Activity Based Costing
ACTIVITY BASED COSTING AND MANAGEMENT : AN OVERVIEW
Activity Based Costing (ABC) is more relevant than traditional costing in companies, where product mix is diverse in; batch sizes, physical sizes, degree or complexity, and raw material characteristics. ABC will also provide more decision useful information for the service industry, characterized by diversity in range of services provided. If the products in a plant or services provided posses similar characteristics, wither volume based or an activity based cost driver will provide reasonably accurate costs. The strategic goal of ABC is to provide decision useful cost and profitability information for optimal pricing decisions, appropriate product mix, and operational improvements by focusing on activities and cost drivers. (Burch 1994)
ABC provides a closer approximation of the cost of product, than that provided by the traditional volume based costing method. The use of ABC in itself will not lead to better profitability management uses information provided by ABCs to decide the optimal product-mix. The action of the management will lead to improved results.
What is ABC ?
There are several elements worthy of note. First is that activities happen because an input has triggered them, e.g., an activity such as "purchase supplies" is caused or triggered by a requisition, secondly, we see that resources are consumed by an activity. Resources are the things that an organisation pays for, such as people, machines and equipment and facilities. We can measure the consumption of resources by activity for example, the activity "purchase supplies" consumes one hour of an employees time per requisition.
Activities can be associated with the outputs or cost objects of the organisation examples of a few of the cost objects for service organisations that we have worked with include such things as mortgages, chequing accounts, railcar movement from point A to point B, or B to C. Cost objects consume activities in much the same way that activities consume resources consequently, we can measure how much of an activity such as "purchase supplies is required by an organisations service output such as "engineering training course". The measurement of consumption is called an activity- cost driver. Of significant note here is that different cost objects do consume activities " in different proportions and that different customers do consume activities indifferent proportions. Traditional allocation modes hide this variation in activity utilisation by allocating these indirect costs based on some common denominator, such as percent of budget allocation, or percent of revenue and hence often provide quite misleading information.
The level at which activities are analysed can vary widely from the very aggregate to the very detailed. The level of detail should be matched to the level of analysis required to improve the decision-making within the organisation. Even within a...