Activity Based Costing can be defined as a costing system that easily determines specific activities of an organization and allocates the costs to these activities in relation to the products and services taking into consideration the actual consumption by each. It involves assigning of overhead or indirect costs into direct costs. This gives an organization an opportunity to determine the position of the costs of its products and services for the sole objective of detecting and doing away with those products and services that are not profitable.
Taking such measures also assists in the reduction in the price of the same products and services that may be overpriced. In 1930's when security and exchange acts placed a greater emphasis on financial accounting, cost accounting was split off as a separate accounting surviving in the mainstream of accounting (Taney, 1998). The application of ABC system of costing and management involve the allocation of resource costs in line with its activities to the products and services.
It is a vital tool used to undertake the important policies such as outsourcing, pricing, improvement of products and services and finally determining procedures that if undertaken could lead to the improvement of the delivery of such products and services to the customers. In the past, accountants applied techniques that were not very effective in price reduction and lacked means of identifying numerous bottlenecks in the achievement of customer satisfaction. The two decades of the 1970s and 1980 saw the further application of ABC as a system of costing especially in the manufacturing segment of the economy.
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The traditional forms of costing do not often attain accurate costs of production and other costs in the service delivery. ABC deviates from the application of broad arbitrary fractions in the determination of actual costs and further goes ahead to locate connections that exists between these costs (Baker, 1998). Upon the identification of costs of an activity, the actual costs of each activity are linked to each product or service that makes use of this activity.
ABC therefore assists in detecting the loopholes of excess overhead costs per unit and creates the opportunity for finding solutions to problems of using excess amounts in the production line (Hicks, 2002). These systems of management can be traced back to early 1980s when the manufacturing industry extensively used them. Technological advancement in the manufacturing sector has led to massive direct costs in labour and raw materials while leading to an upward surge in indirect costs. A good example is the use of automated machines that has considerably led to a decline in costs of labour but has led to the increase in costs of depreciation.
The cross- product- cross -customer subsidies can be made into use by both the manufacturing firms and the financial institutions. The term cost deriver, which refers to the determination of the level of use of a common activity by each product estimates costs involved in shared activities (Richard, Crawford and Rebishcke, 1990). Before the invention of Activity Based Management, it was hard to determine costs linked to the process of developing a product and its final delivery and thus calculating actual figures in profits was not easy.
Activity Based Management takes a deep examination into costs-both direct and indirect, the process and even the type of activity. These indicators then assist in ascertaining the actual expenses system and management improvement (Plowman, 2001). According to Plowman (2001), identification of actual costs in expenses incurred in the whole process of developing a product up to the final step of delivering enables entrepreneurs to find solutions in cutting down overall costs involved in these processes.
To remain competitive in the market, a company is required to understand and know its sources of profits and costs and this is best achieved by the application of Activity Based Management. Determination of level of profitability of each and every product, reasons as to why there exists differences in their profit variations, are some of the important parameters companies must apply to remain profitable by maximizing their profits while minimizing their costs.
Further indicators involve concentrating efforts on activities that bring back greater rewards, insights on how to improve customer relationships and knowledge of customer response and reaction towards a particular product or service are best understood and improved by activity based management system. The constant shifting of customer demands requires a management system that is value driven and that seeks to improve its level of customer and client relationships (Moisello, 2007).
While market trends in the global trade arena have taken considerable change in terms of service and product delivery, such changes must meet strategies aimed at adapting to them and maximizing benefits that come along while minimizing detrimental factors associated with them. Although ABC noted enthusiastic response upon its release, it dropped down in 1990’s and left room for other systems such as the Balanced Scorecard and Economic Value Added. These systems resemble the Activity Based Management and Cost systems in many ways but with little variations and improvements.
It has furthermore stagnated due to the technological advancements in the management and cost evaluation sector of business. Activity Based Cost is moderately used in many parts of the globe due to the benefits that come along with it. The England and Wales National Policy recommended the use of Activity Based Costing system to the UK Police in 2003- 04 in the policy performance assessment framework. Conclusions as to the successful application of this cost system have come up with a big nod describing it a full exploitation of available resources.
ABC costing systems increase and facilitate effective budgeting by recognizing all the costs incurred and the total performance in the organization or company. In today’s environment managers manage and focus on activities, if the activity is managed effectively, a company experiences lower unit costs and become more competitive (Ballast, Rachlin and Sweeny, 1996). Budgeting is a daunting task and its process requires accurate analysis of all the information required for its process.
In this case, an organization which uses ABC system stands a better chance in coming up with the best budget which fits the organization needs and requirements thus enhancing its growth sustainability and development. ABC costing brings out the best information which helps in contract negotiations. When a company tenders for qualification to supply a given product it produces, it is upon this particular costing system that one can come out with an adequate inside information concerning which prices to charge after analyzing all the costs involved .
It is therefore very easy to know whether a company successfully negotiated for a contract which is gainful or not. Without this information which ABC costing provides, it is not easy for a company to critically evaluate the usefulness of Activity Based Costing. Activity Based Costing eliminates waste in an organization or a company . This is because it provides an avenue of knowing non-value added activities in the organization hence the company avoid spending on such activities.
