ABC, BALANCE SCORECARD &

TOTAL QUALITY MANAGEMENT OM-06

ACTIVITY-BASED COSTING (ABC)
 ABC is a costing method that uses ‘activities’ as basis to allocate overhead and indirect costs to products.
 ABC provides reliable data for product costing by using multiple cost drivers that are reflective of the actual
causes of incurred overhead costs on the basis of causal relation, benefits received & reasonableness.
 ABC is an alternative to the broad-averaging, volume-based conventional practice of Traditional Costing.
 Under TRADITIONAL COSTING, overhead costs are allocated to products by using a single cost driver
(usually labor hour). This costing is suitable for labor-intensive, low-overhead companies. Traditional
costing (a.k.a. peanut-butter costing) is simple and inexpensive to implement.
 Under ABC, overhead costs are allocated to products using several cost drivers associated with the
identified cost pools. ABC is suitable for capital-intensive, product-diverse and high-overhead companies.
ABC often leads to accurate product costing and elimination of non-value-added activities.
 While ABC is mostly applied on manufacturing costs, ABC may also be used for shared or common period
costs (e.g., customer service, promotion, record keeping and shipping costs).
 ABC is typically a ‘two-stage’ allocation process: First, overhead costs are traced to activities (intial cost
object); then, overhead costs are allocated to products (final cost object) on the basis of the activities done.
 ABC implementation usually involves the following steps:
1) Identify activities, cost drivers and cost pools.
 Activities are commonly grouped into four categories:
1) Unit-level activities - performed for each unit of product (e.g., direct materials).
2) Batch-level activities - performed for each batch of production or sales (e.g., setup, inspection).
3) Product-level activities - performed to support product line as a whole (e.g., advertisement)
4) Facility-level activities - performed to sustain an entire facility’s overall process (e.g., security)
 COST DRIVER is the particular activity that causes the incurrence of certain costs.
 COST POOL is a group of mostly homogeneous costs associated with a common cost driver.
2) Calculate predetermined overhead rates for each identified activity.
Predetermined overhead rate = Estimated overhead costs ÷ Estimated activity level
NOTE: Estimated figures are used because actual figures are not yet known at the start of the period.
3) Allocate overhead costs to the products on the basis of predetermined overhead rates.
 ACTIVITY-BASED MANAGEMENT (ABM) refers to the application of ABC and process value analysis (identifying
value-added vs. non-value-added activities) in evaluating business activities to improve strategic and
operational decisions in an organization. The main goal of ABM is to maximize customer value and minimize
non-value-added activities/costs.
 VALUE-ADDED activities are necessary activities that incur costs but increase the perceived value of a
particular product to the customer. Example: engineering designs modification.
 NON-VALUE-ADDED activities are operations that are either (1) unnecessary or dispensable, or (2)
necessary, but inefficient and improvable. Example: rework of defective units.
BALANCED SCORECARD
 BALANCED SCORECARD (BSC) is an approach to performance measurement that combines traditional
financial measures with non-financial performance measures.
 BSC was created by David Norton and Robert Kaplan in response to VALUE-BASED MANAGEMENT, which is a
performance evaluation technique that focuses on traditional financial measures.
 BSC translates an organization’s mission and strategy into a comprehensive set of financial (lagging
indicators) and non-financial performance (leading indicators) metrics classified into four (4) perspectives:
1) FINANCIAL (“How do we look to shareholders?”)
Measures: profit, return on investment (RoI), operational cash flows
2) CUSTOMER (“How do customers see us?”)
Measures: rank in customer surveys, repeat order rate, market share, number of complaints
3) INTERNAL BUSINESS PROCESSES (“What must we excel at?”)
Measures: manufacturing cycle efficiency, delivery cycle time, scrap and rework, productivity factor
4) LEARNING & GROWTH (“Can we continue to improve and create value?”)
Measures: employee satisfaction ratings, employee turnover rate, training days for employees
NOTE: Measures in the internal business process, learning and growth perspectives (controllable factors) are
the primary drivers of measures in the customer and financial perspectives (non-controllable factors).
 STRATEGY MAPPING is a process that links the four BSC perspectives with company strategies based on a
cause-and-effect pattern to see where value can be added further. A typical BSC report contains:
 STRATEGIC OBJECTIVES – statements of what the strategy must achieve & what is critical to its success.
 STRATEGIC INITIATIVES – key action programs required to achieve strategic objectives.
 PERFORMANCE MEASURES – describe how success in achieving the strategy will be measured.
 BASELINE PERFORMANCE – the current level of performance for the performance measure.
 TARGETS – the level of performance or rate of improvement needed in the performance measure.
NOTE: Strategic objectives focus on WHAT is to be achieved. Strategic initiatives focus on HOW it will be
achieved. Performance measures, baseline performance and targets relate to how it will be MEASURED.
 KEY PERFORMANCE INDICATORS (KPIs) are specific, measurable financial and non-financial elements of a
firm’s performance that are vital to its competitive advantage.
 BSC provides a framework not only for performance measurement but also for execution of company
strategies by helping management identify what needs to be done and how its achievement can be measured
to determine organizational success.

