Organizations attempt to identify and eliminate the non-value-added activities in their value chains. Value-added activities add to the product’s or service’s desirability in the eyes of the consumer. Non-value-added activities do not add to the product’s desirability. Thus, an organization can decrease its costs if a non-value-added activity that consumes resources can be eliminated without changing the product’s desirability. Examples of value-added and non-value-added activities are included in Exhibit 19–1. One example of a non-value-added activity is having large amounts of raw materials, work in process, or finished goods inventory.
Kimberly-Clark’s management recognizes the non-value-added cost associated with hold- ing inventories because a part of its operating plan is to focus on tight inventory control.
Just-in-time inventory management processes, discussed later in this chapter, have been developed to reduce the consumption of non-value-added resources associated with large amounts of inventories.
Define the value chain and describe its basic components.
L e a r n i n g O b j e c t i v e D
a c e a
LO1
Distinguish between non- value-added and value- added activities.
L e a r n i n g O b j e c t i v e D
v a e a
LO2
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The Value Chain 843
In the previous three chapters, we concentrated our cost analysis only on the production phase of the value chain. However, resources are consumed across the value chain. Organiza- tions attempt to minimize resource consumption at all points on the value chain while simulta- neously providing the products and services desired by consumers at competitive prices. In this chapter, we will consider other cost accounting procedures and techniques that have been devel- oped to assess resource use and costs in all parts of the value chain. These procedures include activity-based management, which is effective over the entire value chain; target costing, designed for the R&D and design phase of the value chain; just-in-time manufacturing procedures; and, finally, total quality management, which is also relevant over the entire value chain.
Exhibit 19–1 VALUE-ADDED AND NON-VALUE-ADDED ACTIVITIES IN THE VALUE CHAIN
Value-added activities in the value chain:
• Designs that meet customer specifications
• Use of suppliers that provide timely high-quality inputs
• Production process that provides just-in-time output for customer
• Timely distribution and easy access to customer
• Clear and truthful marketing
• Competent and timely after-sales customer help
Suppliers and Production
Marketing and Distribution
Customer Service R&D
and Design
Non-value-added activities in the value chain:
• Designs that meet engineering specifications but not customer needs
• Supplier deliveries that are poor quality or not timely, causing delays in production
• Production processes that create rework, scrap, and significant work in process inventories
• Delayed distribution to customer
• Deceptive or misleading marketing
• After-sales customer help that is not valued by customers
Consumers Assume you are the manager of raw materials for a lumber mill. What types of resources
are being consumed when a large amount of redwood logs sits idle, waiting to be put through the mill?
(See our comments on the Online Learning Center Web site.)
Y O U R T U R N You as a Raw Materials Inventory Manager
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Activity-Based Management
Previously, when we introduced activity-based costing (ABC), we provided an ABC example focused on production overhead. You may remember that the basic procedures related to ABC include the following:
1. Identify the activity.
2. Create an associated activity cost pool.
3. Identify an activity measure.
4. Create the cost per unit of activity.
Our earlier focus was on using ABC to assign cost to units of the product. However, activity- based cost information is also important in management decision making. Remember that man- agement is trying to eliminate non-value-added activities from the value chain. For example, if the downtime needed for equipment repair can be eliminated from the value chain without increasing the cost associated with the total value chain, then it is a non-value-added activity.
The process of using activity-based costs to help reduce and eliminate non-value-added activi- ties is activity-based management. Redesigning equipment layout, acquiring higher-quality materials as inputs, buying new equipment, outsourcing repair work, or some combination of these management decisions may reduce or eliminate activity cost and associated resource use.
ACTIVITY-BASED MANAGEMENT ACROSS THE VALUE CHAIN
While activity-based cost information is very important in the production portion of the value chain, it is also very useful for assessing activities associated with most period expenses such as R&D, distribution, administration, finance, marketing, and customer service. In many orga- nizations, period expenses are more significant to overall profitability than product expenses.
Managing Activities: An Illustration Management uses ABC information to identify activities and processes that are non-value-added or where the added costs of those activities and processes outweigh their ben- efits to the customer. One way that managers compare the costs and benefits of activities is by contrasting the internal cost of the activity to the purchased external cost for that activity. To illustrate how activity-based management works, consider Boards and More, Inc., a company that sells lumber, paper, and packaging products. Boards and More’s chief financial officer (CFO) has been approached by a software vendor selling software called “Transaction Reduction.” The software is designed to reduce the cost of processing transac- tions. In order to determine the cost savings for Boards and More, the CFO decides to undertake an ABC study of the activities of his Accounting and Finance (A&F) Department.
