Managerial Accounting, 8e
Chapter 05: Activity-Based
Costing and Management
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition.
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accessible website, in whole or in part.
Chapter Objectives
By the end of this chapter, you should be able to:
05.01 Explain why functional (or volume)-based costing approaches may
produce distorted costs
05.02 Explain how an activity-based costing system works for product costing
05.03 Describe activity-based customer costing and activity-based supplier
costing
05.04 Explain how activity-based management can be used for cost reduction
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Icebreaker
You and your friend went to a dessert parlor in downtown. You ordered a small
chocolate fudge in a plastic cup with no mix-ins, costing $2.00, and your friend
ordered a medium strawberry banana rendezvous in a waffle dish with four
mix-ins, costing $8.00. If the total bill is split evenly between you two, each one
will have to pay $5.00, which doesn’t accurately represent the actual cost of
each dessert. Your dessert’s cost is overstated by $3.00, and your friend’s
dessert’s cost is understated by $3.00. Similarly, think how costs are allocated
in a manufacturing or service providing company and analyze the ideal way of
cost allocation.
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Limitations of Functional-Based Cost Accounting
Systems (1 of 3)
• Plantwide and departmental rates based on direct labor hours, machine
hours, or other volume-based measures have been used for decades to
assign overhead costs to products and continue to be used successfully by
many organizations
• However, for many settings, approach to costing is equivalent to an
averaging approach and may produce distorted, or inaccurate, costs
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Limitations of Functional-Based Cost Accounting
Systems (2 of 3)
• Product cost distortions can be damaging, particularly for those firms whose
business environment is characterized by:
• Intense or increasing competitive pressures
• Small profit margins
• Continuous improvement
• Total quality management
• Total customer satisfaction
• Sophisticated technology
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Limitations of Functional-Based Cost Accounting
Systems (3 of 3)
• Need for more accurate product costs has forced many companies to take a
serious look at their costing procedures
• Two major factors impair the ability of unit-based plantwide and
departmental rates to assign overhead costs accurately:
• Proportion of nonunit-related overhead costs to total overhead costs is
large
• Degree of product diversity is great
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Nonunit-Related Overhead Costs
• Use of plantwide or departmental rates assumes that a product’s
consumption of overhead resources is related strictly to the units produced
• For unit-level activities, this assumption makes sense
• Nonunit-level activities: Associated costs are unlikely to vary with units
produced
• Included in the fixed cost pool of a volume-based cost system
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2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Categorizing Costs under A B C
Type of Cost
Description of Cost Driver
Example
Unit-level
Varies with output volume (e.g.,
units); traditional variable costs
Cost of indirect materials for
labeling each bottle of Victoria’s
Secret perfume
Batch-level
Varies with the number of
batches produced
Cost of setting up laser engraving
equipment for each batch of
Epilog key chains
Product-sustaining
Varies with the number of
product lines
Cost of inventory handling and
warranty servicing of different
brands carried by Best Buy
electronics store
Facility-sustaining
Necessary to operate the plant
facility but does not vary with
units, batches, or product lines
Cost of General Motors plant
manager salary
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2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Activity Drivers and the Consumption of Activities
• Nonunit-level activity drivers: Factors that measure the consumption of
nonunit-level activities by products and other cost objects
• Unit-level activity drivers measure the consumption of unit-level activities
• Activity drivers: Factors that measure the consumption of activities by
products and other cost objects
• Classified as either unit-level or nonunit-level
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2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Distorted Product Costs
• Using only unit-based activity drivers to assign nonunit-related overhead
costs can create distorted product costs
• Severity of this distortion depends on what proportion of total overhead
costs these nonunit-based costs represent
• If nonunit- based overhead costs are only a small percentage of total
overhead costs then distortion of product costs will be quite small
• In such a case, using unit-based activity drivers to assign overhead costs
is acceptable
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2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Product Diversity
• Necessary for product cost distortion to occur
• Products consume overhead activities in systematically different proportions
• May occur for several reasons, including differences in:
• Product size
• Product complexity
• Setup time
• Size of batches
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2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Consumption Ratio (1 of 2)
• Regardless of the nature of the product diversity, product cost will be
distorted whenever:
• Quantity of unit-based overhead that a product consumes does not vary in
direct proportion to the quantity consumed of nonunit-based overhead
• Cost of shared resources should be assigned in proportion to the amount of
the resources consumed
• Activities represent bundles of resources consumed by products
• Reasonable to assign activity costs in proportion to the amount of activity
consumed
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2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Consumption Ratio (2 of 2)
• Activity drivers measure activity output and can be used as measures of
activity consumption
• Proportion of each activity consumed by a product is defined as the
