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This can be of particular value in tracking new products or customers. (Sr.Phil Scholar Department of Commerce Bharathiar University Coimbatore-641046 elaizachf@yahoo. setting up machines. A more accurate cost management system than traditional cost accounting.K. • • • • • • • • • • Activity-Based Costing Important Terms in Activity Based Costing Stages of Activity Based Costing Traditional Costing and Activity Based Costing Activity Based Costing In 1980s And 1990s Activity Based Costing Methodology ABC and Healthcare Activity Based Costing: A Decision Making Tool Software Packages for ABC Growing Interest in Activity Based Costing Activity Based Costing is based on a philosophy of estimation that: "it is better to be approximately right.It is a practice in which activities are identified and all related costs of performing them are calculated. Activity-Based Costing (ABC) is used to identify. P. This paper is presented by the following topics. The concepts of ABC were developed in the manufacturing sector of the United States during the 1970s and 1980s.(SR.in ABSTRACT Activity Based Costing (ABC) is a method for developing cost estimates in which the project is subdivided into discrete. The CIMA technology defines ABC as “a cost attribution to cost units on the basis of benefit received from indirect activities”. operating machines and distributing products.CHELLASAMY Lecturer Department of Commerce Bharathiar University Coimbatore-641046 E-mail: drpcsamy@yahoo.in LIGY V.co.com . For example. activity-based costing is a management decision-making tool. designing products. ABC systems calculate the costs of individual activities and assign costs to cost objects such as products and services on the basis of the activities undertaken to produce each product or services.fibre2fashion. Presented by www. quantifiable activities or a work unit. what is initiating the costs and where to apply efforts to curb inflationary costs. Activity-Based Costing The concepts of ABC were developed in the manufacturing sector of the United States during the 1970s and 1980s.Activity based costing .P.co. a clear relationship can be established between sources of activity demand and the related costs. task or unit of work with a specified purpose. ABC systems calculate the costs of individual activities and assign costs to cost objects such as products and services on the basis of the activities undertaken to produce each product or services. assign costs to." In summary. quantifiable activities or a work unit. providing actual costs chargeable. than precisely wrong. Elaiza Chf) Dr. ABC identifies opportunities to improve business process effectiveness and efficiency by determining the "true" cost of a product or service. It accurately identifies sources of profit and loss. Chellasamy & Ligy V. An activity is an event. By associating cost to the activity. This association can benefit the distributor in determining where costs are being incurred. and report on agency operations.Elaiza Chf) M. Introduction A powerful tool for measuring performance.a tool for decision making By: Dr. describe. The focus of activity based costing is activities. K. Thus identifying activities is a logical first step in designing an activity based costing. Activity Based Costing is a method for developing cost estimates in which the project is subdivided into discrete.

B. Turney defines ABC as "a method of measuring the cost and performance of activities and cost objects. a service. ABC recognizes the causal relationship of cost drivers to activities. production. a product.e. or a customer. Resource cost driver 2. customers. Cost driver: A cost driver is any factor or force that causes a change in the cost of activity. An activity based costing system first traces costs to activities and then to products and other cost objects. Activity cost driver A resource cost driver is a measure of the quantity of resources consumed by an activity.The CIMA technology defines ABC as “a cost attribution to cost units on the basis of benefit received from indirect activities”. Expenses Resource drivers Activity Costs Activity drivers Cost Object Costs (Products.e. Cost driver may be involved two parts: 1. i ) Important Terms in Activity Based Costing The operation of the ABC system involves the use of the following terms: Cost object: It refers to an item for which cost measurement is required. Cost pool: A cost pool is a term used to indicate grouping of costs incurred on a particular activity which drives them. Peter B.com .fibre2fashion. and developments are given below.. The following figure diagrammatically explains the basic flow of Activity-Based Costing.g. placed on activities by cost objects. Presented by www. An activity cost driver is a measure of the frequency and intensity of demand. marketing. The cost drivers for various functions i." ABC can be defined by the following equation: C/A = HD + M + E + S Where C/A = Estimated cost per activity H = Number of labor hours required to perform the activity one time D = Wages per labor hour M = Material costs required to perform the activity one time E = Equipment costs to perform the activity one time S = Subcontracting costs to perform the activity one time The total cost for performing the activity will be based on the number of times the activity is performed during a specific time frame. Assigns cost to activities based on their use of resources and assigns cost to cost objects based on their use of activities. research.