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TOTAL QUALITY MANAGEMENT

 STRATEGIC COST MANAGEMENT (SCM) is the process of reducing total costs while improving the strategic
position of a business, accomplished by managing costs and aligning them to the business strategy.
 Three (3) generic strategies in order to achieve sustainable competitive advantage are:
1) COST LEADERSHIP – providing same or better value to customers at a cost lower than competitors’.
2) DIFFERENTIATION – strives to increase customer value by increasing what the customer receives.
3) FOCUS – a firm selects and emphasizes a customer segment in which to compete (i.e., market niche)
 SCM involves recognition of the importance of cost relationships among various activities in the VALUE CHAIN
(a sequence of activities required to design, develop, produce, market and deliver products and services to
customers) in relation to CUSTOMER VALUE (the difference between what is received and given up by the
customer when buying a product or service).
 LIFE-CYCLE COSTING determines the total cost of a product over its life cycle by dividing costs into:
 UPSTREAM or UPWARD costs (examples: R&D, design engineering, target costing, testing)
 Production costs
 DOWNSTREAM or DOWNWARD costs (examples: marketing, distribution, sales, customer service)
WHOLE-LIFE COSTS = LIFE-CYCLE COSTS + after-purchase costs incurred by the customers
Product’s life cycle (marketing viewpoint) is also based on: 1) introduction 2) growth 3) maturity 4) decline
 TARGET COSTING involves the determination of the desired product cost based on a given market price and
given desired profit. In target costing, a company may reduce its cost to reach the target level through VALUE
ENGINEERING, which involves a thorough examination of the value chain aimed at reducing product costs
without sacrificing customer satisfaction. [See MAS-42D on Target Costing for more details]
 TOTAL QUALITY MANAGEMENT (TQM) is a management technique that integrates all organizational functions
(marketing, finance, design, engineering, production, and customer service) to focus on meeting customer
expectation and business objectives.
 TQM requires developing policies to ensure that products and services exceed customer’s expectations.
 TQM is a formal effort to ensure and improve quality throughout an entity’s value chain.
 QUALITY COSTS are incurred on quality related processes to prevent defects or incurred as a result of defects
occurring. Quality costs are classified into:
1) CONFORMANCE COSTS are incurred to keep defective products from falling into the hands of customers.
 Prevention Costs (examples: employee training, equipment maintenance, systems development)
 Appraisal Costs (examples: inspection and testing)
2) NON-CONFORMANCE COSTS are incurred because defects are produced despite efforts to avoid them.
 Internal Failure Costs (examples: scrap, spoilage, rework, downtime)
 Externa Failure Costs (examples: warranty repairs, product lawsuits)
 CONTINUOUS IMPROVEMENT is the constant effort to eliminate waste, reduce response time, simplify the
design of both products and processes, improve quality and enhance customer service. Continuous
improvement can be done in two ways:
1) KAIZEN is the gradual process of reducing costs during the manufacturing phase of an existing product
through small and continual improvements rather than through radical “big-time” changes.
2) BUSINESS PROCESS REENGINEERING (BPR) involves redesigning business process to reduce costs and
eliminate inefficiencies and opportunities for errors. Common features of BPR include:
 Radical, quick, significant and drastic approach to improvement
 Business process is diagrammed in details, analyzed and completely redesigned
 Simplification of business process
 Elimination of non-value-added activities.
 JUST-IN-TIME (JIT) is a “demand-pull” system where inventories are purchased/produced only as needed for
production/sale, reduced to the minimum level and, in some cases, reduced to zero (i.e., elimination of non-
value-added costs). JIT can be classified into two categories:
 JIT Purchasing - raw materials are received just in time for production; goods for sale are received just
in time for delivery or sale.
 JIT Manufacturing – manufactured materials are completed just in time for production; products are
completed just in time for delivery.
JIT NON-JIT (Traditional/Conventional)
Demand-pull system Push-through system
Insignificant or zero inventories Significant inventories
Small supplier base Large supplier base
Long-term supplier contracts Short-term supplier contracts
Cellular structure (Manufacturing cells) Departmental structure (Process structure)
Multi-skilled labor Specialized labor
Decentralized services Centralized services
High employee involvement Low employee involvement
Facilitating management style Supervisory management style
Total quality management Acceptable quality level
Value-chain focus Value-added focus
 BENCHMARKING involves the three steps: 1) Identifying critical success factors 2) Studying the best practices
of other firms based on identified success factors 3) Implementing needed improvements to match or beat
the performance of other firms.
 THEORY OF CONSTRAINTS (TOC) emphasizes the importance of managing a company’s constraints that
hinder progress toward an objective. TOC is a perfect complement to TQM and BPR – it focuses improvement
efforts where they are likely to be most effective.