consumption ratio and is calculated as:
Amount of Activity Driver per Product
Total Driver Quantity
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2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Solving the Problem of Cost Distortion (1 of 2)
• Cost distortion can be solved using activity rates
• Instead of assigning the overhead costs using a single, plantwide rate, a rate
for each overhead activity can be calculated and used to assign overhead
costs
• Activity rate is the means by which activity costs are assigned to products
• Rate for each activity is calculated by dividing the activity cost by an activity
driver
• Cause-and-effect relationship is the basis for choosing the activity driver
used in the rate calculations divided by units produced then yield the unit
cost
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Solving the Problem of Cost Distortion (2 of 2)
• To increase the accuracy of overhead cost assignments, causal factors,
called activity drivers are chosen
• Measure the amount of activity consumed by a product
• Activity rate multiplied by the amount used of each activity determines the
amount of activity cost assigned to a particular product
• Sum of all such assigned activity costs is the total amount of overhead
consumed by a product
• Overhead costs plus prime costs divided by units produced then yield the
unit cost
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Comparison of Functional- and Activity-Based
Product Costs
• Plantwide rate based on direct labor hours is calculated as:
Total Overhead Costs
Overhead =
Total Direct Labor Hours
• Activity-based cost assignment reflects the pattern of overhead
consumption and is the most accurate
• Activity-based product costing reveals that functional-based costing
undercosts the low-volume deluxe models and overcosts the high-volume
regular models
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Product Diversity and Product Costing Accuracy
(1 of 2)
• For unit-level overhead rates to fail
• Products must consume the nonunit-level activities in proportions
significantly different than the unit-level activities
• Key message of the relationship analysis is that in a diverse product
environment, activity-based costing promises greater accuracy
• Given the importance of making decisions based on accurate facts, a
detailed look at activity-based costing is needed
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Product Diversity and Product Costing Accuracy
(2 of 2)
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2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Data Analytics and Product Costing (1 of 3)
• Integral part of product costing
• Measuring unit production cost satisfies diverse objectives
• Calculating income, valuing inventory, increasing efficiency, and making
decisions
• Concerns
• How to measure unit product cost?
• What data are needed?
• Which product costing data analytic model should be used?
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Data Analytics and Product Costing (2 of 3)
• Data analytic models
• Functional-based costing
• Activity-based costing (A B C) – More powerful and accurate but data
intensive and costly
• A B C data requirements support process value analysis [activity-based
management (A B M)]
• A B M is concerned with cost reduction and involves more subjective
analysis
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Data Analytics and Product Costing (3 of 3)
• When the A B C model is used to calculate and report a product’s existing
cost, it is descriptive in nature
• Comparing A B C product costs with functional-based product costs is both
descriptive and diagnostic
• Combining A B C and A B M can produce both predictive and prescriptive
data analytic types
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Knowledge Check Activity 1
Which of the following is a factor that impairs the ability of unit-based plantwide
and departmental rates to assign overhead costs accurately?
a. Degree of product diversity is low
b. Proportion of nonunit-related overhead costs to total overhead costs is large
c. Percentage of unit-related overhead costs to total manufacturing costs is
less
d. Degree of product quantity is high
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Knowledge Check Activity 1 Debrief
Which of the following is a factor that impairs the ability of unit-based plantwide
and departmental rates to assign overhead costs accurately?
Answer: b. Proportion of nonunit-related overhead costs to total
overhead costs is large
There are two major factors that impair the ability of unit-based plantwide and
departmental rates to assign overhead costs accurately. First, proportion of
nonunit-related overhead costs to total overhead costs is large. Second, the
degree of product diversity is great.
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Activity-Based Product Costing (1 of 2)
• Functional-based overhead costing involves two major stages:
• Overhead costs are assigned to an organizational unit (plant or
department)
• Overhead costs are then assigned to cost objects
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Activity-Based Product Costing (2 of 2)
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2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Identifying Activities and Their Attributes
• An activity is action taken or work performed by equipment or people for
other people
• Identifying activities usually is accomplished by interviewing managers or
representatives of functional work areas
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Questions for Identifying Activities and Their
Attributes (1 of 3)
• A set of key questions is asked in which answers provide much of the data
needed for an A B C system. Here are some examples:
• How many employees are in your department? (Activities consume labor)
• What do they do (please describe)? (Activities are people doing things for
other people)
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Questions for Identifying Activities and Their
Attributes (2 of 3)
• Do customers outside your department use any equipment? (Activities also
can be equipment working for other people. In other words, the equipment
provides the service for someone by itself)
• What resources are used by each activity (equipment, materials, energy)?
