Lecture # 1 WEDNESDAY, 5 SEPTEMBER 2012

ACTIVITY-BASED MANAGEMENT
Putu Agus Ardiana
Faculty of Economics Udayana University

The Relationship Between Activity-Based Costing and Activity-Based Management (1)

Cost Dimension Resources Process Dimension Performance Measures How Well?

Driver Analysis Why?

Activities What?

Cost Objects

The Relationship Between Activity-Based Costing and Activity-Based Management (2)

Activity-Based Management (ABM) is a systematic, integrated approach that focuses managements attention on activities with the objectives of improving customer value and increasing the profit achieved by providing this value Activity-Based Costing (ABC) is the major source of information for ABM

Process Value Analysis (PVA)

PVA 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 PVA is concerned with driver analysis, activity analysis, and performance measurement

PVA: Driver Analysis

Driver analysis is the effort expended to identify those factors that are the root causes of activity costs e.g. an analysis may reveal that the root causes of treating and disposing of toxic waste is product design, thus redesigning product may reduce or eliminate that cost

PVA: Activity Analysis (1)

Activity analysis is the process of identifying, describing, and evaluating the activities an organization performs Activity analysis has four assessments:
What activities are performed How many people perform the activities The time and resources required to perform the activities The value of the activities to the organization, including the a recommendation to select and keep only those that add value

PVA: Activity Analysis (2)

Value added activities are those activities necessary to remain in business because they contribute to customer value or help to meet an organizations needs, or both Value added activities can be either mandatory or discretionary activities A discretionary activity should be classified as a value added activity if only it meets all three conditions: (1) the activity produces a change of state, (2) the change of state was not achievable by proceeding activities, and (3) the activity enables other activities to be performed

PVA: Activity Analysis (3)

e.g. Production of metal components used in medical equipment:
Gating Shelling Pouring

Creates a wax mold replica of the final product

Creates a ceramic shell around the wax mold

Pours the molten metal into the resulting cavity (after the wax is removed), then the shell is broken to reveal the desired metal component

PVA: Activity Analysis (4)

The gating activity is a value added activity because: (1) it causes a change of state (unformed wax is transformed into a wax mold), (2) no prior activity was supposed to create this change of state, and (3) it enables the shelling activity to be performed Similar comments for the shelling and pouring activities

PVA: Activity Analysis (5)

Non value added activities are unnecessary and not valued by internal and external customers because they fail to produce a change in state or they replicate work due to failure in the previous process e.g. scheduling, moving, waiting, inspecting, storing activities

PVA: Activity Analysis (6)

Cost reduction through activity management:
Activity elimination focuses on eliminating nonvalue added activities Activity selection involves choosing various set of activities that are caused by competing strategies Activity reduction decreases the time and resources required by an activity Activity sharing increases activities by using economies of scale

PVA: Activity Measurement

Measures of activity performance have three major dimensions:
Efficiency is concerned with the relationship of activity outputs to activity inputs Quality is concerned with doing the activity right the first time it is performed Time is concerned with the duration to perform an activity

Financial Measures of Activity Efficiency

Financial Measures of Activity Efficiency: Reporting Value-Added and Non-Value Added Costs Trend Reporting of Non-Value Added Costs The Role of Kaizen Standards Benchmarking Activity Flexible Budgeting Activity Capacity Management

Reporting Value-Added and Non-Value Added Costs

Activity
Purchasing Molding Inspecting Grinding

Activity Driver
Purchasing hours Molding hours Inspection hours Number of units

SQ
20,000 30,000 0 0

AQ
23,000 34,000 6,000 5,000

SP
$20 $12 $15 $6

SQ = the value added output level for an activity SP = 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

Reporting Value-Added and Non-Value Added Costs

Value-added costs = SQ x SP Non-value added costs = (AQ-SQ) SP
Activity Purchasing Molding Inspecting Grinding Value-Added Costs $400,000 $360,000 0 0 Non-Value Added Costs $60,000 $48,000 $90,000 $30,000 Actual Costs $460,000 $408,000 $90,000 $30,000

Reducing purchasing costs: redesigning the products and reducing the number of parts required. Reducing molding, inspecting, and grinding costs: improving the molding process and labor skill

