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activity based costing

‡ What is ABC? ‡ Implementation of ABC ‡ Application of activity based costing in logistics. ‡ Advantages and disadvantages .

What is ABC?
‡ Activity based costing is an accounting methodology that assigns costs to activities rather than products or services ‡ This enables resource and overhead costs to be more accurately assigned to the products and the services that consume them.

Decreasing information processing costs resulted in a few firms in USA and Europe implementing ABC type system during the 1980s. Cooper and Kaplan coined the term ABC

‡ Involvement of top leadership ‡ Responsibility of cross functional teams ‡ Evaluation and rewards based on ABC.

‡ Traditional allocation method
Costs Products

‡ Activity-based allocation method

Costs First stage


Products Second stage

‡ In activity based costing: ‡ Non-manufacturing as well as manufacturing costs may be assigned to products. ‡ Some manufacturing costs may be excluded from product costs. ‡ A number of overhead cost pools are used, each of which is allocated to products and other costing objects using its own unique measure of activity.

‡ The allocation bases often differ from those used in traditional costing system. ‡ The overhead rates or activity rates may be based on the level of activity at capacity rather than on the budgeted level of activity.

1. Identify activities and resources 2. Measure the costs of resources used to perform each activity 3. Determine cost drivers and resource 4. Assign activity costs to products by multiplying the use of the cost drivers by the resourceconsumption rates


Implementing ABC
‡ Step 1 ± Plan the system
What are the goals?
x Inventory valuation x Process improvement

Foster active involvement Assemble cross-functional team
x Functional specialists


Implementing ABC
‡ Step 2 ± Define, analyze activities and resources
Decompose organization into elemental activities
x Who does what, and why?
x Interview employees x Determine resources x Determine inputs and outputs


Implementing ABC
Gather statistics on activities
x Inputs and outputs x Transaction, duration, intensity x For possible use as second-stage cost drivers


Implementing ABC
‡ Step 3 ± Establish activity cost pools and determine first stage allocation
First stage allocations assign costs to cost pools
x Requires costs to be re-categorized according to why they are incurred, not by type x Drivers may be employee time, square footage, etc.


Implementing ABC
‡ Step 4 ± Determine second stage drivers and assign costs to cost objects
Outputs of activity analysis may be second stage drivers
x Distance moved, times handled, machine hours, units, etc.

Amount assigned to the cost object is the amount of activity consumed times the rate per unit of the activity


When is ABC Most Useful?
‡ ‡ ‡ ‡ ‡ High amounts of overhead cost Multiple products Complex products Complex production system Significant variation in volume between high and low volume products


When is ABC Most Useful?
‡ Different products place different demands on resources ‡ Problems with current cost allocations due to changes in products or processes ‡ Better cost information is needed

Advantages of Activity Based Costing System: ‡ More accurate costing of products/services, customers, SKUs, distribution channels. ‡ Better understanding overhead. ‡ Easier to understand for everyone. ‡ Utilizes unit cost rather than just total cost.

‡ Integrates well with Six Sigma and other continuous improvement programs. ‡ Makes visible waste and non-value added activities. ‡ Supports performance management and scorecards ‡ Enables costing of processes, supply chains, and value streams ‡ Activity Based Costing mirrors way work is done ‡ Facilitates benchmarking

‡ Implementing an ABC system is a major project that requires substantial resources. Once implemented an activity based costing system is costly to maintain. ‡ ABC produces numbers such as product margins that are odds with the numbers produced by traditional costing systems.

‡ Activity based costing data can be easily misinterpreted and must be used with care when used in making decisions. ‡ Reports generated by this systems do not conform to generally accepted accounting principles (GAAP). Consequently, an organization involved in activity based costing should have two cost systems - one for internal use and one for preparing external reports.

‡ To realize the required level of customer service at the lowest total cost, it is fundamental to analyze the logistics activities presents in the company and the cost that these activities generate ‡ The cost recording and analysis system has to help the companies to identify the best collaboration methods, to correctly define economic advantage.

