## Understanding Managerial Accounting and Activity-Based Costing

This chapter discusses Managerial Accounting and Activity-Based Costing.

### Managerial Accounting and Activity-Based Costing

This section provides an overview of Managerial Accounting and Activity-Based Costing and discusses:

- Managerial accounting and activity-based costing.

- The data model overview for activity-based costing.

- The decision making process.

#### Managerial Accounting and Activity-Based Costing

Managerial accounting processes information used by economic organizations to plan and control operations. Managerial accounting involves analysis at a profit-center level, such as customers and products, instead of an organizational level, such as marketing, administration, and manufacturing.

Activity-based costing enables you to analyze information and costs from multiple departments and internal organizations to improve business processes. With activity-based costing, you can identify activities, processes, and cost objects, and then calculate total and unit costs by cost objects using cause-and-effect relationships.

Even though business practices have evolved significantly during the last ten years, cost accounting techniques have remained relatively static. In today's highly competitive and changing business environment, companies need the ability to analyze cost structures in more detail than they could by using the methods that are provided by traditional cost accounting systems.

All companies want to maximize profitability by either reducing costs (wastes) or increasing sales. Often, high costs are due to cross-departmental processes, but identifying these sources of waste can be difficult and time intensive.

To increase income, companies might find it difficult to identify the most profitable customers without gathering customer profit/loss information. In manufacturing environments, companies have been able to reduce direct costs for material and labor by implementing techniques, such as just-in-time, automation, total quality management, and outsourcing, at the expense of increasing indirect costs.

These changes have affected cross-departmental process costs drastically. Market competition and globalization have added complexity to business management and coordination, resulting in additional support activities. This shift in today's market requires that companies focus on indirect costs, cross-departmental processes, and customer profitability-rather than direct costs and sweeping mandates-to increase company-wide sales, regardless of customer profitability.

#### Data Model Overview for Activity-Based Costing

Company 200 manufactures and distributes bicycles and bicycle accessories. The company wants to improve its competitive advantage in the bicycle market. Although sales have been increasing over the years, the overall profitability of the company has decreased. As a result, the company initiates a performance improvement project that is based on analyzing customer and product profitability.

The company believes that by studying its profitability by customer, product family, and sales marketing channel, it can discover why overall profits have decreased. The analysis focuses on these areas:

- Locating hidden costs in the process of procuring bicycle bags to help the company reduce waste and increase efficiency.

- Assigning marketing and promotional costs to customers, product lines, and sales marketing channels to redirect marketing and sales to the most profitable customers, products, and channels.

- Reviewing the standard costs for painting the bicycle frames. The company suspects that these costs might be incorrect due to rework. Therefore, it would like to determine how much rework, by bicycle model, exists when they paint bicycle frames so that the company can correct the standard cost for painting frames.

#### The Decision Making Process

This example illustrates the decision making process.

Company 200 manufactures and distributes bicycles and bicycle accessories, using these business units:

- M30 to manufacture bicycles.

- D30 to distribute bicycles.

Company 200 sells products to wholesale and retail customers. Each customer has a unique address book number, and Company 200 assigns each customer to a business channel. Although many channels exist, Company 200 uses these:

- Wholesale

- Retail

- Specialty

- Discount

The bicycles and accessories have unique inventory item numbers. Although many types of bicycles and accessories exist, the company focuses on three types of bicycles and two types of bicycle bags. The bicycle types are:

- Touring

- Mountain

- Youth

Black bicycle bags can be imprinted with a predetermined logo or left blank. When the company originates its bicycle sales, the customer can decide whether he or she wants plain black bicycle bags, standard logo imprinted bags, or special custom logos on the bags. The bag types are:

- Imported bags

- Black with logo

- Black without logo.

- Domestic bags: Black without logo

The company categorizes its products by planning families. Within this scenario, it focuses on two family codes:

- Bicycle

- Bicycle accessory

Within the Distribution business unit, D30, the merchandise can incur royalty and warehouse costs, in addition to the initial cost. The business unit has adopted standard costs (inventory and sales method 7) to help track each of these cost components. Depending upon type, the bicycles and bags can contain these cost components:

- Material, component type A1

- Royalty, component type X4

- Warehouse, component type X6

The company believes hidden costs exist in the procurement, manufacturing, and distribution cycles. Therefore, the company wants to determine the customer, product family, or marketing sales channel profitability, as well as internal process costs that are related to manufacturing its bicycles and various suppliers costs by suppler, product family, or marketing sales channel.