Activity-Based Costing (ABC) is a costing methodology used in managerial accounting to allocate costs more accurately to products, services, or activities.
ABC is an alternative to the traditional way of accounting.
In ABC, costs are assigned based on the activities that drive them rather than simply allocating them based on volume or direct labor hours.
It involves identifying the specific activities involved in the production process, determining the cost drivers for each activity, and allocating costs based on the consumption of those drivers.
Traditionally it is assumed that high volume customers are profitable customers.
A loyal customer is also a profitable customer. And profits will follow a happy customer.
Studies about customer profitability have unveiled that the above ideas are not necessarily true.
ABC is a costing model that identifies the cost pools, or activity centers, in an organization.
It assigns costs to products and services (cost drivers), based on the number of events or transactions that are taking place in the process of providing a product or service.
As a result, Activity Based Management can support managers to see how shareholder value can be maximized and how corporate performance can be improved.
Historically, cost accounting models related indirect costs on the basis
of volume.
Typical benefits of Activity-Based Costing:
- Identify the most profitable customers, products and channels.
- Identify the least profitable customers, products and channels.
- Determine the true contributors to- and detractors from- financial performance.
- Accurately predict costs, profits and resources requirements associated
with changes in production volumes, organizational structure and costs of
resources.
- Easily identify the root causes of poor financial performance.
- Track costs of activities and work processes.
- Equip managers with cost intelligence to stimulate improvements.
- Facilitate a better Marketing Mix
- Enhance the bargaining power with the customer.
- Achieve better Positioning
of products
With the costing now based on activities, the cost of serving a customer
can be ascertained individually. Deducting the product cost and the cost to
serve each customer, one can arrive at customer's profitability. This method
of dealing separately with the customer costs and the product costs, enables
the identification of the profitability of each customer. And Positioning
the products and services accordingly.
Continuous Improvement
The implementation of ABC can make the employees understand the various
costs involved. This will then enable them to analyze the cost, and to identify
the activities that add value and those that do not add value. Finally, based
on this, improvements can be implemented and the benefits can be realized.
This is a continuous improvement process
in terms of analyzing the cost, to reduce or eliminate the non value added
activities and to achieve an overall efficiency.
ABC has helped enterprises in answering the market need for better quality
products at competitive prices. Analyzing the product profitability and customer
profitability, the ABC method has contributed effectively for the top management's
decision making process. With ABC, enterprises are able to improve their efficiency
and reduce the cost without sacrificing the value for the customer. Many companies
also use ABC as a basis for a balanced
scorecard.
This has also enabled enterprises to model the impact of cost reduction
and subsequently confirm the savings achieved. Overall, Activity Based Costing
(ABC) is a dynamic method for continuous improvement. With Activity Based
Costing any enterprise can have a built-in competitive cost advantage, so
it can continuously add value to both its stakeholders and customers.
The implementation of Activity Based Costing is not easy - not an ABC.
Special activity based costing software can be helpful.
Time-Driven Activity-Based Costing
Robert Kaplan and Steven Anderson have suggested Time-Driven Activity-Based
Costing. This is a new approach to avoid the difficulties associated with
large-scale ABC implementation (HBR November 2004). In this revised model,
managers estimate the resource demands of each transaction, product, or customer,
rather than relying on time-consuming and costly employee surveys. The Time-Driven
Activity-Based Costing method is simpler since it requires, for each group
of resources, estimates of only two parameters. 1. What are the costs per
time unit of capacity to supply resources to the business activities? (The
total overhead expenditure of a department divided by the total employee time
available). 2. An estimation of the unit times of activities: how much time
it takes to carry out one unit of each kind of activity (as estimated or observed
by the manager). This Time-Driven ABC approach also overcomes a serious technical
problem associated with employee surveys: employees invariably report percentages
that add up to 100, when they are asked to estimate time spent on activities.
Managers should take into account time that is idle or unused. The method
also supports time equations, a feature that enables the ABC model to approximate
the complexity of real-world operations. By showing how specific order, customer,
and activity characteristics cause variation in processing times.