The application of this analysis method to every point in the chain of distribution allows us: ‡ To measure the real cost sustained for every logistic operation made with a specific client, supplier or distribution channel; ‡ To link at every logistics activity cost to their respective performance; ‡ To reduce the wastes of the resources used in the logistics activities.

ABC introduction could be subdivided in the following operating phases: 
identifying and classifying of the main logistics processes;  breaking the processes down into activities;  identifying the resources consumed in performing the activities;  determining the costs of the activities through resource driver;  assigning the costs to the cost objects through activity driver;  assessing the total cost.

The application of ABC in the supply chain Advantages: 
improvement of business profitability. eliminating redundant or unnecessary tasks, and optimizing resource allocations to activities adding more value to the product or customer. ABC permits the planning of more efficient collaborative relationships among the companies in the supply chain.

‡ The lack of perfect cost data ‡ The reluctance of companies to communicate their data ‡ The loss of attention on the customers

‡ ‡ ‡ ‡ ‡ ‡ ‡ ‡ ‡ Colin drury ,2004 ,´management & cost accounting´ ,Thomson Asia Pvt ltd, fifth edition, Singapore, pp.335-360. Christopher M.,´ Logistics and supply chain management: strategies for reducing cost and improving service, Financial Times Pitman,London,1998 Goldsby T. J., Closs D. J., ³Using activity-based costing to reengineer the reverse logistics channe´l, International Journal of Physical Distribution Logistics Management, Vol. 30, no. 6, 2000 Lin B., Collins J., Su R. K., Supply chain costing: an activity-based perspective, International Journal of Physical Distribution Logistics Management, no. 10, 2001 Francesca Bartolacci, Dipartimento di Istituzioni Economiche e Finanziarie, Universit`a di Macerata, Italy. E-mail: Pedone P., Rogora C., Supply chain integration: strategie per affrontare gli anni 2000, Economia Management, n. 2, 1995, p. 61. 7 Goldsby T. J., Closs D. J., Using activity-based costing to reengineer the reverse logistics channel, International Journal of Physical Distribution Logistics Management, no.6, 2000, p. 500. 8 Pohlen T. L., La Londe B. J., Implementing activity-based costing in logistics, Journal of Business Logistics, no. 15, 1994.

‡ 9 Lin B., Collins J., Su R. K., Supply chain costing: an activity-based perspective, International Journal of Physical Distribution Logistics Management, no. 10, 2001, p.702. ‡ 10. Agrawal, D.K, 2003, ³Text Book Of Logistics And Supply Chain Management´, Macmillan India Ltd., First Edition, New Delhi, pp. 179-192. ‡ 11. The Supply Chain Group, 2006, The ABC¶s of SCM-Fundamentals of Supply Chain Management ± Finance, downloaded on 16.08.2011 ‡ 12. Davood Askarany, HassanYazdifar, SaeedAskary, 2009, Supply chain management, activity-based costing and organisational factors, downloaded on 16.08.2011 ‡ 13. Anonymous, 2011, downloaded on 15.08.2011 ‡ 14. Pohlen, 1999, Using Activity Based Costing to Implement Supply Chain Improvements, downloaded on 17.08.2011


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15. Anonymous, 2005, The Context-Specific Benefit of Use of Activity-Based Costing with Supply Chain Management and Technology Integration, downloaded on 18.08.2011 16. Khataie, Amir, H., 2011, Activity-Based Costing in Supply Chain Cost Management Decision Support Systems, downloaded on 18.08.2011 17. Goldsby T. J., Closs D. J., 2000, ³Using activity-based costing to reengineer the reverse logistics channe´l, International Journal of Physical Distribution Logistics Management, Vol. 30, no. 6 18. Horngren C. T., Bhimani A., Foster G., Datar S. M., 1999, Management and cost accounting, London, Prentice Hall Europe 19. Kaplan R. S., Cooper R., 1998, Cost effect using integrated cost systems to drive profitability and performance, Boston, Harvard Business School Press. 20. Lin B., Collins J., Su R. K., 2001, Supply chain costing: an activity-based perspective, International Journal of Physical Distribution Logistics Management, no. 10