1. Fundamentals of Cost Management
Chapter 9

2. Learning Objectives
Explain the concept of activity-based cost management.
Use the hierarchy of costs to manage costs.
Describe how the actions of customers and suppliers affect a firm’s costs.
Use activity-based costing methods to assess customer and supplier costs.
Distinguish between resources used and resources supplied.
Design cost management systems to assign capacity costs.
Identify how activities that influence quality affect costs and profitability.
Compare the costs of quality control to the costs of failing to control quality.

3. Activity-Based Cost Management
L.O. 1 Explain the concept of activity-based cost management.
Activity-based cost management uses activity analysis in decision making.
Activity-based costing focuses on activities
Activity-based management focuses on managing activities

4. Cost Hierarchy
L.O. 2 Use the hierarchy of costs to manage costs.
Classification of cost drivers into general levels of activity; volume, batch, product and so on.

5. Managing the Cost of Customers and Supplies
L.O. 3 Describe how the actions of customers and suppliers affect a firm’s costs.
Resources cost
Customers (and suppliers) use resources
Some customers use more resources than others
Time =
Money

6. ABC and the Cost Customers and Suppliers
L.O. 4 Use activity-based costing methods to assess customer and supplier costs.
Assess customers and suppliers using the same four-step process used for ABC product costing.
Identify the activities that consume resources and assign costs to them.
Identify the cost driver(s) associated with each activity.
Compute a cost rate per cost driver unit or transaction.
Assign costs to customers by multiplying the cost driver rate by the volume of cost driver units consumed by the activity or transaction that occurred.

7. Cost of Customers: An Example
Operating Data
Red’s Lumber

8. Red’s Lumber Step 1 Identify the activities
What activities consume resources for Red’s delivering service?
Process Flow of the Delivery Service
Red’s Lumber
Entering Order
Picking Order
Delivering Order

9. Red’s Lumber Continued
Identify the cost drivers and the expected volume of each cost driver.
Step 2

10. Red’s Lumber Continued
Step 3
Compute the Cost Driver Rates
Computation of Cost Driver Rates

11. Red’s Lumber Continued
Step 4
Assign costs to products

12. Red’s Lumber Continued

13. Using and Supplying Resources
L.O. 5 Distinguish between resources used and resources supplied.
Resources used
Cost driver rate multiplied by the cost driver volume.
Resources supplied
Expenditures or the amounts spent on a specific activity.
Unused capacity
Difference between resources used and resources supplied.

14. Traditional Income Statement Red’s Lumber Year 2
Resources Used and Supplied: An Example
Traditional Income Statement
Red’s Lumber
Year 2

15. Resources Used and Supplied: An Example Continued
Activity-Based Income Statement
Red’s Lumber
Year 2

16. Computing the Cost of Unused Capacity
L.O. 6 Design cost management systems to assign capacity costs.
Theoretical capacity
Amount of production possible under ideal conditions with no time for maintenance, breakdowns, or absenteeism.
Practical capacity
Amount of production possible assuming only the expected downtime for scheduled maintenance and normal breaks and vacations.
Normal activity
Long-run expected volume.
Actual activity
Actual volume for the period.

17. Total Quality Management (TQM)
Managing the Cost of Quality
L.O. 7 Identify how activities that influence quality affect costs and profitability.
Total Quality Management (TQM)
Quality as defined by the customer
Organization is managed to excel on all dimensions.

18. External View of Quality: The Customer
Tangible
Performance
Taste
Functionality
Intangible
Customer service
Delivery time

19. Internal View of Quality
Conformance to specifications
Does the product or service do what it is designed to do?

20. Quality
External View?
Internal View?
Both

21. Cost of Quality Conformance costs Nonconformance costs
L.O. 8 Compare the costs of quality control to the costs of failing to control quality.
Conformance costs
Costs incurred to prevent defects in the products or services being produced.
Prevention
Costs incurred to detect individual units of products that do not conform to specifications.
Appraisal
Nonconformance costs
Costs incurred when nonconforming products and services are detected before being delivered to customers.
Internal failure
Costs incurred when nonconforming products and services are being delivered to customers.
External failure

22. Conformance Costs Prevention Design Inspection Training Appraisal
End of process sampling
Inspecting a sample of finished goods to ensure quality.
Field testing
Testing products in use at customer sites.

23. Nonconformance Costs Internal Failure External Failure Scrap
Materials wasted in the production process.
Rework
Correcting product defects before the product is sold.
Reinspection
Quality control testing after rework is performed.
External Failure
Warranty repairs
Repairing defective products.
Product liability
Accepting company liability resulting from product failure.
Marketing costs
Improving the company’s image tarnished from poor product quality.
Lost sales
Experiencing decreased sales from poor-quality (customers will go to competitors).

24. Cost of Quality Report Red’s Lumber Cost of Quality Report
For the Year Ended February 28

25. Chapter 9
$%*+!
I GUESS I’LL QUIT.
The End