Activity based costing

Activity based costing – ABC
– Created as an answer to criticism of traditional costing
(1987 - Cooper R., Kaplan R. S., How Cost Accounting Systematically Distorts Product
Costs)

Disadvantages of traditional costing
– An assignment of product costs based on the size of production
(unit-based cost system, volume-based cost system)
 Calculation is more exact when more costs can be accounted for directly
 Typical costs drivers include quantities connected to production size
– A grouping of costs according to functions based on organizational structure of
the enterprise
 General productions costs are settled proportionally to the sum of direct
costs and department costs
1
Activity based approach of the enterprise
Enterprise
Person
el
Develop Market Production
ing/Sales
ment
Disadvantages of traditional costing:
 Lack of customer-orientation
 Rigid organizational structure,
hierarchy
 Non-continuous flows
 Excessive supervision and
coordination systems
 Too much documentation
 More possibilities to make
mistakes
 Higher costs
Order
Fulfillment
Product
Development
Customer
Service
Person
el
Develop
ment
Marketing
Sales Production
2
Process flows in the organizational structure

An employee completes his/her part of the process.
Who controls the whole process?
3
From functions to activities
Activity-based costing
Functional-based
costing




Department centered thinking...
Multi-level hierarchy…
Too-detailed division of labour…
Excessive asset-orientation…




....thinking about the whole system,
beyond departments
....flat organizational structures
....increased scope of activities and
responsibilities
....result-oriented
4
Key word: process (1)

„A process is a collection of activities demanded at an input entry phase and
producing a valuable to the client result at the end ”
/M. Hammer, J. Champy/

„A process describes the flow and transformation of materials, information,
operations and decisions”
/T. H. Davenport/

A business process is a flow of sequenced activities, having a beginning and an
end, and precisely and clearly defined input and output, leading to a particular
effect that has a value to the client
Market
purchase
sale
transport
invoice
Information
5
Key word: process (2)
KLIENT
PRZEDSIĘBIORSTWO
Dane
dostawców
Dane
materiałowe
DOSTAWCA
Przygotować
transport
Zrealizowano
dostawę
Zrealizowano
zamówienie
Realizować
zamówienie
Przekazano
do produkcji
Zaopatrzenie
Zaopatrzenie
Zapotrzebowanie
wystąpiło
Przygotować
zlecenie
Zlecenie
gotowe
Dokumentacja
techniczna
Dane
produktu
Dane
klienta
Opracować
zlecenie
Towar
gotowy
Produkt
wytworzyć
Zlecenie
przyjęto
Przedstawiciel
handlowy
Towar
nadesłano
Produkt
wytworzony
Odlewnia
Opracowanie zlecenia
Wytwarzanie
Towar
przyjąć
Dane
klienta
Dane
produktu
Produkt
przesłać
Towar
przyjęty
Zbyt
Zbyt
LEGENDA
Dane
Funkcje
Jednostki
organizacyjne
Zasoby
6
Process levels
Level of the mail processes:
Inventory /Stock / Supply
Level of the partial processes:
Purchase of raw materials
Level of activities:
Choice of
supplier
Purchase
order
Transport
receipt
Invoice
payment
Order delivery
Invoice control/
inspection
Poziom czynności:
Analysis of the
supplier market
Questions to
offerers
Analysis of the
offers
Negotiating
conditions
Agree on the
schedule and
conditions of
freight
Signing an
agreement
Order
confirmation
Quality
inspection of
deliveries
Storeroom
documentation
prepared
Documentation of
operations
Settlement of
payables
7
Changing concepts in organisations

BPR – Business Process Reengineering
(1900s)
– „Business Process Reengineering is a fundamental rethinking and radical
reengineering of processes in an enterprise, leading in a dramatic way to
breakthrough improvements according to modern, critical measures such as
cost, quality, service, and speed ”
/M. Hammer, J. Champy, 1993/

BPO - Business Process Orientation (currently)
– a concept of changes leading to systemic organization, analysis, and
assessment of economic processes in order to obtain improvements in
measures of these processes such as time, cost and quality

BPM - Business Process Management (currently)
– a systemic approach to analysis and continuous improvement of activities in
an enterprise. The important elements of a concept are: actual
documentation of processes, organizational structure process-oriented,
processes' aims and measures, information systems about processes,
motivation system”
8
Process- approach in management

