Activity-Based Costing Essay Sample free essay sample

Activity-based costing ( ABC ) is an accounting method that allows concerns to garner informations about their operating costs. Costss are assigned to specific activitiesuch as planning. technology. or manufacturingnd so the activities are associated with different merchandises or services. In this manner. the ABC method enables a concern to make up ones mind which merchandises. services. and resources are increasing their profitableness. and which are lending to losingss. Directors are so able to bring forth informations to make a better budget and derive a greater overall apprehension of the disbursals that are required to maintain the company running swimmingly. By and large. activity-based costing is most effectual when used over a long period of clip. as opposed to shorter-term solutions such as the theory of restraints ( TOC ) . Activity-based bing first gained ill fame in the early 1980s. It emerged as a logical option to traditional cost direction systems that tended to bring forth deficient consequences when it came to apportioning costs. Harvard Business School Professor Robert S. Kaplan was an early advocator of the ABC system. While chiefly used for private concerns. ABC has late been used in public forums. such as those that measure authorities efficiency. HOW ACTIVITY-BASED COSTING WORKS Activity-based costing plans require proper planning and a committedness from upper direction. If possible. it is best to make a test survey or trial tally on a section whose profit-making public presentation is non populating up to outlooks. These types of state of affairss have a greater opportunity of wining and demoing those in charge that ABC is a feasible manner for the company to salvage money. If no cost-saving steps are determined in this pilot survey. either the activity-based costing system has been improperly implemented. or it may non be right for the company. The first thing a concern must make when utilizing ABC is set up a squad that will be responsible for finding which activities are necessary for the merchandise or service in inquiry. This squad should include experts from different countries of the company ( including finance. engineering. and human resources ) and possibly besides an outside adviser. After the squad is assembled and informations on such subjects as public-service corporations and stuffs is gathered. it is so clip to find the elements of each activity that cost money. Attention to detail is really of import here. as many of these costs may be hidden and non wholly obvious. As Joyce Chutchian-Ferranti wrote in an article for Computerworld: â€Å"The key is to find what makes up fixed costs. such as the cost of a telephone. and variable costs. such as the cost of each phone call. † Chutchian-Ferranti goes on to observe that even though in many cases engineering has replaced human labour costs ( such as in voice-mail systems ) . a concern director must still analyze the hidden costs associated with keeping the service. Nonactivity costs like direct stuffs and services provided from outside the company normally do non hold to be factored in because this has antecedently been done. Once all of these costs are determined and noted. the information must be input into a computing machine application. Chutchian-Ferranti explains that the package can be a simple database. off-the-rack ABC package. or customized package. This will finally give the company plenty informations to calculate out what they can make to increase net income borders and do the activity more efficient. After a concern has had adequate clip to analyse the information obtained through activity-based costing and determine which activities are cost effectual. it can so make up ones mind what stairss can be taken to increase net incomes. Activities that are deemed cost prohibitive can so be outsourced. cut back. or eliminated wholly in an attempt to do them more profitable. The execution of these alterations is known as activity-based direction ( ABM ) . POTENTIAL PITFALLS OF ACTIVITYBASED Costing Companies that implement activity-based costing run the hazard of passing excessively much clip. attempt. and even money on assemblage and traveling over the informations that is collected. Too many inside informations can turn out thwarting for directors involved in ABC. On the other manus. a deficiency of item can take to deficient informations. Another obvious factor that tends to lend to the ruin of activity-based costing is the simple failure to move on the consequences that the informations provide. This by and large happens in concerns that were loath to seek ABC in the first topographic point. In 1999. Gary Cokins wrote an article aimed at certified public comptrollers who have trouble encompassing activity-based costing. In â€Å"Learning to Love ABC. † Cokins explains that activity-based bing normally works best with a minimal sum of item and estimated cost figures. He backs this up by saying that â€Å"typically. when comptrollers try to use ABC. they strive for a degree of exactitude that is both hard to achieve and time-consumingnd that finally becomes the project’s buss of decease. † In 2000. Cokins wrote another article entitled â€Å"Overcoming the Obstacles to Implementing Activity-Based Costing. † In this work Cokins noted that â€Å"activity-based costing undertakings frequently fail because undertaking directors ignore the central regulation: It is better to be about right than to be exactly inaccurate. When it comes to ABC. near adequate is non merely good plenty ; close adequate is frequently the secret to success. † Cokins besides notes that the usage of mean cost rates. the usage of excessively detailed information. and the failure to link information to action can besides impede ABC undertakings. By understanding these constructs. Cokins feels that CPAs can heighten their functions as concern spouses and advisers. Another restricting factor is that activity-based bing package can be pricey. As Mark Henricks wrote in a 1999 article for Entrepreneur: â€Å"Most ABC practicians find that special-purpose ABC package is required to do the undertaking manageable. At $ 6. 