Copyright © by Houghton Miffin Company. All rights reserved.1 Managerial Accounting 2002e Belverd E. Needles, Jr. Susan Crosson - - - - - - - - - - - Multimedia

Copyright © by Houghton Miffin Company. All rights reserved. 1

Managerial AccountingManagerial Accounting2002e2002e

Belverd E. Needles, Jr.Belverd E. Needles, Jr.Susan CrossonSusan Crosson- - - - - - - - - - -

Multimedia Slides by:Harry Hooper

Santa Fe Community College


Chapter 5Chapter 5Activity-Based Activity-Based

Systems:Systems:Activity-Based Activity-Based

Management and Management and Just-in-TimeJust-in-Time


1. Explain the role of activity-based systems in the management cycle.

2. Define activity-based management (ABM) and discuss its relationship with the supply network and value chain.

3. Distinguish between value-adding and nonvalue-adding activities, and describe process value analysis.

LEARNING OBJECTIVESLEARNING OBJECTIVES


4. Define activity-based costing and explain how a cost hierarchy and a bill of activities are used.

5. Define the just-in-time (JIT) operating philosophy and identify the elements of a JIT operating environment.



6. Identify the changes in product costing that result when a firm adopts a JIT operating environment.

7. Define and apply backflush costing, and compare the cost flows in traditional and backflush costing.

8. Compare ABM and JIT as activity-based systems.



Activity-Based SystemsActivity-Based Systemsand Managementand Management

OBJECTIVE 1

Explain the role of activity-based

systems in the management cycle.


Activity-Based SystemsActivity-Based Systems

To create value and to satisfy customer needs for quality, reasonable price, and timely delivery, managers must:


Activity-Based SystemsActivity-Based Systems

Work with suppliers and customers.

View the organization as a collection of value-adding activities.

Use resources for value-adding activities

Reduce or eliminate nonvalue-adding activities.

Know the total cost of creating value for a customer.


Managers work with suppliers and customers: To improve quality To reduce costs To improve delivery time


Activity-Based SystemsActivity-Based Systems Managers need to know the full product cost. Managers focus internally to use resources in the

best way by matching resources to activities that add value.

Full product cost includes not only the costs of direct materials and direct labor, but also the costs of all production and non-production activities required to satisfy the customer.

Activity-based systems are information systems that provide quantitative information about the cost generating activities in an organization.


Using Activity-Based Systems in Using Activity-Based Systems in the Management Cyclethe Management Cycle

Product costing information helps

improve operating processes and make

better pricing decisions.


Planning StagePlanning Stage

In the planning stage,managers want answers to questions like: Which activities add value to a product

or service?

What resources are needed to perform those activities?

How much should the product or service cost?


Activity-Based Systems and the Management CycleActivity-Based Systems and the Management Cycle


Executing StageExecuting Stage In the executing stage, managers want

answers to questions like: What is the actual cost of making our

product or providing our service? What activities are being performed? How well are the activities being performed? What resources are being consumed?

Also, remaining nonvalue-adding activities must be monitored.


Reviewing StageReviewing Stage

In the reviewing stage, managers want answers to questions like: What actions will reduce the full product cost?

Did we meet our cost-reduction goals for

nonvalue-adding activities?

Measure activities’ performance by investigating the difference between their actual and budgeted costs.


Reporting StageReporting Stage

In the reporting stage, internal reports show the application of the costs of activities to cost objects, and external reports answer questions like:How much does inventory cost?

Did the company earn a profit?


Q.Q. What is an activity-based system?

Discussion Discussion

A.A. Activity-based systems are information systems that provide quantitative information about the cost generating activities in an organization and create opportunities to improve the costing information supplied to managers.


Activity-Based Management and Activity-Based Management and Activity-Based CostingActivity-Based Costing

OBJECTIVE 2

Define activity-based management

(ABM) and discuss its relationship with

the supply network and value chain.


