CHAPTER 3
Activity-Based
Management
PowerPoint Presentation by
LuAnn Bean
Professor of Accounting
Florida Institute of Technology
© 2012 Cengage Learning. All Rights Reserved. May
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Managerial Accounting 11E
Maher/Stickney/Weil

1


☼

CHAPTER GOAL

☼

This chapter shows how ABC and ABM rest on
the premise that: Products require activities
and activities consume resources. For
products to be competitive, managers must
know

Activities for producing goods, services
Cost of activities

ABC analyses ways to allocate indirect costs
while ABM uses analysis to manage costs.
2


LO 1

How do ABC and
ABM work?

ABC provides information about
profitability in mix of activities,
products
ABM encourages managers to use
information to become low-cost
producer or seller.

3


LO 1

ABM ACTIVITY ANALYSIS
Chart, start to finish, activities used to
complete product or service
Classify activities as value-added or nonvalue-added
Eliminate non-value-added activities

Continuously improve, reevaluate efficiency
of value-added activities or replace with more
efficient activities
4


LO 1

Value Chain
Organization Strategy and Administration
Production Marketing Distribution Customer
Service
Customer

EXHIBIT 3.1

Research and Design
Development

5


LO 1

Value Chain
Organization Strategy and Administration
Research and Design
Development

Production Marketing Distribution Customer

Service

ABM
ABManalyses
analysesand
and
evaluates
evaluatesevery
every
step
stepof
ofthe
theValue
Value
Chain.
Chain.

EXHIBIT 3.1 & 3.2

Customer

6


LO 1

NON-VALUE-ADDED
NON-VALUE-ADDED COSTS:
COSTS:
Definition

Definition

Are costs of activities that the company
can eliminate without reducing product
quality, performance, or value.

7


LO 1

Value Chain
Organization Strategy and Administration
Research and Design
Development

Production Marketing Distribution Customer
Service

ABM
ABManalyses
analysesand
and
evaluates
evaluatesevery
every
step
stepof
ofthe
theValue

Value
Chain.
Chain.
Eliminate

EXHIBIT 3.1 & 3.2

Customer

8


LO 1

ABC ANALYSIS
Potential candidates for elimination because they
do not add value are
Storage
Moving: parts, materials, etc. around the factory
floor
Idle time
Other production process components

9


LO 2

EXAMPLE
You and a friend go to dinner. You order tea ($2.50) and

a salad ($8.00). Your friend orders appetizer,
expensive entree, and dessert. The total bill is $60.
Traditional cost allocation leads to splitting the bill,
$30 apiece.
What does activity analysis suggest each of you
should pay?
YOU: $ 10.50 + tax & tip
FRIEND: $49.50 + tax & tip
10


LO 2

ABC COST-BENEFIT
Applying ABC has a cost of information gathering.
Managers must take cost-benefit into account.
 Managers reject activity analysis, staying with traditional
methods that are simpler.
Smaller companies don’t need sophisticated information systems

 Managers use ABC because information helps them be
competitive
Complex organizations facing heavy competition use ABC

 Managers use ABC in special circumstances

11


LO 2


COST POOLS
Three major types of cost pools:
The “plant” (traditional)
Sets one indirect cost allocation rate plantwide

The department (traditional)
Sets indirect cost allocation rates for each department

The activity center (ABC)
Determines cost pool for each activity

12


LO 4

ABC STEPS TO FOLLOW
Accountants required to follow four steps:
1. Identify activities that consume resources; assign
costs to those activities.
Example: purchasing materials

1. Identify cost drivers for each activity.
Cost driver for purchasing materials: # of orders

1. Compute a cost rate per cost driver unit.
Cost per order

1. Assign costs to products.

(Cost per order) X (number of purchase orders)
13


LO 4

COST
COST DRIVER:
DRIVER: Definition
Definition
Is a factor that causes,
“drives,” an activity’s
costs.

14


LO 4

Which cost drivers listed below would a law firm use?
Machine hours
Number of surgeries
Computer time
Purchase orders
Labor hours, cost
Scrap/rework orders
Items produced, sold
Quality inspections
Pounds of material handled
Hours of testing time

Clients served
# of parts in product
Pages typed
# of different clients
Flight hours
Miles driven
Machine setups

EXHIBIT 3.3

EXAMPLE: Cost Drivers

15


LO 4

Which cost drivers listed below would a law firm use?
Machine hours
Number of surgeries
Computer time
Purchase orders
Labor hours, cost
Scrap/rework orders
Items produced, sold
Quality inspections
Pounds of material handled
Hours of testing time
Clients served
# of parts in product

Pages typed
# of different clients
Flight hours
Miles driven
Machine setups

EXHIBIT 3.3

EXAMPLE: Cost Drivers

16


LO 4

How do managers decide
which cost driver to use?

Typically, managers choose a
cost driver that causes the
cost.

17


LO 4

COST RATE EQUATION
Predetermined indirect cost rate =
Estimated Indirect Cost


÷
Estimated Volume of Allocation Base

18


LO 4

EXAMPLE: Traditional Costing
Ciudad Juarez factory makes 2 products: mountain bikes and
racing bikes. 1,000 mountain bikes and 200 racing bikes will be
produced. Direct materials include
Frames: $100 per mountain bikes and $200 per racing bike
Direct labor: $30 per mountain bike and $60 per racing bike
Overhead, allocated at 5 times direct labor

What would be the cost of each bike under traditional
costing?
Continued
19


LO 4

EXAMPLE: Traditional Costing
Mountain Bikes Racing Bikes

Direct materials
Direct Labor

Manufacturing overhead1,2
Total cost per bike
1

5 * DL

2

($150 * 1,000 + $300 * 200) = $210,000

$100

$200

30
150

60
300

$280

$560

Continued
20


LO 4


EXAMPLE: ABC Costing
Ciudad Juarez factory makes 2 products: mountain bikes and
racing bikes. 1,000 mountain bikes and 200 racing bikes will be
produced. Direct materials include
Frames: $100 per mountain bikes and $200 per racing bike
Direct labor: $30 per mountain bike and $60 per racing bike
Overhead, allocated by activity costs

What would be the cost of each bike under ABC
costing?
Continued
21


LO 4

EXAMPLE: ABC Costing
Activity

Rate

Mountain Bike

Racing Bike

Cost driver
units

Cost driver
units


Purchasing $20/frame

1,000 frames

Setups

Cost
Allocated

Cost
Allocated

$ 20,000 1,000 frames

$ 4,000

13 setups

26,000 13 setups

60,000

Inspections $100/inspect hr 200 hours

20,000 200 hours

20,000

Running

machines

45,000 1,500 hrs

15,000

$2,000/setup

$30/hour

1,500 hrs

Total

$111,000

$99,000

Mountain Bike = $111,000 / 1,000 = $111
Racing Bike = $99,000 / 200 = $495

EXHIBIT 3.5
22


LO 6

COST
COST HIERARCHY:
HIERARCHY: Definition

Definition
Categorizes costs so
changes in one cost can be
examined for its effects on
other cost categories.

23


LO 6

EXAMPLE: Hierarchy of Costs
Activity Category

Example

Capacity

Size limitations

Aircraft depreciation

Customer

Needs

Special promotions

Product


Production needs

Route schedules

Batch

Batch

Fuel, baggage handling

Unit

Variable costs

Credit card fees
24


LO 7

RESOURCES
RESOURCES USED:
USED: Definition
Definition

Are measured by
ABC.

25