The exact number will depend on how the management subdivides the organization’s activities. Relating the overhead to the activities After identifying the organization’s activities. 5. Classification of as many of the total costs as direct costs as is economically feasible should be made. Spreading the support activities across the primary activities The spreading of support activities (i.fibre2fashion.e. Identify the different activities within the organization After the identification of cost objects. direct labor cost and direct expenses. that caused them. activities which support or assist manufacturing) across the primary activities (correlated to the number of units produced) is done on some suitable base which reflects the use of support activity. It reduces the amount of costs classified as indirect. 7.Business functions Production Marketing Research& development Customer service Cost driver Number of units Number of set-ups Number of sales personnel Number of sales orders Number of research projects Personnel hours spend on projects Technical complexities of the projects Number of service calls Number of products serviced Hours spend on servicing products Stages of Activity Based Costing The different steps or stages in ABC system can be given as follows: 1. 6. 3. Calculating the activity cost driver rates The activity cost rates for each activity are calculated in the way in which overhead absorption rates would be calculated under the traditional system. Determining the activity cost drivers The determination of the activity cost drivers is done in order to relate the overhead collected in cost pools to the cost objects of products. the various items of overhead are related to activities both support and primary. 4. Identify the chosen cost objects The cost objects of any organization are the products or services and the goal is to first calculate the total cost of manufacturing and distributing these products and their unit cost. Identifying the direct cost of products The direct cost of products or objects may comprise direct material cost..com . It can be presented as follows: Activity cost driver rate = Total cost of activity Activity driver These activity cost driver rates are to be used for ascertaining the amount of overhead chargeable to various cost objects or products. have to be identified. The base is the cost driver and is measured of how the support activities are used. Usually the number of activities over cost centers in ABC will be much more as compared to traditional overhead system. Presented by www. ‘cost pool’ or ‘cost buckets’ are created. the main activities. As a result of relating the items of overhead to various activities. which are being performed in the organization. It is done on the basis of the factor that drives the consumption of the activities. 2.

in the same manner as is done in case of traditional costing system. • the number of setups a product consumes is the cost driver of batch-level activities. These systems identify the major activities of a facility’s production process and then classify these activities into one of the following categories: • unit-level activities. • product-sustaining level activities and. Overhead costs are linked to the cost objects based on activities. • the number of direct labor hours a product consumes is the cost driver for unit-level activities. Computing the total cost of products or cost objects The total costs of the products shall be computed by adding all direct and indirect costs assigned to them. Direct costs are identified with.com . has attracted much attention. The amount of overhead chargeable to a product or cost object shall be calculated by multiplying the activity cost drivers rates by different amounts of each activity that each product or other cost object consumes. make or buy etc. ABC differs from the traditional system only in respect of allocations of overheads or indirect costs. described by Robin Cooper and Robert Kaplan in the 1980's and 1990's. or assigned to. product emphasis.fibre2fashion. • facility-sustaining level activities. • and the number of parts a product consumes is the cost driver of product-sustaining level activities. • batch-level activities. the cost object. Traditional Costing and Activity Based Costing Traditional costing can lead to undercosting or overcosting of products or services. described by Robin Cooper. The following Activities figure explains Cost of Activities Cost Drivers Cost allocated to cost objects Activity Based Costing In 1980s And 1990s The activity based costing systems. Presented by www. A poor quality of cost information causes management to make poor decisions for pricing. Over or under costing of products distorts cost information. This is shown in the following figure: Direct Tracing Cost Cost Cost Ascertainment Indirect Cost Cost Allocation Cost of Product or Service Traditional Costing Activity Based Costing Volume based allocation bases Cost drivers are used as allocation bases the entire process of cost allocation under ABC. In the example below.8.

Consumption Patterns by product Unit level activities Batch level activities Productsustaining activities No.00 $500. of parts 1 1 2 $1000 $1000 Total overhead costs Product Size Volume Material costs $60 $600 $660 $66 - P1 Small Low P2 Small High Amounts consumed Activity cost(over head) Aggregated activity cost Direct labor hours 5 50 55 $550 - Machine hours 5 50 55 $825 $1441 No. 00 $131.00 Total overhead costs $3521.0 0 $500.20 Batch level activities $1080.20 $131. of orders 1 3 4 $500 - Times Handled 1 3 4 $100 $1080 $3521 Overhead costs reported by an ABC system Unit level activities Total overhead costs Total cost driver units Consumption intensity $1441.fibre2fashion.00 $270. reprice products or alter the company's product mix.0 0 According to Robin Cooper activity based costing systems can be used to monitor how an organization's resources are consumed and help to manage consumption and spending in a company.00 2 $500. With activity based costing systems managers can attempt to perform its activities more efficiently.00 Unit level activities Dire ct labor hour s 5 50 Consump tion intensity Cost Batch level activities Consump tion intensity Cost trace d $270 . Activity Based Costing Methodology The insight brought in by ABC methodology can be broadly categorized as: Customer Profitability Product Profitability Process Efficiency Customer Profitability Traditionally it is believed that: • High volume customers are profitable customers • Loyal customer is also a profitable one • Profits will follow a happy customer.00 Productsustaining activities $1000.00 55 $26.00 $810 .00 1 1 Part Numbers Product Product-sustaining activities Consumpti Cost traced on intensity $500.00 P1 P2 $26. Presented by www. 00 1 3 setups traced $270.00 4 $270.20 $26. of setups 1 3 4 $480 - No.00 $500.com .

