Chapter 10
Fundamentals of
Cost Management
McGraw-Hill/Irwin
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
Using Activity-Based Cost
Management to Add Value
L.O. 1 Explain the concept of activity-based cost management.
• 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.
10 - 2
Using Cost Hierarchies
L.O. 2 Use the hierarchy of costs to manage costs.
Hierarchy Level
Cost Example
Cost Driver Example
Volume related
Supplies
Lubricating oil
Machine repair
Direct labor cost
Machine-hours
Number of units
Batch related
Setup costs
Material handling
Shipping costs
Setup hours
Production runs
Number of shipments
Product related
Compliance costs
Design and
specification costs
Number of products
Facility related
General plant costs
Plant admin. costs
Direct costs
Value added
10 - 3
Managing the Costs of Customers
and Suppliers
L.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 - 4
Using ABC Costing:
Customers and Suppliers
L.O. 4 Use activity-based costing methods
to assess customer and supplier costs.
• Use the same four-step ABC product costing
process to assess customers and suppliers.
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.
10 - 5
LO4
Cost of Customers
Step 1: Identify the Activities
• What activities consume resources
for Red’s delivering service?
Process Flow of the Delivery Service – Red's Lumber
Enter
order
Pick
order
Deliver
order
10 - 6
LO4
Cost of Customers
Step 2: Identify the Cost Drivers
Activity
Entering order
Picking order
Delivering order
Delivery administration
Cost Driver
Number of orders entered
Number of items picked
Number of deliveries made
Order value
10 - 7
LO4
Cost of Customers
Step 3: Compute the Cost Driver Rates
Computation of Cost Driver Rates – Red's Lumber
Activity
Entering order
Picking order
Delivering order
Delivery administration
Activity
Cost
$100,000
$150,000
$300,000
$250,000
Cost Driver
Volume
÷
÷
÷
÷
10,000 orders
75,000 items
12,500 deliveries
$5,000,000 order value
Cost Driver
Rate
=
=
=
=
$10 per order
$ 2 per item
$24 per delivery
5% of value
10 - 8
LO4
Cost of Customers
Step 4: Assign Costs Using ABC
Cost Driver Information by Customer – Red's Lumber
Cost Driver
Jack
Jill
Number of orders
150
50
Number of items
750
750
Number of deliveries
200
50
Order value (total sales) $50,000 $50,000
10 - 9
LO4
Cost of Customers
Step 4: Assign Costs Using ABC
Estimated Customer Delivery Costs – Red's Lumber
Activity
Jack
Entering order (@ $10 per order
$ 1,500
Picking order (@ $2 per item)
1,500
Delivering order (@ $24 per delivery
4,800
Delivery administration
2,500
Total delivery costs
$10,300
Jill
$ 500
1,500
1,200
2,500
$5,700
10 - 10
Using and Supplying Resources
L.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 supplied
10 - 11
Computing the Cost of Unused Capacity
L.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 - 12
LO6
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 - 13
Managing the Cost of Quality
L.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 dimensions
10 - 14
Cost of Quality
L.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 testing
10 - 15
LO8
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.
– Warranty repairs
– Product liability
– Marketing costs
– Lost sales
10 - 16
End of Chapter 10
McGraw-Hill/Irwin
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.