Chapter Nine

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Fundamentals of Cost Management
Chapter 9
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Learning Objectives
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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
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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.
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Managing the Cost of Customers and Supplies
L.O. 3 Describe how the actions of customers and
suppliers affect a firms costs.
Resources cost
Customers (and suppliers) use resources
Some customers use more resources than others
Time
Money

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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.

1. Identify the activities that consume resources
   and assign costs to them.

1. Identify the cost driver(s) associated with each
   activity.

1. Compute a cost rate per cost driver unit or
   transaction.

1. 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.

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Cost of Customers An Example
Operating Data
Reds Lumber
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Reds Lumber
Identify the activities
Step 1
What activities consume resources for Reds
delivering service?
Process Flow of the Delivery Service
Reds Lumber
Entering Order
Picking Order
Delivering Order
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Reds Lumber Continued
Identify the cost drivers and the expected volume
of each cost driver.
Step 2
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Compute the Cost Driver Rates
Step 3
Computation of Cost Driver Rates
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Step 4
Assign costs to products
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Using and Supplying Resources
L.O. 5 Distinguish between resources used and
resources supplied.
Cost driver rate multiplied by the cost driver
volume.
Resources used
Resources supplied
Expenditures or the amounts spent on a specific
activity.
Unused capacity
Difference between resources used and resources
supplied.
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Resources Used and Supplied An Example
Traditional Income Statement
Reds Lumber
Year 2
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Resources Used and Supplied An Example Continued
Activity-Based Income Statement
Reds Lumber
Year 2
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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.
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Managing the Cost of Quality
L.O. 7 Identify how activities that influence
quality affect costs and profitability.
Total Quality Management (TQM)
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External View of Quality The Customer
Tangible
Performance
Taste
Functionality
Intangible
Customer service
Delivery time
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Internal View of Quality
Conformance to specifications
Does the product or service do what it is
designed to do?
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Quality
External View?
Internal View?
Both
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Cost of Quality
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
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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.
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Nonconformance Costs
Internal 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 companys image tarnished from poor
product quality.
Lost sales
Experiencing decreased sales from poor-quality
(customers will go to competitors).
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Cost of Quality Report
Reds Lumber
Cost of Quality Report
For the Year Ended February 28
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Chapter 9
! I GUESS ILL QUIT.
The End