Question: Activity-based costing is helpful in providing relatively accurate product cost information. However, the value of activity-based costing information goes beyond accurate product costing. When activity-based costing is used in conjunction with activity-based management, organizations are often able to make dramatic improvements to operations. How does activity-based management help an organization reduce costs and become more efficient?
Answer: Activity-based management (ABM)A management tool that uses cost information obtained from an ABC system to improve the efficiency and profitability of operations. provides three steps for managers to use that lead to improved efficiency and profitability of operations.
Step 1. Identify activities required to complete products.
This involves interviewing personnel throughout the company. Recall that activity-based costing also requires the identification of key activities. However, ABM allows for a more detailed analysis because the estimation of costs and related overhead rates are not required when using ABM.
Step 2. Determine whether activities are value-added or non-value-added.
Activities that add to the product’s quality and performance are called value-added activitiesActivities that add to a product’s quality and performance.. Activities that do not add to the product’s quality and performance are called non-value-added activitiesActivities that do not add to a product’s quality and performance.. Examples of value-added activities at SailRite include using materials and machines to produce hulls and assembling each sailboat. Examples of non-value-added activities include storing parts in a warehouse and letting machinery sit idle.
Step 3. Continuously improve the value-added activities and minimize or eliminate the non-value-added activities.
Even if an activity is identified as value-added, ABM requires the continuous improvement of the activity. For example, SailRite’s assembly process (a value-added activity) may require workers to shift back and forth between Basic and Deluxe sailboats throughout the day, each of which uses different parts and requires different tools. Perhaps the efficiency of this process could be improved by assembling the boats in batches—one day working on Basic boats, another day working on Deluxe boats.
Activities that are non-value-added should be minimized or eliminated. For example, storing parts in a warehouse at SailRite (a non-value-added activity) might be minimized by moving to a just-in-time system that requires suppliers to deliver parts immediately before they are needed for production.
The next time you visit a fast-food restaurant, go to a clothing store, or stand in line at a college bookstore, try to identify value-added and non-value-added activities. Think about ways the organization can eliminate non-value-added activities and improve value-added activities.
Why Use Activity-Based Costing (ABC) and Activity-Based Management (ABM)?
A survey of 296 users of activity-based costing and activity-based management showed that the top four objectives of using ABC and ABM were as follows:
All these objectives are important to most organizations and can be achieved with the help of ABC and ABM systems.
Source: Mohan Nair, “Activity-Based Costing: Who’s Using It and Why?” Management Accounting Quarterly, Spring 2000.
Label each of the following activities as value-added or non-value-added:
Solutions to Review Problem 3.4