Activity-Based Costing ( ABC )

Activity Based Costing

ACTIVITY BASED COSTING AND MANAGEMENT : AN OVERVIEW

Activity Based Costing (ABC) is more relevant than traditional costing in companies, where product mix is diverse in; batch sizes, physical sizes, degree or complexity, and raw material characteristics. ABC will also provide more decision useful information for the service industry, characterized by diversity in range of services provided. If the products in a plant or services provided posses similar characteristics, wither volume based or an activity based cost driver will provide reasonably accurate costs. The strategic goal of ABC is to provide decision useful cost and profitability information for optimal pricing decisions, appropriate product mix, and operational improvements by focusing on activities and cost drivers. (Burch 1994)

ABC provides a closer approximation of the cost of product, than that provided by the traditional volume based costing method. The use of ABC in itself will not lead to better profitability management uses information provided by ABCs to decide the optimal product-mix. The action of the management will lead to improved results.

What is ABC ?

There are several elements worthy of note. First is that activities happen because an input has triggered them, e.g., an activity such as "purchase supplies" is caused or triggered by a requisition, secondly, we see that resources are consumed by an activity. Resources are the things that an organisation pays for, such as people, machines and equipment and facilities. We can measure the consumption of resources by activity for example, the activity "purchase supplies" consumes one hour of an employees time per requisition.

Activities can be associated with the outputs or cost objects of the organisation examples of a few of the cost objects for service organisations that we have worked with include such things as mortgages, chequing accounts, railcar movement from point A to point B, or B to C. Cost objects consume activities in much the same way that activities consume resources consequently, we can measure how much of an activity such as "purchase supplies is required by an organisations service output such as "engineering training course". The measurement of consumption is called an activity- cost driver. Of significant note here is that different cost objects do consume activities " in diffe...

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...self rather than using the cost of the final products only. The cost drivers that trigger the activity are also identified and monitored. These cost drivers may be different from the resource or activity drivers. In addition performance measures are developed and monitored to judge the efficiency at which the activity is being performed. These measures may be financial or non-financial variables such as cost per units of activity driver, defects per million items produced or time taken per unit of item produced. These measures then provide a sound basis to the control the performance of the activity with accurate information about the costs involved.

ABM has number of benefits to offer. Here, the focus of attention is an activity rather than a department. A department may have a number of activities which if not segregated may diffuse the vision of the managers while making a particular decision. The areas where specific benefits have been derived from ABM are following

A. Determination of product/service costs

B. Improvements in performance and activities

C. Cost cutting and downsizing

D. Other applications.

Number of benefits are high and harmful effects are less.