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Activity Based Costing (ABC) is an accounting technique that allows an organization to determine the actual cost associated with

each product and service produced by the organization without regard to the organizational structure. It is developed to provide more-accurate ways o assigning the costs o indirect and support resources to activities! bushiness processes! products! services! and customers. ABC systems recognize that many organizational resources are required not or physical production o units o product but to provide a broad array o support activities that enable a variety o products and services to be produced or a diverse group o customers. "he goal o ABC is not to allocate common costs to products. "he goal is to measure and then price out all the resources used or activities that support the production and delivery o products and services to customers. Concept of Activity-Based-Costing: An organization per orms activities to do its business. "hese activities de ine the #ind o business you are in$ a ship owner has an activity to unpac# boats% an accounting irm prepares ta& returns% a manu acturer produces products% a council delivers services% a university teaches students. All activities consume resources. It is the consumption o these resources that adds to overhead costs. "he basis o Activity Based Costing is$ loo# at the activities required to produce the cost o the product or service. "he activities consume resources and the cost o these can be calculated. "he amount o activity required or each product and service is determined! hence the real cost can be determined. What's what in ABC? "he activity is the wor# that is done. "he resource is what the activity uses to do the wor# e.g. people! equipment! and services. 'esources cost money. "he cost o the activity depends on the quantity o resources used to accomplish the activity. "he cost driver or an activity is the actor that in luences the amount o the resources that will be consumed by this activity. (&ample$ the activity is delivering goods. "he costs o this activity include the truc# drivers) wages! uel! depreciation o the truc#! insurance! etc. "he quantities o the resources that will be consumed by this activity are in luenced by the number o deliveries made per year. *ence the cost driver could be the number o deliveries. A cost driver is designed to allocate the delivery activity cost pool to the cost ob+ects. (,ote$ "he so tware has the acility to enter and change the cost drivers as better in ormation becomes available). "he activity driver measures how much o the activity is used by the cost ob+ect. (&ample$ -roduct A is delivered once a month! whereas product B is delivered once a wee#. -roducts A and B require a di erent number o deliveries! hence the cost o the delivery activity should be assigned to each product on the basis o the number o deliveries each uses.

"he cost ob+ect is whatever it is you wish to cost. It could be a product! service! process! +ob or customer.

.hile traditional costing arbitrarily allocates overhead costs! ABC traces overhead costs by loo#ing at the activities that each product and service calls upon. .ith ABC the products consume the activities. It is the activities that cost money. If there were no activities, no resources would be consu activities that you do that define your business! Why use Activity-Based-Costing? Activity-Based-Costing is necessary or the ollowing reasons. / 0nderstand "'0( pro itability o your customers! products! or services / 1uanti y the cost o non-value added activities such as errors and rewor#s / Identi y opportunities to reduce costs and2or increase e iciency / 3btain actionable in ormation to negotiate price increases or unpro itable clients / 0nderstand why pro itability may be mediocre despite good strategic undamentals / 4trati y overhead costs so they can be managed more e ectively "ow #oes ABC Wor$? "he irst stage in an initial ABC study is to develop a undamental understanding o the 'esources (e&penditures) and Activities (wor# per ormed) o an organization. "he 'esources are then mapped to the Activities! thereby quanti ying the cost o per orming each o these Activities. "hese costs are traced to Cost 3b+ects (customers! products! or services) providing tremendous insight into where an organization is ma#ing and losing money. ABC %odel: "he ob+ective o an ABC implementation is to relate all o the costs o doing business to products! services! or customers. 5eveloping the initial model consists o the ollowing ive steps$ 6. Identi y the &esources (e&penditures) o an organization 7. 5etermine Activities (wor# per ormed) that are supported by 'esources 8. 5e ine Cost 'b(ects (products! services! customers) 9. 5evelop &esource #rivers to lin# 'esources to Activities ed! It is the

:. 5evelop Cost #rivers to lin# Activities to Cost 3b+ects "hese steps are discussed in greater length below. )tep *: Identify &esources 'esources represent the e&penditures o an organization. (&amples include production labor! sales and mar#eting labor! occupancy and utilities! equipment! and supplies. "hese are the same costs that are represented in a traditional accounting view% unli#e traditional accounting! ABC lin#s these costs to products! customers! or services. )tep +: Identify Activities Activities represent the wor# per ormed in an organization. ABC Activities or the sales department in a typical organization might include$ ;a#ing sales calls to e&isting customers ;a#ing sales calls to potential customers ;a#ing customer service calls "raining product representatives (valuating products and improving product #nowledge 5istributing samples Attending trade shows and other events

"raditional accounting will o ten brea# the cost o the sales department into salaries! bene its! allocated rent! supplies! and so on. 0nli#e traditional accounting! which reports what the costs are (i.e. salaries! bene its! rent)! ABC accounts or these costs based on what activities caused them to occur. By determining the actual activities that occur in various departments! such as accounting! customer service! and sales! it is then possible to more accurately relate these costs to customers! products! and services. )tep ,: Identify Cost 'b(ects ABC provides pro itability by one or more cost ob+ect! usually represented by products! customers! and2or services. Cost 3b+ect pro itability is utilized to identi y money losing customers! to validate separate divisions or business units! or to measure the per ormance o individual pro+ects! +obs! or contracts. 5e ining the outputs to be viewed is an important step in a success ul ABC implementation. )tep -: #eter ine &esource #rivers

'esource 5rivers provide the lin# between the e&penditures o an organization and the Activities per ormed within the organization. <or e&ample! the total salary o a customer service representative would li#ely be allocated to the Activities per ormed based on the amount o time spent per orming

the Activity. I :=> o her time is spent per orming the activity! ta#ing orders or e&isting customers! :=> o her salary (including all costs such as bene its! ta&es! and insurance) would be allocated to this Activity. )tep .: #eter ine Cost #rivers

5etermination o Cost 5rivers completes the last stage o the model. Cost 5rivers trace! or lin#! the cost o per orming certain Activities to Cost 3b+ects. <or e&ample! ta#ing orders or e&isting customers may be lin#ed to speci ic customers based on the number o orders ta#en! i each order ta#es appro&imately the same amount o time. I order ta#ing time varies based on the customer! this cost may be lin#ed based on another driver or multiple drivers. Conclusion: "oday! companies are using ABC2; to ma#e better-in ormed decisions about pricing! what type o customers to pursue! and what products or services to o er. ActivityBased Costing determines the "'0( C34" ? -'3<I"ABI@I"A o customers! products! and2or services. .hile traditional accounting may provide your business with an accurate sense o the direct costs o your products or services! indirect costs are o ten less accurately applied. 3verhead! such as customer support or mar#eting costs! tend to be allocated based on arbitrary actors. Activity-Based Costing measures the costs and pro its o an organization based on the activities per ormed within that organization. By ocusing on processes that contribute to revenues and business operations! ABC can accurately determine how each process relates bac# to speci ic products! customers! or services. "his can ma#e a big di erence a ter considering warehouse! sales! customer service! administration and other costs that are o ten applied at a standard rate! i at all. .ith ABC you can drill into pro itability and per ormance by almost any actor you can thin# o .