14-1 Activity- Based Management Prepared by Douglas Cloud Pepperdine University Prepared by Douglas Cloud Pepperdine University

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Activity- Activity- Based Based

ManagementManagement

Prepared by Douglas Cloud

Pepperdine University

Prepared by Douglas Cloud

Pepperdine University

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1. Describe how activity-based management and activity-based costing differ.

2. Define process value analysis.3. Describe activity-based financial

performance measurement.4. Discuss the implementation issues associated

with an activity-based management system.

ObjectivesObjectivesObjectivesObjectives

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

ContinuedContinuedContinuedContinued

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5. Explain how activity-based management is a form of responsibility accounting, and tell how it differs from financial-based responsibility accounting.

ObjectivesObjectivesObjectivesObjectives

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The Relationship of Activity-Based The Relationship of Activity-Based Costing and Activity-Based Costing and Activity-Based

Management Management

The Relationship of Activity-Based The Relationship of Activity-Based Costing and Activity-Based Costing and Activity-Based

Management Management

Activity-based management (ABM) is a systemwide, integrated approach that focuses

management’s attention on activities with the objectives of improving customer value

and the profit achieved by providing this value. ABC is the major source of

information for activity-based management.

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Cost Dimension

ResourcesResources

ActivitiesActivities

Cost ObjectsCost Objects

Process Dimension

Driver Driver AnalysisAnalysis

Performance Performance MeasuresMeasures

What?Why? How Well?

The Two-Dimensional

Activity-Based Model

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Process value analysis is fundamental to activity-based responsibility accounting, focuses on

accountability for activities rather than costs, and emphasizes the maximization of systemwide

performance instead of individual performance.

Process Value AnalysisProcess Value AnalysisProcess Value AnalysisProcess Value Analysis

Process value analysis is concerned with:

(1) Driver analysis

(2) Activity analysis

(3) Performance measurement

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Activity AnalysisActivity AnalysisActivity AnalysisActivity Analysis

Activity analysis is the process of identifying, describing, and evaluating the activities an organization performs.

Activity analysis should produce four outcomes:

What activities are performed.

How many people perform the activities.

The time and resources are required to perform the activities.

An assessment of the value of the activities to the organization.

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Those activities necessary to remain in business are called

value-added activities.

Those activities necessary to remain in business are called

value-added activities.

Value-Added ActivitiesValue-Added ActivitiesValue-Added ActivitiesValue-Added Activities

Activities needed to comply with the reporting

requirements, such as the SEC, are value-added by a

mandate.

Activities needed to comply with the reporting

requirements, such as the SEC, are value-added by a

mandate.

Implicit in this definition is the notion that value-added activities may contain

nonessential actions that create unnecessary cost.

Implicit in this definition is the notion that value-added activities may contain

nonessential actions that create unnecessary cost.

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All activities other than those essential to remain in business are referred to as

nonvalue-added activities. These activities fail to produce a change in the

product’s state or those activities that replicate work because it wasn’t done

correctly the first time.

Nonvalue-Added Nonvalue-Added ActivitiesActivities

Nonvalue-Added Nonvalue-Added ActivitiesActivities

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Nonvalue-Nonvalue-Added Added


Nonvalue-Nonvalue-Added Added


Scheduling

Moving

Waiting

Inspecting

Storing

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Cost Reduction Through Activity Management

1. Activity elimination

2. Activity selection

3. Activity reduction

4. Activity sharing

Activity Management Can Reduce Costs in Four Ways:

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Efficiency

Quality

Time

Assessing Activity Performance

Assessing Activity Performance

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Financial Measures of Activity Efficiency

Financial measures of activity efficiency include:

Value- and nonvalue-added activity costs

Trends in activity costs

Kaizen standard setting

Benchmarking

Activity flexible budgeting

Activity capacity management

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Value-added costs = SQ x SP

Nonvalue-added costs = (AQ – SQ)SP

Where SQ = The value-added output level of an activity

SQ = The standard price per unit of activity output measure

AQ = The actual quantity used of flexible resources or the practical activity capacity acquired for committed resources