Forum discussions about Activity Based Costing.
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Degree of Detail in ABC
When planning to build an ABC model it is essential to first make the decision what level of detail ABC is to be captured. This depends on what questions are to be answered:
1. Strategic (about 100-1...
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Time-driven ABC (TDABC)
Is anyone using TDABC as a substitute for traditional activity-based costing? I would love to discuss how it's working, implementation tactics, etc....
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ABC in the Federal Environment
Does anybody have experience implementing ABC in the federal environment? There are obviously a lot of differences, but the same benefits can be reaped from determining the costs of performing certain...
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How to Derive Overhead Cost from a P&L?
Hello reader, I'm trying to decompose the overhead of a company through its Profit and Loss account. I have calculated for my self what their overhead should be and I'd like to compare this with their...
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Courses about Activity Based Costing.
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The best, top-rated topics about Activity Based Costing. Here you will find the most valuable ideas and practical suggestions.
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ABC in an Advertising Firm?
How can ABC be applied in an advertising firm where activities vary per project, depending on the client, its marketing campaign, its objectives, and their budget?...
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Consequences of ABC Analysis
If Activity-based Costing has been correctly implemented, and it turns out a product is causing losses, does this mean automatically that the product should be discontinued?...
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Capacity Minutes and Industry Norms
Productivity levels in minutes - productive time
Work days are about 480 minutes (8 x 60). Where could I find what the industry norms are? Are there examples that show the average for the industry to...
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Drivers still Right?
ABC is one of the most recent developed evolutions in costing. It has a big impact in allocating the cost to the right object... But still the question is: to what extent are the drivers right and eff...
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Conditional Resources in ABC
How does ABC cater for estimating the cost of business processes which may take many different routes depending on the outcome of decisions or events - for instance, a resource may only be used once i...
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Overhead Costing - Food Manufacturing
The company I work for manufactures food. The company is small. How much overhead should I count into my costing?
I do not want to put too much in so I don't overcharge the customers when I price the...
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Advanced insights about Activity Based Costing. Here you will find professional advices by experts.
Consultancy Tips
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4 Steps to Assign Resources to End Products ABC Implementation There are basically 4 steps in assigning production resources to end products:
1. Define Activity Groups, having a dire...
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Disadvantages of ABC Cost Mgt, Decision-making Following disadvantages can be associated with the application of Activity Based Costing:
- Cost effectiveness: Cost e...
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Applicability in Hotel Bussiness Cost Management, Decision-making In recent years, cost accounting systems have been replaced by Activity Based Costing systems in the manufacturing secto...
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Application Challenges of ABC Cost Mgt, Decision-making When applying Activity Based Costing to real world operations, companies face different challenges.
- One of the challe...
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Various sources of information regarding Activity Based Costing. Here you will find powerpoints, videos, news, etc. to use in your own lectures and workshops.
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Time-Driven ABC Activity Based Costing Paper by Robert S. Kaplan and Steven R. Anderson. The traditional ABC model has been difficult for many organizations to...
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Activity Based Costing and Activity Based Management Accounting, Costing Systems This presentation explains the concept of Activity Based Costing (ABC) and also explains an additional form of ABC: Addi...
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Costing Strategies Multinational Companies Paper by Marco Agliati argues that in a globalization context, it becomes of pivotal importance being able to make cost ...
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Product Costing, Process Costing and Job-Order Costing Cost Management, Management Accounting, Managerial Accounting, Activity Based Costing This presentation provides detailed knowledge about Job Order Costing, one of the traditional product based costing syst...
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Interview with Kaplan: ABC in the Public Sector Understanding that Activity Based Costing can be applied to the public sector Interview with Robert S. Kaplan, in which he discusses an example that led to a 35% cost reduction in the public sector ...
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ABC Diagram Activity Based Costing Download and edit this 12manage PowerPoint graphic for limited personal, educational and business use.
Republishing in ...
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Business Intelligence
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