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The activity based costing method development and

After reading you will understand the basics of this powerful financial management tool. What is Activity Based Costing? Activity Based Costing ABC is a system that goes beyond traditional cost price models with respect to indirect cost calculation models. This method was developed in the United States. Robert Kaplan is regarded as the founder of the theoretical principles of activity based costing within the cost management knowledge area.

  1. First, it expands the number of cost pools that can be used to assemble overhead costs. ABC may deliver a better structured analysis in respect to complex processes, and this is no surprise regarding the necessarily spent effort for detailed ABC reporting.
  2. Activity Based Costing identifies cost groups of activity centres in organizations and allocates costs to products and services based on a number of events or transactions that are absolutely necessary in a process to deliver the product or service. These traditional costing systems are often unable to determine accurately the actual costs of production and of the costs of related services.
  3. By making the cost drivers clear, the departments accountable are stimulated to search for improvements of the production process to make them act more cost-conscious. Share your experience and knowledge in the comments box below.
  4. However the more thorough insight into cost composition for the inspected processes justifies the study result. ABC may deliver a better structured analysis in respect to complex processes, and this is no surprise regarding the necessarily spent effort for detailed ABC reporting.
  5. Robert Kaplan is regarded as the founder of the theoretical principles of activity based costing within the cost management knowledge area. Activity Based Costing ABC is a system that goes beyond traditional cost price models with respect to indirect cost calculation models.

In traditional cost price systems such as the cost centre and surcharge methods, indirect costs are allocated based on volumes of products, for instance hours of labour and machine hours. The costs are not allocated to the cost drivers and there is no causal relationship.

This makes it hard to determine the costs of the production factors and overheads as a result of which a distorted picture may be presented in terms of costs.

Benefits and drawbacks of activity based costing

Unlike traditional cost price systems, activity based costing does establish a causal link between the cost drivers and indirect costs. By passing on this insight to the responsible cost drivers, a transparent and cost-conscious conduct is stimulated.

This is also a way to find out what activities do not add value and should therefore be eliminated.

  • This makes it hard to determine the costs of the production factors and overheads as a result of which a distorted picture may be presented in terms of costs;
  • Since personnel expenses represent the largest single component of non-interest expense in financial institutions, these costs must also be attributed more accurately to products and customers.

In this manner improvements can be realized that can lead to higher performance results. It also contributes to strategic developments within cost price calculations.

More accurate cost information can help an organization respond to competitive advantage and certain decisions in the Ansoff Matrix PMM.

Activity-based costing

Activity Based Costing identifies cost groups of activity centres in organizations and allocates costs to products and services based on a number of events or transactions that are absolutely necessary in a process to deliver the product or service.

Though simulation it is easier to calculate the effect of for instance changes in set-up times, fewer defective products, etc.

  • Examples of cost drivers include machine setups, maintenance requests, power consumed, purchase orders, quality inspections, or production orders;
  • There are two categories of activity measures;
  • Definition of Activities in ABC System The ABC system of cost accounting is based on activities, which is any event, unit of work, or task with a specific goal, such as setting up machines for production, designing products, distributing finished goods, or operating machines;
  • Since the early stages of this method, the Anglo-Saxon scholars have tried to develop specific applications and extensions.

By making the cost drivers clear, the departments accountable are stimulated to search for improvements of the production process to make them act more cost-conscious. ABC provides a clear picture of the behaviour and structure of the indirect costs.

This is how for instance overheads can be managed much better. ABC can contribute to better cost price calculations for the benefit of the corporate strategy on the market. ABC is a fairly complex system and this is also the biggest drawback of the system. When implementing ABC, a lot of time needs to be spent on defining the activities, the calculation of the cost price and the finding of cost drivers.

  1. Cost reduction may in this respect also be translated into a better operational efficiency.
  2. However, as the percentages of indirect or overhead costs rose, this technique became increasingly inaccurate, because indirect costs were not caused equally by all products. This method was developed in the United States.
  3. This method was developed in the United States. Objectives[ edit ] With ABC, a company can soundly estimate the cost elements of entire products, activities and services, that may help inform a company's decision to either.
  4. Share your experience and knowledge in the comments box below. The approach has proven useful in many service industry areas including healthcare, construction, financial services, governments, and other industries.
  5. However the more thorough insight into cost composition for the inspected processes justifies the study result.

This requires a company to provide detailed cost information which in turn leads to a complicated process. ABC systems are expensive and they are complicated to maintain and adjust.

Activity-Based Costing (ABC)

Activity Based Costing is cost price calculation, in which the cost drivers are allocated to the costs incurred. In this system it is assumed that there is a causal link between the products and the accompanying costs.

  • ABC can contribute to better cost price calculations for the benefit of the corporate strategy on the market;
  • Consequently, when multiple products share common costs, there is a danger of one product subsidizing another.

Activity Based Costing is especially interesting for companies that, in the light of bad corporate results or strategic considerations cost leadershipneed to achieve an important cost reduction. Cost reduction may in this respect also be translated into a better operational efficiency. Do you recognize the practical explanation or do you have more suggestions? What are your success factors for using a certain costing method?

Share your experience and knowledge in the comments box below. If you liked this article, then please subscribe to our Free Newsletter for the latest posts on Management models and methods.

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More information Garrison, R. Harvard Business School Press. How to cite this article: Retrieved [insert date] from ToolsHero: Your rating is more than welcome or share this article via Social media!

Activity Based Costing (ABC)