Activity Based Costing (ABC)

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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 Forum discussions about Activity Based Costing. ABC in service companies such as airlines? ABC may be appropriate in the manufacturng company, but I doubt applying in service givng companies is worth while. Especially in the airline industry where there are various types of common costs and... 16   2 comments 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... 12   2 comments Activity Based Costing Implementation How can a company implement activity based costing?... 10   2 comments ABC and Decision making Are managers able to make better decisions through the analysis of indirect cost allocation?... 9   2 comments 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.... 9   1 comments Activity Based Management (ABM) What is the modern term or second name for Activity Based Costing?... 7   1 comments ABC or TOC? The Differences between Activity Based Costing and the Theory of Constraints In past literature, the Theory of Constraints (TOC) has been seen as more or less contradicting the concept of ABC-costing and its assumptions. The main contradictions between ABC and TOC mentioned i... 6   Comparison Activity Based Costing, Time-Driven-ABC and Lean Accounting In the article "Activity Based Costing, Time-Driven Activity Based Costing and Lean Accounting: Differences Among Three Accounting Systems", 3 ways of accounting are compared. The comparison is made o... 5   Organizational Issues when Introducing ABC What kind of organizational / behavioral problems can we expect to arise when ABC is being introduced in a firm?... 4   Over Recovery / Under Recovery Level I want to know: Do you calculate an over/under recovery for each activity or do you calculate one singe over/under recovery for the company?... 4   1 comments 🔥 What is Process Costing? In cost accounting systems, what is process costing?... 4   1 comments ABC Costing in Make to Order of Repetive Manufacturing I think ABC costing works better only in repetitive manufacturing type of industry, where the amount of production in a given period is steady. Whereas in a make to order environment ABC may not work... 4   1 comments 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... 3   1 comments An ABC Initiative is Only as Effective as the Software That Supports It For any change initiative or performance improvement initiative that is taken in an organization, it is always important that the goal of the initiative has to be finalized first. This is true for Act... 3   What is Job Order Costing? In cost accounting systems, what is job order costing?... 3   1 comments 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... 2   1 comments Start a new topic about Activity Based Costing Sign up for free

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Best Practices The best, top-rated topics about Activity Based Costing. Here you will find the most valuable ideas and practical suggestions. 🥇 Limitations and Advantages of ABC for Budgeting What are the limitations and advantages of ABC in the context of preparing plans and budgets?... 155   3 comments 🥈 Limitations ABC monitoring operations What are the limitations with regard to monitoring and controlling operations?... 89   1 comments 🥉 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?... 39   4 comments The Cost of Non-value-added Activities Why do non-value activities cause costs to increase unnecessarily?... 35   3 comments ABC: reduce non value adding activities? How far do you agree that Activity Based Costing gives opportunities to reduce or eliminate activities that do not add value in a highly competitive environment?... 29   2 comments 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?... 26   4 comments 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... 24   4 comments 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... 22   3 comments ABC Helps Companies Survive Recession Companies using ABC costing have a better chance of surviving the recession than companies using traditional methods. Please give your comments.... 21   1 comments Traditional Costing versus Activity Based Costing When should I choose the traditional costing instead of ABC? Compared with traditional costing, what are the drawbacks of ABC?... 20   4 comments The Process of Activity Based Costing (ABC) simplified While doing ABC the only thing to be kept in mind is the activity and the cost associated with it. For example : A businessman buys a bus for using it in his public transport business. So he will ana... 18   1 comments 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... 17   1 comments Activity Based Costing (ABC) Company's who use ABC method have a more chance in surviving under recession rather than company's who use Traditional Based Costing.... 17   2 comments 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... 16   2 comments Calculating the Most Profitable Way of Manufacturing a Product Dear all, I am struggling with the start of a project in which I need to figure out what way of supplying a customer with a certain product is most profitable (from buying raw materials till deliverin... 7   3 comments Recommended ABC Software Which software package would you recommend I use in our small business to enable me to setup an ABC-system?... 6   8 comments

Expert Tips Advanced insights about Activity Based Costing. Here you will find professional advices by experts. Consultancy Tips Teaching Tips Practical Implementation Tips 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... Disadvantages of ABC Cost Mgt, Decision-making Following disadvantages can be associated with the application of Activity Based Costing: - Cost effectiveness: Cost e... 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... 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...

Information Sources Various sources of information regarding Activity Based Costing. Here you will find powerpoints, videos, news, etc. to use in your own lectures and workshops. 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... 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... Costing Strategies Multinational Companies Paper by Marco Agliati argues that in a globalization context, it becomes of pivotal importance being able to make cost ... 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... 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 ... 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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