Trend Reporting of Non-Value Added Costs

Activity Purchasing Molding Inspecting Non-Value Added Costs 2009 $60,000 $48,000 $90,000 2010 $20,000 $35,000 $30,000 Change $40,000 $13,000 $60,000

Grinding
TOTAL

$30,000
$228,000

$15,000
$100,000

$15,000
$128,000

The Role of Kaizen Standards

Check Check

Do

Act

Do

Act

Search Plan The Kaizen or Continuous Improvement Cycle

Lock-In Establish

The Maintenance Cycle

Benchmarking
Benchmarking can be internal benchmarking or external benchmarking External benchmarking can be competitive benchmarking, functional benchmarking, generic benchmarking

Flexible Budgeting (1)

Functional-Flexible Budget: Direct Labor Hours Cost Formula Direct Labor Hours

Fixed
Direct Materials Direct Labor $20,000 $15,000 $120,000 $50,000 $220,000

Variable
$10 $8 $3 $1 -

10,000
$100,000 $80,000 $50,000 $25,000 $120,000 $50,000 $220,000

20,000
$200,000 $160,000 $80,000 $35,000 $120,000 $50,000 $220,000

Maintenance
Machining Inspections Setups Purchasing

Flexible Budgeting (2)

Activity-Flexible Budget (1) DRIVER: DIRECT LABOR HOURS Cost Formula Fixed Direct Materials Variable $10 $8 $18 Level of Activity 10,000 $100,000 $80,000 $180,000 20,000 $200,000 $160,000 $360,000

Direct Labor
Subtotals

Flexible Budgeting (3)

Activity-Flexible Budget (2) DRIVER: MACHINE HOURS
Cost Formula Fixed Maintenance Machining Subtotals $20,000 $15,000 $35,000 Variable $4.40 $1.60 $6.0 Level of Activity 10,000 $64,000 $31,000 $95,000 20,000 $108,000 $47,000 $155,000

Flexible Budgeting (4)

Activity-Flexible Budget (3) DRIVER: NUMBER OF SETUPS
Cost Formula Fixed Inspections Setups Subtotals $80,000 Variable $5.25 $4.50 $9.75 Level of Activity 10,000 132,500 $45,000 $177,500 20,000 $185,000 $90,000 $275,000

Flexible Budgeting (5)

Activity-Flexible Budget (4) DRIVER: NUMBER OF ORDERS
Cost Formula Fixed Purchasing Subtotals Totals $211,000 $211,000 Variable $1.50 $1.50 Level of Activity 10,000 $226,000 $226,000 $678,500 20,000 $241,000 $241,000 $1,031,000

Flexible Budgeting (6): Activity-Based Performance Report

Actual Costs*
Direct Materials Direct Labor 101,000 $80,000

Budgeted Costs
$100,000 $80,000

Budged Variance
$1,000 U -

Maintenance
Machining Inspections Setups Purchasing TOTALS

$55,000
$29,000 $125,500 $46,500 $220,000 $657,000

$64,000
$31,000 $132,500 $45,000 $226,000 $678,500

$9,000 F
$2,000 F $7,000 F $1,500 U $6,000 F $21,500 F

Activity Capacity Management (1)

Activity capacity is the number of times an activity can be performed Managing activity capacity refers to analysis of variances (volume variance and unused capacity variance) Volume variance is the difference in costs between the actual capacity level acquired (practical capacity, AQ) and the value-added standard quantity of activity that should be used (SQ). Thus, the formula is (AQ-SQ) x SP, where SP is a fixed activity rate

Activity Capacity Management (1)

Unused capacity variance is the difference is costs between activity availability or practical capacity (AQ) and activity usage (AU). Thus, the formula is (AQ-AU) x SP, where SP is a fixed activity rate

Implementing Activity-Based Management

ABM Model Systems Planning Identify, Define, and Classify Activities PVA Assess Value Content of Activities Define Root Causes of Each Activity Establish Activity Performance Measures Search for Improvement Opportunities Increase Profitability Reduce Costs Improve Decisions ABC Assign Resource Cost to Activities Identify Cost Objects and Activity Drivers Calculate Activity Rates Assign Costs to Cost Objects