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What Is Activity Based Costing
Table of Contents
  1. Introduction
  2. The evolution of ABC
  3. ABC implementation
  4. Conclusion
  5. References

Introduction

Activity based costing (ABC) is a special managerial costing tool developed primarily to identify relevant activities in an organization. ABC is also a tool used when assigning the cost of each activity carried out within the organization, inclusive of all products and services ongoing according to the actual consumption by each. Furthermore, ABC can be defined as a managerial technique that aid in tracing resource costs within the organization (Kennett, Durler & Downs, 2007). Additionally, ABC also assigns specific cost to services, products and customers at large in proportion to their activity usage.

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The evolution of ABC

Activity based costing was developed in early 1980s by Robin Cooper and Robert Kaplan (Kennett, Durler & Downs, 2007). During this time, ABC was precisely used for manufacturing environmental activities. Through the efforts of Cooper and Kaplan, ABC was entirely popularized in the late 80s until the year 1998 when Dale Geiger fully published a series of five articles in this publication (Kennett, Durler & Downs, 2007). This published articles openly discussed the roles of ABC as an effective managerial costing tool especially for governmental organizations. Notable to mention is that, ABC has quickly developed to become a very important aspect basically employed in many manufacturing or service providing organizations.

Being a methodological tool that measures costs and performance of activities, ABC has been credited to be the only alternative paradigm capable of fully replacing the traditional cost based accounting systems (Kennett, Durler & Downs, 2007). Activity based costing was also developed as a tool meant to overcome limitations caused by traditional cost accounting methods. Moreover, ABC has also enhanced its usefulness especially during the strategic decision making by managers (Mansor, Tayles & Pike 2012). Moreover, activity based costing was also started to create clear direct performance measures precisely for costs, time and quality outcomes for variety of activities.

ABC implementation

When implementing the ABC protocol system, managers need to observe the following fundamental steps. The first step the manager has to follow is the identification of the activity for example engineering, machining, inspection and many other (Akyol, Tuncel & Bayhan, 2005). This is followed by the determination of the activity cost. The third step involves the determination of cost drivers for example in the number of set up, machining and engineering hour. Finally, the manager has to collect the activity data and dwell on computing all the product costs.

ABC being an economical model focuses on identifying the major cost pools or activities in a specified organization. This economical model also assigns cost to cost drivers based on the exact number of each activity used. There are various levels at which the cost drivers are related to the activities. The first is the unit level driver. This level assumes that there is an increase in the inputs for every unit undergoing production (Akyol, Tuncel & Bayhan, 2005). The second level is the batch level driver, which concentrates on the variation of inputs for each and every batch that is undergoing production.

The third level is the product level drivers. This level specifically assumes the necessity of inputs directed to support the manufacturing of various types of products. Finally, is the facility level driver, which is also related to the facility manufacturing process. It is mandatory for ABC users to indentify the exact activity that generates costs then cross match them with the level bases used to determine the costs of the products (Akyol, Tuncel & Bayhan, 2005). In summary, “when employing the ABC system, all activities generating costs must at all time be determined and also must be compared to the level drivers used to assign costs to the product.” (Akyol, Tuncel & Bayhan, 2005).

For many decades, it has been noted that majority of management accountings have been gradually increasing their strategic efforts for developments. This is primarily dedicated to ensure that better financial accounting standards were achieved and proper costing procedures well copied within the organization (Mansor, Tayles & Pike 2012). Additionally, several management accounting techniques have also been recently developed. They include; ABC, product life analysis, benchmarking among many others (Mansor, Tayles & Pike 2012). These ABC and its derivatives techniques are currently being absorbed by public utilities, retail and wholesale organizations. This paradigm of ABC has aided many private and public organizations to boost and improve their competitive power.

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Conclusion

In summary, it is important to note that there is a great distinction between the ABC and the traditional cost accounting techniques. This is evident by the fact that traditional cost accounting techniques concentrates on securing costs to products basing on attributes of a single unit. This attributed also involves the number of direct labor hours allocated to completely manufacture a product. (Akyol, Tuncel & Bayhan, 2005). Contrary, ABC technique directly focuses on activities that is required to manufacture each product or services consumption of the activities. This means that ABC directly assigns costs to activities and products precisely basing on the degree at which the cost is consumed by the product. Moreover, “ABC technique provides the manager with clearer picture of the specific cost of processes and the profitability of customers and products” (Akyol, Tuncel & Bayhan, 2005).

References

Akyol, D.,Tuncel, G. & Bayhan, G. (2005). A Comparative Analysis of Activity-Based Coasting and Traditional Coasting. World Academy of Sciences, Engineering & Technology, 3: 44-47

Kennett, D., Durler, M. & Downs, A. (2007). Activity-Based Costing in Large U.S Cities: costs and Benefits. The journal of government financial management, 56 (1): 20.

Mansor, N., Tayles, M. & Pike, R. (2012). Information usefulness and usage in business decision-making: An activity-based costing (ABC) perspective. International journal of management, 29 (1): 14-19

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