Page 37 - Encyclopedia of Business and Finance

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Activity-Based Management

Resources are inputs, such as materials, labor, equipment, VALUE-ADDED AND NON-VALUE-
and other economic elements consumed by an activity in ADDED
the production of an output. Outputs are products, serv- Each of the key (primary and secondary) activities noted
ices, and accompanying information flowing from an from this analysis must be categorized as either value-
activity. In seeking continuous business improvement, an added or non-value-added. This analysis is referred to as
overall examination of variations in performances of key value analysis. An activity is value-added to the extent that
its performance contributes to the completion of the
organizational activities and their causes is referred to as
product or service for consumers. While value-added
activity analysis. Performance is measured by a financial or
activities are necessary, the efficiency with which they are
nonfinancial indicator that is causally related to the per-
performed often can be improved through best practice
formance (adding value to a product or service) of an
analysis and benchmarking. This process of improvement
activity and can be used to manage and improve the per-
is referred to as business process redesign or reengineering.
formance of that activity.
Because many activities may not fit neatly into a
The level of an activity within an organization value-added/non-value-added dichotomy, weightings may
depends on the level of operations supported by that be assigned to indicate the extent to which an activity is
activity. For instance, a unit-level activity is one that is value-added, such as a scale ranging from one to eight,
performed directly on each unit of output of an organiza- with an eight representing total value-additivity and a zero
tional process. A batch-level activity is one performed on representing none. A non-value-added activity transforms
a small group, or batch, of output units at the same time. a product or service in a way that adds no usefulness to the
For example, the setup activity to run a batch job in a product or service. Non-value-added activities should be
production process and the associated cost for com- minimized or eliminated. An overall value-chain analysis
would examine all the activities and associated processes
pleting such a setup is a batch-level activity. A customer-
in an attempt to provide greater value at the same cost, the
sustaining activity supports an individual or a particular
same value at less cost, or both.
grouping of customers, such as mailings or customer serv-
ice. A product-sustaining activity supports an individual
product or product line, such as product (re)design or ACTIVITY-BASED COSTING
(re)engineering. These last two types of activities are Because costs are initially assigned from resource cost
sometimes referred to as service-sustaining activities. Last, pools to activity cost pools and from there to final cost
objects, activity-based costing is viewed as a two-stage
a facility-sustaining activity supports an entire facility,
allocation process. Once activities have been identified, an
such as the actions of the manager of an entire plant, with
activity-based costing analysis can be completed. Activity-
an associated cost equal to the manager’s compensation
based costing is a form of cost refinement, designed to
package. Not every activity within an organization is sig-
obtain greater accuracy than traditional allocations in cost
nificant enough to isolate in an activity analysis.
assignments for product costing and decision-making
A process is a set of logically related activities per- purposes. Costs are assigned to activities from resource
formed in order to achieve a particular objective, such as cost pools. Costs are first accumulated according to the
the production of a unit of product or service. Identifica- type of resource, such as materials or labor, with which
tion of all such processes within an organization along they are associated. Then resource (cost) drivers, which
with a specification of the relationships among them pro- measure the consumption of a resource by an activity, are
vides a value chain. Value chains are often presented in identified and used to assign the costs of resource con-
sumptions to each activity. The result of this assignment is
terms of functional areas (a function provides the organi-
zation with a particular type of service or product, such as an activity cost pool for each activity.
finance, distribution, or purchasing). Within each of these From the activity cost pool, the focus shifts to one or
key processes, activities can be classified as primary activ- more activity drivers. An activity driver measures the fre-
ities, secondary activities, and other activities. Primary quency or intensity with which a cost object requires the
use of an activity, thereby relating the performance of an
activities contribute directly to the providing of the final
activity’s tasks to the needs of one or more cost objects. A
product or service. Secondary activities directly support
cost object is why activities are performed; it is a unit of
primary activities. The “other activities” category is com-
product or service, an operating segment of the organiza-
prised of those actions too far removed from the intended tion, or even another activity for which management
output to be individually noted. They should be examined desires an assignment of costs for unit costing or decision-
to determine if they are necessary and should be contin- making purposes. The activity cost pools are then reas-
ued. signed to the final cost objects according to the intensity

14 ENCYCLOPEDIA OF BUSINESS AND FINANCE, SECOND EDITION