Chapter 10: Fundamentals of Cost Management

Fundamentals ofCost ManagementChapter 10Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/IrwinUsing Activity-Based CostManagement to Add Value 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.L.O. 1 Explain the concept of activity-based cost management.10 - *Using Cost HierarchiesL.O. 2 Use the hierarchy of costs to manage costs.Cost ExampleSuppliesLubricating oilMachine repairHierarchy LevelVolume relatedCost Driver ExampleDirect labor costMachine-hoursNumber of unitsSetup costsMaterial handlingShipping costsBatch relatedSetup hoursProduction runsNumber of shipmentsCompliance costsDesign and specification costsProduct relatedNumber of productsGeneral plant costsPlant admin. costsFacility relatedDirect costsValue added10 - *Managing the Costs of Customersand SuppliersL.O. 3 Describe how the actions of customers and suppliers affect a firm’s costs. Information on customer profitability is important for managers, so they can make decisions that will improve firm performance.10 - *Using ABC Costing:Customers and SuppliersL.O. 4 Use activity-based costing methods to assess customer and supplier costs.Step 1: Identify the activities that consume resources.Step 2: Identify the cost driver associated with each activity.Step 3: Compute a cost rate per cost driver for each unit or transaction. Step 4: Assign costs to customers by multiplying the cost driver rate by the volume of cost driver units consumed by the activity or transaction that occurred. Use the same four-step ABC product costing process to assess customers and suppliers.10 - *Cost of CustomersStep 1: Identify the ActivitiesLO4 What activities consume resources for Red’s delivering service?Process Flow of the Delivery Service – Red's LumberEnterorderPickorderDeliverorder10 - *Cost of CustomersStep 2: Identify the Cost DriversLO4Cost DriverNumber of orders enteredNumber of items pickedNumber of deliveries madeOrder valueActivityEntering orderPicking orderDelivering orderDelivery administration10 - *Cost of CustomersStep 3: Compute the Cost Driver RatesLO4Computation of Cost Driver Rates – Red's LumberEntering orderPicking orderDelivering orderDelivery administrationActivity$100,000$150,000$300,000$250,00010,000 orders75,000 items12,500 deliveries$5,000,000 order value$10 per order$ 2 per item$24 per delivery5% of valueActivityCostCost DriverVolumeCost DriverRate÷÷÷÷====10 - *Cost of CustomersStep 4: Assign Costs Using ABCLO4Cost Driver Information by Customer – Red's LumberNumber of ordersNumber of itemsNumber of deliveriesOrder value (total sales) 150 750 200$50,000 50 750 50$50,000JackJillCost Driver10 - *Cost of CustomersStep 4: Assign Costs Using ABCLO4Entering order (@ $10 per orderPicking order (@ $2 per item)Delivering order (@ $24 per deliveryDelivery administrationTotal delivery costs$ 1,500 1,500 4,800 2,500$10,300$ 500 1,500 1,200 2,500$5,700JackJillActivityEstimated Customer Delivery Costs – Red's Lumber10 - *Using and Supplying ResourcesL.O. 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 supplied10 - *Computing the Cost of Unused CapacityL.O. 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 - *Computing the Cost of Unused CapacityLO6 Practical capacity: Amount of production possible assuming only the expected downtime for scheduled maintenance and normal breaks and vacations. Normal activity: Long-run expected volume10 - *Managing the Cost of QualityL.O. 7 Describe how activities that influence quality affect costs and profitability. Quality as defined by the customer Organization is managed to excel on all dimensions10 - *Cost of QualityL.O. 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 testing10 - *Cost of QualityLO8 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. – Warranty repairs – Product liability – Marketing costs – Lost sales10 - *End of Chapter 10Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin