7/23/2019 ABM Assignment
1/7
1
Activity Based ManagementSail Rite
(Marine tools Industry)
CPM Assignment 1
8/15/2015
IIM INDORESOMA BANIK (2014PGP370)
7/23/2019 ABM Assignment
2/7
Activity Based Management Industry Implementation
2
INTRODUCTION TO ABM[5]
Activity based management is a method
that analyzes how a company incurs costs
from its activities that are driven by cost.For this purpose, activity based costing
plays a major role in proportionately
distributing the manufacturing overhead
costs over products in a logical manner.
Activity analysis, cost driver analysis and
performance analysis are the key
dimensions of management under ABM.
An easy example to first explain the ABC
concept and its importance is the burgerand cola example. If a small shop sells
burger and cola and the total time it takes
to prepare the items is 10 hours daily for
equal quantities of burger and cola, say 50,
then the total cost incurred to produce
these items is say Rs 1000. The traditional
costing method assigns a unit cost of
1000/100 = Rs10 to both burger and
cola(since number of units produced for
both are same). But if we look at the actualmachine run hours devoted to making
burger and cola, we find that the system
takes 8 hours to produce burger and only 2
hours for cola. Thus it does not make sense
to assign overhead costs of Rs 500 each to
burger and cola. This problem mentioned
above is explained diagrammatically to get
clarity on ABC.
Product ABC allocation
Burger 1000 x 8/10 = 800Cola 1000 x 2/10 = 200
Cost Driver Machine runs
Burger 800/50 =Rs 16Cola 200/50 = Rs 4
Hence the unit cost becomes Rs 10 for both
burger and cola. This is not a right way ofsplitting overhead costs since we do not
know how much out of the total 10 hours of
machine run activity was given to making
burger and how much to cola. ABC method
defines costs based on activities, machine run
hours in this scenario. There are usually
many activities and cost drivers. So here we
find out that 8 hours are assigned to burger
and 2 hours to cola making. Thus we assign a
higher cost share of 800 to burger and 200 tocola, making the unit cost for burger as Rs 16
and that of cola as Rs 10. This helps the
shopkeeper to come to a decision making
that burgers need to be sold at a higher price
than cola, since the costs incurred to produce
it are more.
By analyzing the relation between
activities and their costs, ABM helps acompanys management to determine
which activities contribute to productive
efficiency and which do not. ABM also
helps making decisions between
profitable and unprofitable product lines,
which ones to be stopped and which ones
to be invested on.
7/23/2019 ABM Assignment
3/7
3
WHY ABM?[2]
1. Desire to improve cost accuracy
2. To know the true profitability
3. Desire to know value added and
non value added costs
4.
Better analyze the ROI from
different projects
5. Support pricing decisions of final
products
[3]As on 2014, national surveys have
reported that the highest percentage of
companies using ABC is in the
manufacturing sector (20-50%)
followed by financial services (25%),public sector (20%) and
communications. After doing a
literature reading on some of the
existing research papers, it is found
that ABC costing has been the base for
cost calculations in many emerging
industries, the new ones being the
hospital, medicine and airline industry.
Every company has adopted the ABC
and made modifications to it to suit totheir organizational needs and goals.
However, the basic steps of ABC
remain the same, being
1. Identifying the cost object
2. Identifying the direct and overhead
costs
3.
Selecting the activities and cost
allocation base for assigning cost
overheads to the cost object4.
Developing the overhead rate per
unit for allocating overhead to the
cost object
ABM ANALYSIS OF SAIL RITE[1]
In this report, I will be discussing the
ABM model of a company called
SailRite. This is owned by Matt and
Hallie Grant and a full stock onlineretailer of fabrics, tools, kits and their
flagship product, sewing machines. It
started in 1969 and slowly began
diversification into not only boats but
also home fabrics.
Sail Rite believes the cost of itsmanufacturing equipments are costly
and it is essential that they keep a
count on which material is used in
which activity to produce what
product. Hence Sail Rite has recently
dived into ABC costing. Sail Rite has a
5-step methodology to ABM.
Before ABC, Sail Rite was aware that
the total overhead costs in the
company were around $8 million.
After evaluating the balance sheets and
other financial statements, the
company accountant came up with the
following activity list:-
Step 1: Identifying activities
contributing to overhead costs
1. Purchasing materials
2.
Machine set ups
3.
Machine runs
4. Assembly of products
5.
Inspecting finished goods
Step 2: Assigning overhead costs to
the activities
Activity Estimated
Annual
Overhead cost
Purchasingmaterials
$1.2 M
Machine set ups $1.6 M
Machine runs $2.7 M
Product assembly $1.5 M
Finished productsinspection
$1 M
Total =$8M
7/23/2019 ABM Assignment
4/7
Activity Based Management Industry Implementation
4
Step 3: Identifying the cost driver for
each activity in step 2
A cost driver is a cause for cost for a
particular activity. It can also be imagined
as the unit of measurement of cost for anyactivity. The following cost drivers were
identified for Sail Rite activities:-
Activity Cost driver Annual cost
driver usage
Purchasingmaterials
Purchaseorders
10,000 orders
Machine setups
# setups 2,000 setups
Machine runs Machinehours
90,000 hours
Productassembly
Direct laborhours
250,000hours
Finishedproducts
inspection
Inspectionhours
20,000 hours
The above information table shows an
estimate of level of activity, which is
further used to calculate activity rates in
the next step. We have still not allocated
the overheads to final products.
Step 4: Calculate a pre-determined
overhead rate for each activity
Overhead Rate = Overhead cost/Level of
cost driver activity
Overhead
costs
Cost driver
activity
Overhead rate
$1.2 M $10,000
orders
120 per order
$1.6 M 2,000 setups 800 per setup
$2.7 M 90,000 hours 30 per machinehour
$1.5 M 250,000hours
6 per labor hour
$1 M 20,000hours
50 perinspection hour
Step 5: Allocating overhead costs to
products as per their utility
The total annual cost driver utilization
calculated in the last column of step 3 is
not used and the total cost is split betweenactivities that have used it. In this example,
the company had allocated these cost
driver usages to 2 major product lines
Basic Sailboat and Deluxe Sailboat.
Activity Basic
Sailboat
Deluxe
Sailboat
Total
Purchasingmaterials
7000orders
3000orders
10,000orders
Machine
set ups
1100
setups
900
setups
2000 setups
Machineruns
50,000hours
40,000hours
90,000hours
Productassembly
200,000hours
50,000hours
250,000hours
Finishedproductsinspection
12,000hours
8,000hours
20,000inspectionhours
The overhead costs are now allocated
based on the above table to the respective
products based on the proportion of theactivity they have utilized during
production (step 4 overhead rate x step 5
allocations of cost driver activity)
Overhead
costs
Basic
Sailboat
Deluxe
Sailboat
Purchasingmaterials
120x7000=840,000
360,000
Machine set
ups
800x1100=880,000
720,000
Machine
runs
30x50000=1,500,000
1,200,000
Product
assembly
6x200,000=1,200,000
300,000
Finished
productsinspection
50x12,000=600,000
400,000
Total 5,020,000 2,980,000
$8,000,000
7/23/2019 ABM Assignment
5/7
5
The overhead cost hence calculated is divided by the total number of units of basic and
deluxe sailboats which are 5000 and 1000 respectively. The overhead unit cost hence comes
out to be
Basic Sailboat = 5.02M/5000 = $1,004
Deluxe Sailboat=2.98mM/1000=$2,980
How is the overhead cost per unit per product used further in the benefit of the company? To
answer this question, we already know that a products cost component is split into 3 parts
Direct Labor, Direct Material and Overhead costs (indirect). The following information about
direct costs is given about Sail rite:-
Sail Rite was initially selling the basic boats at a price of $3,200 gaining a profit of 3200-
2604=$596and deluxe boats at a price of $4,500 having a loss of 5030 4500 = $(530).
With traditional costing, the step 5 would have looked like the following:-
Total costs = $8,000,000
#basic units = 5000 ; #deluxe units = 1000; #unit cost = 8,000,000/6,000=$1,333 per unit
The above table of unit production cost would have then looked like :-
Basic Sailboat Deluxe Sailboat
DM + DL costs per unit 1600 2050
Overhead costs per unit 1333 1333
Total 2933 3383
By selling Basic at $3500, Sail rite thought it was making a profit of 3500 2933 = $517.
By selling Deluxe at $4500, Sail rite thought it was also making a profit of 4500 3383 =
$1117
Actual profits through ABC costing vs expected profits through traditional costing
Basic Sailboat Deluxe Sailboat
Traditional profits $517 $1117
ABC profits (real) $596 ($530) - loss
Hence ABC costing protected the company by helping them decide a price point for deluxe to
make the product profitable, where it had to charge the customer a value greater than $5030.
7/23/2019 ABM Assignment
6/7
Activity Based Management Industry Implementation
6
Recommendationsfor Sail Rite:[4]
1. Economies of scale are not taken into account in ABC method. For such kind of
industries where there is a possibility of making more production units by utilizing
more resources, a large portion of overhead costs are actually fixed costs which must
be spread proportionately among number of units produced. For example, if 2,000units of deluxe boats were produced instead of 1000, the product unit cost will vary
accordingly and the new value, say x will now be divided among 2000 units, thereby
reducing the unit production cost. The company then has to dynamically change its
pricing policy since the product can now be sold at a cheaper price with similar or
more profits. Companies must keep this in mind.
2. The number of hours allocated to each activity or product may not lead to efficient
output. Just like if we study for 8 hours a day and achieve some output level, the
same could be achieved in maybe 5 hours if we were more efficient and studied with
more attention. Similarly, actual hours allocated leading to useful production is lessthan what is called the expected production level. As a company grows across its
learning curve, it may be able to surpass this disadvantage over time. ABM can
hence take a progressive approach towards this aspect of ABC costing.
3. We should not rely only on numbers onlythat are derived from ABC techniques. A
strategic goal and vision mission should always be sustained in any solution we
propose. For example, if deluxe boats are currently not profit making and raising the
prices will reduce the demand, we should not simply discard that product line. We
need to find ways to differentiate the deluxe boat so that people are willing to pay a
higher price for it, and simultaneously work on reduction of internal manufacturingcosts over time.
ABM is a strategic approach to
cost management. As the diagram
explains, ABM closes the needs of
short and long range planning in
addition to deployment of
proactive strategy. It is always
aligned to the business model ofthe company and sustains the value
proposition explained by the
company. [6]
4. ABM does not give a
holistic view on Economic Value
Added and other opportunity costs
involved in the business. A
scenario planning and analysis
taking each of these costs in
revenue planning could be a
7/23/2019 ABM Assignment
7/7
Activity Based Management Industry Implementation
7
recommended option for wider acceptance of ABM. [7]
References:
[1]http://catalog.flatworldknowledge.com/bookhub/reader/4402?e=heisinger_1.0-ch03_s03
[2]http://accountingexplained.com/managerial/cost-allocation/
[3]https://www.business-case-analysis.com/activity-based-costing.html
[4]http://www.brighthub.com/office/finance/articles/78752.aspx
[5]http://www.youtube.com/watch?v=ivlI0HvUPQo
[6]http://www.imanet.org/docs/default-
source/thought_leadership/internal_measurement_systems/implementing_activity_based-
management.pdf?sfvrsn=2[7]http://www.salient.com/docs/LIT_ABM.pdf
http://catalog.flatworldknowledge.com/bookhub/reader/4402?e=heisinger_1.0-ch03_s03http://catalog.flatworldknowledge.com/bookhub/reader/4402?e=heisinger_1.0-ch03_s03http://catalog.flatworldknowledge.com/bookhub/reader/4402?e=heisinger_1.0-ch03_s03http://accountingexplained.com/managerial/cost-allocation/http://accountingexplained.com/managerial/cost-allocation/http://accountingexplained.com/managerial/cost-allocation/https://www.business-case-analysis.com/activity-based-costing.htmlhttps://www.business-case-analysis.com/activity-based-costing.htmlhttps://www.business-case-analysis.com/activity-based-costing.htmlhttp://www.brighthub.com/office/finance/articles/78752.aspxhttp://www.brighthub.com/office/finance/articles/78752.aspxhttp://www.brighthub.com/office/finance/articles/78752.aspxhttp://www.youtube.com/watch?v=ivlI0HvUPQohttp://www.youtube.com/watch?v=ivlI0HvUPQohttp://www.youtube.com/watch?v=ivlI0HvUPQohttp://www.imanet.org/docs/default-source/thought_leadership/internal_measurement_systems/implementing_activity_based-management.pdf?sfvrsn=2http://www.imanet.org/docs/default-source/thought_leadership/internal_measurement_systems/implementing_activity_based-management.pdf?sfvrsn=2http://www.imanet.org/docs/default-source/thought_leadership/internal_measurement_systems/implementing_activity_based-management.pdf?sfvrsn=2http://www.imanet.org/docs/default-source/thought_leadership/internal_measurement_systems/implementing_activity_based-management.pdf?sfvrsn=2http://www.imanet.org/docs/default-source/thought_leadership/internal_measurement_systems/implementing_activity_based-management.pdf?sfvrsn=2http://www.salient.com/docs/LIT_ABM.pdfhttp://www.salient.com/docs/LIT_ABM.pdfhttp://www.salient.com/docs/LIT_ABM.pdfhttp://www.salient.com/docs/LIT_ABM.pdfhttp://www.imanet.org/docs/default-source/thought_leadership/internal_measurement_systems/implementing_activity_based-management.pdf?sfvrsn=2http://www.imanet.org/docs/default-source/thought_leadership/internal_measurement_systems/implementing_activity_based-management.pdf?sfvrsn=2http://www.imanet.org/docs/default-source/thought_leadership/internal_measurement_systems/implementing_activity_based-management.pdf?sfvrsn=2http://www.youtube.com/watch?v=ivlI0HvUPQohttp://www.brighthub.com/office/finance/articles/78752.aspxhttps://www.business-case-analysis.com/activity-based-costing.htmlhttp://accountingexplained.com/managerial/cost-allocation/http://catalog.flatworldknowledge.com/bookhub/reader/4402?e=heisinger_1.0-ch03_s03Top Related