Explain the term ‘activity analysis’ (include an appropriate illustration /example).

Explain with an appropriate illustration why a new product costing system may be
needed when line managers suggest that an apparently profitable product be dropped.
Implementing ABC / ABM, can be difficult due to behavioural issues. What can
managers do to overcome these challenges?

Activity analysis are usually used by companies to determine the quality costs, in
which often they include prevention, appraisal, internal failure and external failure costs.
These activities are usually reported on a Pareto chart. As shown in the pareto chart example
below.

The chart below will usually highlight the quality costs which is the highest. In
addition to the Pareto chart, a quality cost report will be used to summarized the quality costs
by each of the four major classification. Another method being used to summarized the
quality costs will be the value added and non-value-added classifications. The activity
analysis could also be used to determine the cost of prosses. The process costs can be
improved by either upgrading the processing methods or eliminating redundant or wasteful
work.

Line managers are close to the production process and may realize that a complex
product, which is difficult to manufacture, is under-costed by a traditional, volume- based
costing system Line managers do not believe the product costs reported by accounting
department. Marketing personnel are unwilling to use product costs in making pricing
decisions. Complex products that are difficult to manufacture are reported to be very
profitable, although they are not priced at a premium. Product line profit margins are difficult
to explain. Sales are increasing but profits are decreasing. Line managers suggest that
apparently profitable products be dropped. Marketing or production managers are using
bootleg costing system which are informal systems they designed, often on a personal
computer. Some products that have reported high profit margins are not sold by competitors.
Competitor’s high-volume products seem to be priced unrealistically low. The accounting
department spends significant amounts of time on special costing projects to support bids or
pricing decisions

Many pitfalls and problems may occur during the implementation of ABC.
Knowledge of these pitfalls helps an implementation team develop methods to avoid them
and to deal effectively with problems as they occur. These pitfalls and problems are not
insurmountable. In fact, getting ABM off the ground is more than possible—it’s probable,
especially when the following solutions are applied to deal with the common pitfall. Expose
senior management to potential benefits of ABM through visits to other successful companies
and via benchmarking reports; find competitors who are using or experimenting with the
approach; understand fully the ongoing commitment costs of ABM before adopting it; ensure
the complexity of ABM is not underestimated; select a team leader to lead the ABM project
who understands the business and works well with people from many functional areas within
the company; ensure the time to complete a comprehensive implementation is not
underestimated; and train employees on how ABM will be used.