Activity Based Costing: Analysis of Implementation and Improvement

This report provides an overview of activity-based costing (ABC), tracing its origins to the limitations of traditional absorption costing methods. It defines ABC as a management accounting approach that monitors organizational activities and allocates resources based on actual usage, enabling accurate product cost calculation. The report highlights key differences between ABC and traditional costing, including the assignment of both manufacturing and non-manufacturing costs, the use of multiple cost pools, and the integration with Six Sigma. It discusses the advantages of ABC, such as accurate costing and systematic overhead allocation, as well as disadvantages like high initial investment and maintenance costs. Motivations for ABC adoption, exemplified by General Motors' use in energy consumption estimation, are explored. The report further examines ABC implementation for predicting operational costs, achieving realistic results, and identifying process improvement areas, particularly in waste reduction. It emphasizes the necessity for identifying non-value-adding activities and proposes using ABC in management accounting for in-depth cost understanding. The report concludes by referencing several academic sources.

Activity Based
Costing

 During the mid 1980, it was felt that
absorption costing has certain limitations
 The absorption costing is introduced when
companies manufactured only few products
and it is easy to allocate the indirect costs
 The limitation of absorption has to the
introduction of the Activity based costing
(ABC) model
Origin of ABC

 As per definition provided by the CIMA for
ABC Costing:
◦ As per CIMA, activity based costing means an
approach used in management accounting
◦ It is introduced to monitor various activities within
the organization
◦ It allocate the resources to each activity on the
basis of the resource actually used by the
particular activity
◦ Though using the activity based costing actual
cost of each product can be easily calculated
ABC Costing (Definition and Concept)

 Mainly three main differences between the
ABC costing and traditional costing
 Through use of ABC costing both
manufacturing and non manufacturing cost
can be assigns to the product
 All types of manufacturing cost that is assigned in
traditional costing is not assigned in ABC Costing
 ABC uses more than one cost pool to allocate the
cost while traditional use only one cost pool to
allocate the cost
How ABC differ from the traditional Costing
system

 Advantages
◦ Activity based costing helps in providing the
accurate costing of products and services
◦ Overhead costs are divided to the various
products and services in the systematic manner
◦ The activity based costing also integrated with six
sigma technology to further improve the costing
system
◦ It helps in benchmarking of other products
Advantages of Activity based costing

 Disadvantages
◦ Big investment is required at the initial stage of
implementation of ABC costing model
◦ The maintenance cost of the ABC costing model is
very high and it requires frequent change to the
system
Disadvantages of Activity based costing

 Activity Based Costing (ABC) use in
manufacturing organizations is more over
the traditional cost accounting systems
 The most prominent example from the
manufacturing industry adopting the use
of ABC costing is General Motors (GM)
 The company uses ABC in estimation of
energy consumption according to
difference schedule of production
Motivations for ABC Introduction

 Used in accurate prediction of different
operations costs such as equipment, labor
and materials
 Help in achieving more realistic results
about the operational cost
 Beneficial in estimating the cost of any
additional activity such as environmental
factors
Implementation of ABC

 Can be used by GM only for identification
and allocation of overhead costs
 Could be used by GM only for identification
and allocation of overhead costs
 Identification of different areas for process
improvement and reducing the waste
generation
 Removal of Non-Value Adding Activities
Area of Improvement

 Necessary for GM to identify the non-value
adding activities to reduce the waste
generation
 Identification of the resources consumed by
the cost objects
 Enabling the company to develop actions
plans for reducing the cost involved in
production
Requirement of Improvement

 The area of improvement identified in the
company through the use of ABC is
proposed to be implemented in the
management accounting area
 Gaining an in-depth understanding of the
actual cost of good and services produced
 Use in management accounting area to
accurately identify activities consuming
large resources
Proposal & Evidence

 Emblemsvåg, J. and Bras, J. 2005. Activity-Based Cost and
Environmental Management - A Different Approach to the
ISO 14000 Compliance. Kluwer Academic Publishers.
 Weil, R.L. and Maher, M.W. 2005. Handbook of Cost
Management. New Jersey: John Wiley & Sons.
 Cokins, G. 2001. Activity-based Cost Management: An
Executive's Guide. John Wiley & Sons, 2001. .
 Popesko, B. 2010. ABC Application Methodology for
Manufacturing Industries. E+M Ekonomie a Management, 1
(7), pp. 103-115, 2010.
 Jurek,P. and Bras, B. 2012. Activity-Based Costing Applied To
Automotive Manufacturing. [Online]. Available at:
http://www.manufacturing.gatech.edu/sites/default/files/uplo
ads/pdf/Final%20version%20_Jan%2026%202012_.pdf
[Accessed on: 23 April 2018].
References