(Activities consume resources in addition to labor)
• What are the outputs of each activity? (Helps to identify activity drivers)
• Who or what uses the activity output? (Identifies the cost object: products,
other activities, customers, etc.)
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2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Questions for Identifying Activities and Their
Attributes (3 of 3)
• How much time do workers spend on each activity? Time on each activity
by equipment? (Information assigns the cost of labor and equipment to
activities)
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2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Activity Dictionary
• Lists the activities in an organization along with some critical activity
attributes
• Activity attributes: Financial and nonfinancial information items that
describe individual activities
• Prepared using interview-derived data
• Examples include:
• Types of resources consumed
• Amount of time spent on an activity by workers
• Cost objects that consume the activity output
• Measure of the activity output
• Activity name
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2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Activity Dictionary Example for a Credit Card
Department
Activity Name
Activity Description
Cost Object(s)
Activity Driver
Processing
Sorting, keying, and
transactions verifying
Credit cards
Number of
transactions
Preparing statements
Reviewing, printing,
stuffing, and mailing
Credit cards
Number of statements
Answering questions
Answering, logging,
reviewing database,
and making call
backs
Credit cards
Number of cards
Providing automatic
tellers
Accessing accounts,
withdrawing funds
Credit cards,
Number of teller
checking and savings transactions
accounts
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Assigning Costs to Activities (1 of 2)
• Next task is to determine how much it costs to perform each activity
• Cost of labor, energy, materials, and capital is found in the general ledger,
but the amount spent on each activity is not revealed
• For shared resources, driver tracing is used
• Drivers used to assign resource costs to activities are called resource
drivers, which are factors that measure the consumption of resources by
activities
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Assigning Costs to Activities (2 of 2)
• A work distribution matrix is developed which identifies the amount of labor
consumed by each activity
• Derived from the interview process (or a written survey)
• Here is an example:
Activity
Percentage of Time per Activity
Processing Transactions
40%
Preparing statements
30%
Answering questions
30%
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2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Assigning Costs to Products
• Assigned to products by multiplying a predetermined activity rate by the
usage of the activity, as measured by activity drivers
• To calculate an activity rate, the practical capacity of each activity must be
determined
• Maximum activity output that can be realized if everything operates
efficiently
• To assign costs, the amount of each activity consumed by each product must
also be known
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Discussion Activity 1
Delta Company manufactures an electronic component—Component A—that
is used in the manufacture of home appliances.
a. Can you think of different types of activities associated with the production
of the component? Mention any three.
b. What do you think are the cost drivers for each of these activities?
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2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Discussion Activity 1 Debrief
Delta Company manufactures an electronic component—Component A—that
is used in the manufacture of home appliances.
a. Can you think of different types of activities associated with the production
of the component? Mention any three.
b. What do you think are the cost drivers for each of these activities?
Answer:
Some of the activities that are involved in the production of Component A can
be setting up equipment, machining, inspecting, and reworking. For setting up
equipment, the cost driver is setup hour. For machining, the cost driver is
machine hours. For inspecting, the cost driver is inspection hours. Finally, for
reworking, the cost driver is rework hours.
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Activity-Based Customer Costing and ActivityBased Supplier Costing (1 of 2)
• A B C systems originally became popular for their ability to improve productcosting accuracy by tracing activity costs to the products that consume the
activities
• A B C has expanded into areas
• Upstream
• Before the production section of the value chain—research and
development, prototyping, etc.
• Downstream
• After the production section of the value chain—marketing, distribution,
customer service, etc.
