Fundamentals ofCost Management

Chapter 10

Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Using Activity-Based CostManagement to Add Value

• Activity-based cost management usesactivity analysis in decision making.

• Activity-based costing focuses on activitiesin allocating overhead costs to products.

• Activity-based management focuses onmanaging activities to reduce costs.

L.O. 1 Explain the concept of activity-based cost management.

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Using Cost HierarchiesL.O. 2 Use the hierarchy of costs to manage costs.

Cost Example

SuppliesLubricating oilMachine repair

Hierarchy Level

Volume related

Cost Driver Example

Direct labor costMachine-hoursNumber of units

Setup costsMaterial handlingShipping costs

Batch related Setup hoursProduction runsNumber of shipments

Compliance costsDesign and specification costs

Product related Number of products

General plant costsPlant admin. costs

Facility related Direct costsValue added

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Managing the Costs of Customersand Suppliers

L.O. 3 Describe how the actions of customersand suppliers affect a firm’s costs.

• Information on customer profitability isimportant for managers, so they can makedecisions that will improve firm performance.

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Using ABC Costing:Customers and Suppliers

L.O. 4 Use activity-based costing methodsto assess customer and supplier costs.

Step 1: Identify the activities that consume resources.

Step 2: Identify the cost driver associated with each activity.

Step 3: Compute a cost rate per cost driver for each unitor transaction.

Step 4: Assign costs to customers by multiplying the cost driverrate by the volume of cost driver units consumed by theactivity or transaction that occurred.

• Use the same four-step ABC product costingprocess to assess customers and suppliers.

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Cost of CustomersStep 1: Identify the Activities

LO4

• What activities consume resourcesfor Red’s delivering service?

Process Flow of the Delivery Service – Red's Lumber

Enterorder

Pickorder

Deliverorder

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Cost of CustomersStep 2: Identify the Cost Drivers

LO4

Cost Driver

Number of orders enteredNumber of items pickedNumber of deliveries madeOrder value

Activity

Entering orderPicking orderDelivering orderDelivery administration

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Cost of CustomersStep 3: Compute the Cost Driver Rates

LO4

Computation of Cost Driver Rates – Red's Lumber

Entering orderPicking orderDelivering orderDelivery administration

Activity

$100,000$150,000$300,000$250,000

10,000 orders75,000 items12,500 deliveries$5,000,000 order value

$10 per order$ 2 per item$24 per delivery5% of value

ActivityCost

Cost DriverVolume

Cost DriverRate

÷÷÷÷

====

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Cost of CustomersStep 4: Assign Costs Using ABC

LO4

Cost Driver Information by Customer – Red's Lumber

Number of ordersNumber of itemsNumber of deliveriesOrder value (total sales)

150 750 200$50,000

50 750 50$50,000

Jack JillCost Driver

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Cost of CustomersStep 4: Assign Costs Using ABC

LO4

Entering order (@ $10 per orderPicking order (@ $2 per item)Delivering order (@ $24 per deliveryDelivery administrationTotal delivery costs

$ 1,500 1,500 4,800 2,500$10,300

$ 500 1,500 1,200 2,500$5,700

Jack JillActivity

Estimated Customer Delivery Costs – Red's Lumber

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Using and Supplying Resources

L.O. 5 Distinguish between resources usedand resources supplied.

• Resources used:Cost driver rate multiplied bythe cost driver volume

• Resources supplies:Expenditures or the amountsspent on a specific activity

• Unused capacity:Difference between resourcesused and resources supplied

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Computing the Cost of Unused Capacity

L.O. 6 Design cost management systems to assign capacity costs.

• Actual activity:Actual volume for the period

• Theoretical capacity:Amount of production possible under idealconditions with no time for maintenance,breakdowns, or absenteeism.

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Computing the Cost of Unused CapacityLO6

• Practical capacity:Amount of production possible assuming only theexpected downtime for scheduled maintenanceand normal breaks and vacations.

• Normal activity:Long-run expected volume

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Managing the Cost of Quality

L.O. 7 Describe how activities that influencequality affect costs and profitability.

• Quality as defined by the customer

• Organization is managed to excel on all dimensions

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Cost of QualityL.O. 8 Compare the costs of quality control

to the costs of failing to control quality.

• Prevention: Costs incurred to prevent defects in theproducts or services being produced– Materials inspection– Process control– Quality training– Machine inspection– Product design

• Appraisal: Costs incurred to detect individual units ofproducts that do not conform to specifications– End-of-process sampling– Field testing

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Cost of QualityLO8

• Internal failure: Costs incurred when nonconforming productsand services are detected before beingdelivered to customers.– Scrap– Rework– Reinspection/Retesting

• External failure: Costs incurred when nonconforming productsand services are detected after being deliveredto customers.– Warranty repairs– Product liability– Marketing costs– Lost sales

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End of Chapter 10

Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin