5-1 Value Chain Analysis and Activity-Based Management C hapter 5 Prepared by Douglas Cloud...
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5-1
Value Chain Value Chain Analysis and Analysis and
Activity-Based Activity-Based ManagementManagement
Value Chain Value Chain Analysis and Analysis and
Activity-Based Activity-Based ManagementManagement
CChaptehapterr
55
Prepared by Douglas Cloud
Pepperdine University
Prepared by Douglas Cloud
Pepperdine University
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1. Describe strategic cost management.2. Discuss the importance of the value chain approach
to analyzing decision alternatives.3. Analyze an organization’s internal value chain,
dividing it into process and activities.4. Explain how process management can help improve
organizational performance.5. Determine the costs of individual activities and the
activity costs associated with various cost objectives.
ObjectivesObjectivesObjectivesObjectives
After studying this After studying this chapter, you should chapter, you should
be able to:be able to:
After studying this After studying this chapter, you should chapter, you should
be able to:be able to:
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Strategic Cost ManagementStrategic Cost ManagementStrategic Cost ManagementStrategic Cost Management
Strategic cost management is defined as making decisions concerning specific cost
drivers within the context of an organization’s business strategy, its internal value chain, and its place in a larger value chain stretching from the development and
use of resources to the final consumers.
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Elements of a Value-Chain for a Beverage-Packaging Plant
First level: Business entities
Timber Farm
PulpMill
Paperboard Manufacturer
Paperboard Converter
Beverage Company
Grocery Store
Final Customer
to second level
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Second level: Processes
Procurement Storage Display
from first level
Sell to customer
Third level: Activities
Preparing purchase
order
Receiving order
Inspecting delivery
Moving to
Storage
Paying invoice
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Usefulness of the Value Usefulness of the Value Chain PerspectiveChain Perspective
Usefulness of the Value Usefulness of the Value Chain PerspectiveChain Perspective
The goal of maximizing final customer value while
minimizing final customer cost leads organizations to
examine internal and external links in the value chain.
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The Value Chain Perspective The Value Chain Perspective Fosters Supplier-Buyer Fosters Supplier-Buyer
PartnershipsPartnerships
The Value Chain Perspective The Value Chain Perspective Fosters Supplier-Buyer Fosters Supplier-Buyer
PartnershipsPartnerships
Value Chain Perspective Focuses Value Chain Perspective Focuses on Processes, Not Departmentson Processes, Not Departments
Value Chain Perspective Focuses Value Chain Perspective Focuses on Processes, Not Departmentson Processes, Not Departments
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The Value-Chain PerspectiveThe Value-Chain Perspective
Comprehensive
Focused on the final customers
Strategic
Basic for partnerships between vendors and customers
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Structural Cost DriversStructural Cost DriversStructural Cost DriversStructural Cost Drivers
Structural Cost Drivers
Organizational Cost Drivers
Activity Cost Drivers
Making fundamental choices about the size and scope of operations
and technologies involved.
Making choices concerning the organization of
processes and activities
Performing specific units of work (activities) to serve
customer needs.
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GoalsLocationScaleScopeTechnologyComplexity
Structural cost drivers include decisions affecting--
Structural Cost DriversStructural Cost Drivers
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Organization of processes Layout efficiency Product configuration Exploitation of linkages in
the value chain Work force involvement Attitudes toward total
quality management
Organizational cost drivers include decisions affecting--
Structural Cost DriversStructural Cost Drivers
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Measures of ActivityMeasures of ActivityMeasures of ActivityMeasures of Activity
Preparing purchase
order
Receiving delivery
Inspecting delivery
Moving to
storage
Paying invoice
Number of orders
Number of orders
Number of units in order
Units in order
Number of orders
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Generic Internal ProcessesGeneric Internal Processes
OperationsInbound Logistics
Outbound Logistics
Marketing and Sales Service
Source: The basic idea for this exhibit is based on concepts contained in Michael E. Porter, Competitive Advantage (New York: The Free Press, 1985), p. 37.
Supporting Processes: Accounting, Design, Finance, Supporting Processes: Accounting, Design, Finance, Human Resources, Maintenance, and so forth.in Human Resources, Maintenance, and so forth.in
Supporting Processes: Accounting, Design, Finance, Supporting Processes: Accounting, Design, Finance, Human Resources, Maintenance, and so forth.in Human Resources, Maintenance, and so forth.in
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Representative ActivitiesRepresentative ActivitiesRepresentative ActivitiesRepresentative Activities
• Processing employee paychecks
• Developing budgets
• Determining activity costs
• Verifying the existence of recorded assets
AccountingAccounting
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• Developing specifications for products or services delivered to customers
Developing specifications for procedures to produce products or services
DesignDesign
Representative ActivitiesRepresentative ActivitiesRepresentative ActivitiesRepresentative Activities
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• Signing checks
• Obtaining financial resources
FinanceFinance
Representative ActivitiesRepresentative ActivitiesRepresentative ActivitiesRepresentative Activities
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Human Resources
•Hiring employees•Training employees
•Repairing equipment•Cleaning buildings
Representative ActivitiesRepresentative ActivitiesRepresentative ActivitiesRepresentative Activities
Maintenance
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Process MapProcess MapProcess MapProcess Map
It is a schematic overview of all the activities within a
process.
It is a schematic overview of all the activities within a
process.
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Accept shipmentyes
no
Process MapProcess MapProcess MapProcess Map
Is there anexisting order
Reject shipment
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Process MapProcess MapProcess MapProcess Map
Activity: Placing a Purchase Order
Go to file
cabinet
Open drawer containing blank purchase orders
Remove one purchase
order
Close drawer
Return to desk
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In cIn continuous improvementontinuous improvement, an , an organization’s employees organization’s employees
constantly evaluate products, constantly evaluate products, services, and processes seeking services, and processes seeking
ways to do better.ways to do better.
In cIn continuous improvementontinuous improvement, an , an organization’s employees organization’s employees
constantly evaluate products, constantly evaluate products, services, and processes seeking services, and processes seeking
ways to do better.ways to do better.wawa
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Activity-based costing (ABC) involves determining the cost of activities and tracing their
costs to cost objectives on the basis of the cost objectives utilization of units of activity.
Activity-based costing (ABC) involves determining the cost of activities and tracing their
costs to cost objectives on the basis of the cost objectives utilization of units of activity.
Activity-Based CostingActivity-Based CostingActivity-Based CostingActivity-Based Costing
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Activity-Based CostingActivity-Based CostingActivity-Based CostingActivity-Based Costing
Activity-based costing is used to develop cost information for the following (and other) purposes in which management might be interested:
The cost of processing a purchase order to assist in continuous improvement.
The cost of a product or service to determine the profitability of the product or service.
The cost of alternative long-distance telephone carriers to identify the carrier with the best combination of quality, service, and cost.
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Activities performed to fill customer needs consume resources that cost money.
Customer Activitiesserved by
Resources
consume
Costshave cost
money
Activity-Based CostingActivity-Based CostingActivity-Based CostingActivity-Based Costing
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The cost of resources consumed by activities should be assigned to cost objectives.
Costs Resourcesassigned
to
Activities Pools
assigned to
Cost Objectives
Reassigned to
Activity-Based CostingActivity-Based CostingActivity-Based CostingActivity-Based Costing
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1. Identifying activities.2. Assigning costs to activities.3. Determining the basis (activity cost driver) for
assigning the cost of activities to cost objectives.4. Determining the cost per unit of activity.5. Reassigning costs from the activity to the cost
objective in the basis of the cost objective’s volume of consumption of activities.
Operationalizing the two-stage model requires the following:
Activity-Based CostingActivity-Based CostingActivity-Based CostingActivity-Based Costing
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Detroit Metal Shop produces custom metal parts in response to customer job orders. Inbound logistics
and operations for the firm is as follows:
Place Place purchase purchase
orderorder
Receive Receive materialsmaterials
Setup Setup each jobeach job
Perform Perform activitiesactivities
Inbound Logistics
Purchasing Department
Operations
Machining Department
ContinuedContinued
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PolishPolish
Operations
Finishing Department
PackPack
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Monthly Costs: Purchasing Dept.Monthly Costs: Purchasing Dept.Monthly Costs: Purchasing Dept.Monthly Costs: Purchasing Dept.
