ACTG 4310

Chapter 10 – Fundamentals of Cost Management

Activity-Based Cost Management

• Used to control activities• Add value• Give detailed information about product costs• Provide better information about the cost of

activities and processes• Allows one to perform activity analysis• Helps with cost reduction and process

improvement decisions• Helps with product pricing/ product-mix decisions

Adding Value

1. Identify what the customer wants or expects from the process

2. Chart the activities used to complete the product or service

3. Classify all activities as value-added or nonvalue-added

4. Continuously improve the efficiency of value-added activities and eliminate non-value added activities.

Activity Analysis of Cost Hierarchies

• Unit level – Volume based– Tough to change these costs

• Batch level– Good place to make improvements

• Product level– Good place to make improvements

• Customer level– Good place to make improvements

• Facility level– Depends on the capacity determined by management– Hard to change in the short-run

ABC of Customers

• Customer Profitability Analysis– Determine the revenue per customer– Determine the direct costs of the customer– Determine the activities used by customers and

multiply by the activity rate– Determine the total net income per customer– If considering dropping the customer,

• Only those costs and revenues that can be eliminated if client is dropped should be considered

• Consider opportunity costs of time spent on client• Consider effects on other clients• Consider nonfinancial considerations

ABC of Suppliers

• Essentially the same analysis as ABC of customers

• Look at the following characteristics of suppliers:– Accuracy of deliveries– Time of deliveries– Quality of goods and services

• Include the costs to correct failures to purchase price paid

Managing the Cost of Capacity

• Resources used = cost driver rate x cost driver volume

• Resources supplied = expenditures spent on the activity

• Unused resource capacity =Resources supplied – Resources used

Activity-based Income Statement

• Different from the traditional income statement (which shows resources supplied only)

• Shows resources used, resources supplied, and unused resource capacity

• Can list amounts by cost hierarchy (unit, batch, product/customer, capacity)

• Managers can try to manage the unused resources effectively

Activity-based Income Statement

Computing the Cost of Unused Capacity

• Actual activity – actual volume for period• Normal activity – long-run expected volume• Practical capacity – includes scheduled

maintenance and breaks• Theoretical capacity – ideal conditions

• Theoretical capacity will have the lowest costs per unit

Cost of Unused Capacity

• Should not be assigned to products unless seasonal

• Should be a period cost • Calculating it makes managers aware of the

cost• If seasonal demand affects capacity– Cost of unused capacity should be to assigned to

seasonal customers only, not to off-season customers

Quality

• Quality has become very important in today’s competitive environment.

• Definition – total features and characteristics of a product or a service made or performed according to specifications to satisfy customers at the time of purchase and during use.

Quality

• Customer Viewpoint (External)– Service– Quality– Cost– Customer satisfaction measures

• Company Viewpoint (Internal)– Technical measurements– Zero defects– Value-added versus non-value added– Total quality control

Classification of Quality Costs

• Prevention costs – preclude nonconformance with specifications

• Appraisal costs – tests to determine conformance with specifications

• Internal failure costs – redo defective products in order to sell as a normal product

• External failure costs - costs incurred to right defective products in customer’s hands

• Prevention costs best, external failure costs worst

Measurement

• Lost profits – due to having to sell products at lower prices

• Opportunity costs – forgone sales due to defective products (word of mouth to friends)– Not an accounting cost in the general ledger but a true

economic cost

• Cost of quality report

Quality Programs

• Just-in Time– Throughput time – total time from when a product

starts the production process until it is ready for sale.• Six Sigma – 3 defects per million• Lean manufacturing and accounting – Eliminate

all non-value added activities• Lean Six Sigma• TQM programs cause accounting changes in the

firm