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2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Activity-Based Customer Costing and ActivityBased Supplier Costing (2 of 2)
• A B C often is used to more accurately determine the upstream costs of
suppliers and the downstream costs of customers
• Knowing the costs of suppliers and customers can be vital information for
improving a company’s profitability
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Cumulative Customer Profitability (1 of 2)
• A high-tech producer of semiconductors, implemented A B C customer
costing and discovered that 10% of its customers were responsible for about
90% of its profits
• It also discovered it was actually losing money on about 50% of its
customers
• It worked to convert its unprofitable customers into profitable ones and
invited those who would not provide a fair return to take their business
elsewhere
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2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Cumulative Customer Profitability (2 of 2)
• As a consequence, company sales decreased, but its profit tripled
• The following slide depicts this interesting yet common relationship between
customers and their contribution to company profitability
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2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Whale Curve of Cumulative Customer Profitability
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2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Activity-Based Customer Costing
• Customers are cost objects of fundamental interest
• Knowing how much it costs to service different customers can be vital
information for the following purposes:
• Setting pricing
• Determining customer mix
• Improving profitability
• Furthermore, because of diversity of customers, multiple drivers are needed
to trace costs accurately
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2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Customer Costing versus Product Costing
• Assigning the costs of customer service to customers is done in the same
way that manufacturing costs are assigned to products
• Customer-driven activities such as order entry, order picking, shipping, etc.,
are identified and listed in an activity dictionary
• Cost of the resources consumed is assigned to activities, and the cost of the
activities is assigned to individual customers using activity drivers
• Knowing the costs of individual customers or customer types can be helpful
in setting prices, determining the best customer mix, and improving
profitability
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Activity-Based Supplier Costing
• A B C help managers identify the true cost of a firm’s suppliers
• Cost of a supplier is much more than the purchase price of the components
• Suppliers can affect many internal activities of a firm and significantly
increase the cost of purchasing
• Managers are required to evaluate suppliers based on total cost, not just
purchase price
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Supplier Costing (1 of 2)
• Assigning the costs of supplier-related activities to suppliers follows the
same pattern as A B C product and customer costing
• Examples of supplier-driven activities are:
• Purchasing
• Receiving
• Inspection of incoming components
• Reworking products
• Expediting products
• Warranty work
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Supplier Costing (2 of 2)
• Cost of the resources consumed is assigned to these activities, and then
activity drivers assign the resulting activity cost to individual suppliers
• Costs are then added to direct purchase costs
• Outcome enables managers to improve their evaluation and selection of
suppliers, with the objective of reducing total supplier costs
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Knowledge Check Activity 2
Which of the following is a true statement about activity-based supplier
costing?
a) The cost of a supplier is the purchase price of the components or materials
acquired.
b) It encourages managers to increase the number of suppliers.
c) It encourages managers to evaluate suppliers based on purchase cost.
d) Suppliers can affect many internal activities of a firm and significantly
increase the cost of purchasing.
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2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Knowledge Check Activity 2 Answer
Which of the following is a true statement about activity-based supplier
costing?
Answer: d. Suppliers can affect many internal activities of a firm and
significantly increase the cost of purchasing.
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Process-Value Analysis
• Fundamental to activity-based management
• Activity-based management
• System-wide, integrated approach that focuses management’s
attention on activities with the objective of improving customer value
and profit achieved by providing this value
• Focuses on cost reduction instead of cost assignment and emphasizes the
maximization of system-wide performance
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Process-Value Analysis Model
Process-Value Analysis is concerned with:
• Driver analysis
• Activity analysis
• Performance measurement
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2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Driver Analysis: The Search for Root Causes
• Managing activities requires an understanding of what causes activity costs
• Every activity has inputs and outputs
• Activity inputs are the resources consumed by the activity in producing its
output
• Activity output is the result or product of an activity
• Measures number of times the activity is performed
• Quantifiable measure of the output
• Driver analysis is the effort expended to identify those factors that are the
root causes of activity costs
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Activity Analysis: Identifying and Assessing Value
Content
• The heart of process-value analysis is activity analysis
• Process of identifying, describing, and evaluating the activities that an
organization performs
• Activity analysis produces four outcomes:
• What activities are done
• How many people perform the activities
• Time and resources required to perform the activities
• An assessment of the value of the activities to the organization, including
a recommendation to select and keep only those that add value
• Activities can be classified as value-added or nonvalue-added
