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ise304.01-132-lec24-ch10-costmanagement.pdf
Cost Management
Lecture 24
Chapter 10 * Modified from PPT slides of McGraw-Hill/Irwin
Activities
consume
resources Products
consume
activities
Recap of what we covered last class
Costing method that first assigns costs to
activities and then allocate them to products
based on the products’ consumption of
activities.
Activity-Based Costing
Activity-Based Cost Management
Activity-based cost
management uses activity
analysis in decision making.
Activity-based costing
focuses on activities in
allocating overhead
costs to products.
Activity-based
management focuses
on managing activities
to reduce costs.
Overview:
1. Explain the concept of activity-based cost management.
2. Use activity-based costing methods to assess customer and supplier costs.
3. Distinguish between resources used and resources supplied.
4. Design cost management systems to assign capacity costs.
5. Describe how activities that influence quality affect costs and profitability.
Managing the Cost of Customers and Supplies
Resources cost Customers (and suppliers)
use resources
Some customers use more
resources than others
Time Money=
Activities consume
resources
Services consume
activities
ABC and the Cost: Customers and Suppliers
Use the same four-step ABC product costing process to
assess customers and suppliers.
3. Compute a cost rate per cost driver unit or
transaction.
4. Allocate costs to customers by multiplying the
cost driver rate by the volume of cost driver units
consumed by the activity or transaction that
occurred.
1. Identify the activities that consume resources and assign costs to them.
2. Identify the cost driver(s) associated with each
activity.
Example: Cost of Customers
Operating Data Red’s Lumber
Jack Jill Firm
Sales 50,000$ 50,000$ 5,000,000$
Cost of goods (@60%) 30,000 30,000 3,000,000
Gross margin 20,000 20,000 2,000,000
Order/Delivery Charges (@16%) 8,000 8,000 800,000
Delivery costs 800,000
Other operating costs 1,435,000
Operating profit 565,000$
All customers pay a 16% delivery charge
Example: Red’s Lumber – Step 1
What activities consume resources
for Red’s delivering service?
Process Flow of the Delivery Service
Red’s Lumber
Entering
Order
Loading
Order
Delivering
Order
Identify the activitiesStep 1
Example: Red’s Lumber – Step 2
Identify the cost drivers and the
expected volume of each cost driver.Step 2
Entering order Number of orders entered
Loading order Number of items loaded
Delivering order Number of deliveries made
Delivery administration Order value
Activity Cost Driver
Example: Red’s Lumber – Step 2
Identify the cost drivers and the
expected volume of each cost driver.Step 2
Entering order Number of orders entered
Loading order Number of items loaded
Delivering order Number of deliveries made
Delivery administration Order value
Activity Cost Driver
Cost Hierarchy
Classification of cost drivers into general levels
of activity; volume, batch, product and so on.
Supplies Direct labor costs
Volume related Lubricating oil Machine-hours
Machine repair Number of units
Set-up costs Set-up hours
Batch related Material handling Production runs
Shipping costs Number of shipments
Product related Number of designs/products
Design and
specification costs
Facility related General plant costs Direct costs
Example: Red’s Lumber – Step 2
Identify the cost drivers and the
expected volume of each cost driver.Step 2
Entering order Number of orders entered
Loading order Number of items loaded
Delivering order Number of deliveries made
Delivery administration Order value
Activity Cost Driver
Batch related
Volume related
Batch related
Facility related
Hierarchy Level
Example: Red’s Lumber – Step 3
Computation of Cost Driver Rates
Compute the Cost Driver RatesStep 3
Activity Activity Cost
Cost Driver
Volume Cost Driver Rate
Entering order 100,000$ 10,000 orders $10 per order
Loading order 150,000$ 75,000 items $2 per item
Delivering order 300,000$ 12,500 deliveries $24 per delivery
Delivery administration 250,000$ 5,000,000$ 5% of value
Example: Red’s Lumber – Step 4
Jack Jill
Entering order (@$10 per order) 1,500$ 500$
Loading order (@$2 per item) 1,500 1,500
Devliering order (@$24 per delivery) 4,800 1,200
Delivery administration (@5%) 2,500 2,500
Total delivery costs 10,300$ 5,700$
Activity
Cost Driver Jack Jill
Number of orders entered 150 50
Number of items loaded 750 750
Number of deliveries made 200 50
Order Value 50,000$ 50,000$
Cost Driver Rate
$10 per order $2 per item $24 per delivery 5% of value
Step 4 Assign costs to Customers
Using and Supplying Resources
Resources
used
Cost driver rate multiplied by
the cost driver volume.
