Activity
Based costing (ABC) is a costing model that
identifies the cost pools, or activity centres, in an organisation and assigns
costs to products and services (cost drivers) based on the number of events or
transactions involved in the process of providing a product or service.
There are costs that vary with the number
of transactions. These are known as activity
costs. As the diversity and complexity of the production process increases,
additional support services tend to be required thus the greater number of
goods and services produced, the greater number of transactions required to
support them.
It works like this:
·
Identify a group of cost
activities through which a product must pass before it is delivered to the customer
·
The total cost of operating
each of the activities for a year must be estimated
·
The total number of hours that
will be spent on each of the activities must be estimated
·
Based on this a ‘cost driver’
for each of the activities can be calculated
·
Assign a suitable cost driver
to each of the activities and calculate an estimate for each cost driver unit.
Here is an example courtesy of the School
of Business New York.
ACME Inc produces two products.
1.
Product A
·
1 hour direct labour ( direct
labour cost for I1hour @ $20 / hour = $20)
·
demand = 100
2.
Product B
·
2 hours of direct labour (
direct labour cost for 2 hours @ $20 /
hour = $40)
·
demand = 950
Total overheads:
$100,000
Total direct
labour: $2,000 hours
$100,000/ 2,000
hours = $50/ hour
Thus Product A
is $50 a unit and Product B $100/ unit on Traditional
cost accounting (TCA)
Let us now look
at what Activity based accounting gives us.
ACME inc
Activities |
Cost drivers |
Activity cost |
Total used |
Set-Up |
No. of set-ups
|
$10,000
|
4
|
|
Machining
|
Machining hours
|
$40,000
|
1900
|
|
Receiving
|
No. of Receipts
|
$10,000
|
4
|
|
Packing
|
No. of Deliveries
|
$10,000
|
4
|
|
Engineering
|
Engineering Hours
|
$30,000
|
1000
|
This then gives us Our Activity Data
|
Activity
|
Cost
($)
|
Product
A
|
$
|
Product
B
|
$
|
Set-Up |
10,000
|
1
|
2,500
|
3
|
7,500
|
|
Machining
|
40,000
|
100
|
2,000
|
1900
|
38,000
|
|
Receiving
|
10,000
|
1
|
2,500
|
3
|
7,500
|
|
Packing
|
10,000
|
1
|
2,500
|
3
|
7,500
|
|
Engineering
|
30,000
|
500
|
15,000
|
500
|
15,000
|
Total Cost |
|
|
24,500
|
|
75,500
|
Thus we get Overhead costs:
·
Product A is $24,500/ 100 =
$245
·
Product B is $75,500/ 950 =
$79.47
Comparison of ABC versus TCA
Cost for Product A:
Overhead TCA $50 ABC $245
Direct cost $20 $20
Total $70 $265
Cost for Product B:
Overhead TCA $100 ABC
$79.47
Direct cost $40 $40
Total $140 $119.47
Thus not only do we get a more accurate
cost of the product we also get to know which customer is your best customer ie
contributes more to net profit
By not pricing properly you do a lot of
work for seemingly little reward.
As can be seen you need professional advice
to do this however it is worth it both for your bank balance and your sanity!
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