Chapter 14
Activity-Based Management and
Performance Measurement/Reward
Learning Objectives
Chapter 14
•Distinguish between value-added and non-value-added
activities as part of activity-based management.
•Identify cost drivers of activities.
•Allocate costs using activity-based costing.
•Identify financial and nonfinancial performance
measurements for different responsibility centers.
•Discuss the use of a balanced scorecard in performance
evaluation.
•Align the use of rewards with the performance of
measurement system.
Chapter 14 2
Value Added or Non Value Added
Research & Development Moving
Engineering Storage
Production Scheduling
Set-ups
Waiting
Inspecting
Rework
Chapter 14 3
Cost Drivers
A cost driver is the factor that has a direct cause-effect
relationship on a cost.
Examples include:
Cost Driver
Direct Materials Units produced
Maintenance Expense Machine Hours
Supervisor Salary Labor Hours
Insurance Square Footage
Chapter 14 4
Activity Based Costing
(1) classifying costs
into multiple levels
Activity-based of incurrence
(2) accumulating
costing (ABC) is an costs by cost
overhead allocation drivers
method. (3) using cost drivers
to assign costs to
products and
services.
Chapter 14 5
Allocation Overhead: Traditional
versus Activity-Based Costing
Chapter 14 6
Activity-Based Costing Example
•Assume that Hyde, Inc. produces two products:
•Product Q sells for $40 and has direct material and direct
labor costs of $27. Product Q requires 2.5 labor hours.
•Product R sells for $150 and has direct material and direct
labor of $89. Product R requires 6 labor hours.
•In 2009, Hyde produced and sold 70,000 units of Q and 8,000
units of R.
•Total overhead for 2009 was $579,000.
•The next slide illustrates Hyde, Inc.’s overhead allocation
process using the traditional cost driver of direct labor hours.
Chapter 14 7
Hyde, Inc. Overhead Allocation (Traditional)
Chapter 14 8
Activity-Based Costing Example
•If Hyde, Inc. used activity-based costing, the overhead would
be divided into groups, and each group would be applied using
a different driver.
•Assume that the $579,800 of total overhead consists of
$240,000 in material movement costs, $189,000 in utilities,
$126,800 in cleanup costs, and $24,000 in setup costs.
•The next two slide indicate the overhead allocations to the
two products if ABC were used.
•We have four drivers and allocation bases, one for each
overhead category.
Chapter 14 9
Hyde , Inc. Overhead Allocation (Activity-Based Costing)
Chapter 14 10
Hyde , Inc. Overhead Allocation (Activity-Based Costing)
Chapter 14 11
Overhead Cost Comparison
One Driver ABC
Product Q $6.50 $3.26
Product R $15.60 $43.91
Chapter 14 12
Responsibility Centers
• Cost Center
• Profit Center
• Investment Center
Chapter 14 13
Cost Center
•In a cost center, the only means to judge performance is an
assessment of whether the center’s costs were in line with
budgeted amounts.
•Actual costs are compared to budgeted costs at the same
level of activity to determine the variance amount.
Chapter 14 14
Cost Center Example
•Lee Larkind is the manager of the Reservations Department
in HLS Corp.
•For October, the department’s budget was as follows, based
on an activity level of 480 hours (three people working 40
hours per week for four weeks in the month):
Chapter 14 15
Cost Center Example Continued
•During October, company management gave reservations
employees a $0.50 per hour wage increase.
•The employees worked a total of 500 hours, and the
department reported the following costs:
Chapter 14 16
Cost Center Example Continued
•At first glance, it appears that Larkind has not controlled
departmental costs well during October.
•However, the two sets of figures should not be compared
directly because they have been calculated using different
levels of activity.
•The original budget first needs to be restated at the actual
activity level of 500 hours before making the comparison.
Chapter 14 17
Profit Center
•In a profit center, performance can be judged on both cost
control and revenue generation.
•A profit center manager’s goal is to maximize the center’s net
income.
•Performance evaluation in a profit center will also include
revenue and profit measurements.
•We can calculate two variances for a profit center.
•The sales price variance is the difference between total actual
selling price and budgeted selling price at actual volume.
•The sales volume variance is the difference between budgeted
selling price at actual volume and total budgeted sales.
•The next slide shows the revenue variance model.
Chapter 14 18
Revenue Variance Model
Chapter 14 19
Revenue Center Example
•Assume that the Reservations Department from our previous
example is a profit center, rather than a cost center.
•The Reservations Department charges the hotel $10 for each
reservation generated by the department.
•It was estimated that the department would make 2,000
reservations during October; thus, expected revenue for the
department was $20,000.
•In October, the department actually generated 2,200
reservations. During the month, a new reservation system
was implemented that reduced the work involved; therefore,
the hotel charge per reservation was lowered to $9.50.
•Price, volume, and revenue variances for October are shown
on the next slide.
Chapter 14 20
Revenue Center Example
Continued
Budgeted profits for the Reservations Department should also be
compared to actual profits in evaluating performance as follows:
Chapter 14 21
Investment Center
•In an investment center, performance can be judged on the
basis of cost control, revenue generation, and return on
investment.
•Center managers can acquire, use, and sell plant assets to earn
the highest rate of return on the center’s asset base.
•In addition to the measures shown previously for cost and
profit centers, an investment center’s performance can also be
measure by calculating return on investment (ROI).
ROI = Income Assets
Chapter 14 22
Investment Center Example
•Assume that Larkind of the Reservations Department has
control over the department’s asset base of $50,000.
•Using the actual income of $5,075, ROI is computed as:
Chapter 14 23
Du Pont Model
Profit Margin = Income Revenues
Asset Turnover = Revenues ÷ Assets
ROI = Profit Margin - Asset Turnover
Chapter 14 24
Du Pont Model Example
Using the information from the Reservations Department, we
can use the Du Pont model of ROI.
Chapter 14 25
Balanced Scorecard
•Financial
•Customer
•Internal Process
•Learning and Growth
Chapter 14 26
Balanced Scorecard Illustration
Chapter 14 27
Balanced Scorecard Illustration
Continued
•Each balanced scorecard section should indicate specific
measurements that would help assess the organization’s
process toward its long-run goals and objectives.
•The measurements should be easy to understand and to
compute.
•The following slide shows some examples of nonmonetary
measurements for each scorecard area other than the financial
section.
Chapter 14 28
Balanced Scorecard Nonmonetary
Measurements
Chapter 14 29
Activity-Based Management
Activity-based management (ABM) is
concerned with the activities performed during the
manufacturing or service process and the related
costs of those activities.
• Analyzing Activities
• Identification
• Value or Non Value Added
• Activity Costs
Chapter 14 30
Motivation
Benchmarking
Performance Measurement
Rewards:
Financial
Non Financial
Chapter 14 31
Choice of Performance Measures
Chapter 14 32
Conclusions
• Activities Drive Costs
•ABC Provides More Accurate
Information
•A Performance Measurement
System Allows Activities to be
monitored and rewarded.
•Success is Judged by Financial and
Non Financial Measures
Chapter 14 33