Formulas

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Value- and Nonvalue-Added Cost Reporting


Activity Activity Driver SQ AQ SP

Purchasing Purchasing hours 20,000 23,000 $20

Molding Molding hours 30,000 34,000 12

Inspecting Inspection hours 0 6,000 15

Grinding Number of units 0 5,000 6

Value-added standards call for

elimination

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Activity Activity Driver SQ AQ SP

Purchasing Purchasing hours 20,000 23,000 $20

Molding Molding hours 30,000 34,000 12

Inspecting Inspection hours 0 6,000 15

Grinding Number of units 0 5,000 6

Value-added standards call for

elimination

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Value- and Nonvalue-Added Cost Report Value- and Nonvalue-Added Cost Report for the Year Ended December 31, 2003for the Year Ended December 31, 2003

Value- and Nonvalue-Added Cost Report Value- and Nonvalue-Added Cost Report for the Year Ended December 31, 2003for the Year Ended December 31, 2003

Activity Value-Added Costs Nonvalue-Added Costs Actual CostsActivity Value-Added Costs Nonvalue-Added Costs Actual Costs

Purchasing $400,000 $ 60,000 $460,000

Molding 360,000 48,000 408,000

Inspecting 0 90,000 90,000

Grinding 0 30,000 30,000

Total $760,000 $228,000 $988,000

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Purchasing $ 60,000 $ 20,000 $ 40,000

Molding 48,000 35,000 13,000

Inspecting 90,000 30,000 60,000

Grinding 30,000 15,000 15,000

Total $228,000 $100,000 $128,000

Nonvalue-Added CostsNonvalue-Added Costs Activity 2003 2004 ChangeActivity 2003 2004 Change

Trend Report: Nonvalue-Added Costs

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The Role of Kaizen Standards

Kaizen costing is concerned with reducing the costs of existing products and processes.

Controlling this cost reduction process is accomplished through the repetitive use of two major subcycles:

(1) the kaizen or continuous improvement cycle, and

(2) the maintenance cycle.

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ActAct

Kaizen Cost Reduction ProcessKaizen Cost Reduction Process

DoDo DoDo

CheckCheck

PlanPlanSearch

CheckCheck

ActAct

EstablishEstablishLock in

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Benchmarking uses best practices as the standard for

evaluating activity performance.

Benchmarking uses best practices as the standard for

evaluating activity performance.

Benchmarking against internal

operations is called internal benchmarking.

Benchmarking against internal

operations is called internal benchmarking.

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External BenchmarkingExternal BenchmarkingExternal BenchmarkingExternal Benchmarking

Benchmarking that involves comparisons with others outside the organization is called external benchmarking.

The three types of external benchmarking are:

Competitive benchmarking

Functional benchmarking

Generic benchmarking

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Activity Flexible BudgetingActivity Flexible BudgetingActivity Flexible BudgetingActivity Flexible Budgeting

Cost Formula Direct Labor HoursCost Formula Direct Labor Hours

Fixed Variable 10,000 20,000Fixed Variable 10,000 20,000

Direct materials --- $10 $100,000 $200,000Direct labor --- 8 80,000 160,000Maintenance $ 20,000 3 50,000 80,000Machining 15,000 1 25,000 35,000Inspections 120,000 --- 120,000 120,000Setups 50,000 --- 50,000 50,000Purchasing 220,000 --- 220,000 220,000 Total $425,000 $22 $645,000 $865,000

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DRIVER: DIRECT LABOR HOURSDRIVER: DIRECT LABOR HOURS

Formula Level of ActivityFormula Level of Activity


Direct materials $--- $10 $100,000 $200,000

Direct labor --- 8 80,000 160,000

Subtotal $--- $18 $180,000 $360,000


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DRIVER: MACHINE HOURSDRIVER: MACHINE HOURS


Maintenance $20,000 $5.50 $64,000 $108,000

Machining 15,000 2.00 31,000 47,000

Subtotal $35,000 $7.50 $95,000 $155,000


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DRIVER: NUMBER OF SETUPSDRIVER: NUMBER OF SETUPS

Fixed Variable 25 30Fixed Variable 25 30

Inspections $80,000 $2,100 $132,500 $143,000

Setups --- 1,800 45,000 54,000

Subtotal $80,000 $3,900 $177,500 $197,000


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DRIVER: NUMBER OF ORDERSDRIVER: NUMBER OF ORDERS


Purchasing $211,000 $1 $226,000 $236,000

Total $678,500 $948,000

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Budgeted CostActivity Actual Cost 25 Setups Level Variance