Activity-Based ManagementActivity-Based Management

Activity-based management (ABM) is an approach to management that includes:

Identifying all major operating activities.

Determining what resources are consumed by each activity.

Categorizing the activities as either adding value to a product or service or not adding value.


Activity-Based ManagementActivity-Based Management Focuses on the reduction or elimination of

nonvalue-adding activities. ABM provides financial and operational

performance information at the activity level that:

Is helpful for making decisions about product lines, market segments and customer groups.

Helps managers eliminate waste and inefficiencies and redirect resources to activities that add value to the product or service.


Activity-Based CostingActivity-Based Costing

ABC is the tool used in an ABM environment to assist in assigning activity costs to cost objects for product costing and decision making.

Improves pricing and profitability decisions and inventory valuations.


Supply Networks andSupply Networks andValue ChainsValue Chains

Two tools of ABM, supply chains and

value chains, help managers better

understand their organization’s

external and internal operations.


Supply NetworkSupply Network

A supply network is an interdependent web

of organizations that supply materials,

products, or services to a customer.

A supply network includes suppliers and

suppliers’ suppliers as well as customers and

customers’ customers.

It moves from materials through production,

distribution and retailing to the final customer.


Value ChainValue Chain

A value chain is a related sequence of value-

creating activities within an organization.

It helps managers better understand the

interdependencies of those activities.

A company’s value chain is part of its supply

chain.

It includes the value chains of suppliers and

customers.


Supply Network and Value Chain for a Manufacturing CompanySupply Network and Value Chain for a Manufacturing Company


Value ChainValue Chain

When organizations work

cooperatively with others in their

supply chain or larger value chain, new

processes can be introduced to reduce

the total cost of products or services.


ABM in a Service OrganizationABM in a Service Organization

The supply network includes the suppliers of goods and services, the organization itself, its customers and the customers’ customers.

The value chain includes marketing, market research, purchasing supplies, processing orders, providing services and customer relations.


Supply Network and Value Chain for a Service OrganizationSupply Network and Value Chain for a Service Organization


Q.Q. What is a supply chain?


A. A supply chain is an interdependent

collection of organizations that

supplies materials, products, or

services to a customer.


Value-Adding and Nonvalue-Value-Adding and Nonvalue-Adding Activities and Process Adding Activities and Process

Value AnalysisValue Analysis

OBJECTIVE 3

Distinguish between value-adding

and nonvalue-adding activities, and

describe process value analysis.


Value-Adding ActivitiesValue-Adding Activities

A value-adding activity is an activity that adds value to a product or service as perceived by the customer.

Examples include: Designing a car. Assembling a car. Painting a car. Installing brakes on a car.


Nonvalue-Adding ActivitiesNonvalue-Adding Activities

A nonvalue-adding activity is an activity that adds cost to a product or service but does not increase its market value.

Examples include: Moving materials. Storing materials.


Process Value AnalysisProcess Value Analysis

Process value analysis (PVA) is an

analytical method of identifying all

activities and relating them to events

that cause or drive the need for the

activities and the resources consumed.


Costs and ResourcesCosts and Resources

By identifying nonvalue-adding

activities, organizations can reduce costs

and redirect resources to value-adding

activities.

To manage the cost of an activity, the

frequency of the activity can be reduced

or it can be eliminated.

Outsourcing may also reduce costs.


Value-Adding ActivitiesValue-Adding Activitiesin a Service Organizationin a Service Organization

Western Data Services, Inc.Value-Adding Activities for the Classic Letter

Value-Adding Activities How the Activity Adds Value

Design the letter Enhances the effectiveness of the communication

Create a database of customer Increases the probability that the clientnames and addresses sorted in will efficiently and effectively reach the ZIP code order targeted customer group

Verify the conformity of mailing Ensures that the client’s mailing willinformation with USPS receive the best postal raterequirements

Process the job Creates the client mailing

Deliver the letters to the post office Begins the delivery process


Nonvalue Adding Activities in a Nonvalue Adding Activities in a Service OrganizationService Organization

Prepare a job order form and schedule the job.

