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

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. ObjectivesObjectives After studying this chapter, you should be able to: ContinuedContinued

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

14-4 The Relationship of Activity-Based Costing and Activity-Based 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.

14-5 Cost Dimension Resources Activities Cost Objects Process Dimension Driver Analysis Performance Measures What?Why? How Well? The Two- Dimensional Activity-Based Model

14-6 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 Analysis Process value analysis is concerned with: (1) Driver analysis (2) Activity analysis (3) Performance measurement

14-7 Activity 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.

14-8 Those activities necessary to remain in business are called value-added activities. Value-Added Activities 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.

14-9 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 Activities

14-10 Nonvalue- Added Activities  Scheduling  Moving  Waiting  Inspecting  Storing

14-11 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:

14-12 Efficiency Quality Time Assessing Activity Performance

14-13 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

14-14 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

14-15 Value- and Nonvalue-Added Cost Reporting ActivityActivity DriverSQAQSP PurchasingPurchasing hours20,00023,000$20 MoldingMolding hours30,00034,00012 InspectingInspection hours06,00015 GrindingNumber of units05,0006 Value-added standards call for elimination

14-16 Value- and Nonvalue-Added Cost Reporting ActivityActivity DriverSQAQSP PurchasingPurchasing hours20,00023,000$20 MoldingMolding hours30,00034,00012 InspectingInspection hours06,00015 GrindingNumber of units05,0006 Value-added standards call for elimination

14-17 Value- and Nonvalue-Added Cost Report for the Year Ended December 31, 2003 Activity Value-Added Costs Nonvalue-Added Costs Actual Costs Activity Value-Added Costs Nonvalue-Added Costs Actual Costs Purchasing$400,000$ 60,000$460,000 Molding360,00048,000408,000 Inspecting090,00090,000 Grinding 0 30,000 30,000 Total$760,000$228,000$988,000

14-18 Purchasing$ 60,000$ 20,000$ 40,000 Molding48,00035,00013,000 Inspecting90,00030,00060,000 Grinding 30,000 15,000 15,000 Total$228,000$100,000$128,000 Nonvalue-Added Costs Nonvalue-Added Costs Activity Change Activity Change Trend Report: Nonvalue-Added Costs

14-19 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.

14-20 Act Kaizen Cost Reduction Process DoDo Check Plan Search Check Act Establish Lock in

14-21 Benchmarking uses best practices as the standard for evaluating activity performance. Benchmarking against internal operations is called internal benchmarking.

14-22 External 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

14-23 Activity Flexible Budgeting Cost Formula Direct Labor Hours Fixed Variable 10,000 20,000 Fixed Variable 10,000 20,000 Direct materials---$10$100,000$200,000 Direct labor---880,000160,000 Maintenance$ 20,000350,00080,000 Machining15,000125,00035,000 Inspections120, ,000120,000 Setups50, ,00050,000 Purchasing 220, , ,000 Total$425,000$22$645,000$865,000

14-24 Activity Flexible Budgeting DRIVER: DIRECT LABOR HOURS Formula Level of Activity Formula Level of Activity Fixed Variable 10,000 20,000 Fixed Variable 10,000 20,000 Direct materials$---$10$100,000$200,000 Direct labor , ,000 Subtotal$---$18$180,000$360,000 ContinuedContinued

14-25 Activity Flexible Budgeting DRIVER: MACHINE HOURS Fixed Variable 8,000 16,000 Fixed Variable 8,000 16,000 Maintenance$20,000$5.50$64,000$108,000 Machining 15, ,000 47,000 Subtotal$35,000$7.50$95,000$155,000 ContinuedContinued

14-26 Activity Flexible Budgeting DRIVER: NUMBER OF SETUPS Fixed Variable Fixed Variable 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 ContinuedContinued

14-27 Activity Flexible Budgeting DRIVER: NUMBER OF ORDERS Fixed Variable 15,000 25,000 Fixed Variable 15,000 25,000 Purchasing$211,000$1$226,000$236,000 Total$678,500$948,000

14-28 Activity Flexible Budgeting Budgeted Cost Activity Actual Cost 25 Setups Level Variance Inspection: Fixed$ 82,000$ 80,000$2,000U Variable 43,500 52,500 9,000F Total$125,500$132,500$7,000F

14-29 Activity Capacity Management Activity capacity is the number of times an activity can be performed.

14-30 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 Unused Capacity Variance $40,000 F SP x AQ $2,000 x 60 $120,000 SP x AU $2000 x 40 $80,000 Activity Capacity Management

14-31 Systems Planning Systems 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.

14-32 Why ABM Implementations 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.

14-33 The Responsibility Accounting Model Responsibility is defined. Performance measures are established.Performance is measured.Rewards are provided based on performance.

14-34 Responsibility Assignments Compared Financial-Based Responsibility Action-Based Responsibility Financial-Based Responsibility Action-Based Responsibility 1.Organizational units1.Proceeds 2.Local operating efficiency2.Systemwide efficiency 3.Individual accountability3.Team accountability 4.Financial outcomes4.Financial outcomes

14-35 Performance Measures Compared Financial-Based Measures Activity-Based Measures Financial-Based Measures Activity-Based Measures 1.Organizational units budgets1.Process-oriented standards 2.Standard costing2.Value-added standards 3.Static standards3.Dynamic standards 4.Currently attainable standards4.Optimal standards

14-36 Performance Evaluation Compared Financial-Based Activity-Based Financial-Based Activity-Based Performance Evaluation Performance Evaluation Performance Evaluation Performance Evaluation 1.Financial efficiency1.Time reductions 2.Controllable costs2.Quality improvements 3.Actual versus standard3.Cost reductions 4.Financial measures4.Trend measurement

14-37 Rewards Compared 1.Financial performance basis1.Multidimensional performance basis 2.Individual rewards2.Group rewards 3.Salary increases3.Salary increases 4.Promotions4.Promotions 5.Bonuses and profit sharing5.Bonuses, profit sharing, and gainsharing Financial-Based Rewards Activity-Based Rewards Financial-Based Rewards Activity-Based Rewards

14-38 End of Chapter

14-39