Inspection:

Fixed $ 82,000 $ 80,000 $2,000 U

Variable 43,500 52,500 9,000 F

Total $125,500 $132,500 $7,000 F

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Activity Capacity ManagementActivity Capacity ManagementActivity Capacity ManagementActivity Capacity Management

Activity capacity is the number of times

an activity can be performed.

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AQ = Activity capacity acquired (practical capacity)

SQ = Activity capacity that should be used

AU = Actual usage of the activity

SP = Fixed activity rate

SP x SQ$2,000 x 0

$0

Volume Variance$120,000 U

UnusedCapacity Variance

$40,000 F

SP x AQ$2,000 x 60

$120,000

SP x AU$2000 x 40

$80,000

Activity Capacity ManagementActivity Capacity ManagementActivity Capacity ManagementActivity Capacity Management

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Systems PlanningSystems PlanningSystems PlanningSystems PlanningSystems planning provides the justification for implementing ABM and address the following issues:

1. The purpose and objectives of the ABM system.

2. The organization’s current and desired competitive position.

3. The organization’s business processes and product mix.

4. The timeline, assigned responsibilities, and resources required for implementation.

5. The ability of the organization to implement, learn, and use new information.

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Why ABM Why ABM Implementations FailImplementations Fail

Why ABM Why ABM Implementations FailImplementations Fail

Lack of support of higher-level management.

Failure to maintain support from higher-level management.

Resistance to change.

Failure to integrate the new system.

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The Responsibility Accounting ModelThe Responsibility Accounting ModelThe Responsibility Accounting ModelThe Responsibility Accounting Model

Responsibility is defined.

Performance measures are established.

Performance is measured.

Rewards are provided based on performance.

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Responsibility Assignments ComparedResponsibility Assignments ComparedResponsibility Assignments ComparedResponsibility Assignments Compared

Financial-Based Responsibility Action-Based ResponsibilityFinancial-Based Responsibility Action-Based Responsibility

1. Organizational units 1. Proceeds

2. Local operating efficiency 2. Systemwide efficiency

3. Individual accountability 3. Team accountability

4. Financial outcomes 4. Financial outcomes

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Performance Measures ComparedPerformance Measures ComparedPerformance Measures ComparedPerformance Measures Compared

Financial-Based Measures Activity-Based MeasuresFinancial-Based Measures Activity-Based Measures

1. Organizational units budgets 1. Process-oriented standards

2. Standard costing 2. Value-added standards

3. Static standards 3. Dynamic standards

4. Currently attainable standards 4. Optimal standards

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Performance Evaluation ComparedPerformance Evaluation ComparedPerformance Evaluation ComparedPerformance Evaluation Compared

Financial-Based Activity-BasedFinancial-Based Activity-Based Performance Evaluation Performance EvaluationPerformance Evaluation Performance Evaluation

1. Financial efficiency 1. Time reductions

2. Controllable costs 2. Quality improvements

3. Actual versus standard 3. Cost reductions

4. Financial measures 4. Trend measurement

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Rewards ComparedRewards ComparedRewards ComparedRewards Compared

1. Financial performance basis 1. Multidimensional performance basis

2. Individual rewards 2. Group rewards

3. Salary increases 3. Salary increases

4. Promotions 4. Promotions

5. Bonuses and profit sharing 5. Bonuses, profit sharing, and gainsharing

Financial-Based Rewards Activity-Based RewardsFinancial-Based Rewards Activity-Based Rewards

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End ofEnd of

ChapterChapter

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Documents

14-1 Activity- Based Management Prepared by Douglas Cloud Pepperdine University Prepared by Douglas Cloud Pepperdine University