Presented by www. It offers an approach and the type of information required to realize performance breakthroughs: • It recognizes that cost and quality are the direct result of the activities providers undertake to deliver services to their patients. et al. across functions. This is a continuous improvement process in terms of analyzing the cost. nurses. between functional departments. When indirect costs are large. and invites cooperation. Product Profitability ABC costs the products based on the activities that goes into it. it is still feasible in a developing country. which will in turn enable them to • Analyze the Cost. ABC and Healthcare More and more. • It is developed based on the process knowledge and insight of those directly involved in the delivery of the service.The ABC studies on customer profitability have unveiled that the above are often exceptions. the cost of serving a customer can be ascertained individually. activity-based cost information is both intuitive and logical. ABC solves this problem by estimating the cost of the work activity that consume resources and by linking these costs to the services that are provided. therapists.” And even though the authors say that ABC may be difficult to implement. Example applications include: • • • • • Evaluating the cost implications of alternative clinical pathways Streamlining care delivery practices across the care continuum Decision-making regarding management levels and spans of control Enhancing staff utilization by time of day Resourcing consolidated departments/deployed functions A report by the US-aided Quality Assurance Project on “Can ABC work in developing countries?” with Peruvian Healthcare System as the case. even in the US. • Implement the improvements and realize the benefit. rather than competition.fibre2fashion.com . it makes sense to those charged with the responsibility for improving performance and provides them with transparent information on the cost ramifications of their decisions. This approach tends to overestimate the unit cost of high volume services and underestimate low-volume services. often the case in healthcare. healthcare providers are discovering ABC. With the costing based on activities. In their quest to reduce costs and develop an advantaged marketplace position. This facilitates arriving at the accurate cost of the products and enhances effective strategic decisions to: • Position their products better • Facilitate better Product mix for the market • Enhance the bargaining power with the customer Process Efficiency ABC implementation will make the employees. to understand the various costs involved. Deducting the product cost and the cost to serve each customer one can arrive at customer’s profitability. This method of dealing customer cost and product cost separately has lead to identifying the profitability of each customer and to position their products or services accordingly. participate and contribute to its development. healthcare enterprises are finding that their accounting systems do not provide useful operations management information. to reduce or eliminate the Non Value Added activities and to achieve an over all efficiency. In short. says: “Traditional cost accounting methods pool all indirect costs and then allocate them to the various services in proportion to service direct costs. • It is business-process and end-product focused. physicians. In the case of patient care. the cost of services may be misinterpreted. As a result. • Identify the Value Added and Non Value Added Activities.

500.000.000 $450.000 90. customers. processes. management should take corrective action to bring this segment up to acceptable profitability levels. consolidated reporting and a very competitive pricing regime make it suitable for large and small business in virtually any industry.500.000 $1. management might conclude that all channels are performing relatively well. These two channels—though smaller in overall revenue—appear more attractive after cost allocations and could realize explosive. Table 2. companies typically calculated profitability using the allocation method.5% Catalog $1.000 5 $100. marketing. Table 2 shows the more realistic outcome when an organization applies ABC and apportions call center expenses to each customer channel. but the big opportunity lies in growing the catalog and internet channels through additional investments. In this example.000 $400.000 $10 $100. management can see that the catalog channel uses far more resources and is actually less profitable than other channels.000 20.000. After allocating costs based on the consumption of resources.com .7% Store $2.Activity Based Costing: A Decision Making Tool Prior to the emergence of ABC.000 5 $500. IT. This allocation method involves allocating costs to a product or customer using metrics such as the total number of accounts. products produced. Table 1 gives a hypothetical example of how this method calculates the profitability of three customer channels: store.000 50.000 $600.000 5.000 80.0% Internet $500.000 $900.000 85.000 5 $400.0% Internet $500. Table 1. It provides a platform on which to confidently adjust pricing and activities for competitive advantage.000.fibre2fashion." ABC Focus provides a structured approach to cost products.cxoamerica.000. profitable growth—given management attention and aggressive investments.000 90.cxoamerica.000 0 5 $0 $2. Presented by www.000 $3. this channel should incur a greater proportion of the total cost. Since catalog customers create 80% of the incoming call-center volume. services.com) From the example above.000 35. activities and unused capacity.000 $10 $50.000 60. and internet.000 $10 $500. Simple Allocation of Call-Center Overhead Total $3. or transactions. catalog. and call-center costs—to customer channels.000 82.0% Revenue Number of Customers Cost per Customer Call-Center Costs Net Revenue Margin (Source: www. "ABC Focus is a tool which makes ABC concepts simple to understand and use.com) The insight from this analysis is far different.000 80% Revenue Number of Calls Cost Per Call Call-Center Costs Net Revenue Margin (Source: www.000 $3.000. based on the number of customers per channel.000 100% Catalog $1.650.000 $10 $350.000 100.000 85.000 10.000. Rather than throwing away additional investment to grow this channel. the company allocates overhead costs—including accounting. Software Packages for ABC ABC Focus It is tool for costing products and services and improving efficiencies. based on the number of incoming calls each channel generates.7% Store $2.000. ABC Allocation of Call-Center Overhead Total $3. It is a very attractive package because its flexible costing model.