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EXERCISES: ACTIVITY-BASED COSTING, BALANCED SCORECARD & STRATEGIC COST MANAGEMENT

1. Activity Levels
Determine the appropriate level for each of the following activities or costs. Indicate whether the activity is
unit-level (UL), batch-level (BL), product-level (PL), facility-level (FL):
A) Machine setups F) Designing, changing and advertising
B) Direct materials G) Heating, lighting and security
C) Plant supervision H) Research and development
D) Packaging and shipments I) Quality inspection
E) Building depreciation J) Product order processing

2. Traditional Costing vs. ABC

CPA Company incurs P 800,000 in manufacturing overhead costs. The company has been allocating overhead
to individual product lines based on direct labor hours.
Cost Driver Amount in Cost Pool Amount of Activity
Direct labor hours P 300,000 40,000
Number of batches 300,000
, 1,000
Number of shipments 200,000 500
Total overhead costs P 800,000
Two products have the following characteristics:
Product ABS Product CBN
Direct labor hours 2,000 1,000
Number of batches 39 20
Number of shipments 2 150
REQUIRED:
Determine the overhead costs to be allocated to each product (ABS and CBN) using:
A) Traditional costing (based on direct labor hours)
B) Activity-based costing (ABC)
3. Application of Overhead Costs
3A) CMA Company uses a predetermined overhead rate based on direct labor hours to apply manufacturing
overhead to jobs. Estimated and actual data for direct labor and manufacturing overhead are as follows:
Estimated Actual
Manufacturing overhead P 720,000 P 680,000
Direct labor hours 60,000 55,000

What was the manufacturing overhead for CMA Company for last year?
a. Over-applied by P 20,000 c. Over-applied by P 40,000
b. Under-applied by P 20,000 d. Under-applied by P 40,000

3B) CIA Company uses activity-based costing to compute product costs for external reports. The company
has three activity centers and applies overhead using predetermined overhead rates for each activity
center. Estimated costs and activities for the current year are presented below:
Estimated Overhead Cost Expected Activity
Activity 1 P 18,000 1,200
Activity 2 P 57,600 2,400
Activity 3 P 97,200 3,600
Actual costs and activities for the current year were as follows:
Actual Overhead Cost Actual Activity
Activity 1 P 19,500 1,250
Activity 2 P 55,000 2,500
Activity 3 P 90,000 3,750

What was the amount of overhead applied for Activity 2 during the year?
a. P 5,000 over-applied c. P 2,400 over-applied
b. P 5,000 under-applied d. P 2,400 under-applied

4. Manufacturing Cycle Efficiency

CFA Company keeps careful track of the time related to orders and their production. During the most recent
quarter, the following average times were recorded for each unit or order:
Inspection time 12 days
Process time 16 days
Queue time 4 days
Move time 8 days
Wait time 20 days
REQUIRED:
A) How long in days is the manufacturing cycle time or throughput time?
B) What is the manufacturing cycle efficiency ratio?
C) What percentage of the production time is spent on non-value-added activities?
D) How long in days is the delivery cycle time?