000 and up for one bundle sold by ABC Technologies. package can add significantly to outlays for this type of accounting technique. There are. nevertheless. some pilot bundles available for $ 500. † Time can besides be a factor for concerns seeking a speedy hole. Henricks notes that â€Å"although some companies see consequences about immediately. it typically takes three months or so for most concerns to see the benefits of ABC. And depending on your merchandise or concern rhythm. it could take much longer. † ACTIVITY-BASED COSTING AND SMALL BUSINESSES It used to be that big corporations were the lone concerns involved in activity-based costing. Not so today. Service industries such as Bankss. infirmaries. insurance companies. and existent estate bureaus have all had success with ABC. But since its origin. activity-based costing has seemed to hold been more successful when implemented by larger companies instead than by smaller 1s. As Henrick noted. â€Å"Companies with merely a few merchandises and markets aren’t likely to acquire every bit much benefit from establishing costs on activities as companies runing with diverse merchandises. service lines. channels and clients. † But since puting up activity-based costing for a concern normally takes less clip for a smaller undertaking. a little concern that is diffident about the effectivity of ABC can see a simple trial plan to find whether it is right for them. Douglas T. Hicks is one expert who feels that the clip is right for little concerns to implement activity-bas ed costing. In a 1999 Journal of Accountancy article entitled â€Å"Yes. ABC is for Small Business. Too. † Hicks presented a instance survey for one of his clients. a little maker that builds constituents for the car industry. Yokels detailed how they were able to treble gross revenues and increase net incomes fivefold in a four-year span after following ABC. â€Å"Much of this betterment came from a profitable mix of contracts generated by a costing/quoting procedure that more closely reflects the existent cost construction of the company. † Hicks stated. â€Å"This has enabled the company to better the direction of its contracts. † Isolating and mensurating the cost of material motion and utilizing the information to warrant many operational alterations were other factors Hicks cited for the success his client had with ABC. Hicks besides noted a alteration in management’s attitude after the success of ABC: â€Å"On an of import but less touchable degree. management’s cognition of and attitude toward cost information have undergone a significant alteration. Where once directors had their ain manner of mensurating the cost impact of direction actions. they now measure those cos ts in a formal. unvarying manner. When directors contemplate alterations. they have a mental theoretical account that directs them toward alterations that genuinely benefit the organisation. † Hicks went on to state that â€Å"any little or midsize organisation can develop an ABC system. It doesn’t necessitate a great committedness of clip or fiscal resources. Nor does it necessitate the execution of particular package integrated into the general ledgerlthough for larger organisations that may be a benefit. It requires merely that direction position its operations through ‘the lens of ABC’ and make a theoretical account that will enable it to mensurate costs in conformity with that position. † Gary Cokins. manager of industry for a celebrated ABC package and services house. tends to hold with Hicks. In his book Activity-Based Cost Management: Making It Work. he proclaimed that â€Å"Within 10 to 20 old ages. everyone will hold some kind of ABC. It’s a affair of when. non if. à ¢â‚¬  Further Reading: Cokins. Gary. Activity-Based Costing: Making It Work. 1998.Cokins. Gary. â€Å"Learning to Love ABC. † Journal of Accountancy. August 1999. Cokins. Gary. â€Å"Overcoming the Obstacles to Implementing Activity-Based Costing. † Bank Accounting and Finance. Fall 2000. Chutchain-Ferranti. Joyce. â€Å"Activity-Based Costing. † Computerworld. August 1999. Henricks. Mark. â€Å"Beneath the Surface. † Entrepreneur. October 1999. Hicks. Douglas T. Activity-Based Costing: Making it Work for Small and Mid-Sized Companies. 1998. Hicks. Douglas T. â€Å"Yes. ABC Is for Small Business. Too. † Journal of Accountancy. August 1999. Lobo. Yane R. O. . and Paulo C. Lima. â€Å"A New Approach to Product Development Costing. † CMAhe Management Accounting Magazine. March 1998. SEE ALSO: Operating expense Costss ; Product Costing Beginning: Encyclopedia of Small Business.  ©2002 Gale Cengage. All Rights Reserved. Full right of first publication.