Placing Purchase Receiving Orders Materials
Purchasing agent salaries ($4,000 x 3) $12,000
Receiving room employees ($3,000 x 5) $15,000
Supervisor:($6,000 x .38 time with purchasing agent) 2,250($6,000 x .63 of time with receiving agent) 3,750
Other costs:($12,000 x 0.15 purchasing space) 1,800($12,000 x 0.85 receiving space) 10,200
Total $16,050 $28,950
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Refining into Three ActivitiesRefining into Three ActivitiesRefining into Three ActivitiesRefining into Three Activities Placing Verifying Unloading/ Purchase Purchase Unpacking Orders Orders Inspecting
Purchasing agent salaries ($4,000 x 3) $12,000
Receiving room employees: ($3,000 x 5 x 0.20 verifying time) $ 3,000($3,000 x 5 x 0.80 unloading/ unpacking/inspect time) $12,000
ContinuedContinuedContinuedContinued
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Placing Verifying Unloading/ Purchase Purchase Unpacking Orders Orders Inspecting
Carried forward $12,000 $ 3,000 $12,000Supervisor:
($6,000 x .38 of time with purchasing agents) 2,250($6,000 x .63 of time with receiving employees x 0.20 employees’ verifying time) 750($6,000 x .63 of time with receiving employees x 0.80 employees’ unloading/ unpacking/inspecting time) 3,000
ContinuedContinuedContinuedContinued
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Carried forward $14,250 $ 3,750 $15,000Other costs*:
($12,000 x 0.15 purchasing space) 1,800($12,000 x 0.85 receiving space) 10,200
Total $16,050 $ 3,750 $25,200
* Because the purchase order is verified before delivery trucks are unloaded, the space devoted to this activity is assumed to be insignificant.
Placing Verifying Unloading/ Purchase Purchase Unpacking Orders Orders Inspecting
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Cost per Unit of ActivityCost per Unit of ActivityCost per Unit of ActivityCost per Unit of Activity
Cost per unit of activity cost driver
Cost of activity
Units of cost driver=
Cost per unit of activity cost driver
$16,050
200=
Placing Purchasing Orders
Cost per unit of activity cost driver
$80.25 per order=
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Cost per unit of activity cost driver
Cost of activity
Units of cost driver=
Cost per unit of activity cost driver
$3,750
200=
Verifying Purchasing Orders
Cost per unit of activity cost driver
$18.75 per order=
Cost per Unit of ActivityCost per Unit of ActivityCost per Unit of ActivityCost per Unit of Activity
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Cost per unit of activity cost driver
Cost of activity
Units of cost driver=
Cost per unit of activity cost driver
$25,200
$800,000 (direct materials)
=
Unloading/Unpacking/Inspecting
Cost per unit of activity cost driver
0.0315 per dollar=
Cost per Unit of ActivityCost per Unit of ActivityCost per Unit of ActivityCost per Unit of Activity
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Assigning Activity CostsAssigning Activity CostsAssigning Activity CostsAssigning Activity Costs Purchase Purchase Order 1 Order 2 Total
Direct materials costs $5,000.00 $3,500.00 $8,500.00
Activity costs:
Placing purchase order $ 80.25 $ 80.25 $ 160.50
Verifying purchase order 18.75 18.75 37.50
Unloading/unpacking/inspecting ($5,000 x 0.0315) 157.50
($3,500 x 0.0315) 110.25 267.75
Total 256.50 209.25 465.75
Total costs assigned to costobjective $5,256.50 $3,709.25 $8,965.75
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Purchasing Department
$45,000
Resource Costs
Placing Placing purchase purchase
orders orders $16,050$16,050
VerifyingVerifyingpurchase purchase
orders orders $3,750$3,750
Unloading/Unloading/unpacking/ unpacking/ inspectinginspecting $25,200$25,200
Activity Cost Pool
Purchase Purchase Order 1 Order 1
$5,256.50$5,256.50
Cost Objectives
Purchase Purchase Order 2 Order 2
$3,709.25$3,709.25
Other Other purchase purchase
