Needles Finman Irm Ch19

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CHAPTER 19
Value-Based Systems: ABM and Lean
PLANNING MATRIX
Enhancing
Building Your Basic Knowledge Knowledge, Skills, and
Learning Objective and Skills Critical Thinking
1. Explain why managers use value- SE 1, 2, 3, E 1, 2, 3, 4, 5 P 1, 6 C1
based systems and discuss their 4 C6
relationship to the supply chain
and the value chain.
2. Define activity-based costing and SE 5, 6 E 6, 7, 8 P 2, 3, C1
explain how a cost hierarchy and a 6, 7, 8 C2
bill of activities are used. C3
C6
3. Define the elements of a lean SE 7, 8 E 9, 10, 11 P 4, 9 C4
operation and identify the changes C5
in inventory management that C6
result when a firm adopts its just-
in-time operating philosophy.
4. Define and apply backflush SE 9 E 12, 13 P 5, 10
costing, and compare the cost
flows in traditional and backflush
costing.
5. Compare ABM and lean SE 10 E 14, 15 C6
operations as activity-based
systems.
MEMORANDA:
SE: Short Exercises
E: Exercises
P: Problems (Each problem has a User Insight question.)
All questions are in the text with related Learning Objectives (Stop, Think, and Apply).
SUGGESTED INSTRUCTIONAL STRATEGY

Output Skills Developed:
Technical, Communication, Interpersonal
Related Learning Objective:

3
© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
242 Chapter 19: Value-Based Systems: ABM and Lean
Instructional Strategy
Learning activity: Discussion, group task
Learning environment: Modified lecture, active, in-class and out-of-class
Learning tool: Textbook assignment Case 4
Steps to Implement
1. Assign Case 4 at least a week before introducing this learning activity in class. Students are to
work on Case 4 individually.
2. Prepare an in-class assignment for groups that includes the following tasks:
a. Discuss and agree upon the activities involved in restaurant operations.
b. Explain how the lean philosophy does or does not apply to each operation.
3. After the groups have completed the in-class assignment, ask a representative from each group to
present one of the completed tasks. Have the students use the chalkboard, overhead projector, or
flip charts for their presentations.
4. Discuss each group’s results. Ask students to consider alternatives to the lean philosophy that
would eliminate waste and increase quality. Discuss activity-based management methods of
identifying opportunities for continuous improvement.
Assessment
Technical skills: Grade each group’s and/or each student’s work. Give a brief quiz at the end of the
period to test recall and comprehension. Ask a related question on the next examination.
Communication skills: Instructor or students can informally grade the presenter based on the content,
format, and style of the presentation. Feedback of this information can help students improve their
presentation skills.
Interpersonal skills: Ask students one or more of the following questions: How well did your group
interact? How many in the group were prepared for the assignment? How many were fully involved?
What could the group do to improve its performance next time?
RESOURCE MATERIALS AND OUTLINES

OBJECTIVE 1: Explain why managers use value-based systems and discuss their
relationship to the supply chain and the value chain.
Summary Statement
Value-based systems are information systems that provideTo create value and to satisfy customers’
needs for quality, reasonable price, and timely delivery, managers must work with suppliers and
customers, view the organization as a collection of value-adding activities, use resources for value-
adding activities, reduce or eliminate non-value-adding activities, and know the total cost of creating
value for a customer. Managers need to know the full product cost, which includes not only the costs of
direct materials and direct labor, but also the costs of all production and nonproduction activities
required to satisfy the customer.
A value chain is a sequence of activities that add value to a company’s product or service. Managers
see their company’s value chain as part of a larger system that includes the value chains of suppliers
and customers. This larger system is the supply chain—the path that leads from the suppliers of the
Chapter 19: Value-Based Systems: ABM and Lean 243
materials from which a product is made to the final customer. The supply chain (also called the supply
network) includes both suppliers and suppliers’ suppliers, and customers and customers’ customers.
Value chains and supply chains give managers a better grasp of their company’s internal and external
operations. Managers who understand the supply chain and how their company’s value-adding
activities fit into their suppliers’ and customers’ value chains can see their company’s role in the overall
process of creating and delivering products or services. Such an understanding can also make a
company more profitable. When organizations work cooperatively with others in their supply chain,
they can develop new processes that reduce the total costs of their products or services.
Process value analysis (PVA) is a technique that managers use to identify and link all the activities
involved in the value chain. It analyzes business processes by relating activities to the events that
prompt the activities and to the resources that the activities consume. By using PVA to identify non-
value-adding activities, companies can reduce costs and redirect resources to activities that enhance the
value of their products or services.
A value-adding activity adds value to a product or service as perceived by the customer. Examples
include designing the components of a new car, assembling the car, painting it, and installing seats and
airbags. A non-value-adding activity adds cost to a product or service but does not increase its market
value. Examples include moving materials and repairing machinery.
Activity-based management (ABM) is an approach to managing an organization that identifies all major
operating activities, determines the resources consumed by each activity and the cause of the resource
usage, and categorizes the activities as either adding value to a product or service or not adding value.
Because it provides financial and performance information at the activity level, ABM is useful both for
strategic planning and for making operational decisions about business segments. It also helps
managers eliminate waste and inefficiencies and redirect resources to activities that add value to the
product or service.
A lean operation focuses on eliminating waste in an organization: through good planning and design; by
smart scheduling and standardized product and processing plans; and analysis of worker and machine
actions.
New Concepts and Terminology

