Activity Based Costing †Definition and Concept Essay

An approach to the be and monitoring of activities which involves tracing pick consumption and damageing final outputs. Resources atomic number 18 arrogateed to activities, and activities to bell objects ground on consumption estimates. The last mentioned utilise cost drivers to attach exertion be to outputs. Activity-establish cost ( first rudiment) is a costing methodology that identifies activities in an presidency and assigns the cost of each activity with resources to all harvests and services according to the actual consumption by each. This model assigns to a greater extent(prenominal) in hire be(overhead) into direct cost compared to conventional costing. CIMA semiofficial Terminology, 2005A development of the principles of activity based costing (ABC) is activity based management (ABM). Operational ABM is defined asActions, based on activity driver analysis, that increase efficiency, lower cost and/or improve asset utilisation. CIMA Official Terminology, 2005 Strategic ABM is defined asActions, based on activity based cost analysis, that take up to change the demand for activities so as to improve profitability. CIMA Official Terminology, 2005 The main focus of this topic admission is ABC. However, the development of ABC into ABM will be discussed further under Application. The concept of ABC was depression defined in the late 1980s by Robert Kaplan and William Burns. Initially ABC foc utilize on manufacturing patience where technological developments and productivity improvements had reduced the analogy of direct labour and material be, but increased the proportion of indirect or overhead costs.Comparison of traditional costing and ABCThe traditional method of costing relied on the arbitrary addition of a proportion of overhead costs on to direct costs to attain a total product cost. The traditional approach to cost allocation relies on triplet basic steps. 1. Accumulate costs within a issue or non-production department. 2. All ocate non-production costs to production departments. 3. Allocate the resulting production department costs to various products, services or customers. This type of costing carcass usually allocates costs based on a single volume meter, such as direct labour hours or machine hours.While using such a simplistic volume measure to allocate overheads as an overall cost driver, this approach seldom meets the cause-and-effect criteria desired in accurate cost allocation. This method of costing has become increasing inaccurate as the relative proportion of overhead costs has risen. This distortion of costs bed result in inappropriate decision making. ABC is therefore an alternative approach to the traditional method or arbitrary allocation of overheads to product, services and customers. AIM of the modelWith ABC, an organization can soundly estimate the cost elements of entire products and services. That may help inform a go withs decision to either * cite and eliminate those product s and services that are unprofitable and lower the prices of those that are overpriced (product and service portfolio aim) * Or identify and eliminate production or service processes that are unable(p) and allocate processing concepts that lead to the very same product at a better suffer (process re-engineering aim). In a business organization, the ABC methodology assigns an organizations resource costs through and through activities to the products andservices willd to its customers. ABC is generally used as a tool for understanding product and customer cost and profitability based on the production or performing processes. As such, ABC has predominantly been used to support strategic decisions such as pricing, outsourcing, identification and measurement of process improvement initiatives.ApplicationIn contrast to traditional cost accounting systems, ABC systems first accumulate overheads for each organisational activity. They then assign the costs of these activities to product s, services or customers (referred to as cost objects) causing that activity. The initial activity analysis is distinctly the most difficult aspect of ABC. Activity analysis is the process of identifying appropriate output measures of activities and resources (cost drivers) and their effects on the costs of making a product or providing a service.ABC systems have the flexibility to provide special reports so that management can take decisions active the costs of designing, selling and delivering a product or service. The key aspect is that ABC focuses on accumulating costs via activities, whereas traditional cost allocation focuses on accumulating costs within functional areas. The main advantage of ABC is that it minimises or avoids distortions on product costs that might occur from arbitrary allocation of overhead costs. Steps in development of an ABC organisationABC uses cost drivers to assign the costs of resources to activities and unit cost as a way of bill an output. Ther e are four steps to implementing ABC.1. set activitiesThe organisation needs to undertake an in-depth analysis of the in operation(p) processes of each responsibility centre. Each process might consist of one or more activities mandatory to produce an output. 2. deputize resource costs to activitiesThis involves tracing costs to cost objects to determine why the cost occurred. Costs can be categorised in three ways i. Direct costs that can be traced directly to one output. For example, the wood and paint that it takes to make a chair. ii. Indirect costs that cannot be allocated to an individual output, that is, they benefit two or more outputs, but not all outputs. For example, maintenance costs or storage costs. iii. General/administration costs that cannot be associated with any product or service. These costs are likely to remain unchanged, whatever output is produced. For example, salaries of administration staff, security costs or depreciation.3. Identify outputsIdentify all of the output for which an activity segment performs activities and consumes resources. Outputs might be products, services or customers. 4. Assign activity costs to outputsThis is done using activity drivers. Activity drivers assign activity costs to outputs (cost objects) based on the consumption or demand for activities.ABC in practiceSteps to implement Activity-Based costing1. Identify and assess ABC needs Determine viability of ABC method within an organization. 2. Training requirements prefatory training for all employees and workshop sessions for senior managers. 3. Define the project scope Evaluate mission and objectives for the project. 4. Identify activities and drivers Determine what drives what activity. 5. Create a cost and operational flow diagram How resources and activities are related to products and services. 6. salt away data Collecting data where the diagram shows operational relationship. 7. Build a software model, validate and reconcile.8. witness results and prepare management reports.9. Integrate data necessitateion and reporting.ABC activities have been around for nearly 20 years and many companies in a variety of sectors have implemented activity based opinion. ABC and ABM have brought to the highest degree radical changes in cost management systems. The principles and philosophies of activity based thinking apply equally to service companies, government agencies, process and manufacturing industries. Management practices and methods have changed over the last ten dollar bill and will continue to change. Organisations have moved from managing vertically to managing horizontally. There has also been a move from a function orientation to a process orientation.However, management information systems to track and provide information about the horizontal aspects of business have lagged significantly behind managers needs. ABC and ABM fill this information falling out by providing cost and operation information that mirror s a horizontal view.ABC focuses on accurate information about the true cost of products, services, processes, activities and customers. Using ABC, organisations gain a thorough understanding of their business processes and cost demeanour during ABC analysis. Management then applies this insight to improve decision making at operating and strategic levels. This is then known as ABM. Simply, ABM is ABC in action.HOW ABC IS USED IN THE faceThis detailed study of how organisations are practically applying ABC can be found on the BetterManagement.com website (to annoy this study you must register, and then click on the link to activity based management in the top left hand corner of the home page). Available from www.bettermanagement.com Accessed 4 November 2008 The study was carried out in July 2005 to determine the state of ABC within over 500 organisations across numerous industries of different sizes and locations. It provides a useful and interesting insight into how ABC is used in organisations.Reported benefits ABC provides a more accurate method of costing of products and services. It allows for a better and more comprehensive understanding of overheads and what causes them to occur. It makes costly and non-value adding activities more visible, so allowing managers to focus on these areas to reduce or eliminate them. It supports other management techniques such as continuous improvement, scorecards and performance management. Reported drawbacks ABC can be difficult and time consuming to collect the data about activities and cost drivers. It can be costly to implement, run and manage an ABC system. level(p) in ABC some overhead costs are difficult to assign to products and customers. These costs fluid have to be arbitrarily applied to products and customers.