The activities performed by the A&F Department include:
1. Transaction-related activities.
2. External financial reporting.
3. Annual planning and budgeting.
4. Specially requested analyses.
In addition, the labor cost pool and associated wages are:
1. Twelve clerks at $20 per hour.
2. Five finance analysts at a salary of $45,000 each.
3. Six budget analysts at a salary of $39,000 each.
4. Three senior analysts at $75,000 each and the CFO at $185,000.
The CFO, with the help of the employees, completes an extensive activity analysis of the labor time consumed for the four identified activities. The CFO then determines the percentage of
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time devoted to each of the four activities by each of the four labor categories. Please study Exhibit 19–2 carefully. It shows the related percentages, cost pools, and activities for the A&F Department.
Remember that the objective of the ABC analysis is to compare the internal cost of pro- cessing transactions with the external cost of the proposed software. Thus, the next step in the activity analysis is to calculate the detailed cost for each activity. Exhibit 19–3 breaks out the cost of each activity by using the percentages from Exhibit 19–2 and the cost of each type of labor. The ABC analysis in Exhibit 19–2 will help the CFO manage his own activities and those of the 26 employees in the A&F Department. In particular, the CFO can consider whether the internal transaction-related activity costs are non-value-added in comparison to the external cost of the Transaction Reduction software.
Exhibit 19–2 IDENTIFYING COST POOLS AND ACTIVITIES Boards and More, Inc.
Department of Accounting and Finance
662⁄3%
121⁄2%
121⁄2% 25%
50%
25%
50%
75% 50%
LABOR COST POOLS
A C T I V I T I E S
3 senior analysts and 1 CFO
$410,000 6 budget
analysts
$234,000 5 finance
analysts
$225,000 12 clerks
$441,600
Financial reporting
Special request projects Planning & 2
budgeting 6622⁄
1211 2⁄⁄⁄ % Transactions
331⁄3%
Examine the transaction-related activity costs in the first column in Exhibit 19–3. These costs are required to make sure basic journal entries are properly recorded and monitored throughout the firm to safeguard the firm’s assets. Account clerks complete much of the detailed work. However, financial analysts are also involved in assessing transactions and undertaking analysis in order to complete their financial reporting responsibilities. As a result of the ABC analysis, the CFO estimates $406,200 of the total labor cost pool of $1,310,600 is associated with transaction-related activities.
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Exhibit 19–3 ACTIVITY COST ANALYSES
Activity Category
Planning Total
Transaction- Financial and Special Labor Labor Category Related Reporting Budgeting Analyses Resources
Clerks 3⁄4 1⁄8 1⁄8 22,080 hours (12 clerks,
(75%) (12.5%) (12.5%) 0 46 weeks @ 40 hrs.
per week @ $20/hr)
$331,200 $55,200 $55,200 $0 $441,600
Finance analysts 1⁄3 2⁄3 0 0 5 salaried analysts
(33.33%) (66.67%) @$45,000
each
$75,000 $150,000 $0 $0 $225,000
Budget 0 1⁄2 1⁄2 0 6 salaried
analysts (50%) (50%) analysts @
$39,000
$0 $117,000 $117,000 $0 $234,000
Senior analysts 0 1⁄4 1⁄4 1⁄2 3 seniors @$75,000
and CFO (25%) (25%) (50%) each and 1 CFO
@$185,000
$0 $102,500 $102,500 $205,000 $410,000
Total
activity $406,200 $424,700 $274,700 $205,000 $1,310,600 resources
The software vendor affirms that other companies installing and using Transaction Reduction have experienced a 50 percent per year reduction in transaction-related costs. Transaction Reduc- tion’s quoted price is $450,000 for the fully installed package, including employee training and customer support services. If the CFO purchases the software and the vendor’s savings estimates are correct, the software will recover its initial cost after 2.22 years, computed as follows:
Transaction Activities Cost Pool $406,200 50% savings per year $203,100 per year
“Transaction Reduction” Costs $450,000 $203,100 per year 2.22 years to recover
We know that the CFO will have many other concerns in addition to the cost savings from the software. For example, since ắ of the clerks (9 clerks) are engaged in transaction-related activities, would 4ẵ need to be fired? If so, what are the legal and human implications?
These days, value chain activities such as drawing up detailed architectural blueprints, slicing and dicing a company’s financial disclosures, or designing a revolutionary micro- processor are often outsourced overseas. That’s why Intel Inc. and Texas Instruments Inc. are furiously hiring Indian and Chinese engineers, many with graduate degrees, to design chip circuits. Dutch consumer electronics giant Philips has shifted research and development on most televisions, cell phones, and audio products to Shanghai. Procter
& Gamble Co. has employees in Manila, most of whom have business and finance degrees, to help prepare P&G ’s tax returns around the world.
One of the biggest trends reshaping the global economy is in process. The driving forces are digitization, the Internet, and high-speed data networks that girdle the globe.
Now, all kinds of knowledge work can be done almost anywhere. Predictions are that at least 3.3 million white-collar jobs and $136 billion in wages will be added to low-cost countries by 2015.
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The CFO may also be concerned that a longer time to recover the initial investment would be undesirable given rapid change in software technology. In order to determine the exact resources (clerks versus analysts) that might be affected by the new software, a more detailed analysis than that just displayed must be undertaken.