Processes are starting point for:
–
–
–
–
–
–
–
–
–
Internal changes in an organization
Defining the value chain inside the organization
Defining the value chain among organizations
Implementing IMS
Obtaining ISO 9000:2000 certificate
E- business
Use of activity based costing (ABC)
Activity based management
Implementation of Customer Relationship Management and
Knowledge Management concepts
9
Activity based costing - process approach
Amortization
Labour
Materials
Energy
Social
insurance
Employee
benefits
Foreign services
Taxes, charges
and fees
Costs incurred
Materials
Employees
Equipment
Space
Resources required
Activity
1
Activity
2
Activity
3
Activity
N
...
Need to do activities
Product
A
Product
B
Product
C
Product
D
...
Product
Z
10
ABC's definition

Activity Based Costing – ABC
– A method of measuring costs and an effectiveness of activities,
resources, products, and clients as well as other cost objects,
consisting of relating resources to activities and activities to other
cost objects based on the degree of use of an activity and also
understanding of the casual relations among cost-raising variables
and activities
/Cooper R., Kaplan R. S./
– Resources of an enterprise are used by activities (processes), not
by products or organizational units
– The main part of general and overhead costs does not depend on
the product volume, but rather changes with the intensity of
conducted activities
11
Model calculation in ABC
Amortization
Labour
Materials
Energy
Foreign services
Social insuranceEmployee benefits
Taxes, charges
and fees
Assigning simple costs to compound costs
Materials
Employees
Equipment
Space
Resource cost drivers
Activity
1
Activity
2
Activity
3
Activity
N
...
Activity cost drivers
Product
A
Product
B
Product
C
Product
D
...
Product
Z
12
Concept of resources in ABC
Compound resources
Simple
resources
Materials
Employees
Equipment
Space
Purchase
price
Taxes,
charges, and
fees
Transport
Insurance
Loading,
unloading
Control
Storing
Compensation
Social insurance
Equipping the work
area
Tools/Equipment
Trainings
Food and drinks
Clothing
Safety measures
(BPH)
Medical care
Amortization
Electricity/Gas/
Water
Supplies link to
usage
Tooling of the
machine
Computer
programs
Maintenance
Insurance
Amortization
Equipping the area
Tooling
Electricity/Gas/
Water
Installations
Upkeep
Security
Taxes, charges,
and fees
Renovations/fixing
Insurance
13
Concept of cost driver



Cost driver
– The main cost-creating variable used as a settlement driver (a key)
of cost object on other objects
– Shows an origin of the costs
Resource cost driver
– A variable measuring the usage of a resource in an activity
Activity cost driver
– Describes the main origin of the costs in an activity
– Presents a casual relation between activities and other objects
– Main types of activity cost drivers:
 Time
 Transaction
 Intensity
14
Examples of activity cost drivers
Activity
Activity cost driver
Technical preparation of production
Time spent for technical preparation of production
Production planning
Number of production orders
Setting/Adjustment of equipment
Production
Storeroom management
Internal transport
Quality control
Changing the technical conditions of production
Production steered by a computer
Time spent
Number of production rounds
Time spend (labour-hours LH)
Number of production rounds
Number of components
Weight of the components
Time spent
Number of moves
Weight of the components/materials transported
Time spent
Number of tests
Time needed to prepare the changes
Number of changes
Number of production rounds
15
Calculating costs under ABC

Phases of calculating costs under ABC:
–
–
–
–
Where do costs originate - an analysis of activities and variables
Defining the costs of activities based on resource costs
Choice of the cost driver and calculation of cost per cost driver unit
Assigning activity costs to products
Accounting
Delivery
Prepare an offer
Part of
the
proce
ss
Activity cost driver
Rate of the process
costs
Order materials
Part
of the
proce
ss
Check the
invoice
Make payment
Part
of the
proce
ss
Part of
the
proce
ss
Main
process
Number
of offers
Number
of orders
Number of lines
In the invoice
Number of
invoices
Cost
per offer
Cost
per order
Cost per
line in the invoice
Cost
per invoice
Cost per
driver
16