Activity-Based Costing

In today’s business world, there is hardly any industry with little to no rivals or competition. Hence, in order to compete successfully against others, companies (be it a manufacturing company or a simple service provider) have no options but to change the way they analyse, report and manage the costs of every activity they perform. What this means is that, there’s that need of replacing old institutions of cost accounting and inventory valuation with new and latest ones. For that reason, several cost management strategies have been introduced; one of which is referred to as Activity Based Costing.

Activity Based Costing (otherwise known as ABC in the business and manufacturing circle) is a financial assessment model that is used in business organisations or manufacturing industries for analysing products, services or customers’ profitability. It is a concept that enables an organisation to: identify profitable products (or services) and customers; use resources more efficiently; eliminate non-value added activities; perform powerful ‘what if’ analysis and benchmarking, and assess shared service and outsourcing opportunities. In other words, it aims to identify activities in an organization and assigns the cost of each activity resource to all products and services according to the actual consumption by each: it assigns more indirect costs (overhead) into direct costs.

How to Implement Activity Based Costing (ABC):

There are several steps or ways of effectively implementing Activity Based Costing. No one way is seen as the best because it completely depends on the management staff, the organisation and, to some extent, the industry the company is being operated in.  However, following the steps below may very well work for any company especially if they’re properly modified. They are:

Step 1: Prepare Your Company for Activity Based Costing (ABC) -  This step involves: defining the mission behind implementing ABC, creating an implementation plan, developing innovative cost reports, identifying general accounting rules, determining training requirements and other events. Activity Based Costing usually works best if everyone in the organisation is involved and there’s no better way for that than to make it happen from the word go.

Step 2: Develop Reasonable a data integrity process – Here the need to have good data integrity is tackled. This is because the impact of poor data in any cost model can be very severe to the image and functionality of an organisation. This can be achieved by analysing the current state of the present operation methodology and collecting useful data for future use. These data will help determine which areas need more attention when implementing activity based cost.

Step 3: Implement activity based cost – This step is the most necessary of them all. It requires that the management determines the real sources of products and their exact or approximate cost. This may require that management dig deep into past records but could be worthwhile in the long run.

Now that Activity Based Cost has been implemented, there’s that need to always monitor the whole thing to ensure it continuously works as initially planned. In order words, the whole process should be monitored from time to time to maintain the practice.