Chapter 10: Fundamentals of Cost
Management
USING ACTIVITY-BASED COST
MANAGEMENT TO ADD VALUE
Activity-based cost management
 approach that uses activity-based
costing data to evaluate the cost of
value-chain activities and to identify
opportunities for improvement
 uses activity-based costing data to
evaluate the cost of value-chain
activities within the firm and identify
opportunities for improvement
Activity-based costing (ABC)
 system used to assign costs to products
based on the products’ use of activities,
which are the discrete tasks an
organization undertakes to make or
deliver the product
Value chain
 set of activities that transforms raw
resources into products for customers
Options when reducing costs:
1. adjust the frequency of activity to match
resources
2. use fewer or lower-cost resources to
improve efficiencies
Companies that implement ABC and ABCM
commonly report two benefits:
1. Better information about product
costs.
 helps managers make decisions
about pricing and whether to keep or
drop products
 consider product costs in setting
prices
 use information to decide whether to
continue selling certain products
 if product’s profit margin is too low
or if it loses money, managers will
probably consider discontinuing it
2. Better information about the cost of
activities and processes.
 help managers gain useful
information that may have been
hidden by the previous accounting
system
USING ACTIVITY-BASED COST
INFORMATION TO IMPROVE PROCESSES
First step in ABCM: Activity Analysis
 analyzing the costs of key activities
Steps
1. Identify what the customer wants or
expects from the firm’s products or
services, including key features, price,
and quality.
2. Chart, from start to finish, the company’s
activities for completing the product.
3. Develop activity-based costing data for
each activity, based on the resources
used in each activity.
4. Classify all activities as value-added or
nonvalue-added.
5. Compare the costs of each activity with
the value that customers assign to it.
6. Continuously improve efficiency of all
value added activities. Eliminates or
reduce nonvalue-added activities.
Process reengineering
 changing operational processes to
improve performance, often after
examining activity-based costing data to
determine opportunities for improvement
Types of activities that are candidates for
elimination (nonvalue-added):
1. Storing items.
2. Moving items.
3. Waiting for work.
LEAN MANUFACTURING AND ACTIVITY-
BASED COST
Lean manufacturing
  approach to production that looks to
significantly reduce production costs Unused resource capacity
using solutions such as just-in-time  difference between resources supplied
inventory and production, elimination of and resources used
waste, and tighter quality
4 Possibilities When Using Capacity as
Lean accounting Allocation Base
 cost accounting system that provided
measures at the work cell or process 1. Actual activity
level and minimizes wasteful or  actual volume for the period
unnecessary transaction processes  leads to information that can
 cost accounting system designed distort pricing decisions
around the value chain of major 2. Theoretical capacity
products to support lean manufacturing  amount of production possible
 applying lean production methods to under ideal conditions with no
accounting work itself time for maintenance,
breakdowns, or absenteeism
 cannot be achieved
Lean manufacturer 3. Practical capacity
 organizes its factory around the process  volume that could be produced
flow of a single major product, not allowing for expected breaks and
around groups of similar machines normal (expected) maintenance
and downtime
USING COST HIERACHIES 4. Normal activity
 long-run expected volume
 managers analyze only the volume-
related costs if they make decisions that Seasonal demand
affect units, but not in batches, products,  occurs when demand for the
customers, or capacity. capacity is uneven over some
 if managers make decisions that affect period such as the year
capacity, costs in all levels of hierarchy-
volume, batch, product and facility-will HOW CAN WE LIMIT CONFLICT BETWEEN
probably be affected, and activities in all TRADITIONAL MANAGERIAL ACCOUNTIGN
four categories should be analyzed. SYSTEMS AND TOTAL QUALITY
MANAGEMENT
USING AND SUPPLYING RESOURCES
Effective implementation of TQM requires 5
Activity-based costing changes to traditional managerial
 estimates the cost of resources used accounting systems

Resources used 1. information should include problem-

 cost driver rate x cost driver volume solving data such as that from quality
control charts, not just financial reports
Resources supplied 2. the workers themselves should collect
 expenditures or the amounts spent on a the information and use it to obtain
specific activity feedback and solve problems
 amount that appears on financial
statements
 3. the information should be available  materials inspections, process
quickly so workers can get feedback control (process inspection), process
quickly control (equipment inspection),
4. information should be more detailed and quality training, machine inspection,
should include types and causes of product design
defects
5. rewards should be based on quality and Appraisal costs (detection costs)
customer satisfaction measures of  are incurred to detect individual units of
performance to obtain quality products that do not conform to
specifications
Customer expectations of quality  end-of-process sampling, field
 refer to what customers expect from a testing
product’s tangible and intangible
features NONCOMFORMANCE COSTS

Tangible features Internal failure costs

 performance, taste, and functionality
Intangible features
 how the product’s salespeople treat
customers and the time required to
deliver the product to the customer after
it is ordered
Conformance to specification
 the degree to which a product or service
performs as designed (specified)
 there has to be a link between the
specifications we develop for our
product and the expectations customers
have for it
 are incurred when nonconforming
products and services are detected
before being delivered to customers
 scrap, rework, reinspection/retesting
External failure costs
 incurred when nonconforming products
and services are detected after being
delivered to customers
 warranty repairs, product liability,
marketing costs, lost sales

Cost of quality system

 is based on the idea that a tension
exists between incurring costs to ensure
that products meet the company’s
definition of quality and the cost incurred
by not meeting that definition
 by classifying the firm’s quality-related
into categories, managers can better
manage them

CONFORMANCE COSTS

Prevention costs
 incurred to prevent defects in the
products or services being produced