orders orders $36,034.25$36,034.25
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Detroit Metal Shop ExampleDetroit Metal Shop ExampleDetroit Metal Shop ExampleDetroit Metal Shop Example
The following activity costs were determined in the Machining and Finishing Departments:
Machining Department:Setup
$ 250Conversion ($100 x 35MH)
3,500Finishing Department:
Polish ($50 x 20 labor hours)
1,000Pack ($5 x 450 kilograms)
2,250Total cost assigned to cost object
$7,000
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Machining Department
Finishing Department
SetupSetup ConversionConversion PolishPolish PackPack
Job102Job102 Other jobsOther jobs
Detroit Metal Shop ExampleDetroit Metal Shop ExampleDetroit Metal Shop ExampleDetroit Metal Shop Example
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Detroit Metal Shop ExampleDetroit Metal Shop ExampleDetroit Metal Shop ExampleDetroit Metal Shop ExampleDirect materials:
Order 1 $5,000.00
Order 2 3,500.00$ 8,500.00
Inbound logistics:Placing purchase order $ 160.50Verifying purchase order 37.50Unloading/unpacking/inspecting 267.75465.75
Operations:Setup $ 250.00Conversion 3,500.00Polish 1,000.00Pack 2,250.00 7,000.00
Total cost assigned to Job 102$15,965.75
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Two-Stage Activity Based Costing MethodTwo-Stage Activity Based Costing MethodTwo-Stage Activity Based Costing MethodTwo-Stage Activity Based Costing Method
Direct Resource Costs
Costs of resources directly Costs of resources directly traceable to cost objectivestraceable to cost objectives
To Objective 1, 2, 3, through n costs
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Two-Stage Activity Based Costing MethodTwo-Stage Activity Based Costing MethodTwo-Stage Activity Based Costing MethodTwo-Stage Activity Based Costing Method
Stage 1: Indirect resources costs are assigned to activity pools.
Cost of Resource 1
Cost of Resource 2
Cost of Resource 3
Cost of Resource n
Activity 1
Activity 2
Activity 3
Activity 4
Activity n
ContinuedContinuedContinuedContinued
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Stage 2: Activity costs are reassigned to cost objectives using an activity drivers.
Activity 1
Activity 2
Activity 3
Activity 4
Activity n
Two-Stage Activity Based Costing MethodTwo-Stage Activity Based Costing MethodTwo-Stage Activity Based Costing MethodTwo-Stage Activity Based Costing Method
Objective nObjective 2 Objective 3Objective 1
from Direct Resource Costs
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Additional ConsiderationsAdditional ConsiderationsAdditional ConsiderationsAdditional Considerations
Because activity-based costing is not guided by financial accounting
requirements, there is wide variation in the components of ABC systems.
Because activity-based costing is not guided by financial accounting
requirements, there is wide variation in the components of ABC systems.
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Reducing Non-Value-Reducing Non-Value-Added ActivitiesAdded Activities
Reducing Non-Value-Reducing Non-Value-Added ActivitiesAdded Activities
• Movement
• Waiting
• Setup
• Inspection
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Continuous improvement and
process reengineering seek to minimize non-value-added activities.
Reducing Non-Value-Reducing Non-Value-Added ActivitiesAdded Activities
Reducing Non-Value-Reducing Non-Value-Added ActivitiesAdded Activities
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The ABC/ABM CrossThe ABC/ABM Cross
Process View (ABM)
Cost Assignment View (ABC)
Resources (What is used to do
work?)
Activities (Work)
Cost Objects (The object of
work)
Cost Drivers (Why is work
done?)
Performance Measures
(How well is work done?)
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CChapter
55
The The EndEndThe The EndEnd
5-49