Activity

Based Costing
Activity-Based Costing (ABC) is a
costing model that identifies
activities in an organization and
assigns the cost of each activity
resource to all products and
services according to the actual
consumption by each: it assigns
more indirect costs (overhead)
into direct costs.
In this way an organization can
establish the true cost of its
individual products and services
for the purposes of identifying
and eliminating those which are
unprofitable and lowering the
prices of those which are
overpriced.
In a business organization, the
ABC methodology assigns an
organization's resource costs
through activities to the products
 and services provided to its
customers. It is generally used as
a tool for understanding product
and customer cost and
profitability. As such, ABC has
predominantly been used to
support strategic decisions such
as pricing, outsourcing and
identification and measurement of
process improvement initiatives.
Benefits of activity based
costing:
identify the most profitable
product, customer and channel.
Identify the least profitable
product, customer and channel.
Determine the true contributors
and detarctors.
Accurately predict costs, profit
and resource requirement
associated with changes in
production volumes,
organizational structire and cost
of resources.
Easily identify the root cause of
poor finbancial performance.
Track the cost of activities and
work processes.
Equip managers with cost
intelligence for cost improvement.
Facilitate a better marketing mix.
Enhance the bargaining power
with customer.
Achieve better positioning of
product.
What's what in ABC?
• The activity is the work that is
done.
• The resource is what the activity
uses to do the work e.g. people,
equipment, and services.
Resources cost money.
• The cost of the activity depends on
the quantity of resources used to
accomplish the activity.
• The cost driver for an activity is the
factor that influences the amount
of the resources that will be
consumed by this activity.
Example: the activity is delivering
goods. The costs of this activity
include the truck drivers' wages,
fuel, depreciation of the truck,
insurance, etc. The quantities of
the resources that will be
consumed by this activity are
influenced by the number of
deliveries made per year. Hence
the cost driver could be the
number of deliveries. A cost driver
is designed to allocate the delivery
activity cost pool to the cost
objects.
(Note: The software has the facility
to enter and change the cost
 drivers as better information
becomes available).
• The activity driver measures how
much of the activity is used by the
cost object. Example: Product A is
delivered once a month, whereas
product B is delivered once a week.
Products A and B require a
different number of deliveries,
hence the cost of the delivery
activity should be assigned to each
product on the basis of the number
of deliveries each uses.
• The cost object is whatever it is
you wish to cost. It could be a
product, service, process, job or
customer.
While traditional costing arbitrarily allocates
overhead costs, ABC traces overhead costs by
looking at the activities that each product and
service calls upon. With ABC the products
consume the activities. It is the activities that
cost money.
ABC Model:
The objective of an ABC
implementation is to relate all of the
costs of doing business to products,
services, or customers. Developing the
initial model consists of the following
five steps:
1. Identify the Resources
(expenditures) of an organization
2. Determine Activities (work
performed) that are supported by
Resources
3. Define Cost Objects (products,
services, customers)
4. Develop Resource Drivers to link
Resources to Activities
5. Develop Cost Drivers to link Activities to
Cost Objects
Conclusion:
Today, companies are using ABC/M to
make better-informed decisions about
pricing, what type of customers to
pursue, and what products or services
to offer. Activity-Based Costing
determines the TRUE COST &
PROFITABILITY of customers,
products, and/or services. While
traditional accounting may provide
your business with an accurate sense
of the direct costs of your products or
services, indirect costs are often less
accurately applied. Overhead, such as
customer support or marketing costs,
tend to be allocated based on arbitrary
factors.
Activity-Based Costing measures the
costs and profits of an organization
based on the activities performed
within that organization. By focusing
on processes that contribute to
revenues and business operations,
ABC can accurately determine how
each process relates back to specific
products, customers, or services. This
can make a big difference after
considering warehouse, sales,
customer service, administration and
other costs that are often applied at a
standard rate, if at all. With ABC you
can drill into profitability and
performance by almost any factor you
can think of.