Activity Base costing (ABC) and its steps only theory
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Step 7: Activity-Based Costing
Activity-based costing is a technique that is used for activity cost accounting.
Cost and performance data of activities can be gathered using ABC for further analysis.
The application of different technologies can help identify alternative or innovative
approaches.
To improve profitability and performance, it is critical to understand where an
organization’s time is spent and, in detail, what the organization does and how it does
it. ABC is used to achieve this, through the following steps:
Build an activity model of relevant activities.
Establish cost and performance measures.
Identify and eliminate non value-added activities.
Simplify, integrate and streamline value-added activities.
Emphasize reuse of assets.
Activity cost and performance data provide information
that is used to identify accurate product costs, waste
in activities, improved business process
opportunities, cost drivers (factors causing costs),
business strategies, and tactical and operational
plans.
Process improvement using ABC results in increased
effectiveness (i.e., improvements in quality) and
efficiency (i.e., improvements in productivity).
Steps of Activity-Based Costing
Five steps are involved in the application of ABC:
ABC Step 1: Analyze activities.
ABC Step 2: Analyze costs.
ABC Step 3: Establish measures.
ABC Step 4: Calculate activity costs.
ABC Step 5: Analyze activity costs.
ABC Step 1: Analyze Activities
This step determines the scope of the activity analysis.
It identifies and defines the activities, and then builds and classifies activity models.
As defined by James Brimson and John Antos in their book [8]:
Activities are a combination of people, technology, supplies, methods, and
environment that produce a given service. Activities describe what the enterprise
does; that is, the way time is spent and the outputs of the process.
ABC Step 2: Analyze Costs
This step identifies the cost elements of each activity and
subactivity.
The cost basis that is to be used is determined
It traces all significant costs to activities and determines total
resource consumption by activity or subactivity.
If an exact tracing of costs to activities is not feasible, costs
that cannot be directly linked to an activity are allocated in the
best way possible.
Once the costs are known, the measures can be established.
ABC Step 3: Establish Measures
Activity measures and performance measures are
determined and classified in this step.
An activity measure is a measure of the volume of
the activity. A performance measure is a measure
of how well the activity is performed.
ABC Step 4: Calculate Activity Costs
Once the activity measure has been determined, the total
cost for the activity can then be calculated. The allocated
portion of the non traceable costs is added to the activity
cost. The sum of each activity’s costs is multiplied by the
activity’s frequency—
The number of times the activity is performed relative to
a single execution of the parent activity—to obtain the
total cost for that activity.
The total volume of the activity measure is divided into
the total activity cost to obtain the cost per activity
measure. This provides the basis for analysis of the
activity costs in the next step.
ABC Step 5: Analyze Activity Costs
In analyzing costs, the emphasis is to decide:
which activities add value,
Which activities incur the highest cost,
What drives that high cost.
From this, an analysis can be done to determine what
will streamline, improve, delete, or automate the cost
driver.
Part of the rationale for identifying cost drivers is to
consider elimination or changes in activities.
The most important information determined during
this analysis is the identification of non value-added
activities.
A non value-added activity may be one that is
performed due to nonconformance to standards or
policies, or used to correct or revise some form of
deficiency.
The cost drivers may be responsible for the
nonvalue-added activities. Nonvalue-added activities
introduce nonvalue-added costs.
Forming Activity Alternatives
Alternatives consider the effect of changes made to one or more
components of an activity model. These alternatives include the
following:
A different input: Costs may be reduced by simplifying an input
or changing an input’s properties while retaining form, fit, and
function.
A different control: A revised regulation or specification may
relax a process tolerance, thus causing a cost decrease.
A different by-product: An improved process may reduce or
eliminate waste so a by-product can be reused. For example, in a
wood process mill, the sawdust waste can be used to produce
other types of wood products such as in the manufacture of
particle board.
A different mechanism:
Changing the skill level of the resources may reduce the time and
cost to execute a task;
Automating a process may reduce cost by displacing a manual
activity
A different set of activities: Changing activities can eliminate
non value-added activities.
Monitoring the Benefits
The result of activity analysis is that ABC is an ongoing
management tool that compares actual costs to projected costs
for continual process improvement.
Variance tracking is also used to track the difference between
projected and actual costs. This should include a “tolerance
band” for costs and performance measures.
If the results are not within the tolerance band, the alternative
should be reevaluated and perhaps a new improvement
opportunity identified.
When an activity alternative is selected, it then becomes the new
functional baseline for the activity. This results in an ongoing
reengineering or process improvement.
Step 8: Workflow Modeling
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