STRATEGIC COST MANAGEMENT BA122B Fall 2007Slide 31

1
Activity Based Costing (ABC)
2
Trad. Costing Limits

• Overall purpose accounting values
• Volume
• Size
• Complexity

3
Activity Based Costing

• Benefits
• More accurate costs
• More accurate operating information
• Better access to relevant costs
• Limits
• Allocations are still used
• Cost omission
• Time and expense

4
Contemporary Advantages

• Comprehensive cost information
• Emphasis on operations and activities
• Costs are attached to activities
• Provides driver visibility

5
Ansari MOA

• Strategic Implications
• Info _at_ the cost of value-added features
• Info _at_ the overall cost of the product
• Reflects time considerations in the attribution
  process

6
MOA, cont.

• Attribute Implications
• Technical
• Provides decision relevant information
• Enhances process understanding
• Behavioral
• Cost structure visibility
• Facilitates communication
• Empowers employees
• Risk of failed expectations re true cost
• Cultural
• Supports process focus
• Encourages cross-functional participation

7
ABC Implementation

• Select an area
• Identify primary activities (5-10)
• Cost each activity
• Determine one driver for each activity
• Apply the costs to the final cost objectives on
  the basis of the drivers.

8
Remember...

• ABC does NOT yield true costs!

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 Racer Cruiser Direct
Material 35 50 Direct Labor 25
13 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 2000
1250 750 Purchasing Rework Hrs.
(Hrs) 200 450 200 250
Quality Control Invoices () 200 600 150
450 Billing Change Orders () 150
300 150 150 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.
10
Gulfstream Recreation Solution

• Standard Overhead Rate
• 850K/70K Mhrs. 12.14 per machine hour
• Traditional Cost Structure
• Racer Cruiser
• Direct materials 35 50
• Direct labor 25 13
• Overhead 24 12
• Total 84 75

11
Gulfstream Solution, continued

• ABC Overhead Rate
• Racer Cruiser
• 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
• Racer Cruiser
• Direct materials 35 50
• Direct labor 25 13
• Overhead 40 9
• Total 100 72

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Implementation Strategy

• Involve management and employees
• Parallel system approach
• Find a winner
• KISS
• Incentivize
• Education users

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Activity Based Management (ABM)
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Ansari ABM

• Strategic Implications
• Visibility on the efficiency effectiveness (the
  quality) of activities
• Visibility of costs for process redesign
• Insight into timing consideration of actions

15
ABM, cont.

• Attribute Implications
• Technical
• Greater focus on work
• Provides cross-functional cost impact
• Highlights operational interdependencies
• Behavioral
• Heightens importance of process knowledge
• Reinforces continuous improvement
• Empowers employees--be careful of non-value
  terminology
• Cultural
• Reorients focus on process not people
• Challenges current thinking
• May add cultural conflict

16
ABM, cont.

• ABM Process
• Obtain existing cost information
• Determine the major processes
• Identify process inputs and outputs
• Determine the specific activities
• Identify the resources used
• Define output measures (what we measure)
• Define performance measures (how we measure it)
• Assess performance through benchmarking
• Brainstorm improvements

17
ABC, ABM Strategic Cost Applications

• Comparison of cost structure to competition
• Pricing, design and other operational impact
• Mass customization impact
• Behavioral impact of common components
• Changes in the production process
• Changes in the distribution system
• Changes in source and types of supplies/suppliers
• Profitability impact
• Identification and elimination of non-value added
  activities
• Quality and time implications