Cornerstones of Managerial

Accounting 2e

Chapter Seven
Activity-Based Costing and Management
Mowen/Hansen

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Functional-based Cost Systems

Functional-based systems

Based on volume measures, such as

Two types

Direct labor hours

Machine hours
Plantwide rates
Departmental rates

Often produce average costs that severely

under- or overstate individual product costs

Functional-based Cost System

Limitations
Two major factors impair their ability to
assign overhead costs accurately:
1. Proportion of non-unit-related
overhead costs to total overhead
costs is large
2. Degree of product diversity is great

Unit and Non-Unit Activities

Unit-level-activities-- Activities that are performed
each time a unit is
produced.
Non-unit-level-activities-- Activities that are not
performed each time a
unit of product is
produced

Non-Unit-Related Overhead Costs

What is needed for accurate cost assignment
of non-unit-level activities?
Non-unit-level activity drivers
Factors that measure the consumption of
non-unit-level activities by products and
other cost objects

Product Diversity
Products consume overhead
activities in systematically different
proportions.
Consumption Ratio --- Proportion of each activity
consumed by a product.

Calculate activity rates.

Setup rate
Materials
handling rate

$1,200/4 setup hours

$800/10 moves

Machining rate $1,500/50 machine

hours
Assembly rate

$500/100 machine
hours

$300 per setup hour

$80 per move

$30 per machine
hour
$5 per direct
labor hour
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Identifying Activities and Their

Attributes
Activity Dictionary

Lists the activities in an

organization along with
some critical activity
attributes

Activity Attributes

Financial and
nonfinancial information
items that describe
individual items
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Key Questions to Identify Activities

1. How many employees are in your department?
2. What do they do?
3. Do customers outside your department use any
equipment?
4. What resources are used by each activity?
5. What are the outputs of each activity?
6. Who or what uses the activity output?
7. How much time do workers spend on each
activity? Time on each activity by equipment?

Assigning Costs to Activities

Must determine how much it costs to

perform each activity

Requires identification of the resources being

consumed

Labor, materials, energy, and capital

Cost of resources is found in the general ledger

Resources must be assigned using driver
tracing

Work distribution matrix

Used to assign labor resources

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Resource Drivers

Factors that measure the consumption of

resources by activity.

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Assigning Costs to Products

Predetermined
activity rate

Usage of the activity

(as measured by
activity drivers)

To calculate this rate, the

practical capacity of each
activity must be determined

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Activity-Based Customer Costing

Customers are cost objects of fundamental
interest.
Customer management can produce significant
gains in profit.
Customers can consume customer-driven
activities in different proportions.
Assigning the costs of customer service to
customers is much the same as assigning
manufacturing costs to products.

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Supplier Costing Methodology

Cost of a supplier is much more than the
purchase price of the components or
materials acquired.
Assigning the cost to suppliers is similar to
cost assignments we have seen for
products and customers.

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Process-Value Analysis
Focuses on cost reduction instead of cost
assignment
Emphasizes the maximization of
systemwide performance.
Concerned with:
Driver analysis
Activity analysis
Performance measurement

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Activity Inputs and Outputs

Activity Inputs

Resources consumed
by the activity in
producing its output

Activity Outputs

Result or product of an
activity

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Driver Analysis: The Search for Root

Causes
Activity Output
Measure

The number of times the

activity is performed

Driver Analysis

The effort expended to

identify those factors
that are the root causes
of activity costs

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Activity Analysis
Process of identifying, describing, and evaluating
the activities
It should produce four outcomes:
What activities are done
How many people perform the activities
The time and resources required to perform
the activities
An assessment of the value of the activities to
the organization
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Value-Added Activities
Activities necessary to remain in business
Two types:
Value-added by mandate
Necessary to comply with legal
mandate
Discretionary activities

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Discretionary Value-Added Activities

Three conditions must be met simultaneously
for the activity to be classified as valueadded:
1. Produces a change of state
2. Change of state was not achievable by
preceding conditions
3. Enables other activities to be performed

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Non-Value-Added Activities

All activities other than those that are

absolutely essential to remain in business
Examples:
Scheduling

Storing

Moving
Waiting

Inspecting

Challenge of activity analysis is

to find ways to produce the
good without using any of
these activities.

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Cost Reduction
Four Ways:
1.
2.
3.
4.

Activity elimination
Activity selection
Activity reduction
Activity sharing

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Activity Elimination

Once activities that fail to add value

are identified, measures must be
taken to rid the organization of these
activities.

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Activity Selection
Involves choosing among different
sets of activities that are caused by
competing strategies. The lowestcost design strategy should be
chosen.

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Activity Reduction
Decreases the time and resources
required by an activity. This
approach focuses on improving
efficiency.

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Activity Sharing
Increases the efficiency by using
economies of scale. This lowers the
per-unit cost of the cost driver and
the amount of cost traceable to the
products that consume the activity.

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Warranty work
Is the activity non value-added or value-added?
Performing warranty work is a
non value-added activity
Why? It is done to correct
something that wasnt done
right the first time.
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Activity Performance Measurement

Designed to assess how well an activity was
performed and the results achieved.
Measures are both financial and nonfinancial
Centers on 3 dimensions:
Efficiency
Quality
Time
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Efficiency, Quality, & Time

Efficiency

Focuses on the relationship

of activity inputs to activity
outputs.

Quality

Concerned with doing the

activity right the first time.

Time

Longer times usually mean

more resource consumption
and less ability to respond to
customer demands.
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Assume that a company takes 10,000 hours to

produce 20,000 units of a product.
What is the velocity? Cycle time?
Velocity = 20,000/10,000 = 2 units per hour

Velocity is the number of units

of output that can be produced
in a given period of time.
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Assume that a company takes 10,000 hours to

product 20,000 units of a product.
What is the velocity? Cycle time?
Cycle Time = 10,000/20,000 = hour
Cycle time is the length of time it takes to
produce a unit of output from the time the
raw materials are received until the good is
delivered to finished goods inventory.
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