Chapter 04: Activity Based Management and Activity-Based Costing IM 1
Learning Objectives
5. Under what conditions is activity-based costing useful in an organization and what information do
activity-based costing systems provide to management?
ACTIVITY-BASED MANAGEMENT AND
ACTIVITY-BASED COSTING
CHAPTER
4
Chapter 04: Activity Based Management and Activity-Based Costing IM 2
Terminology
Activity: A repetitive action performed in fulfillment of business functions
Activity analysis: The process of studying activities to classify them and to devise ways to minimize or
Activity-based costing (ABC): A cost accounting system that focuses on the various activities
Activity-based management (ABM): A management approach that focuses on controlling production or
Activity center: A segment of the production or service process for which management wants to
Activity driver: A measure of the demands on activities and, thus, the resources consumed by products
Batch-level cost: A cost that is caused by a group of things being made, handled, or processed at a
single time
Business-value-added (BVA) activity: An activity that is necessary for the operation of the business but
Continuous improvement: An ongoing process whose objective is to reduce cycle time, make products
Cost driver analysis: The process of investigating, quantifying, and explaining the relationships of cost
Cycle (lead) time: The time between the receipt to completion of an order for a product or service; it is
Idle time: The amount of (non-value-added) time spent storing inventory or waiting at a production
operation for processing
Manufacturing cycle efficiency (MCE): A ratio resulting from dividing the total value-added processing
Mass customization: Personalized production generally accomplished through the use of flexible
Non-value-added activity (NVA): An activity that increases the time spent on a product or service but
does not increase its worth
Chapter 04: Activity Based Management and Activity-Based Costing IM 3
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Pareto principle: A principle that suggests that in many situations, it is common to observe that
Process: A series of activities that, when performed together, satisfy a specific objective
Processing (service) time: The actual (value-added) time consumed performing the functions necessary
to manufacture a product
Product complexity: Refers to the number of components included in a product
Service cycle efficiency: A ratio resulting by dividing total actual service time by total cycle time
Transfer time: The (non-value-added) time consumed by moving products or components from one
place to another
Value chart: A visual representation indicating the value-added and non-value-added activities and time
Chapter 04: Activity Based Management and Activity-Based Costing IM 4
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Lecture Outline
LO.1: In an activity-based management system, what are value-added and non-value-added
activities?
A. Introduction
services and have competitive cost structures.
efficiencies.
3. Traditionally, a single driver (e.g., direct labor hours, or direct labor costs, or machine hours) was
an organization.
4. This chapter discusses activity-based management and activity-based costing which allow a
created by those actions.
B. Activity-Based Management
1. Product cost determination, although specifically designated as an accounting function, is a major
concern of all managers.
value for the price.
2. Activity-Based Management (see text Exhibit 4.1 on p. 105) focuses on controlling the
enhance profitability.
a. Activity analysis is the process of studying activities to classify them as value-added or non-
3. Value-Added versus Non-Value-Added Activities
a. An activity is a repetitive action performed in fulfillment of business functions.
or service but does not increase its worth.
i. NVA activities can be reduced, redesigned, or eliminated without affecting the market
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publicly accessible website, in whole or in part.
storage and thus increasing MCE.
f. Cycle time in a retail environment is the time from ordering an item to the sale of that item to
minimize setup costs.
ii. For example, NVA activities caused by physical factors include having to move raw
iii. For example, NVA activities caused by human factors include increased cycle time due to
efforts on diminishing or eliminating.
i. Constructing a value chart for selected products or services will help management
i. The concentration of attention on the elimination of NVA activities should cause product
C. Cost Driver Analysis
1. All activities have cost drivers that consume resources and cause costs to be incurred.
a. Cost drivers are the factors having direct cause-effect relationships with costs.
performed, and appropriate for performance measurement.
ii. Text Exhibit 4.1 (p. 109) shows six possible cost drivers for shipping costs.
b. A greater number of cost drivers can normally be identified than should be used for cost
or variable and fixed factory overhead.
d. Pooled costs have traditionally been assigned to products and services using one or two cost
Chapter 04: Activity Based Management and Activity-Based Costing IM 8
publicly accessible website, in whole or in part.
LO. 4: How are product costs computed using an activity-based costing system?
D. Activity Based Costing
of those activities.
a. Recognizing that costs are incurred at different organizational levels, accumulating costs into
b. ABC focuses on attaching costs to products and services based on the activities required to
2. Two–Step Allocation
a. Costs, after being initially recorded, are accumulated in activity center cost pools using first–
i. An activity center is a segment of the production or service process for which
products and services in an ABC system.
i. Costs at the lowest (unit) level of activity should be allocated to products by use of
volume-related drivers.
ii. Costs incurred at higher (batch and product/process) levels can also be allocated to
service volume.
d. Text Exhibit 4.9 (p. 116) identifies some common drivers for various activity centers.
i. Three significant cost drivers that have traditionally been disregarded are related to
variety and complexity:
Product variety (the number of different types of products made);
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publicly accessible website, in whole or in part.
warehousing, purchasing, setups, and inspections – all of which can be seen as long-
term variable costs because they will increase as the number of products increase.
Therefore, accountants should consider using drivers such as number of product
3. Activity-Based Costing Illustrated
volume products and complex production operations.
ii. Activity-based costing systems typically shift a substantial amount of overhead cost from
iii. The ABC costs of moderately complex products and services (those that are neither
extremely simple nor complex nor are produced in extremely low or high volumes) tend to
iv. Profit margins that are difficult to explain; and
v. Hard-to-make products that show big profits and easy-to-make products that show
losses.
E. Determining Whether ABC is Useful
1. A vital loss of information may occur in an accounting system that ignores activity and cost
relationships.
a. There are some general operating activity clues that may alert managers to the need to
review the cost data being provided by their conventional accounting system: