STRATEGIC COST MANAGEMENT - BA122B - Fall 2010Slide 6-1 Activity Based Costing (ABC)

STRATEGIC COST MANAGEMENT - BA122B - Fall 2010Slide 6-2 Trad. Costing Limits n Overall purpose: accounting values n Volume n Size n Complexity

STRATEGIC COST MANAGEMENT - BA122B - Fall 2010Slide 6-3 Activity Based Costing n Benefits n More accurate costs n More accurate operating information n Better access to relevant costs n Limits n Allocations are still used n Cost omission n Time and expense

STRATEGIC COST MANAGEMENT - BA122B - Fall 2010Slide 6-4 Contemporary Advantages n Comprehensive cost information n Emphasis on operations and activities n Costs are attached to activities n Provides driver visibility

STRATEGIC COST MANAGEMENT - BA122B - Fall 2010Slide 6-5 Ansari: MOA n Strategic Implications n value-added features—focusing on what the customer wants n the overall cost of the product n Reflects time considerations in the attribution process

STRATEGIC COST MANAGEMENT - BA122B - Fall 2010Slide 6-6 MOA, cont. n Attribute Implications n Technical n Provides decision relevant information n Enhances process understanding n Behavioral n Cost structure visibility n Facilitates communication n Empowers employees n Risk of “failed expectations” re: “true” cost n Cultural n Supports process focus n Encourages cross-functional participation

STRATEGIC COST MANAGEMENT - BA122B - Fall 2010Slide 6-7 ABC Implementation n Select an area n Identify primary activities (5-10) n Cost each activity n Determine one driver for each activity n Apply the costs to the final cost objectives on the basis of the drivers.

STRATEGIC COST MANAGEMENT - BA122B - Fall 2010Slide 6-8 Remember... n ABC does NOT yield “true” costs!

STRATEGIC COST MANAGEMENT - BA122B - Fall 2010Slide 6-9 ABC/ABM Case- Gulfstream Recreation Gulf Stream Recreation, a major sporting goods firm in California has two major products--the Bobcat Racer and the Snidley Whiplash Cruiser. For the current year, overhead was planned at $850K. Overhead is applied on the basis of machine hours. Each racer uses 2 machine hours and each cruiser uses 1 machine hour. GSR planned to build 10K racers and 50K cruisers. The cost structure for each product is as follows: RacerCruiser Direct Material$35$50 Direct Labor Machine Hours 2 1 GSR is considering some type of activity based costing system. Sandra Jones, the cost accounting manager, suggested the following drivers: Driver Relationship to FCO Driver Total Activity Cost Total Racer Cruiser Activity P.O.'s(#)$300K Purchasing Rework Hrs. (Hrs)$ Quality Control Invoices (#)$ Billing Change Orders (#)$ Mfg. Eng. 1.Calculate the unit costs of each product under the traditional method. 2.Calculate the unit costs of each product under activity based costing. 3.What pricing implications are inherent in this example.

STRATEGIC COST MANAGEMENT - BA122B - Fall 2010Slide 6-10 Gulfstream Recreation Solution Standard Overhead Rate: $850K/70K Mhrs. = $12.14 per machine hour Traditional Cost Structure: RacerCruiser Direct materials$35$50 Direct labor$25$13 Overhead$24$12 Total$84$75

STRATEGIC COST MANAGEMENT - BA122B - Fall 2010Slide 6-11 Gulfstream Solution, continued ABC Overhead Rate: RacerCruiser Purchasing$187.5$112.5 Quality control $ 88.9$111.1 Billing$ 50.0$150.0 Mfg. Engineering$ 75.0$ 75.0 Total$401.4$448.6 Per unit$40.10$ 8.97 ABC Cost Structure: RacerCruiser Direct materials$35$50 Direct labor$25$13 Overhead$40$ 9 Total $100$72

STRATEGIC COST MANAGEMENT - BA122B - Fall 2010Slide 6-12 Implementation Strategy n Obtain senior management buy-in n Make it a way of life n Start gradually n Keep it simple n Educate the users on benefits

STRATEGIC COST MANAGEMENT - BA122B - Fall 2010Slide 6-13 Activity Based Management (ABM)

STRATEGIC COST MANAGEMENT - BA122B - Fall 2010Slide 6-14 Ansari: ABM n Strategic Implications n Visibility on the efficiency & effectiveness (the quality) of activities n Visibility of costs for process redesign n Insight into timing consideration of actions

STRATEGIC COST MANAGEMENT - BA122B - Fall 2010Slide 6-15 ABM, cont. n Attribute Implications n Technical n Greater focus on work n Provides cross-functional cost impact n Highlights operational interdependencies n Behavioral n Heightens importance of process knowledge n Reinforces continuous improvement n Empowers employees--be careful of “non-value” terminology n Cultural n Reorients focus on process not people n Challenges current thinking n May add cultural conflict

STRATEGIC COST MANAGEMENT - BA122B - Fall 2010Slide 6-16 ABM, cont. n ABM Process n Obtain existing cost information n Determine the major processes n Identify process inputs and outputs n Determine the specific activities n Identify the resources used n Define output measures (what we measure) n Define performance measures (how we measure it) n Assess performance through benchmarking n Brainstorm improvements Part of ABC Part of PBM- performance based measurement