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Fundamentals of
Cost Management
Chapter 10

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA

McGraw-Hill/Irwin

Copyright 2014 by The McGraw-Hill Companies, Inc. All rights reserved.

LO 1

Using Activity-Based Cost Management

to Add Value
LO 10-1 Describe how activity-based cost management can
be used to improve operations.

Activity-based costing (ABC) is a system used to assign costs to

products based on the products use of activities, which are the
discrete tasks an organization undertakes to make or deliver the
product.
The value chain is the set of activities that transforms raw
resources into products for customers. Activities in the value
chain are the things that customers will pay for.
Activity-based management focuses on managing
activities to
reduce costs.
Activity-based costing focuses on activities in allocating overhead
costs to products.

10-3

LO 1

Using Activity-Based Cost Information

to Improve Processes
The first step in ABCM is activity analysis. We begin by analyzing
the costs of key activities. Activity analysis has six steps:
1.Identify what the customer wants or expects from the firms
products or services, including key features, price, and quality.
2.Chart, from start to finish, the companys activities for
completing the product.
3.Develop activity-based costing data for each activity, based on
the resources used in each activity.
4.Classify all activities as value-added or non-value-added.
5.Compare the costs of each activity with the value that customers
assign to it. (The value of non-value-added activities would be
zero.)
6.Continuously improve the efficiency of all value-added activities.
Eliminate or reduce non-value-added activities.

10-4

LO 2

Using Cost Hierarchies

LO 10-2
Hierarchy
Hierarchy Level
Level
Volume
Volume related
related

Batch
Batch related
related

Product
Product related
related

Facility
Facility related
related

Use the hierarchy of costs to manage costs.

Cost
Cost Example
Example
Supplies
Supplies
Lubricating
Lubricating oil
oil
Machine
Machine repair
repair
Setup
Setup costs
costs
Material
Material handling
handling
Shipping
Shipping costs
costs
Compliance
Compliance costs
costs
Design
Design and
and
specification
specification costs
costs
General
General plant
plant costs
costs
Plant
Plant admin.
admin. costs
costs

Cost
Cost Driver
Driver Example
Example
Direct
Direct labor
labor cost
cost
Machine-hours
Machine-hours
Number
Number of
of units
units
Setup
Setup hours
hours
Production
Production runs
runs
Number
Number of
of shipments
shipments
Number
Number of
of products
products

Direct
Direct costs
costs
Value
Value added
added
10-5

LO 3

Managing the Costs of Customers

and Suppliers

Customers (and suppliers) use resources.

Some customers use more resources than others.
Think about the last time you stood in line to purchase a
ticket, check in for a flight, or make a transaction in a bank.
Many people ahead of you are purchasing the same service
(a ticket, a flight, or a deposit), but some take longer
(sometimes much longer) to complete the transaction. The
additional time those customers take adds cost to the
company.
10-6

LO 4

Cost of Customers
Step 1: Identify the Activities
What activities consume resources for
Reds delivering service?
Process Flow of the Delivery Service Red's Lumber

10-7

LO 4

Cost of Customers
Step 2: Identify the Cost Drivers

10-8

LO 5

Using and Supplying Resources

LO 10-5 Distinguish between resources used
and resources supplied.

Resources used:
Cost driver rate multiplied by
the cost driver volume
Resources supplies:
Expenditures or the amounts
spent on a specific activity
Unused capacity:
Difference between resources
used and resources supplied
10-9

LO 6

Computing the Cost of Unused Capacity

LO 10-6

Design cost management systems to assign capacity costs.

Actual activity:
Actual volume for the period
Theoretical capacity:
Amount of production possible under ideal
conditions with no time for maintenance,
breakdowns, or absenteeism.

10-10

LO 6

Computing the Cost of Unused

Capacity
Practical capacity:
Amount of production possible assuming only the
expected downtime for scheduled maintenance
and normal breaks and vacations.
Normal activity:
Long-run expected volume

10-11

LO 7

Managing the Cost of Quality

LO 10-7 Describe how activities that influence
quality affect costs and profitability.

Quality as defined by the customer

Organization is managed to excel on all dimensions

10-12

LO 7

External View of Quality: Customer

Expectations
Tangible:
Performance
Taste
Functionality
Intangible:
Customer service
Delivery time

10-13

LO 8

Cost of Quality
LO 10-8 Compare the costs of quality control
to the costs of failing to control quality.

Prevention: Costs incurred to prevent defects in the

products or services being produced
Materials inspection
Process control
Quality training
Machine inspection
Product design
Appraisal:

Costs incurred to detect individual units of

products that do not conform to specifications
End-of-process sampling
Field testing
10-14

LO 8

Cost of Quality
Internal failure:

Costs incurred when nonconforming products

and services are detected before being
delivered to customers.
Scrap
Rework
Reinspection/Retesting

External failure:

Costs incurred when nonconforming products

and services are detected after being delivered
to customers.
Warrant repairs
Product liability
Marketing costs
Lost sales
10-15

End of Chapter 10

10-16