a review of activity based cost management principles

8/2/2019 A Review of Activity Based Cost Management Principles

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A Review of Activity Based

Cost Management Principles


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E N T E R P R I S E P E R F O R M A N C E O P T I M I Z A T I O N

It is a means of identifying the resources - money,people, assets - consumed by each activity that isperformed in an enterprise.

It identifies theevents or driversthat cause eachactivity to beperformed.

These drivers and their relationship to products, servicesand customers are used to assess product, service andcustomer cost and profitability.

What is Activity BasedCosting?


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Definitions

Definition Example

Function An area of related skillssupporting one area in thebusiness

Accounts Receivable

ActivityA series of related taskscarried out repeatedly

Chase a customer for

late payment

Driver An event or factor whichcauses an activity to beperformed

Unpaid Invoices

Process A series of activitiesrequired to achieve anoutcome

Invoicing Process


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Traditional (Standard) Costing

- Direct Labour- Machine Time- Direct Cost Ratio- Floor Area- etc., etc.

Customer, Productor Service costs

Standard costing fails to applycost in the way it is reallyincurred!

It produces a result that isprecisely wrong

Indirect costs


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Activity Based Costing

Activities and

their driverscreate ameaningfullink betweenproducts,

customers,and theresourcesthey eachconsume.

Customer A

Customer A

Customer A

Customer A

Customer A

Customer A

Product 1

Product 1

Product 1

Product 1

Product 1

Product 1

Cost Driver 1

Cost Driver 1

Cost Driver 1

Cost Driver 1

Cost Driver 1

Cost Driver X

Activity 1

Activity 1

Activity 1

Activity 1

Activity 1

Activity 1


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Customer A

18Kgross

margin

0debtchases

0incurred

cost

18Kadjustedmargin

Example of Activity Drivers

Customer B

20Kgross

margin

12debtchases

3Kincurred

cost

17Kadjustedmargin

ABC cost ofdebt chasing:

250,000

Number of debtchases: 1000

Average unitdriver cost:250/chase


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Receive customer orderValidate customer orderInput order to systemProduce order confirmationSchedule orderProduce picking documentsPick order in warehousePack orderProduce despatch documents

Despatch and deliver orderProduce and mail invoiceReceive payment

Activity driven bya Customer Order

Customer A

Margin 100K

Monthly Order

12 orders/year

Customer B

Margin 120K

Weekly Order

52 orders/year

Do these customerscost the same to

deal with ?

Example of Activity Drivers


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Assigning Base Costs toActivities

Activity-specificcosts

Costs from chartof accounts

ActivityAnalysis

Allocation methods

Employment costs:Hours worked per activity or %age oftime spentOccupancy costs:Square or cubic meters (or feet)Network costs:Log-on time, Processing time etc.

Activity relatedcosts areassigned toindividualactivities on thebasis of rationalallocationmethods

For example:


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Costs

Activity Analysis

Internalsupportactivity

Sustainingactivity with no

link

Activity driven byproducts, services

& customers

AllocationMethods

AllocationMethods

AllocationMethods

e.g., Personnel, IT,Office services

Activity directlydriven by

front-line delivery

Flow of Costs

e.g., Managementaccounting, Strategydevelopment,Corporate planning


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Costs

Activity Analysis

Internalsupportactivity

Sustainingactivity with no

link

Activity driven byproducts, services

& customers

AllocationMethods

AllocationMethods

AllocationMethods

ProductsServices

Customers

Sustainingcost

Activity costs taken toproducts,services,customers using thedriver volume of eachactivity by service or

customer

# Driver

Flow of Costs


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# of domestic customers# of export customers# of orders placed# of orderlines - domestic# of orderlines - export# of machine set-ups# of production defects

# of schedules placed# of units processed# of new products introduced# of supplier late deliveries# of schedule changes# of supplier defects

# of order lines - goods In# of inspections

# of cash payments in# of new accounts set-up# of account closures# of customer claims made# of refunds# of invoices processed# of customer returns

# of customer enquiries# of customer complaints# of telephone calls received# of policies issued# of cheques processed# of direct debits

# of late payments# of terminals connected

Some Examples of Drivers


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Activity specificcosts

Costs

Non-specificcosts

From chart of accounts

Product,customer,

service orchannel

specific costs

Some costs might relate tospecific customers orservices and not be relatedto activity... e.g. rawmaterials

Other costs may have noreasonable direct

relationship to activities,products or customers...e.g. changing thecorporate logo

Costs Not Related to Activities


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Activity specificcosts

Costs

CustomersServicesProducts

Non-specificcosts

Unabsorbedcost

From chart of accounts

Activity analysis

Drivers or%age

allocations

Drivers or%age

allocations

Product,customer,service orchannel

specific costs

Drivers or%age

allocations

Final Flowchart of Costs


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Revenue from Customers/Products

less Service/Product Driven Costs

Customer Driven Costs

Channel/Distribution Driven Costs

ABC Contribution

less Unabsorbed Sustaining Costs

Profit (or Loss)

True Overhead

Profit and Loss from aDifferent Perspective

a review of activity based cost management principles

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