Order, receive, inspect and store paper, envelopes and supplies.

Set up machines to process a specific lettersize.

Log the total number of items processed in a batch.

Bill the client and record and deposit payments.


A.A. Moving materials.

Storing materials.

Repairing equipment.

Building maintenance.


Q.Q. What are examples of nonvalue-

adding activities?


ImplementingImplementingActivity-Based CostingActivity-Based Costing

OBJECTIVE 4

Define activity-based costing and

explain how a cost hierarchy and a

bill of activities are used.


To implement ABC, managers:1. Identify and classify each activity.2. Estimate the cost of resources for each

activity.3. Identify a cost driver for each activity

and estimate the quantity of each cost driver.

4. Calculate an activity cost rate. 5. Assign costs to cost objects based on the

level of activity required to make the product or provide the service.


Cost HierarchyCost Hierarchy Many companies use a cost hierarchy to

manage the assignment of activity-based costs to the level at which costs are incurred.

A cost hierarchy for a manufacturer typically has four levels: Unit level. Batch level. Product level. Facility level.


Unit-Level ActivitiesUnit-Level Activities Unit-level activities are performed each

time a unit is produced.

These activities vary with the number of

units produced.

Insertion of a component during assembly.

Examples: assembling engine

subassemblies, connecting engines to car

frames


Batch-Level ActivitiesBatch-Level Activities

Batch-level activities are performed

each time a batch of goods is produced. These activities vary with the number of

batches prepared.

Examples: setup, scheduling, and

materials handling.


Product-Level ActivitiesProduct-Level Activities

Product-level activities are performed

to support the diversity of products in a

manufacturing plant. Examples: implementing engineering

change notices,

redesigning the installation process.


Facility-Level ActivitiesFacility-Level Activities

Facility-level activities are performed

to support a facility’s general

manufacturing process. Examples: lighting the manufacturing

plant,

securing the manufacturing plant,

insuring the manufacturing plant.


The cost hierarchy includes both

value-adding and nonvalue-adding

activities.

Service organizations also use a cost

hierarchy.


Sample Activities in Cost HierarchiesSample Activities in Cost Hierarchies

Activity LevelCar Manufacturer:Engine Installation

Direct Mail Service:Preparing BankCustomer Mailing

Unit level Install engineTest engine

Print and fold letterInsert letter and other information into envelopeSeal and meter envelope

Batch level Set up installation processMove engines

Retool machinesVerify correct postageBill client

Product orservice level

Redesign installation process

Train employeesDevelop and maintain computer systems and databases

Facility oroperations level

Provide facility management, maintenance, lighting, security, and space

Provide facility management, maintenance, lighting, security, and space

Inspect engines


Bill of ActivitiesBill of Activities

A bill of activities is a list of activities

and related costs that is used to

compute the costs assigned to

activities and the product unit cost.


Bill of ActivitiesBill of Activities

More complex bills of activities include cost pool rates and cost driver levels used to assign costs to cost objects.

A bill of activities may be used as the primary document or a supporting schedule to calculate the product unit cost in job order or process costing for manufacturing and service organizations.


Activity-Based Costing for Selling Activity-Based Costing for Selling and Administrative Activitiesand Administrative Activities

ABC can be used to group S&A activities and assign the costs of those activities to cost objects such as sales territories or customer groups.

S&A cost pools include salaries, depreciation, sales commissions and utilities.

Cost drivers may include number of sales calls, sales orders, invoices or billings.


Q.Q. What are the four cost hierarchy levels

common to a manufacturer?


A.A. 1. Unit level.

2. Batch level.

3. Product level.

4. Facility level.


The New Manufacturing The New Manufacturing Environment and JIT OperationsEnvironment and JIT Operations

OBJECTIVE 5

Define the just-in-time (JIT)

operating philosophy and identify

the elements of a JIT operating

environment.


