194 PART ONE MANAGEMENT ACCOUNTING, INFORMATION AND DECISONS

If an item is accou n ted for as a by-produ ct, on ly separable costs are assign ed to it. All join t costs are allocated to m ain produ cts. An y reven u es from by-prod- u cts, less th eir separable costs, are dedu cted from th e cost of th e m ain produ cts.

Con sider a lu m ber com pan y th at sells sawdu st gen erated in th e produ ction of lu m ber to com pan ies m akin g particle board. Su ppose th e com pan y regards th e sawdu st as a by-produ ct. In 2001, sales of sawdu st totalled $30,000, an d th e cost of loadin g an d sh ippin g th e sawdu st (th at is, costs in cu rred beyon d th e split-off poin t) was $20,000. Th e in ven tory cost of th e sawdu st wou ld con sist of on ly th e $20,000 separable cost. Non e of th e join t cost of produ cin g lu m ber an d sawdu st wou ld be allocated to th e sawdu st. Th e differen ce between th e reven u e an d separable cost, $30,000 – $20,000 = $10,000, wou ld be dedu cted from th e cost of th e lu m ber produ ced.

ACTI VI TY-BASED CO STI N G (ABC)

O BJECTI V E 8 In th e past, th e vast m ajority of departm en ts u sed direct labou r h ou rs as th e on ly

cost driver for applyin g costs to produ cts. Bu t direct labou r h ou rs is n ot a very

Use activity-based

good m easu re of th e cau se of costs in m odern , h igh ly au tom ated departm en ts.

costing to allocate costs

Labou r-related costs in an au tom ated system m ay be on ly 5 percen t to 10 per-

to products or services.

cen t of th e total m an u factu rin g costs an d often are n ot related to th e cau ses of m ost m an u factu rin g overh ead costs. Th erefore, m an y com pan ies are begin n in g to u se m ach in e-h ou rs as th eir cost-allocation base. However, som e m an agers in m odern m an u factu rin g firm s an d au tom ated service com pan ies believe it is in ap- propriate to allocate all costs based on m easu res of volu m e. Usin g direct labou r

h ou rs or cost—or even m ach in e h ou rs—as th e on ly cost driver seldom m eets th e cau se/ effect criterion desired in cost allocation . If m an y costs are cau sed by n on - volu m e-based cost drivers, A ctivity-Base d Co stin g (A BC) sh ou ld be con sidered.

COMPANY

STRATEGIES

ACTIVITY-BASED CO STIN G AT J. M . SCH N EID ER IN C.

S products. The company’s mission statement, which provides a common focus to all

chneider Corporation is one of Canada’s largest producers of premium-quality food

J.M . Schneider www.jmschneider.com

activities within the corporation, is:

To generate profitable growth by providing high-quality food products of superior value in specific market seg- ments while maintaining our status as a financially secure, well-managed, ethical company.

The majority of the Corporation’s meat processing is done through its subsidiary, J. M. Schneider Inc. In the late 1980s the Canadian meat-packing industry, in which the company’s core business operated, was in

critical condition. Red meat consumption levels were declining at an alarming rate, as consumers adopted chang- ing lifestyles and eating habits. Meat producers and food retailers rationalized into a handful of participants engaged in intense price competition. This development resulted in a sharp decline in profitability for Schneider.

In the absence of significant market growth opportunities, Schneider launched an initiative to internally generate efficiencies and cost reductions in order to improve profit margins. The vehicle chosen to drive these improvements was the implementation of a broadly based continuous improvement program. 2

This program, in order to be successful, required the support of a more up-to-date and relevant cost system. Up until this time, Schneider had used a standard cost system to meet the requirements of measuring the suc- cess of its labour and materials yield productivity program. This program measured productivity gains by com- paring actual results to costs in the standard cost system. 3

Chapter 5 Cost Allocation and Activity-Based Costing Systems

COMPANY

STRATEGIES

Continued There were a number of shortcomings with the company’s conventional standard cost system, however:

1. The focus was on minimizing costs within each department. Consequently, actions would be taken in one department that would reduce their costs, but would create additional costs in downstream departments. 2. Targets were limited to material yield and direct labour productivity. Opportunities to better control and manage a number of other manufacturing costs and overheads were not measured. 3. Comparisons were made to standards that incorporated allowances for waste and non-value-added activity. Although meeting the standard costs satisfied management, it resulted in “ satisfactory” costs rather than “ minimum” costs.

Schneider realized that the primary emphasis of its cost system should be to provide relevant and reliable information for management decision making rather than focusing only on financial reporting requirements. Under continuous improvement, the focus on minimizing costs broadened from control of yields and direct labour productivity to better understanding and managing the entire business cycle. Continuous improvement ini- tiatives were launched to address just-in-time, productive maintenance, total quality control, quick changeover tech- niques, cycle time, identification and elimination of non-value-added activities. The standard cost system was unable to accurately measure and report the true costs of these activities, and was in need of an overhaul.

In order to better measure and, in turn, understand production cost behaviour, Schneider decided to implement Activity-Based Costing (ABC). ABC systems are designed on the premise that products require “ activities” and that these activities, in turn, consume “ resources,” i.e., incur costs. Non-value- added activities and waste are more clearly highlighted and therefore better managed. Non-financial measures have also been recognized as key yardsticks in measuring operational performance (i.e., tonnage throughput, machine downtime hours, process cycle time, etc.).

The information generated by this updated management accounting system will be supportive of the firm’s continuous improvement and cost reduction programs, providing relevant and reliable decision-making information.

2 Dodds, Douglas W., “ MAKING IT BETTER....and better,” CMA MAGAZINE, February 1992, pp. 16–21. 3 For a more complete discussion of the standard cost system, see Armitage, H.M., and A. A. Atkinson,

“ The Choice of Productivity Measures in Organizations: A Field Study of Practice in Seven Canadian Firms.” Society of Management Accountants of Canada, Hamilton, Ontario, 1990.

CM A M agazine

Source: Written by John Carney, Manager Accounting Services and Larry Wozniak,

www.cma-canada.org

Senior Cost Analyst, J. M. Schneider Inc.

Activity-Based Costing

A ct iv it y -base d co st in g (A BC) system s first accu m u late overh ead costs for each

(ABC).

A system that first

of th e activities of an organ ization , an d th en assign th e costs of activities to th e

accumulates overhead

produ cts, services, or oth er cost objects th at cau sed th at activity. To establish a

costs for each of the activities of an organiza-

cau se-effect relation sh ip between an activity an d a cost object, cost drivers are

tion, and then assigns the

iden tified for each activity. Con sider th e followin g activities an d cost drivers for th e

costs of activities to the

Belm on t m an u factu rin g plan t departm en t of a m ajor applian ce produ cer:

products, services, or other cost objects that

A CTIVITY

COST D RIVER

caused that activity.

Produ ction set-u p

Nu m ber of produ ction ru n s

Produ ction con trol

Nu m ber of produ ction process ch an ges

En gin eerin g

Nu m ber of en gin eerin g ch an ge orders

Main ten an ce

Nu m ber of m ach in e h ou rs

Power

Nu m ber of kilowatt h ou rs

194 PART ONE MANAGEMENT ACCOUNTING, INFORMATION AND DECISONS