Activity-Based Costing Cost Accounting Is Term Paper

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General & Administrative-costs cannot reasonably be associated with any particular product or service produced (overhead). These costs would remain the same no matter what output the activity produced. An example would be salaries of personnel in purchasing department, depreciation on equipment, and plant security.

In the next step the results of analyzing activities and the gathered organizational inputs and costs are brought together, which produces the total input cost for each activity. A simple formula for costs is provided - outputs consume activities that in turn have consumed costs associated with resources. This leads to a simple method to calculate total costs consumed by an activity - multiply the percent of time expended by an organizational unit, e.g., branch, division, on each activity by the total input cost for that entity. Here we are not calculating costs, just finding where they come from.

Next, the actual activity unit cost is calculated. Even though activities may have multiple outputs, only one is identified as the primary output. Activity unit cost is calculated by dividing the total input cost, including assigned costs from secondary activities, by the primary activity output volume; the primary output must be measurable and its volume or quantity obtainable. From this, a bill of activities can then be calculated which contains or lists a set of activities and the amount of each activity consumed. The amount of each activity consumed is extended by the activity unit cost and is added up as a total cost for the bill of activity. Below is an example of a form used to capture first stage cost drivers.

Expense Category

Cost ($)

Cost Drivers

Administration

Time (hours)

Depreciation

Dollar use of resources ($)

Rent and utilities

Space (ft2)

Office expenses

Level of use of office resources (%)

Transport

Distance (miles)

Interest

Cost of the activity ($)

Product shipment

Weight (Lb)

Business travel

Distance (miles)

Business insurance and legal expenses

Cost of resource used by the activity ($)

Advertising

Level of benefit (%)

Entertainment

Level of importance of customer (%)

Miscellaneous expenses

The organization assigns activity costs to outputs using activity drivers. Activity drivers assign activity costs to outputs based on individual outputs' consumption or demand for activities. For example, a driver may be the number of times an activity is performed (transaction driver) or the length of time an activity is performed (duration driver). Below is example of a form used to capture second stage cost drivers where activities are traced to products.

Activity

Cost Driver

Customer contact

Number of customer contacts

Quote preparation

Number of quotes

Engineering work

Engineering hour

Material purchasing

Number of purchase orders

Production preparation

Number of production runs

Material receiving and handling

Number of receptions

Production management and supervision

Product complexity

Quality assurance

Product complexity

Product shipping

Distance

Customer payment administration

Number of payments

General management and administration

Intensity of activities

In the final step, the calculated activity unit costs and bills of activity are used to identify candidates for improving the business processes. Managers can use the information by stratifying, for a Pareto analysis, the activity costs and identifying a certain percentage of activities that consume the majority of costs. The identification of non-value added activities occurs through this process with a clarity that allows the organization to eliminate them, and at the same time permits the product or service to be provided to the customer with greater efficiency.

It is an unwritten rule respected by many in the business world that you generally treat your best customers the best. The problem is, does an organization really know who their best customers are, or do they think you know? The majority of business people have the false perception that the best customer is the one that accounts for the largest portion of their income every year. This is not always the case because that same customer may also be responsible for the biggest part of their expenses. Activity-based costing is a costing method that provides managers with useful information they need regarding the contribution that each customer makes to overall profitability. Also, ABC allows managers to see how to maximize performance and implement sound profit-growth strategies.

ABC also makes it very clear that integrated costs associated with the services that the customer demands play a crucial role in determining each customer's contribution to net profit.

Studies have shown that 20% of all customers virtually provide all the profits of a company. Another 60% break-even and the remaining 20% only reduce the bottom line. Wouldn't it be nice if the organization had the names of that 20% of headache-inducing customers that are literally more trouble than they're worth?

To determine how much a customer is costing you, you must first identify the activities that relate to each customer and determine the total cost absorbed by those activities. These activities or "cost drivers" should be then considered to measure the level of activity absorbed by each customer. The ultimate purpose of implementing ABC is to separate these activities into individual cost drivers. Then, all that is needed is to measure each customer's participation in the specific cost. When choosing cost drivers, they should be relevant and easy to measure. Relevancy relates to the direct or indirect relationship bearing on the cost of doing business, and ease of measurement means that the organization must be able to allocate to each customer the portion attributable to the activities consumed.

Cost drivers might include, but not be limited to, inside/outside sales, order processing, credit, delivery, telephone expenses, training, application expertise, after-hour service, design time, machining etc.

In conclusion, the major objective of the ABC process is to objectively determine a better way of doing business. "ABC provides not only relatively accurate cost data, but also information about the origin of the cost. ABC has been implemented in numerous companies, and managers familiar with the ABC method were able to manage costs more successfully." The analysis of these costs and models serves to provide the basis from which these decisions can be made and evaluated. The determination of different and improved ways of accomplishing the major objectives and goals in a better, faster, and cheaper way is difficult to achieve even in the simplest structures. The project team and activity accountant must keep the ultimate goals of the project ever in mind if the project will ever be completed in a successful manner. When this is done and the work is accomplished, the results will more than pay for the means to get there. The bottom line is to achieve a better method of doing the right business of the organization.

Bibliography

Cagwin, Douglass and Marinus J. Bouwman, (2000) the Association Between Activity-Based Costing and Improvement in Financial Performance, University of Texas at Brownsville.

Dunkley, James and David Payne, the Essence of ABC - the OffTech Approach, ABC White Paper, OffTech Computing Pty Ltd., Cumberland Park South Australia.

Edith Cowan University, Activity-Based Costing (ABC) - an Executive Summary, Retrieved July 12, 2005 at http://www.ecu.edu.au/msc/manacct/abc/.

Granof, Michael H., David E. Platt and Igor Vaysman, Using Activity-Based Costing to Manage More Effectively, Grant Report, January 2000.

Roztocki, Narcyz, Jorge F. Valenzuela, Jose D. Porter, Robin M. Monk and Kim LaScola Needy, a Procedure for Smooth Implementation of Activity-Based Costing in Small Companies, State University of New York.

Roztocki Narcyz and Kim LaScola Needy, an Integrated Activity-Based Costing and Economic Value Added System as an Engineering Management Tool for Manufacturers, University of Pittsburgh.

Michael H. Granof, David E. Platt and Igor Vaysman, Using Activity-Based Costing to Manage More Effectively, Grant Report, January 2000, p. 7.

Douglass Cagwin and Marinus J. Bouwman, (2000) the Association Between Activity-Based Costing and Improvement in Financial Performance, University of Texas at Brownsville, p. 27.

James Dunkley and David Payne, the Essence of ABC - the OffTech Approach, ABC White Paper, OffTech Computing Pty Ltd., Cumberland Park South Australia, p. 2.

Edith Cowan University, Activity-Based Costing (ABC) - an Executive Summary, Retrieved July 12, 2005 at http://www.ecu.edu.au/msc/manacct/abc/.

Narcyz Roztocki, Jorge F. Valenzuela, Jose D. Porter, Robin M. Monk and Kim LaScola Needy, a Procedure for Smooth Implementation of Activity-Based Costing in Small Companies, State University of New York, p. 3.

Roztocki, p. 5.

Narcyz Roztocki and Kim LaScola…[continue]

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