value-based systems; full product cost; value chain; supply chain; process value analysis (PVA); value-
adding activity; non-value-adding activity; activity-based management (ABM); lean operation
Related Text Illustration

Figure 1: The Supply Chain and Value Chain in a Furniture Company
Focus on Business Practice: What Is VBM?
Lecture Outline
I. Managers create value and satisfy customers five ways.
A. Work with suppliers and customers
B. View the organization as a collection of value-adding activities
C. Use resources for value-adding activities
D. Reduce or eliminate non-value-adding activities
E. Know the total cost of creating value for a customer
II. Value chains and supply chains give managers a better understanding of their company’s internal
and external operations.
A. A value chain is a sequence of activities that add value to a company’s product or service.
B. A supply chain is the path that leads from the suppliers of the materials from which a
product is made to the final customer; it includes both suppliers and suppliers’ suppliers, and
customers and customers’ customers.
IIII. Process value analysis helps managers reduce costs by identifying and eliminating non-value-
adding activities.
IVV. Compare value-adding and non-value-adding activities.
A. A value-adding activity adds market value to a product or service.
B. A non-value-adding activity adds cost to a product or service but does not increase its
market value.
V. Value-based systems
A. Create opportunities to improve nonfinancial performance measures and cost information
supplied to managers
B. Help managers view their organization as a collection of activities
VI. Activity-based management (ABM)
A. Provides financial and performance information at key operational activity levels.
B. Eliminates waste and inefficiencies.
VII. A lean operation eliminates waste three ways
A. Good planning and design
B. Smart production scheduling and standardized product and processing plans
C. Analysis of worker and machine actions
Teaching Strategy
Discuss what managers must do to create value and satisfy customers’ needs for quality, reasonable
price, and responsiveness (in terms of both timely product innovation and timely product delivery).
Short Exercise 1 provides a good basis for identifying actions that a manager of a retail store can take to
reverse a decline in sales.
Using Figure 1, discuss a supple chain and value chain for a furniture company. Exercise 2 applies the
concepts to a lawn and garden nursery and Exercise 3 applies the concepts to a bank.
OBJECTIVE 2: Define activity-based costing and explain how a cost hierarchy and a bill of
activities are used.
Summary Statement
Activity-based costing (ABC) is a method of assigning costs that calculates a more accurate product cost
than traditional methods. It does so by categorizing all indirect costs by activity, tracing the indirect
costs to those activities, and assigning those costs to products using a cost driver related to the cause of
the cost. To implement activity-based costing, managers (1) identify and classify each activity, (2)
estimate the cost of resources for each activity, (3) identify a cost driver for each activity and estimate
the quantity of each cost driver, (4) calculate an activity cost rate for each activity, and (5) assign costs
to cost objects based on the level of activity required to make the product or provide the service.
To manage the assignment of activity-based costs, many companies use a cost hierarchy, which is a
framework for classifying activities according to the level at which their costs are incurred. In a
manufacturing company, the cost hierarchy typically has four levels: the unit, batch, product, and
facility levels. Unit-level activities are performed each time a unit is produced. Inserting a component as
a unit is being assembled is an example of a unit-level activity. Batch-level activities are performed
each time a batch of goods is produced. These activities vary with the number of batches prepared.
Examples of batch-level activities include setup, scheduling, and materials handling. Product-level
activities are performed to support the diversity of product lines in a manufacturing plant; examples
include implementing engineering changes and redesigning the installation process for a particular
brand or product line. Facility-level activities are performed to support a facility’s general
manufacturing process; examples include lighting, securing, and insuring the manufacturing plant. Note
that the frequency of activities varies across levels and that the cost hierarchy includes both value-
adding and nonvalue-adding activities.
A bill of activities is a list of activities and related costs that is used to compute the costs assigned to
activities and the product unit cost. More complex bills of activities group activities into activity pools
and include activity cost rates and the cost driver levels used to assign costs to cost objects. A bill of
activities may be used as the primary document or as a supporting schedule to calculate the product unit
cost in both job order and process costing systems.

