ABM

STUDENT
CHAPTER 3
MANAGERIAL
ACCOUNTING
PowerPoint Presentation by
Gail B. Wright 10TH EDITION
Professor Emeritus of Accounting
Bryant University BY
© Copyright 2008 Thomson South-Western, a part of The
Thomson Corporation. Thomson, the Star Logo, and South-
Western are trademarks used herein under license. MAHER, STICKNEY & WEIL
1
ACTIVITY-BASED MANAGEMENT
LEARNING OBJECTIVES
1. Identify strategic & operational uses of activity-
based management (ABM).
2. Differentiate between traditional cost allocation
methods & activity-based costing (ABC).
3. Understand the concept of ABC.
4. Identify steps in ABC.
5. Apply ABM & ABC to marketing.
Overview & Basic Concepts
Continued
2
LEARNING OBJECTIVES
6. Use cost hierarchy to organize cost information
for decision making.
7. Distinguish between resources used & resources
supplied; measure unused resource capacity.
8. Explain difficulties of implementing advanced
cost-management systems.
3
☼ ☼
CHAPTER GOAL
This chapter shows how ABC & ABM rest on
premise that: Products require activities &
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.
4
LO 1
How do ABC &

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.
5
LO 1
ABM ACTIVITY ANALYSIS

Chart, start to finish, activities used to
complete product or service
Classify activities as value-added or non-
value-added
Eliminate non-value-added activities
Continuously improve, reevaluate efficiency
of value-added activities or replace with more

efficient activities
6
LO 1
NON-VALUE-ADDED COSTS:
Definition
Are costs of activities that the company

can eliminate without reducing product
quality, performance, or value.
7
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
8
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
9
LO 2
COST POOLS: Definition
Are ways of grouping

costs for analysis.
10
LO 2
COST POOLS
3 Major types of cost pools
The “plant” (traditional)
Sets 1 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
11
LO 3
ACTIVITY-BASED COSTING
(ABC): Definition
Assigns costs first to

activities then to products
based on each product’s
use of the activity.
12
LO 4
ABC STEPS TO FOLLOW

Accountants required to follow 4 steps:
1. Identify activities that consume resources; assign
costs to those activities.
Example: purchasing materials
2. Identify cost drivers for each activity.
Cost driver for purchasing materials: # of orders
3. Compute a cost rate per cost driver unit.
Cost per order
4. Assign costs to products.

Cost per order x number of purchase orders
13
LO 4
COST DRIVER: Definition
Is a factor that causes,

“drives,” an activity’s
costs.
14
LO 4
How do managers decide

which cost driver to use?
Typically, managers choose a

cost driver that causes the
cost.
15
LO 4
COST RATE EQUATION

Predetermined indirect cost rate =
Estimated Indirect Cost

÷
Estimated Volume of Allocation Base
16
LO 4
MANAGERIAL APPLICATION
When Hewlett-Packard
outsourced overhead costs
identified under ABC,
what was the result?
Product costs rose when

overhead costs dropped &
managerial emphasis shifted

to managing suppliers.
17
LO 5
How can ABC analysis

be applied to marketing?
In marketing it is still important to

a) identify activities, e.g., selling,
advertising, etc. and b) identify
cost drivers to reduce, eliminate

non-value-added costs.
18
LO 6
COST HIERARCHY: Definition
Categorizes costs so
changes in one cost can be
examined for its effects on
other cost categories.
19
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
20
LO 7
RESOURCES USED: Definition
Are measured by
ABC.
21
LO 7
UNUSED RESOURCES
Knowing the difference between

resources used and supplied
helps managers to identify unused
capacity. Finding unused capacity
helps managers reduce or use it.
22
LO 7
What is the difference between

capacity-sustaining & unit
level costs?
Capacity-sustaining costs are

fixed & indirect. Unit level
costs are variable, direct costs.
23
LO 7
Imprinting a
hierarchy of costs
on ABM statements
helps managers
understand what
costs can be reduced
or better used.
Capacity-sustaining
costs will have
unused resources
unless operating at
full capacity.
EXHIBIT 3.5
24
LO 8
MANAGERIAL APPLICATION
Do the benefits of
ABC go beyond
managing costs?
YES! Research shows that
companies adopting ABC
have superior financial
performance because of
better cost controls & asset

utilization.
25
CHAPTER 3
THE END
26

ABM

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STUDENT

ABC analyses ways to allocate indirect costs

How do ABC &

ABC provides information about

ABM ACTIVITY ANALYSIS

of value-added activities or replace with more

Are costs of activities that the company

Managers use ABC in special circumstances

COST POOLS: Definition

Are ways of grouping

Assigns costs first to

ABC STEPS TO FOLLOW

4. Assign costs to products.

COST DRIVER: Definition

Is a factor that causes,

How do managers decide

Typically, managers choose a

COST RATE EQUATION

Estimated Indirect Cost

Product costs rose when

managerial emphasis shifted

How can ABC analysis

In marketing it is still important to

cost drivers to reduce, eliminate

COST HIERARCHY: Definition

EXAMPLE: Hierarchy of Costs

Customer Needs Special promotions

Product Production needs Route schedules

Batch Batch Fuel, baggage handling

Unit Variable costs Credit card fees

RESOURCES USED: Definition

Knowing the difference between

What is the difference between

Capacity-sustaining costs are

better cost controls & asset

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