Question

Answer the following three (3) questions:-

(i) The authors argued that “Initially, managers viewed the ABC approach as a more accurate way of calculating product costs. But ABC has emerged as a tremendously useful guide to management action that can translate directly into higher profits”. Discuss. [40 marks].  

(ii) Describe the Hierarchy of Factory Operating Expenses.

(iii) Explain how the manager can use ABC to analyse a company’s operation beyond factory.

Answer 1

i.In recent years, companies have reduced their dependency on traditional accounting systems by developing, activity-based cost management systems. Initially, managers viewed the ABC approach as a more accurate way of calculating product costs. But ABC has emerged as a tremendously useful guide to management action that can translate directly into higher profits. Moreover, the ABC approach is broadly applicable across the spectrum of company functions and not just in the factory.

Because ABC reveals the links between performing particular activities and demands those activities make on the organization's resources,it can give managers a clear clear picture of how products,brands,facilities,region,distribution channels both generate revenues and consume resources.The profitability picture that emerges from the ABC analysis help managers focus their attention and energy on improving activities that will have the biggest impact on the bottom line .

ii.Operating Expense (OPEX) is the cost that is incurred in the normal course of business and does not include expenses such as the cost of goods sold which are directly related to product manufacturing or service delivery. They are easily available in the income statement along with other costs which are subtracted from the operating income to determine net profit.

• Labor Cost, Factory Overheads etc – This expense can also include costs which are referred to as COGS (cost of goods sold) and the category comprises of inventory cost, freight expense, labor cost, factory overhead etc.

iii.

Activity-based management (ABM) 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 activities. Activities that do not add to the product’s quality and performance are called non-value-added activities. 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.