activity-based costing (ABC); cost hierarchy; unit-level activities; batch-level activities; product-level
activities; facility-level activities; bill of activities
Related Text Illustrations

Table 1: Sample Activities in Cost Hierarchies
Exhibit 1: Bill of Activities for a FurnitureTown, LLC, Order
Focus on Business Practice: The Evolution to Lean Operations
Lecture Outline
I. Activity-based costing (ABC) calculates a more accurate product cost than traditional methods.
II. A cost hierarchy is a framework for classifying activities according to the level at which their
costs are incurred; in a manufacturing organization, the cost hierarchy typically has four levels:
A. Unit level
B. Batch level
C. Product level
D. Facility level
III. A bill of activities is used to compute the following:
A. Costs assigned to activities
B. Product unit cost
Teaching Strategy
Have students identify the cost hierarchy level for a particular activity by starting at the unit level. If the
activity increases as the number of units in a batch increases, the activity will be unit level. If it
increases as the number of batches increases, it will be batch level. Suppose the activity is unaffected at
the unit or batch levels. If it increases as the number of different products produced increases, it will be
a product-level activity. Otherwise, it must be must be a facility-level activity. Use Exercise 6 to
demonstrate this technique.
OBJECTIVE 3: Define the elements of a lean operation and identify the changes in
inventory management that result when a firm adopts its just-in-time operating
philosophy.
Summary Statement
To remain competitive in today’s changing business environment, companies have had to rethink their
organizational processes and basic operating methods. One of the operating philosophies that managers
have devised for the new operating environment is lean operations. Lean operations requires that all
resources—materials, personnel, and facilities—be acquired and used only as needed. Its objectives are
to eliminate waste and reduce costs, enhance productivity, and improve product quality. Accomplishing
these objectives may entail redesigning operating systems, plant layout, and basic management
methods.
To implement a JIT operating environment, a company must (1) maintain minimum inventory levels;
(2) use pull-through production, a system in which a customer’s order triggers the purchase of materials
and the scheduling of production, rather than the push-through method used in traditional
manufacturing operations; (3) perform quick, inexpensive machine setups using flexible work cells; (4)
develop a multiskilled work force; (5) maintain high levels of product quality; (6) enforce effective
preventive maintenance; and (7) encourage continuous improvement of the work environment.
The traditional production process can be divided into five time frames: processing time, inspection
time, moving time, queue time, and storage time. In product costing under JIT, costs associated with
processing time are categorized as either direct materials costs or conversion costs. Conversion costs
are the sum of the direct labor costs and overhead costs incurred by a department, work cell, or other
work center.
The key measure in a JIT operating environment is throughput time, the time it takes to move a product
through the entire production process. Under JIT, the costs associated with all the time frames of the
traditional production process are reduced or eliminated. With computerized monitoring of the work
cells, many costs that are treated as indirect costs in traditional manufacturing settings, such as the costs
of utilities and operating supplies, can be traced directly to work cells. The only costs that remain
indirect costs and that must be assigned to the work cells for inclusion in the conversion cost are those
associated with building occupancy, insurance, and property taxes.

just-in-time (JIT) operating philosophy; pull-through production; push-through method; work cell;
processing time; inspection time; moving time; queue time; storage time; conversion costs; throughput
time;

Table 2: Direct and Indirect Costs in Traditional and JIT Environments
Lecture Outline
I. Lean operations philosophy
A. Simple is better
B. Quality of product or service critical
C. Work environment emphasizes continuous improvement
D. Large inventories was resources and might hide poor work
E. Reduce or eliminate activities or functions that do not add value
F. Goods should be produced only when needed
G. Workers must be multiskilled and help eliminate waste
H. Long-term relationships with suppliers is important
II. Just-in-time (JIT) operating environment eliminates waste through 6 principles.
A. Minimum inventory levels
B. Pull-through production
C. Quick setup and flexible work cells
D. A multiskilled work force
E. High levels of product quality
F. Effective preventive maintenance
III. Continuous improvement of the work environment
IV. Accounting for product costs in a JIT Operating Environment