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5. Productivity Measures
CISA Company manufactures and sells a single product. The following information was made available:
2020 2021
Unit sales (P 60 per unit) 10,000 15,000
Material usage 4,000 pounds 5,000 pounds
Material cost P 5 per pound P 10 per pound
Labor hours 2,000 hours 2,500 hours
Labor cost P 20 per hour P 25 per hour
5A) Determine the operational partial productivity of DIRECT MATERIAL for (1) 2020 and (2) 2021.
a. (1) 2.50 (2) 3.00 c. (1) 0.25 (2) 0.24
b. (1) 5.00 (2) 6.00 d. (1) 0.50 (2) 0.30
5B) Determine the financial partial productivity of DIRECT MATERIAL for (1) 2020 and (2) 2021.
a. (1) 2.50 (2) 3.00 c. (1) 0.25 (2) 0.24
b. (1) 5.00 (2) 6.00 d. (1) 0.50 (2) 0.30
5C) Determine the operational partial productivity of DIRECT LABOR for (1) 2020 and (2) 2021.
a. (1) 2.50 (2) 3.00 c. (1) 0.25 (2) 0.24
b. (1) 5.00 (2) 6.00 d. (1) 0.50 (2) 0.30
5D) Determine the financial partial productivity of DIRECT LABOR for (1) 2020 and (2) 2021.
a. (1) 2.50 (2) 3.00 c. (1) 0.25 (2) 0.24
b. (1) 5.00 (2) 6.00 d. (1) 0.50 (2) 0.30
5E) Determine the total productivity for 2020 as measured in both (1) units and (2) sales pesos.
a. (1) 0.667 (2) 40.00 c. (1) 1.667 (2) 100.00
b. (1) 0.167 (2) 10.00 d. (2) 6.667 (2) 400.00

WRAP-UP EXERCISES (MULTIPLE-CHOICE QUESTIONS)

1. Activity-based costing (ABC) can be applied to
a. Selling overheads c. Manufacturing overheads
b. Administrative overheads d. All of the choices

2. Which of these situations is most likely to use traditional costing rather than ABC?
a. High-overhead operations c. Labor-intensive production
b. Product-diverse companies d. Capital-intensive production

3. A good example of a unit-level activity is:

a. Machine hours c. TV advertisement
b. Machine setups d. Landscaping

4. A major objective of activity-based management (ABM) is to reduce or eliminate

a. Value-added activities c. Capital-intensive activities
b. Non-value-added activities d. Labor-intensive activities

5. In activity-based costing, which of the following would be considered as a value-added activity?

a. Repair of machines c. Storage and warehousing
b. Engineering design d. Bookkeeping and accounting

6. CFE Company produces two products in a single factory. The controller has determined total overhead
costs to be P 480,000: P 140,000 of which relates to material moves, P 150,000 relates to testing and
the remainder is related to labor time.
Product A1 Product B2
Production 10,000 2,000
Material moves (total) 100 40
Product tests (total) 250 125
Direct labor hours per unit 1 5
Under activity-based costing (ABC), how much is product B2’s overhead cost per unit?
a. P 12.00 c. P 29.50
b. P 24.00 d. P 40.00

7. The most common treatment of under-applied and over-applied overhead costs is to close it out to
a. Work in process c. Cost of goods sold
b. Retained earnings d. Finished goods

8. It translates an organization’s mission and strategy into a comprehensive set of performance measures
that provide the framework for implementing the company’s strategy.
a. Focus c. Balanced scorecard
b. Cost leadership d. Product differentiation

9. What is the MOST important purpose of a balanced scorecard?

a. Develop strategy c. Develop cause-and-effect linkages
b. Measure performance d. Set priorities

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10. The balanced scorecard is said to be “balanced” because it measures

a. Internal and external objectives c. Financial and non-financial objectives
b. Short-term and long-term objectives d. All of the choices

11. Which of the following is NOT one of the four perspectives of the balanced scorecard?
a. Investment in resources perspective c. Customer perspective
b. Learning and growth perspective d. Financial perspective

12. Which balance scorecard perspective is considered to be a lagging (rather than leading) indicator?
a. Customer c. Learning & growth
b. Financial d. Internal business processes

13. What is the correct order of strategy mapping that links the four balanced scorecard perspectives?
a. Financial, customer, internal business processes, learning & growth
b. Internal business processes, learning & growth, financial, customer
c. Learning & growth, internal business processes, customer, financial
d. Customer, financial, learning & growth, internal business processes

14. Which of the following is NOT a component of a typical balanced scorecard report?
a. Strategic objectives c. Strategy initiatives
b. Targets d. Assessment of human resources

15. Which is NOT among the three (3) generic strategies for a company to achieve competitive advantage?
a. Focus c. Market segmentation
b. Cost leadership d. Product differentiation

16. What is the correct formula for manufacturing cycle efficiency (MCE) ratio?
a. Value-added time ÷ Lead time c. Throughput time ÷ Delivery cycle time
b. Value-added time ÷ Throughput time d. Non-value-added time ÷ Throughput time

17. In MCE computation, which of the following is considered as a value-added activity?

a. Inspection time c. Move time
b. Processing time d. Idle time

18. The unyielding and continuing improving effort by everyone in the organization to understand, meet and
exceed the customer expectations and uses front-line workers to solve problems systematically.
a. Just-in-time manufacturing c. Total quality management
b. Conventional manufacturing d. Total quantity management