Resources
supplied
Expenditures or the amounts
supplied for a specific activity.
Unused
capacity
Difference between resources
used and resources supplied.
Example: Resources Used and Supplied
Traditional Income Statement Red’s Lumber
Year 2
Gross margin 2,000,000$
Delivery revenue 800,000
Delivery costs
Depreciation and equipment leases 420,000$
Energy 100,000
Salaries and wages 250,000
Other delivery costs 30,000
Total delivery costs (800,000)
Less other operating costs (1,435,000)
Operating profit 565,000$
Example: Resources Used and Supplied, Continued. . .
Unused
Resources Resource Resources
Used Capacity Supplied
Sales 5,000,000$
Costs of goods (@60%) (3,000,000)
Gross margin 2,000,000$
Delivery revenue 800,000
Delivery costs
Volume Related
Loading items 135,000$ 15,000$ 150,000$
Batch related
Entering orders 65,000$ 35,000$ 100,000$
Delivering orders 200,000 100,000 300,000
Total batch related 265,000$ 135,000$ 400,000$
Facility related 175,000 75,000 250,000
Total delivery costs 575,000 225,000 800,000 (800,000)
Other operating costs (1,435,000)
Operating profits 565,000$
Activity-Based Income Statement Red’s Lumber – Year 2
Computing the Cost of Unused Capacity
Amount of production possible under ideal conditions with no time
for maintenance, or breakdowns.
Amount of production possible assuming only the expected
downtime for scheduled maintenance and normal breaks and
vacations.
Long-run expected volume.
Actual volume for the period.
Theoretical capacity
Normal activity
Actual activity
Practical capacity
Managing the Cost of Quality
Organization is
managed to excel on
all dimensions.
Quality as defined by the customer
External View of Quality: The Customer
Tangible Performance
Taste
Functionality
Intangible Customer service
Delivery time
Internal View of Quality
Conformance to specifications
Does the product or
service do what it is
designed to do?
Quality
Cost of Quality
Conformance costs
Prevention Costs incurred to prevent defects in the
products or services being produced.
Appraisal Costs incurred to detect individual units of
products that do not conform to specifications.
Material Inspection
Process Control
Quality Training
Machine Inspection
Product Design
End of Process Sampling
Field Testing
Nonconformance costs
Cost of Quality, Continued. . .
Nonconformance costs
Internal Failure Costs incurred when nonconforming products
and services are detected before being
delivered to customers.
External Failure Costs incurred when nonconforming products
and services are detected after being delivered
to customers.
Scrap
Rework
Re-inspecting / Re-testing
Warranty Repairs
Marketing Costs
Product Liability
Lost Sales
Cost of Quality Report
Red’s Lumber
Cost of Quality Report
For the Year Ended February 28
Sales = $5,000,000
Prevention costs
Quality training 35,600$
Machine inspections 22,000 57,600$ 1.15%
Appraisal costs
Inspect copies 30,000 0.60%
Internal failure costs
Paper scrap 36,000 0.72%
External failure costs
Customer complaints 30,000 0.60%
Total cost of quality 153,600$ 3.07%
Chapter 10 * Modified from PPT slides of McGraw-Hill/Irwin
Cost Management Practice Problems
29
Practice Problem 1: ABC of customers
30
Practice Problem 1: ABC of customers
31
Practice Problem 1: ABC of customers
32
Practice Problem 1: ABC of customers
33
Practice Problem 1: ABC of customers
Practice Problem 2: Recourses Used vs. Recourses Supplied
Practice Problem 3: Recourses Used vs. Recourses Supplied
(A) (B) (C)
