Chapter 5 Activity-Based Management

Activity-based management (ABM) is a systemwide, integrated approach that focuses management's attention on activitties with the objective of improving customer value and the profit achieved by providing this value. The cost dimension provides cost information about resources, activities, and cost objects of interest such as products, customers, suppliers, and distribution channels. The objective of the cost dimension is improving the accuracy of cost assignment. ABM adds a process view to the cost view of ABC. ABM can be viewed as an information system that has the broad objectives 1. Improving decision making by providing accurate cost information 2. Reducing costs by encouraging and supporting continuous improvement efforts Objective of ABM is to improve a firms's profitability, an objective achieved by indetifying and selecting opportunities for improvement and using more accurate information to make better decisions. The two steps common to ABC and PVA are systems planning; activity identification, definition, and classification. Systems planning provide the justification for implementing ABM and address the following issues: 1. 2. 3. 4. 5. The purpose and objective of the ABM system The organization's current and desired competitive position The organization's business process and product mix The timeline, assigned responsibilities, and resources required for implementation The ability of the organization to implement, learn, and use new information

Planning also entails establishing a timeline for the implementation project, assigning specific responsibilities to individuals or teams, and developing a detailed budget. Responsibility accounting is a fundamental tool of managerial control and is defined by four essential elements: 1. 2. 3. 4. Assigning responsibility Establishing performance measures of benchmarks Evaluating performance Assigning rewards

The objective of responsibility accounting is to influence behavior in a such a way that individual and organizational initiatives are aligned to achieve a common goal or goals. Three

types of responsibility accounting systems have evolved over time: financial (functional)-based, activity-based, and strategic-based. A financial (functional)-based responsibility accounting system assigns responsibility to organizational units and expresses performance measures in financial terms. Activity-based responsibility accounting is the responsibility accounting system developed for firms operating in continuous-improvement environment. Financial-based responsibility accounting focuses on functional organizational units and individuals. Three methods can change the way things are done: 1. Process improvement, incremental and constant increases in the efficiency of an existing process 2. Process innovation (business reengineering), the performance of a process in a radicallynew way with the objective of achieving dramatic improvements in response time, quality, and efficiency 3. Process creation, the installation of an entirely new process with the objective of meeting customer and financial objectives. Process value analysis is fundamental to activity-based responsibility accounting; it focuses on accountability for activities rather than costs; and it emphasizes the maximaztion of systemwide performance instead of individual performance. Process value analysis is concerned with: 1. Driver analysis, the effort expended to indetify those factors that are the root causes of activity costs. Activity input are the resources consumed by the activity in producing its output. Activity output is the result or product of an activity. Activity output measure is the number of times the activity is performed. Root causes are the most basic causes for an activity being performed. 2. Activity analysis, the process of identifying, describing, evaluating the activities an organization performs. Activity analysis should produce four outcomes: 1) what activities are done, 2) how many people perform the activities, 3) the time and resources required to perform the activities, 4) an assessment of the value of the activities to the organization, including a recommendation to select and keep only those that add value. Value-added activities are those acrivities necessary to remain in business. A discreationary activity is classified as value-added provided it simultaneously satisfies three conditions: 1) the activity produces a change of state, 2) the change of state was not achievable by preceding activities, and 3) the activity enables othee activities to be performed. Value added costs are the costs to perform value-added activities with perfect efficiency. Non-value-added activities are costs that are caused either by non-value-added activities or the inefficient performance of valued-added activities. 3. Activity performance measurement consists of three major dimensions: 1) efficiency, 2) quality, 3) time. Efficiency focuses on the relationship of activity outputs. Quality is

concerned with doing the activity right the first time it is performed. Time required to perform an activity is also critical. Financial measures of activity efficiency include: 1. 2. 3. 4. 5. Value- and non-value-added activity cost reports Trends in activity cost reports Kaizen standard setting Benchmarking Life-cycle costing

Tracing customer-driven costs to customers can provide significant information to managers. Accurate customer costs allow managers to make better pricing decisions, customermix decisions, and other customer-related decisions that improve profitability. Similarly, tracing supplier-driven costs to suppliers can enable managers to choose the true low-cost supplies, producing a stronger competitive position and increased profitability.