The services based on the resources that they consume & the system assigning costs to products is known as ABC [Activity based costing] Its objective is to change the way in which costs are calculated. Activity based costing is another way to the traditional accounting in which a business's overheads indirect costs such as marketing, heating and lighting are allocated in proportion to an activitys direct costs. ABC & activity based management are the two have been around for more than 15 years. Most forward minded firms have implemented them or are in the process of implementations. Mass produced industrial robots for instance may use the same amount of materials & labour as a customised robots. Alternatively the customised robot uses far more of the firms engineers time an overhead than does the huge mass produced one. This kind of differences is not reflected in traditional costing systems. This is the reason a firm that makes huge customised products which are bases its pricing on historic costings can soon find itself making large losses The new technologies that make it easier for firms to customise its products, the importance of allocating indirect costs accurately rises Introducing abc is not a simple task , it is by no means as easy as activity based accounting. To start most business activities must be broken down into their discrete components. In abc programme for Eg, ABB a Swiss Swedish power company who divided its purchasing activity into updating the database ,negotiating with suppliers, handling complaints and issuing purchase orders. Big company should try a pilot scheme before implementing the system throughout their organisations .The information important for abc may not be readily available and may have to be counted specially for the purpose.This involves makes many new measurements. Big companies often recrute consultants who are specialists in the area to help them get a system up & running. The most easiest approach is to use ABC software in conjunction with a firms's existing accounting computers The traditional system continues to as a former ABC structure with an additional requirement would be when the specific cost information to help make the special needs decision. When the costing of the activities have been completed costs incurred and made a total, then the total cost in accordance with the product range, customer base, target market or project subject to assessment.Compared with other accounting systems, the accounting system based on the application of cost accounting, compared to the total costs to direct labor and machine hours approach, closer to the actual situation.
Activity-based costing (Activity based Costing) which is also known as absorption costing (Absorption Costing). When the costing of the activities have been completed costs incurred and made a total, then the total cost in accordance with the product range, customer base, target market or project subject to assessment compared with other accounting systems, the application of the accounting system based on cost accounting, compared to the total costs to direct labor and machine hours approach, closer to the actual situation.
A brief history
In 1980 activity based costing arose as a result of increasing dissatisfaction with traditional ways of allocating costs. This idea is behind the work of Michael Porter ( Competitive Advantage p- 33) who developed the idea of the business as a chain of inter-linked activities. In his study profits are no more than the adding up of the difference between the price that customers pay for an and the cost of that activity. Measuring the activities cost correctly then becomes central to made a profit. ABC went into a period of disrepute. Robert Kaplan (Harvard Business School ) professor sometimes credited with being its founding father has admitted that it is stagnated in 1990's. The difficulty in translating the theory into realty. Most companies were not-prepared to give up their traditional cost control mechanisms in favour of activity based cost.In his famous book "Cost & Effect" Kaplan States that "most people are taking advantage of only a fraction of the potential benefits of modern cost management".
Moreover activity based costing has many satisfied clients. An American Automobile (Chrysler) manufacturer is now part of DaimlerChrysler who claims that it saved 100 of millions of dollars through a programme that it started in the 1990 era's . ABC also showed that the true cost of certain Chrysler parts was thirty times what had originally been estimated and calculated , a research that persuaded the company bound to outsource the Manufacture of many of those parts.
Activity Based Costing Advantages & Disadvantages
Better understanding of overhead
More time consuming to collect data
Easier to understand for everyone
Cost of buying, implementing and maintaining activity based system
More accurate costing of products/services
Utilizes unit cost rather than just total cost
Makes visible waste and non-value added
Activity based costing methodology are widely used by numbers of global companies as a system of management, budgeting,and controlling, planning has purposes mentioned below [Dugdalein 1990: 36, Kaplan & Cooper in 1992: 11, Morgan in 1993: 9 and Cokins 1996:9 ]
â€¢ To find main sources of problems and to solve them,
â€¢ To remove incorrect analysis and to solve problems caused by inefficient cost allocation & to remove or minimize costs that have less value added and do not create value.
The above purposes confirm the relations between target costing methodologies and activity based costing & especially the last purpose makes a very vital role [Can in 2004 , 131]. Because it make the cost drivers of firms more understandable and visible [Horvath in 1991, 211; Glaser in 1991 ,p227, Mayer in 1991 p 211] In most related literature the importance and relations about the combination between activity based costing and target costing is underlined and it is firmly put emphasis on using the mentioned methodologies together [ Buggert & Wielpütz in1995 , p 129). When targeting costing methodology informs managers about target costs and market demand , ABC shows the effects of releted production styles on indirect cost center [ Horvath in 1993 & Koons in 1994 p 11). In activity based costing (ABC) the cost drivers are better & more right to be determined in order to achieve the target of reaching the target costs related with products or services & this enables firms to adapt their cost management plans accordingly with the market demand (Cervellini in 1994 p70)
The costs of manufacturing a product have been categorized as direct labor, overhead and direct material , traditional cost systems is also called (VBC) volume based cost systems trace overhead cost to the product based on the various assumption that the products cause the costs. ABC on another side, focuses on various activities performed in manufacturing the products. ABC is defined by CAMI (Computer Aided Manufacturing International) as "the collection of financial and operating performance information tracing the significant activities of the firm to product costs" (47 page 2).
Liggett et-al says the underlying philosophy of Activity based costing as follows-
(Certain activities are carried out in the manufacture of products. Those Activities consume firm's resources, thereby creating costs. The products, in turn, consume activities. by determining the amount of resource (and the Resulting cost) consumed by an activity and the amount of activity consumed in Manufacturing a product, it is possible to directly trace manufacturing costs to Products) [32 page.4].
We can analysis that the methodology used for Activity Based Costing is good, and can found that sometimes it is great savings to a company who is willing to take the effort, time and expense to implement a wonderful plan. Though there are few demerits to the process with perseverance & a good commitment from management Activity based costing can be of good benefit to a manufacturing company.ABC is a another way of viewing at an organizations costs in order to get profit margins. If Activity Based Costing is implemented with the correct understanding for the right purpose then it can return a good long term monetary value to the company.