19. Total Quality Management (TQM) should be viewed as

a. Goal centered and standard driven c. Customer centered and employee driven
b. Policy centered and procedure driven d. Management centered and technology driven

20. What are the four categories of quality costs?

a. Prevention, appraisal, internal failure, and external failure costs
b. Internal failure, external failure, carrying and ordering costs
c. Product liability, warranty, appraisal, and training costs
d. Training, testing, failure, and conformance costs

21. Identify the two (2) CONFORMANCE costs of quality.

a. Prevention and appraisal costs c. Appraisal and internal failure costs
b. Internal and external failure costs d. Prevention and internal failure costs

22. Identify the two (2) NON-CONFORMANCE costs of quality.

a. Prevention and appraisal costs c. Appraisal and internal failure costs
b. Internal and external failure costs d. Prevention and internal failure costs

23. Quality is achieved more economically if the company focuses on

a. Appraisal costs c. Internal failure costs
b. Prevention costs d. External failure costs

24. A quality cost incurred to detect individual units that do not conform to specifications is an example of
a. Appraisal cost c. Internal failure cost
b. Prevention cost d. External failure cost

25. Determine the false statement regarding failure costs.

a. Internal failure costs result from identification of defects during the appraisal process.
b. It is generally better to incur internal failure costs than to incur external failure costs.
c. Internal failure costs include scrap, rejected products, rework and downtime.
d. External failure costs are generally classified as value-added costs.

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26. Following are items included in the quality cost report prepared for the last month:
Employee training costs P 50,000
Product testing P 20,000
Equipment maintenance P 80,000
Rework upon inspection P 25,000
a. Appraisal cost is P 25,000 c. External failure cost is P 20,000
b. Prevention cost is P 130,000 d. Internal failure cost is P 105,000

27. In a product’s life cycle, the first symptom of the decline stage is a decline in
a. Product’s prices c. Product’s production cost
b. Product’s sales d. Firm’s inventory level

28. Determine the correct order of target costing process.

a. Market price, desired profit, target cost, cost reduction thru value engineering
b. Cost reduction thru value engineering, target cost, desired profit, market price
c. Target cost, desired profit, market price, cost reduction thru value engineering
d. Market price, target cost, cost reduction thru value engineering, desired profit

29. Value engineering

a. Is a basis for product costing and pricing
b. Determines the outcome and value added by each activity
c. Is a way of understanding how a company generates its output
d. Is a systematic approach to reaching a targeted cost level during a value chain analysis
without reducing customer satisfaction

30. Which of the following is at the core of the definition of total quality management (TQM)?
a. Customer surveys c. Employee satisfaction
b. Continuous improvement d. Supplier inspections

31. A company desiring to achieve radical or drastic improvements in customer relationship management
would most likely undertake:
a. Kaizen c. Total quality management
b. Benchmarking d. Business process reengineering

32. Which of the following quality tools is another term for gradual yet continuous improvement?
a. Theory of constraints c. Six-sigma
b. Kaizen d. Lean manufacturing

33. “Kaizen costing” refers to

a. Radical cost reductions during the design phase of a product
b. Radical cost reductions during the manufacturing phase of a product
c. Small, continual cost reductions during the design phase of a product
d. Small, continual cost reductions during the manufacturing phase of a product

34. The just-in-time manufacturing (JIT) system is also called the

a. Job-in-training system c. Zero-cost system
b. Job-in-transit system d. Zero-inventories system

35. In JIT system, work is initiated only in response to customer orders. This practice is described as
a. Demand-pull c. Supply-pull
b. Demand-push d. Supply-push
36. Just-in-time purchasing (demand-pull system) requires
a. Smaller and more frequent purchase orders
b. Larger and more frequent purchase orders
c. Smaller and less frequent purchase orders
d. Larger and less frequent purchase orders
37. Which of the following is among the benefits of adopting a JIT system?
a. Increase in the number of suppliers
b. Reduction in the number of deliveries
c. Performance of non-value-added activities
d. Maximization of standard delivery quality
38. The comparison of a company's practices and performance levels against those of other organizations (or
against the best possible level of performance) is most commonly known as
a. Benchmarking c. Comparative analysis
b. Re-engineering d. Continuous improvement
39. The Theory of Constraints suggests that improvement efforts shall be focused on the company’s
a. Value-added activities c. Constraints
b. Non-value-added activities d. Non-Constraints
40. Which of the following scenarios is considered as counter-productive?
a. Same outputs, fewer inputs c. More outputs, fewer inputs
b. More outputs, same inputs d. Fewer outputs, same inputs

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