This has also enabled enterprises to model the impact of cost reduction and subsequently confirm the savings achieved (12manage, 2009). All organizations or companies are after wise use of the available resources for their sustainability and development; therefore, this costing system is of great significance for the growth and development of the organization. ABC also helps in decision making in an organization since it brings forth the ideas of estimation and pricing which are geared on product costing during manufacturing process.
This particular information on costs and prices is the key in the analysis of the progress of an organization or a company. It is always noted that ABC improves the profits of an organization or a company as it analyses and monitors the whole life cycle of all costs involved and the general performance. The life of an organization is always pegged on its ability to generate profits and a system which promotes such gain is beneficial to the organization. Poor negotiation of contract always turns out to be a big loss to the company hence jeopodising the sustainability, growth and developments of the company.
Furthermore, it is upon this costing system that one can identify market cost of a product and its distribution channel cost because of its total analysis of all the costs involved in a product manufacturing process up to the last point when it is available for the consumer in the market. ABC costing monitors all the cost involved in the life–cycle of a project and it thus facilitates the process of tracking project cost accurately. In many cases some projects stall for a period of time then starts again.
In such a case you will find that some costing system normally leaves out some elements of costing for instance time and hence does not give out the accurate project cost. ABC costing system therefore monitors all the costs involved and thus the result is reliable for accurate decision making regarding the project. With the costing based on activities, the cost of serving a customer can be ascertained individually (Value Based Management. net, 2009). ABC costing system also helps in quantifying contract cost.
Normally in organizations and companies whose main objective is to make profit, sustain their operations and grow, quantifying contract costs is inevitable . This is because a company or an organization which wants to know quantitatively the cost of products and services it out-sources, it will easily use the information offered by ABC costing system. Quantifying a contract will also require that it is put in monitory terms whether it’s a product or a service offered for it to be understood easily by anyone. It is also identified that ABC costing system encourages continuous progress, growth and control of all activities.
This makes it easy for an organization or a company to predict the future growth and budget for it adequately. Corporate strategies are easily linked to operational decision making by ABC costing system since it provides all the information concerning all costs at all stages. This makes it easy to plan, budget and make choices on which areas earn most to the organization or company. Apparently, Activity Based Costing/Management system has been with us for more than one and a half decade has only been used in few organizations (Cokins, 1999).
While a considerable number of financial institutions and manufacturing industries have appreciated the effectiveness of ABC/ABM system of costing and management and gone further ahead to embrace it, a sizeable fraction of the said number of organizations have not taken the advantages of the application of these system. This is basically due to the limitation that comes along with the benefit of ABC/M system of costing and management. The slow response to its embracement is associated with its high cost of implementation.
It is therefore true to say that Activity Based Costing/Management has revolutionized the costing and management systems but has not been widely embraced globally. It is a success story and innovation that is waiting to be fully exploited. It is worth noting that these systems require skilled manpower to understand them and fully exploit the benefits which come along with them. It is only through this, that these systems will eventually take over a good percentage of the overall costing and management globally.
Finally, advancements in the level of technology must provide cheaper solutions and open the windows of opportunities that come when there is a considerable reduction in their implementation cost.
12Manage, 2009, Activity Based Costing (ABC). Retrieved on 26th April 2009 from: http://www. 12manage. com/methods_abc. html Baker, J. J. , 1998, Activity-based costing and activity-based management for health care. ISBN 0834211157, 9780834211155, Jones ; Bartlett Publishers Ballast, D. K. , Rachlin, R. and Sweeny, A. , 1996, Accounting and financial fundamentals for nonfinancial executives, (2nd Edition).
ISBN 0814479286, 9780814479285. AMACOM Div American Mgmt Assn Cokins, G. , 1999, Learning to Love ABC, Journal of Accountancy, Vol. 188, pp. 19-42 Hicks, D. T. , 2002, Activity-Based Costing: Making It Work for Small and Mid-Sized Companies, (2nd Edition), ISBN: 978-0-471-23754-9, Wiley Moisello, A. M. , 2007, Activity Based Costing as a Marketing Tool. International Journal of Knowledge, Culture and Change Management, Volume 8, No. 8, pp. 59-68 Plowman, B. , 2001, Activity based management: improving processes and profitability. ISBN 0566081458, 9780566081453, Gower Publishing, Ltd.
Richard, S. Crawford, D. and Rebishcke, S. , 1990, Activity-based costing and simulation modeling, Journal of Bank Cost and Management Accounting, Vol. 3, No. 2, pp 45-63 Taney, C. R. , (1998, January), Activity-based costing: The missing ingredient. The Journal of Bank Cost ; Management Accounting, Vol. 4, pp 29-36 Value Based Management. net. Activity Based Costing (ABC): Analyzing Product and customer profitability: (Time-Driven) Activity Based Costing, (2009, March). Retrieved on 26th April 2009 from: http://www. valuebasedmanag
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