Traditional Operating EnvironmentTraditional Operating Environment

In a traditional operating environment, a company usually:

1. Maintains large amounts of inventory.

2. Uses push-through production methods.

3. Purchases materials in larger lot sizes with fewer deliveries.

4. Performs infrequent setups (long production runs).

5. Manufactures products in batches.

6. Uses a work force skilled in only one area.


The New EnvironmentThe New Environment

The new manufacturing environment emphasizes streamlined and improved manufacturing.

1. Waste in materials, inventory, labor, space, and production time are reduced.

2. Recordkeeping is reduced.

3. The number of nonvalue-adding activities can be reduced.

4. The sources of poor quality products, services or materials can be pinpointed and eliminated.


JIT: Basic ConceptsJIT: Basic Concepts Underlying the new methods are several basic

concepts.1. Simple is better.2. The quality of the product or service is critical.3. The work environment must emphasize continuous

improvement.4. Maintaining inventories wastes resources and may hide

poor work. 5. Any activity or function that does not add value should

be reduced.6. Goods should be produced only when needed.7. Workers must be multiskilled and participate in

improving efficiency and quality.


JIT Operating EnvironmentJIT Operating Environment

The elements of a JIT operating environment are:

1. Maintain minimum inventory levels.

2. Develop pull-through production

planning and scheduling.

3. Purchase materials and produce as

needed, in smaller lot sizes.

4. Perform quick, inexpensive machine

setups.


5. Create flexible manufacturing work

cells.

6. Develop a multiskilled work force.

7. Maintain high levels of product quality.

8. Enforce a system of effective preventive

maintenance.

9. Encourage continuous improvement of

the work environment.


Q.Q. What is pull-through production?


A.A. Pull-through production is a system in which a customer’s order triggers the purchase of materials and the scheduling of production for the required products.


Accounting for Accounting for Product Costs in the New Product Costs in the New

Manufacturing EnvironmentManufacturing Environment

OBJECTIVE 6

Identify the changes in product costing that result when a firm adopts a JIT operating environment.


Traditional Operating EnvironmentTraditional Operating Environment

The traditional operating environment divides the production into five parts:1. Processing time.

2. Inspection time.

3. Moving time.

4. Queue time.

5. Storage time.



In product costing under JIT, costs associated with processing time are grouped as either materials costs or conversion costs.

Conversion costs include the total of direct labor costs and manufacturing overhead costs incurred by a production department, JIT work cell, or other work center.


JIT Operating EnvironmentsJIT Operating Environments

Costs of Inspection

Moving

Queue time

Storage time

should be reduced or eliminated because these are nonvalue-added activities.


Throughput TimeThroughput Time

The key measure in a JIT operating

environment is throughput time.

Throughput time is the time it takes

to move a product through the entire

production process.


Changes Caused by JIT:Changes Caused by JIT:Direct Versus Indirect CostsDirect Versus Indirect Costs

Traditional JITEnvironment Environment

Direct Materials and parts DirectDirect Direct labor DirectIndirect Repairs and maintenance Direct to work cellIndirect Materials handling Direct to work cellIndirect Operating supplies Direct to work cellIndirect Utility costs Direct to work cellIndirect Supervision Direct to work cellIndirect Depreciation Direct to work cellIndirect Supporting service functions Mostly direct to

work cellsIndirect Building occupancy IndirectIndirect Insurance and taxes Indirect


Assigning CostsAssigning Costs

In the JIT operating environment, indirect costs have little correlation with direct labor hours.

Since automation has replaced direct labor hours with machine hours, machine hours become more important with JIT.

Depreciation costs are based on output units (not time), so are charged directly to work cells.


Indirect CostsIndirect Costs

Several costs that were treated as indirect

costs in a traditional production

environment are directly traceable to a JIT

production cell such as materials handling,

utilities, supplies and supervision.

