Activity-based management

Activity-based management (ABM) is a systemwide, integrated approach that focuses

managements attention on activities with the objective of improving customer value and the
profit achieved by providing this value. ABC is a major source of information for activity-based
management. Thus, the activity-based management model has two dimensions: a cost dimension
and a process dimension. This twodimensional model is presented in Figure 8-13. The cost
dimension provides cost information about resources, activities, and cost objects of interests such
as products, customers, suppliers, and distribution channels. The objective of the cost dimension
is improving the accuracy of cost assignments. As the model suggests, the cost of resources is
traced to activities, and then the cost of activities is assigned to cost objects. This activity-based
costing dimension is useful for product costing, strategic cost management, and tactical analysis.
The second dimension, the process dimension, provides information about what activities are
performed, why they are performed, and how well they are performed. This dimensions
objective is cost reduction. It is this dimension that provides the ability to engage in and measure
continuous improvement.

Implementing ABM
Activity-based management (ABM) is a more comprehensive system than an ABC system. ABM
adds a process view to the cost view of ABC. ABM encompasses ABC and uses it as a major
source of information. ABM can be viewed as an information system that has the broad
objectives of (1) improving decision making by providing accurate cost information and (2)
reducing costs by encouraging and supporting continuous improvement efforts. The first
objective is the domain of ABC, while the second objective belongs to process value analysis.
The second objective requires more detailed data than ABCs objective of improving the
accuracy of costing assignments. If a company intends to use both ABC and process value
analysis (PVA), then its approach to implementation must be carefully conceived. For example,

if ABC creates aggregate cost pools based on homogeneity or approximating techniques, much
of the detailed activity information may not be needed. Yet, for PVA, this detail must be retained
Systems Planning Systems planning provides the justification for implementing ABM and
addresses the following issues:
1. The purpose and objectives of the ABM system
2. The organizations current and desired competitive position
3. The organizations business processes and product mix
4. The timeline, assigned responsibilities, and resources required for implementation
5. The ability of the organization to implement, learn, and use new information
Activity Identification, Definition, and Classification
Identifying, defining,and classifying activities requires more attention for ABM than for ABC.
The activity dictionary should include a detailed listing of the tasks that define each activity.
Knowing the tasks that define an activity can be very helpful for improving the efficiency of
value-added activities. Classification of activities also allows ABM to connect with other
continuous improvement initiatives such as just-in-time (JIT) manufacturing, total quality
management, and total environmental quality cost management. For example, identifying
quality-related and environmental activities enables management to focus attention on the nonvalue-added activities of the quality and environmental categories. ABC also provides a more
complete understanding of the effect that quality and environmental costs have on products,
processes, and customers. It is important to realize that successful implementation requires time
and patience. This is especially true when it comes to using the new information provided by an
ABM system.

ABM and Responsibility Accounting

Responsibility accounting is a fundamental tool of managerial control and is defined by four
essential elements: (1) assigning responsibility, (2) establishing performance measures or
benchmarks, (3) evaluating performance, and (4) assigning rewards. The objective of
responsibility accounting is to influence behavior in such a way that individual and
organizational initiatives are aligned to achieve a common goal or goals.
A financial (functional)-based responsibility accounting system assigns responsibility to
organizational units and expresses performance measures in financial terms. Essentially, firms
choose the responsibility accounting system that is compatible with the
requirementsandeconomics of their particular operating environment
Responsibility
Is define

Performance
Measurment
Are Establish

Performance
Is Measured

Individual
Rewarded

Process Value Analysis

Process value analysis is fundamental to activity-based responsibility accounting; it focuses on
accountability for activities rather than costs; and it emphasizes the maximization of systemwide
performance instead of individual performance. Process value analysis helps convert the
concepts of activity-based responsibility accounting from a conceptual basis to an operational

basis. As the models in Exhibits 5-1 and 5-3 illustrate, process value analysis is concerned with
(1) driver analysis, (2) activity
analysis, and (3) activity performance measurement.

Job-Order And Process Costing

Job-order costing and process costing are two major cost assignment systems. Job-order costing
is used in firms that produce a wide variety of heterogeneous (unique) products. Process costing
is used by firms that mass produce a homogeneous product.
In job-order costing, the key document or record for accumulating manufacturing costs is the
job-order cost sheet. Materials requisition forms (for direct materials), time tickets (for direct
labor), and source documents for manufacturing activities are the source
documents needed to assign manufacturing costs to jobs. The cost of each job is accumulated on
the job-order cost sheet. The total job cost consists of actual direct materials, actual direct labor,
and overhead applied using a predetermined rate (or rates). The balance in Work in Process
consists of the balances of all incomplete jobs. When a job is finished, its cost is transferred from
Work in Process to Finished Goods, and then, when sold, to Cost of Goods Sold.

Cost Flow
Cost flows under process costing are similar to those under job-order costing. Raw materials are
purchased and debited to the raw materials account. Direct materials used in production, direct
labor, and applied overhead are charged to the work-in-process account. In a production process
with several processes, there is a work-in-process account for each department or process. Goods
completed in one department are transferred out to the next department. When units are
completed in the final department or process,their cost is credited to Work in Process and debited
to Finished Goods.

Equivalent unit
Equivalent units of production are the complete units that could have been produced given the
total amount of manufacturing effort expended during the period. The number of physical units
is multiplied by the percentage of completion to calculate equivalent units. Two approaches have
evolved for dealing with beginning work-in-process inventory costs. The weighted average
costing method combines beginning inventory costs with current-period costs to compute
unit costs. The FIFO costing method separates units in beginning inventory from those produced
during the current period.

Two Methods of Treating Beginning Work-in-Process Inventory

weighted averagecosting method combines beginning inventory costs with current-period costs
to compute unit cost. In essence, the costs are pooled, and only one average unit cost is computed
and applied to both units transferred out and units remaining in ending inventory.
The production report summarizes the manufacturing activity occurring in a department for a
given period. It discloses information concerning the physical flow of units, equivalent units, unit
costs, and the disposition of the manufacturing costs associated with the period.
The FIFO costing method, on the other hand, separates units in beginning inventory from those
produced during the current period. It is assumed that units from beginning inventory are
completed first and transferred out along with all of the prior-period costs as well as the currentperiod costs necessary to complete those units. Then, current-period production is started and
completed (and transferred out with only current costs) or left incomplete as ending work-inprocess inventory.

Differences between the FIFO and Weighted Average Methods

If changes occur in the prices of the manufacturing inputs from one period to the next, then FIFO
produces a more accurate (that is, more current) unit cost than does the weighted average
method. A more accurate unit cost means better cost control, better pricing decisions, and so on.
Keep in mind that if the period is as short as a week or a month, however, the unit costs
calculated under the two methods are not likely to differ much. In that case, the FIFO method has
little, if anything, to offer over the weighted average method. Perhaps for this reason, many firms
use the weighted average method.
Since FIFO excludes prior-period work and costs, we need to create two categories of completed
units. The FIFO method assumes that units in beginning work in process are completed first,
before any new units are started. Thus, one category of completed units is beginning work-inprocess units. The second category is for those units started and completed during the current
period.

Nonuniform Aplication of Manufacturing Input

Nonuniform application of productive inputs requires the determination of separate percentage of
completion figures for each input. This, in turn, requires the computation of separate equivalent
units and unit costs. When a company has more than one processing department, the output of
one department becomes the material of a succeeding department. The usual method is to handle
the transferred-in units and costs as another form of material.