A. Classifying costs
1. Processing time
2. Inspection time
3. Moving time
4. Queue time
5. Storage time
B. Assigning costs
1. Managers focus on throughput time.
2. Several costs that are treated as indirect costs in a traditional environment are treated as
direct costs of a JIT work cell.
Teaching Strategy
As you introduce the elements of a lean operating environment, discuss why each of these is necessary
or beneficial. Exercise 9 may aid in this discussion. Assign Case 4 as an in-class group activity related
to a lean operating philosophy.
Ask students to identify ways that JIT reduces or eliminates processing time, inspection time, moving
time, queue time, and storage time. Use Exercise 11 to explain how some costs that are indirect costs in
traditional manufacturing settings become direct costs in a JIT operating environment.
OBJECTIVE 4: Define and apply backflush costing, and compare the cost flows in
traditional and backflush costing.
Summary Statement
Because a JIT environment reduces labor costs, the accounting system can combine the costs of direct
labor and overhead into the single category of conversion costs, and because materials arrive just in
time to be used in the production process, there is little reason to maintain a separate Materials
Inventory account. Thus, by simplifying cost flows through the accounting records, a JIT environment
makes it possible to reduce the time it takes to record and account for the costs of the manufacturing
process. An organization that uses JIT can further streamline its accounting process by using backflush
costing. In backflush costing, all product costs are first accumulated in the Cost of Goods Sold account,
and at the end of the accounting period, they are “flushed back,” or worked backward, into the
appropriate inventory accounts. By using fewer accounts and by recording fewer transactions,
backflush costing saves recording time, thus reducing costs.

backflush costing
Related Text Illustrations

Figure 2: Comparison of Cost Flows in Traditional and Backflush Costing
Figure 3: Cost Flows Through T Accounts in Traditional and Backflush Costing
Lecture Outline
I. A JIT operating environment simplifies cost flows through the accounting system.
A. Conversion costs
B. Elimination of Materials Inventory account
II. Backflush costing saves time and cuts costs.
Teaching Strategy
Use Exercise 13 to illustrate the flow of costs through T accounts in a backflush costing system. Assign
Problem 5 or 10, which requires students to show the flow of costs through T accounts in a backflush
costing system and in a traditional costing system.
OBJECTIVE 5: Compare ABM and lean operations as value-based systems.

Summary Statement
As value-based systems, both ABM and lean operations analyze processes and identify value-adding
and non-value-adding activities. Both seek to eliminate waste, reduce non-value-adding activities, and
improve the allocation of resources. However, the two systems differ in their methods of costing and
cost assignment. ABM uses ABC to assign indirect costs to products using cost drivers; lean uses JIT to
reorganize activities so that they are performed within work cells, and the overhead costs incurred in a
work cell become direct costs of the products made in that cell. ABM uses job order or process costing
to calculate product costs, whereas lean may use backflush costing.

Table 3: Comparison of ABM and Lean Value-Based Systems
Lecture Outline
I. Both ABM and lean seek to eliminate waste, reduce non-value-adding activities, and improve
allocation of resources.
II. The two systems differ in their methods of costing and cost assignment:
A. ABM uses cost drivers to assign indirect costs.
B. The overhead costs incurred in a JIT work cell become direct costs of the products made in
that cell.
C. ABM uses job order or process costing to calculate product costs.
D. Lean may use backflush costing.
Teaching Strategy
Assign Short Exercise 10, which requires students to decide whether lean and backflush costing or
ABM and ABC is most appropriate given the needs of a particular organization. Assign Exercise 14 or
15 to reinforce an understanding of the characteristics of ABM and lean.
REVIEW QUIZ
True-False
1. T F Full product cost includes not only the costs of direct materials and direct labor, but
also the costs of all production and nonproduction activities required to satisfy the
customer.
2. T F A supply chain is an interdependent collection of organizations that supply materials,
products, or services to a customer.
3. T F In a lean operating environment, a key objective is the elimination of waste.
4. T F Although machine hours are a key measure in a traditional production environment,
most lean organizations focus on direct labor hours instead.
5. T F Throughput time is the time between finishing a product and delivering it to the
customer.
6. T F ABM and lean are similar in that both analyze processes and identify value-adding and
non-value-adding activities.
7. T F The primary goal of lean is to calculate the most accurate product cost.
Multiple Choice
8. To create value and to satisfy customers’ needs for quality, reasonable price, and timely delivery,
managers must
a. pay attention to customers but ignore suppliers.
b. view the organization as a collection of costs.
c. use resources for nonvalue-adding activities.
d. know the total cost of creating value for a customer.
e. increase nonvalue-adding activities.
9. When in the management process do managers seek an answer to the question “Did we meet our
cost-reduction goals for non-value-adding activities?”
a. Planning
b. Performing
c. Evaluating
d. Communicating
e. None of these
10. Which of the following statements about a value chain is false?