Only costs associated with building

occupancy, insurance, and property taxes

remain indirect costs of work cells.


A.A. Only facility-level activities costs remain indirect costs of work cells, such as: costs of building occupancy, insurance and property taxes.


Q.Q. What are some indirect costs associated with work cells in a JIT operating environment?


Backflush CostingBackflush Costing

OBJECTIVE 7

Define and apply backflush costing, and compare the cost flows in traditional and backflush costing.



In a JIT operating environment, the cost flows

through the accounting system are simplified.

Backflush costing involves initially accumulating

all product costs in Cost of Goods Sold.

At period end, work costs backward to determine

the proper inventory account balances.

Recording time is reduced.



Since labor costs are reduced, the

accounting system combines direct labor

costs and manufacturing overhead costs

into a single category: conversion costs.


Comparison of Cost Flows in Traditional and Back-flush CostingComparison of Cost Flows in Traditional and Back-flush Costing


Cost Flows through T Accounts in Traditional and Back-flush CostingCost Flows through T Accounts in Traditional and Back-flush Costing


A.A. Backflush costing saves recording time by using fewer accounts and by recording fewer transactions, which cuts costs.


Q.Q. How does the use of backflush costing help JIT organizations cut costs?


Comparison of ABM and JITComparison of ABM and JIT

OBJECTIVE 8

Compare ABM and JIT as

activity-based systems.


Similarities of ABM and JITSimilarities of ABM and JIT Both ABM and JIT analyze processes and

identify value-adding and nonvalue-adding

activities. They both seek to: eliminate or reduce nonvalue-adding activities.

improve the allocation of resources.

improve quality, efficiency and productivity.

improve information quality for decision-making.


System DifferencesSystem Differences

The two systems differ in their primary

goals. The primary goal of ABM is to calculate the

most accurate product cost by using activity-

based costing (ABC). ABC is an accounting

method.

The primary goal of JIT is to simplify and

standardize production and purchasing

activities.


Comparison of ABM and JITComparison of ABM and JITApproaches to Activity-Based SystemsApproaches to Activity-Based Systems

ABMABM JIT JIT

Purpose Reduce or eliminate Reduce or eliminate waste. nonvalue-adding

activities

Cost Use ABC to assign Reorganize service activities so assignment manufacturing over- that they are performed within

head costs to the work cells and manufacturing product cost by overhead costs incurred in the using appropriate work cell become direct costs of cost drivers the products made in the work cell

Costing Integrate ABC with Use backflush costing to calculatemethod either job order or product costs when the products

process costing to are completedcalculate product costs


A.A. Only facility-level activities costs remain indirect costs of work cells, the costs associated with the building occupancy, insurance and property taxes..


Q.Q. What are some indirect costs associated with work cells in a JIT operating environment?


OKAY, LET’S REVIEW...OKAY, LET’S REVIEW...

1. Explain the role of activity-based systems in the management cycle.

2. Define activity-based management (ABM) and discuss its relationship with the supply chain and the value chain.

3. Distinguish between value-adding and nonvalue-adding activities and describe process value analysis


CONTINUING OUR REVIEW…CONTINUING OUR REVIEW…

4. Define a cost hierarchy, describe its elements, and explain how a cost hierarchy and a bill of activities are used in activity-based costing.

5. Define the just-in-time (JIT) operating philosophy and identify the elements of a JIT operating environment.


AND FINALLY…AND FINALLY…

6. Identify the changes in product costing that result when a firm adopts a JIT operating environment.

7. Define and apply backflush costing, and compare the cost flows in traditional and backflush costing.

8. Compare ABM and JIT as activity-based systems.

Documents

Copyright © by Houghton Miffin Company. All rights reserved.1 Managerial Accounting 2002e Belverd E. Needles, Jr. Susan Crosson - - - - - - - - - - - Multimedia