Agenda Today

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Session 8

• Agenda Today
• Discuss what is motivating the study,
  development, and implementation of ABC and ABM
• Present an overview of activity based costing

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Agenda Today

1. Outline the implementation process as described
   by professionals in the area
2. Describe and illustrate the conditions under
   which one would expect to see a difference in
   costs using ABC as oppose to more traditional
   methods.

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Motivation for ABC - I

• One outcome of the increased focus on strategic
  planning over the past 20 years has been the
  emphasis on improving business processes either
  as part of a re-engineering effort or a program
  of continuous improvement.

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Motivation for ABC - II

• I would argue that the need for strategic
  planning is itself an outgrowth of global
  competition. Global competition has increased
  both cost competition and an opportunity to
  consolidate businesses into a fewer, larger
  competitors.

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Motivation for ABC - III

• Since processes are composed of activities, the
  focus has evolved from processes to sequences of
  activities at the operating level. Hence the
  interest in ABC.

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Motivation for ABC - IV

• A second factor is the gradual but significant
  change over time in the make-up of manufacturing
  costs. Labor once make up over 50 of total cost
  and was used to allocate indirect costs to
  activities and products. Labor costs now total
  as little as 8 in some industries.

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Motivation for ABC - V

• At the same time, however, material costs have
  been relatively stable as a percent of total
  manufacturing cost.
• Environmental laws have led to cost savings, net
  cost savings in many cases
• Improved quality and new materials

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Motivation for ABC - VI

• The increasing component of total manufacturing
  cost is in the indirect costs of technology,
  product design, and other support activities.

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Motivation for ABC - VII

• Because managerial cost accounting systems did
  not change much in the 1980s and early 1990s, our
  systems have not kept up with the need for change.

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Motivation for ABC - VIII

• Equally important is the improvement in the
  means to change. Technology drastically reduces
  the cost of accounting information systems and
  permits the development of new systems within the
  cost constraints of the prior systems.

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Current Status Report

• The bottom line is that ABC is seen as an answer
  to the need to improve costing systems, but
  implementation efforts have yet to achieve the
  hoped-for results.

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So what is ABC?

• Activity-based costing involves researching those
  factors that drive cost in a context. Once the
  main drivers of cost have been identified, the
  system of accounting is organized around these
  drivers to improve the validity of the costing
  system.

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Puzzle

• A shipping company had trouble determining how
  much it should cost to ship materials from Ohio
  to a point near the Atlantic ocean. In spite of
  numerous trips within the Great Lakes area, the
  company still found it difficult to predict
  costs. What do you suppose was making cost
  estimation so difficult?

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Basic Activity View
Activity
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Activities

• Activities are about actions, doing something,
  effort, work done, not the consequences of the
  work or effort.
• Metrics or measures are the ways we are going to
  quantify the volume of activity during a time
  period. Different activities require different
  metrics.

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Activity Terminology

• Statistics represent the numeric values assigned
  to the metrics for a period.
• Data sources are the primary or secondary sources
  of the statistics.

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Thinking About Activities

• Inputs Activities Outputs
• Labor Assembling Products
• Materials Processing Intermediate
• products
• 3. Parts Assembling Assembly
• 4. Equipment Stamping Steel part
• 5. Services Insurance Risk reduction
  6. Warehouse Storing Availability

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An Observation

• Defining activities can be difficult,
  particularly in service and creative work.
• Even when we can define an activity, it can be
  difficult to separate measures of activity level
  from measures of output. It is simpler to focus
  on outputs, which is what the text tends to do in
  places.
• But properly defining activities is crucial

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Related Terminology

• What does it mean to be efficient?
• What does it mean to be effective?

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Efficiency - I

• Measures of efficiency nearly always compare the
  inputs to an activity or process with its
  outputs. The greater the output per unit of
  input, the more efficient. The fewer the units
  of input required to make one unit of output, the
  greater the efficiency.

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Efficiency - II

• Efficiency is a general concept that relates to
  entities ranging from individuals performing a
  single task to whole economies.

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Efficiency - III

• Since the productivity of labor has been so key
  to the wealth of a society, we continue to focus
  on the productivity of people. Sales per person,
  gross margin per person, and physical output per
  person, are measures of efficiency as well as
  measures of productivity.

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Efficiency - IV

• Cost per sales dollar, or cost per unit of output
  are the most common measures of efficiency used
  in managerial accounting.

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Efficiency in Accounting

• In accounting we use cost standards, flexible
  budgets, and profitability measures to evaluate
  efficiency. These standards relate the work done
  to the cost incurred to achieve that work.
  Physical measures are useful, but the ultimate
  measures include profitability.

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Efficiency in Accounting

• We may measure other operating (non-financial)
  variables because we believe they relate to
  profitability in the longer run. They are the
  means to profitability, not measures of
  profitability.

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Basic Activity View
Just in time
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Input/Output Relationships
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Basic Activity View
Utilization Rates
Productivity
Activity
INPUTS
Outputs
Input/Output
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Effectiveness

• Effectiveness is concerned with the achievement
  of objectives. Making a sales goal, achieving a
  target market share, completing a project on
  schedule, satisfying customers, and retaining
  employees--which may or may not change
  productivity. So effectiveness is a separate
  issue

Did we achieve the goal?
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Effectiveness Measures

• Percent of the goal achieved.
• Percent variance from goal.
• Improvement from past experience
• Percent of the goal achieved compared with last
  period.
• Percent variance from goal compared with last
  period.
• Examples from your experience?

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Effectiveness Measures

• Headcount, cycle time, customer satisfaction, and
  other measures are believed to lead to greater
  profitability. But they are not measures of
  efficiency per se.

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Staubus on Activity Costing

• Basic unit of analysis is the activity
• Direct and indirect cost classifications are
  unimportant in the context of product costing for
  decision or inventory purposes.

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Staubus on Activity Costing

• In manufacturing, ABC applies to labor and
  materials, not just indirect manufacturing costs
• Applies to all costs, not just Manufacturing
  (product) costs.

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Staubus on Activity Costing

• The objective is improved decision-making through
  more accurate cost estimates.
• One result of implementing activity costing
  should be a data base of activity costs to be
  available for all manner of decisions.

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Staubus on Activity Costing

• Examples include the pooling of labor-related
  costs, including human resource functions, to be
  charged to those activities utilizing the labor
  services.
• A similar process would be used for materials.

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Staubus on Activity Costing

• How do these comments relate to the explanations
  used in the textnot the problems, just the text?

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Assigned Problems

• LePlant (workbook)
• Jones (workbook)
• Exercise 4-28

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Agenda Next Time

1. Go over Theygo
2. Start our study of process costing

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• See Ya!