A survey of US companies in the food and beverage industry found 18% of the respondents implementing ABC and 58% considering it. An Australian survey found that 43% of the respondents were either using ABC or implementing it. Growing Interest in Activity Based Costing Activity based costing is being implemented by a growing number of companies around the globe.special studies within subparts of the organization. A survey of Dutch companies in the food and beverage industry found 12% currently using ABC and another 25% are considering it. but the use of ABC appears to be increasing. ABC implementers generally believe that that ABC provides more accurate cost information than conventional costing does. A few organizations use ABC as their basic. ongoing cost accounting system.fibre2fashion. product. Using the proven approach Activity Based Costing / Management. A survey of Irish manufacturing companies that have implemented ABC reported the following percentages for the actual benefits experienced: 1 2 3 4 5 More accurate cost information for product costing and pricing Improved cost control and management Improved insight into cost drivers Better performance measures More accurate customer profitability analysis 71% 66% 58% 46% 25% A survey of Irish service-sector companies reports similar percentages for the benefits experienced . • Product pricing and decisions of whether to continue producing a product or keeping a particular customer.Management can use more accurate cost information to improve budgets and measures of department and division performance. hospitals and government agencies. the United Kingdom. QPR Cost Control gives the information to make decisions about the most profitable path for the business. and Canada to determine why companies choose ABC. QPR Cost Control is used successfully by all types of organizations. implementing and maintaining activity based system In some cases. The ABC system has replaced existing system for 24% of the Canadian respondents and it is a supplementary (off-line) system for 76%. • Cost Reduction: . A majority of companies still use traditional costing methods. from large international corporations to universities. • Budgeting and performance measurement: . service or activity. ABC does not conform to generally accepted accounting principles in some areas.ABC measures how much activities that are costly and then take steps to reduce their costs by changing the productions process or outsourcing those activities. But many ABC applications are selective. Specific ABC applications vary from organization to organization. Management can use this information to negotiate price increases with customers or to drop unprofitable products.QPR Cost Control The user-friendly QPR Cost Control system helps to understand the real cost structure of the company and identify how the business really works. Significance of Activity Based Costing The following list reflects the results of several surveys of practice in the United States.Results from similar studies in developed economies around the world indicate that ABC is not a passing fad. Limitations of Activity Based Costing • • • • More time consuming to collect data Cost of buying. the establishment of cause and effect relationship between cost driver and costs not be a simple affair. the software identifies exactly what costs are linked to each individual customer. such as business divisions or particular functions. A United Kingdom survey found that just under 20% of 251 respondents had used ABC. Among Canadian companies one survey indicates that 14% of the interviewed businesses have implemented ABC and another 15% are considering using ABC it.com . Presented by www.

Mahar&Selto-Cost Management Strategies for Business Decisions." In summary. what is initiating the costs and where to apply efforts to curb inflationary costs.org en. Fashion.managerialaccounting.com To promote your company. Technical Textile. By associating cost to the activity. 8. Machinery. This can be of particular value in tracking new products or customers. Leather.com . 9. 10. Dyes & Chemicals. This association can benefit the distributor in determining where costs are being incurred.fibre2fashion.fibre2fashion. M.Thukaram Rao-Cost Accounting www.fibre2fashion.E. activity-based costing is a management decision-making tool. 6.asp Presented by www. Footwear & Jewellery.greenbusinesscentre. Apparel. It is based on a philosophy of estimation that: "it is better to be approximately right. follow this link: http://www. It provides financial support data structured in a fashion fundamentally different from accounting data provided in the general ledger. Datar&Foster-Cost Accounting-A Managerial Emphasis. a clear relationship can be established between sources of activity demand and the related costs.cashfocus.com www. Horngren. Hilton. Retail. 4.com www.org/activity based costing To read more articles on Textile. than precisely wrong. planning. Technology. Software and General please visit http://articles. Hansen&Mowen-Cost Management Accounting and Control.com www.cxoamerica. Bhabatosh Baneerjee-Cost Accounting-Theory and Practice.Conclusion Activity based costing has revolutionized product costing. References: 1.wikipedia.com/services/article-writing-service/content-promotion-services. 5. Industry. and forecasting in the last decade. product and services via promotional article. 2. 3. 7.

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