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Value-Added Activities
• Activities necessary to remain in business
• Some activities are value-added by mandate
• Required by S E C and I R S
• Remaining activities in the firm are discretionary
• Discretionary activity is classified as value-added provided it
simultaneously satisfies all of the following conditions:
• Activity produces a change of state
• Change of state was not achievable by preceding activities
• Activity enables other activities to be performed
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Nonvalue-Added Activities (1 of 2)
• All activities other than those that are absolutely essential to remain in
business, and therefore considered unnecessary
• Identified by its failure to satisfy any one of the three previous defining
conditions for adding value
• For example, inspection is nonvalue-added because it is a state-detection
activity, not a state-changing activity
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Nonvalue-Added Activities (2 of 2)
• Costs that are caused either by nonvalue-added activities or the inefficient
performance of value-added activities
• For nonvalue-added activities, the nonvalue-added cost is the cost of the
activity itself
• For inefficient value-added activities, the activity cost must be broken into
its value-added and nonvalue-added components
• Value-added component is the waste-free component of the value-added
activity and is, therefore, the value-added standard
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Examples of Nonvalue-Added Activities (1 of 2)
• In the manufacturing operation, the following major activities are often cited
as wasteful and unnecessary:
• Scheduling: An activity that uses time and resources to determine when
different products have access to processes and how much will be
produced
• Moving: An activity that uses time and resources to move raw materials,
work in process, and finished goods from one department to another
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Examples of Nonvalue-Added Activities (2 of 2)
• Waiting: An activity in which raw materials or work in process use time
and resources by waiting on the next process
• Inspecting: An activity in which time and resources are spent ensuring
that the product meets specifications
• Storing: An activity that uses time and resources while a good or raw
material is held in inventory
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Activity Management Reduces Costs in Four Ways
• Activity elimination focuses on nonvalue-added activities
• Activity selection involves choosing among different sets of activities that
are caused by competing strategies
• Activity reduction decreases the time and resources required by an activity
• Activity sharing increases the efficiency of necessary activities by using
economies of scale
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Assessing Nonvalue-Added Costs
• Nonvalue-added costs are caused either by nonvalue-added activities or
value-added activities performed inefficiently
• Determining the nonvalue-added cost is followed by a root-cause analysis
and then by the selection of an approach to reduce the waste found in the
activity
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Activity Performance Measurement
• Assessing how well activities (and processes) are performed is fundamental
to management’s efforts to improve profitability
• Activity performance measures exist in both financial and nonfinancial forms
• Measures of activity performance center on three major dimensions:
• Efficiency: Relationship of activity inputs to activity outputs
• Time: Time required to perform an activity
• Quality: Doing the activity right the first time it is performed
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Cycle Time and Velocity (1 of 3)
• Operational measures of time-based performance
• Measure the time it takes for a firm to respond to such things as customer
orders, customer complaints, and the development of new products
• Objective is to reduce cycle time and improve response time, making the
firm more competitive
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Cycle Time and Velocity (2 of 3)
• Cycle time measures how long it takes to produce an output from start to
finish
Time
Cycle time =
Units produced
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Cycle Time and Velocity (3 of 3)
• Velocity is the number of units of output that can be produced in a given
period of time
Units produced
Velocity =
Time
• Velocity is the reciprocal of cycle time
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Knowledge Check Activity 3
Suppose that a company is spending $60,000 per year for inspecting, $30,000
for purchasing, and $40,000 for reworking products. A good estimate of
nonvalue-added costs would be:
a. $70,000.
b. $130,000.
c. $40,000.
d. $90,000.
e. $100,000.
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Knowledge Check Activity 3 Answer
Suppose that a company is spending $60,000 per year for inspecting, $30,000
for purchasing, and $40,000 for reworking products. A good estimate of
nonvalue-added costs would be:
Answer: e. $100,000.
Nonvalue-added costs are caused either by nonvalue-added activities or valueadded activities performed inefficiently. Here, the nonvalue added costs include
the cost of inspecting and the cost of rework.
Nonvalue-added costs = Cost of inspecting + Cost of rework = $60,000 +
$40,000 = $100,000
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Self-Assessment
• Explain why functional based costing approaches may produce distorted
costs
• Describe how an activity-based costing system works for product costing
• Describe activity-based customer costing and activity-based supplier costing
• Explain how activity-based management can be used for cost reduction
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Summary
Now that the lesson has ended, you should have learned how to:
• Explain why functional (or volume)-based costing approaches may produce
distorted costs
• Explain how an activity-based costing system works for product costing
• Describe activity-based customer costing and activity-based supplier costing
• Explain how activity-based management can be used for cost reduction
Mowen/Hansen/Heitger, Managerial Accounting: The Cornerstone of Business Decision Making, 8th Edition. ©
2023 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
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