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Chapter 5 - Activity-Based Costing and Customer Profitability Analysis
5-48 Personnel Planning; TDABC(30 min)
1. Unlike a manufacturing company, almost all costs for a service company
are indirect in nature. Almost all of these costs are supplied in advance;
short-term spending is generally not affected by fluctuations in demand or
produce/service mix. Thus, traditional accounting practice is to view such
costs (to customers, clients, etc.).
2. As indicated in the text, two items need to be estimated for each
department or process in conjunction with a TDABC model: (1) the unit
cost of supplying capacity for the department or process in question (this
is also referred to as the capacity cost rate), and (2) the consumption of
capacity (i.e., an estimate of how much capacity (measured, generally
speaking, in terms of time) by activities performed. As to item (1), we
include total resource spending (labor, utilities, computer systems,
level of practical capacity is estimated as 5,000 hours).
3. and 4.
Claim information
Remote
Processing
On-site
Processing Total
Processing time/claim 0.50 1.00
Customer record maintenance/claim 0.20 0.20
Total time per claim 0.70 1.20
× Number of claims 1,900 2,900 4,800
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Chapter 5 - Activity-Based Costing and Customer Profitability Analysis
5-48 (continued -1)
5.
Claim information
Remote
Processing
On-site
Processing Total
Processing time/claim 0.50 1.00
Customer record maintenance/claim 0.20 0.20
Total time per claim 0.70 1.20
× Number of claims 2,700 2,000 4,700
Note that the capacity cost per hour is unchanged because 3 workers are still needed to handle the
demand. (1 worker has about 1,667 hours of capacity, which is 5,000 hours ÷ 3 workers, so 4,290 hours
needed ÷ 1,667 = 2.6 workers).
6. As noted above in response to Requirement 1, many support costs are
short-term fixed costs, related to the supply of capacity/service. Thus, after
companies institute cost-saving measures or process improvements in
response to ABC-based data, there might not be immediate financial
improvements. The committed nature of many, if not all, support costs
7. The underlying theory is that when cost-allocation rates are estimated in
conjunction with an ABC system the denominator volume level should be
consistent with the numerator (resource spending). That is, the numerator
represents the dollar amount of resource cost for a given activity (e.g.,
claims processing). The denominator should logically be measured as the
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Chapter 5 - Activity-Based Costing and Customer Profitability Analysis
5-48 (continued -2)
terms of bringing the demand for and supply of resources in each
support area (process).
5-49 Research Assignments; Assessing Customer Lifetime Value (45
min)
1. The primary issue addressed in the article is the effort to boost the
total value of each of the firm’s customers.
2. Customer lifetime value is the estimate of how much a customer is
expected to spend on a company’s products and/or services for some
designated time, less the cost of marketing to that customer. Customer
referral value is an estimate of the lifetime value of a customer that
would not otherwise have become a customer if the referral had not
been made. A second type of customer referral value is the lifetime
value of a customer that would likely have become a customer even if
3. Customer referral value is more difficult to estimate because of the
number of variables involved. In addition to estimating the expected
lifetime value of each referral, the number of successful referrals must
also be estimated. This entails estimating how many new customers
actually become customers because of a specific person’s referral and
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Chapter 5 - Activity-Based Costing and Customer Profitability Analysis
5-49 (continued -1)
4. The customer value matrix is a method of categorizing the
organization’s customers based on their value to the firm. Since the
authors found that CLV is not a good predictor of CRV, it became
necessary to capture these two different dimensions of a customer’s
value. The two-by-two customer value matrix makes this classification
resources.
5. The determination of CLV and CRV both require the ability to identify the
resources directed toward the acquisition and retention of customers.
This fundamental requirement matches up with the underlying theme of
activity-based costing: that activities, like customer acquisition and
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Chapter 5 - Activity-Based Costing and Customer Profitability Analysis
5-50 Ethics, Cost System Selection (5 min)
Unfortunately, there are a number of reasons why ABC costing systems are
studied by firms and then not adopted. In some cases the reason is to protect
a product line that is favored by top executives, even though the ABC results
show it to be unprofitable. Other times it is because a customer that is
considered critical to the firm is shown to be unprofitable by the ABC results.
In the case of Aero Dynamics, the reason has to do with an ethical issue, that
is, the use of cost allocation to improperly charge a cost-plus customer (the
federal government) for overhead costs. The management accountant should
keep the professional ethics code in mind. First, he or she should try to
persuade other ABC pilot project members and the company controller to
strongly recommend that top management adopt the more accurate ABC
method. If the company top management still would not listen, then the
management accountant should report the situation to the company’s audit
committee. Because of the management accountant’s responsibility for
confidentiality, he or she should not report the matter outside the firm. (See
the Institute of Management Accountant’s Code of Ethics in Exhibit 1-10).
An interesting footnote to the case is that the Government Accounting Office,
to assist the Dept of Defense, in part due to issues of this nature, developed in
the 1970s a series of cost accounting standards. These standards apply
generally to companies contracting with the federal government, especially the
DOD. See http://www.gao.gov/casb1.htm for the CASB website. Also, the
Federal Government in 1990 created the Federal Accounting Standards
Advisory Board (www.fasab.gov) which sets standards for financial and
managerial reporting within the federal government. The FASAB web site is
an interesting place to see the progress/continuing issues of accounting at the
federal government.
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Chapter 5 - Activity-Based Costing and Customer Profitability Analysis
5-51 Environmental Costing (30 minutes)
1. Social and customer pressures, along with regulatory requirements have
caused organizations’ environmental costs to rise over the past few decades.
Environmental cost accounting or just environmental accounting addresses
the limitations of conventional accounting methods by incorporating both direct
and less obvious costs associated with environmental sustainability.
2. Some of the obvious environmental costs include:
Materials, equipment, and labor costs that can be readily identified from the
general ledger of an organization.
Some of the “hidden” or less obvious costs include:
Upfront costs, such a process analysis and preliminary site studies
Regulatory costs, such as paperwork preparation and data collection and
storage
Back-end costs, such a facility closure related costs
Relationship costs, including relationships with customer, suppliers and
investors
3. Both ABC and ABM require a clear understanding of processes. Therefore,
the process analysis step will help managers better understand the scope of
an environmental sustainability initiative. Once the process is understood, the
resources required to execute the process can be more readily identified.
Once the resources are identified, the ABC methodology allows for the
assignment of costs of activities to the various sustainability efforts, which
would be the cost objects. Starting on page 758 of the article, the authors
provide a more detailed description of the approach.
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