpirat

Activity Analysis Methodology

Assoc. Prof. Dr. Patcharaporn Yanpirat

Activity Analysis Methodology: Determine activity analysis scope

Assoc. Prof. Dr. Patcharaporn Yanpirat

Activity Analysis Methodology: Determine activity analysis units

Assoc. Prof. Dr. Patcharaporn Yanpirat

Activity Analysis Methodology: Define activities

The primary techniques

Assoc. Prof. Dr. Patcharaporn Yanpirat

Activity-Based Costing and Management

A Structured Approach: Worksheet

Assoc. Prof. Dr. Patcharaporn Yanpirat

Activity-Based Costing and Management

Define activities: Techniques

Analysis of historical records

Assoc. Prof. Dr. Patcharaporn Yanpirat

Activity-Based Costing and Management

Miscellaneous Order supply File diaries

2 Weekly error 1 report

Assoc. Prof. Dr. Patcharaporn Yanpirat

Activity-Based Costing and Management

Activity Analysis Methodology: Define activities

Analysis of organizational units

Assoc. Prof. Dr. Patcharaporn Yanpirat

Activity-Based Costing and Management

Assoc. Prof. Dr. Patcharaporn Yanpirat

Activity Analysis Methodology: Define activities

Analysis of business process

Assoc. Prof. Dr. Patcharaporn Yanpirat

Activity-Based Costing and Management

Business Process of Procuring Material

It is composed of the following activities:

The The The The The The

Assoc. Prof. Dr. Patcharaporn Yanpirat

A business process analysis traces inputs to outputs

Assoc. Prof. Dr. Patcharaporn Yanpirat

Assoc. Prof. Dr. Patcharaporn Yanpirat

Activity Analysis Methodology: Define activities

Analyze Business Functions

Assoc. Prof. Dr. Patcharaporn Yanpirat

Activity-Based Costing and Management

Activity Analysis Methodology: Define activities

Directed industrial engineering study

Assoc. Prof. Dr. Patcharaporn Yanpirat

Activity Analysis Methodology: Reconciliation of activity definition

Assoc. Prof. Dr. Patcharaporn Yanpirat

Step 4: Rationalize Activities

Assoc. Prof. Dr. Patcharaporn Yanpirat

Activity-Based Costing and Management

Activity Analysis Methodology: Determine activity analysis scope

Assoc. Prof. Dr. Patcharaporn Yanpirat

Activity-Based Costing and Management

Activity Analysis Methodology: Determine activity analysis scope

Assoc. Prof. Dr. Patcharaporn Yanpirat

Activity-Based Costing and Management

Assoc. Prof. Dr. Patcharaporn Yanpirat

Activity-Based Costing and Management

Assoc. Prof. Dr. Patcharaporn Yanpirat