a. It helps managers understand the independence of activities within an organization.
b. A company’s value chain is part of its supply chain.
c. A value chain is a related sequence of value-creating activities within an organization.
d. A company can enhance its profitability by understanding not only its own value chain, but
also how its value chain fits into suppliers’ and customers’ value chains.
e. All of the above are true statements.
11. Which of the following statements regarding activity-based costing (ABC) is false?
a. ABC can be implemented in service organizations as well as manufacturing organizations.
b. ABC cannot be used to identify the relative profitability of different customer groups.
c. ABC uses multiple activity cost rates.
d. ABC can be used with either process costing or job order costing.
12. Process value analysis

a. is a technique that analyzes business processes by relating activities to the events that
prompt the activities and to the resources that the activities consume.
b. is useful for companies that use ABM to manage activities.
c. forces managers to look critically at all phases of their operations.
d. is all of the above.
e. is none of the above.
13. A cost hierarchy

a. classifies costs as value-adding or non-value-adding.
b. is a framework used in traditional product costing settings in which a single predetermined
overhead rate is used to apply indirect costs to products.
c. is a useful framework for grouping activities and assigning activity-based costs.
d. assumes that the cost behavior of any activity can be classified either as variable or fixed
with respect to changes in the number of units produced.
e. classifies costs as direct or indirect costs.
14. Which of the following statements about a bill of activities is false?

a. A bill of activities is identical to a bill of materials.
b. A bill of activities is a list of activities and related costs that is used to compute the costs
assigned to activities.
c. A complex bill of activities may include activity cost rates and cost driver levels used to
assign costs to cost objects.
d. A bill of activities may be used as the primary document to calculate the product cost in both
job order and process costing systems.
15. Queue time is the

a. time spent looking for product flaws.
b. time a product spends waiting to be worked on once it arrives at the next operation or
department.
c. time spent moving a product between operations or departments.
d. actual amount of time spent working on a product.
e. time spent inspecting a product.
16. Which of the following is a reason why traditional product costing techniques have become
obsolete in a lean operating environment?
a. More complex accounting is required in a lean operating environment.
b. Computerized processes and systems under lean enable direct tracing of many costs.
c. Automation has not significantly replaced direct labor hours with machine hours.
d. Lean operations have not changed many of the cost patterns associated with traditional
manufacturing.
e. All of the above apply.
17. When an organization switches from a traditional production environment to a just-in-time

operating environment, which of the following costs will most likely become a direct cost of a JIT
work cell?
a. Cost of building occupancy for the plant
b. Cost of insurance on the manufacturing facility
c. Cost of property taxes on the plant
d. Cost of materials handling
e. All of the above
ANSWERS TO REVIEW QUIZ
True-False Multiple Choice

1. T 8. d
2. T 9. c
3. T 10. a
4. F 11. b
5. F 12. d
6. T 13. c
7. F 14. a
15. b
16. b
17. d

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ً ‫ صفحة الباحث العلوي هجانا‬Alaa.aliasrei@gmail.

com ‫@ عالء هحسن شحن‬Aliasrei ‫تلكرام‬

SUGGESTED INSTRUCTIONAL STRATEGY

Related Learning Objective:

RESOURCE MATERIALS AND OUTLINES

New Concepts and Terminology

Related Text Illustration

New Concepts and Terminology

Related Text Illustrations

New Concepts and Terminology

Related Text Illustration

IV. Accounting for product costs in a JIT Operating Environment

New Concepts and Terminology

Related Text Illustrations

OBJECTIVE 5: Compare ABM and lean operations as value-based systems.

Related Text Illustration

10. Which of the following statements about a value chain is false?

12. Process value analysis

13. A cost hierarchy

14. Which of the following statements about a bill of activities is false?

15. Queue time is the

17. When an organization switches from a traditional production environment to a just-in-time

ANSWERS TO REVIEW QUIZ

True-False Multiple Choice

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