Definition Of Activity Based Costing example essay topic

The implementation of activity-based costing systems Summary of topic area Activity based costing is an evolution of traditional accounting methods, brought about by traditional accounting methods? inadequacy in accurate allocation of costs. The ever-growing globalization of markets makes it an immense challenge for organizations trying to survive in today's international marketplace. Sinking market prices drag profit margins down, rapidly changing technologies lead to automation and expenses for new equipment, and demand for better services drive organizations to continually rethink their service expenses. All the while the time available to make the return payments on such investment is in decline, due to the shortening of product life cycles, and the shift towards investor demand for short term returns on invested capital. The over-riding trend of such investment is a marked increase in overheads. The primary goal of Activity Based Costing is to understand how these overheads cut into the profitability of products and customers.

Activity Based Costing (ABC) is an accounting system that assigns costs to products based on the resources they consume. The costs of all activities are traced to the product for which they performed. Overhead costs are also traced to a particular product rather than spread across all product lines. It is an information system that maintains and processes data on a firm's activities and products.

It identifies the activities performed, traces cost to these activities, and then uses various cost drivers to trace the cost of activities to products. These cost drivers, such as the number of persons performing work or the number of setups required per product reflect the consumption of activities by the products. The true cost of a product can therefore be determined with much more certainty than was previously available with a traditional accounting system. An ABC system gives visibility as to how effectively resources are being used and how all activities are contributing to the total cost of a product. The information that an ABC system provides can be used for many things, such as, determining a competitive price for a product, developing budgets, future cost estimating and measuring performance. Activity Based Costing also allows management teams to understand what triggers costs and how to manage them.

ABC is a cost management system that provides a clear insight into the efficiency with which it converts resources into value. This visibility enables a company to identify activities with disproportionately large cost and little value added, so these activities can be eliminated, reduced or out-sourced to another company. ABC can help employees make cost conscious decisions at all levels of any company, and promotes proactive cost reduction rather than reactive investigation of poor company or product performance. When ABC is used as a management system, it is a powerful tool for re-thinking and improving products, services, processes and market strategies. When overhead cost are allocated directly to products, managers will often find that a particular product is not profitable, which can lead to a change of strategy.

ABC provides the means to allow a company to decide if resource consumption for a particular product is consistent with its business objectives. The implementation of such schemes should however not be under taken lightly. The size of the company and the desired outcome must be considered before changing to an ABC system. Larger firms especially should consider pilot programs before implementing the new system across the whole organization. This is due to the fact that existing codes of practice and methodology may already be doing a good job, along with the difficulty of converting all old systems and training to a new concept. The easiest and most basic approach is to use ABC in conjunction with a company's current accounting system.

As the concept of ABC is now not so new, ABC computer software exists, and can be bought to help structure the conversion from the traditional accounting system, to a detailed activity based accounting configuration. The traditional accounting system is kept, and the ABC system is used as an add-on or an enhancement to the original system, for whenever specific information is needed for any given report or decision. Used as an add-on or as a back up, the ABC system can allow an organisation to improve their costs information without disrupting their current information and financial systems. The biggest obstacle to incorporating ABC as standard practice is employee resistance. Unit managers may be afraid ABC is just a way for upper management to discover detailed information about a department or to reveal inefficient practices that had previously been hidden by the traditional accounting system.

The corporate culture must be such the new information is not used against a unit, but to help make improvements in its performance. Implementation of ABC systems can take anywhere from three to fifteen months, depending on the size of the company or plant. After the new system is in place, the old accounting system should be dumped as soon as possible if ABC is to be used exclusively. A database must be established for each product that tracks all activities performed for the product and all the resources the activities consume. This can usually be done by searching through existing documentation and historical cost information, workshops, surveys and interviews with the relevant employees.

Many statistical measurements must be developed to spread overhead costs to products and processes The reason Activity based costing produces such significant results is that it changes the culture of an organization. If a company's priority is to make cost conscious decisions and eliminate inefficiencies and unprofitable activities, then all employees must be given the tools to work towards that objective. ABC provides visibility to information that was previously hidden in a traditional accounting system. With the right data and corporate culture, employees will have the means and the incentive to work towards eliminating excess costs and to work towards achieving the most affordable product possible. Activity Based Costing. Reading list.

Lucas, M (1998) ABC for quantitative policy decisions. Management Accounting, 70, 5, 26-27. May, M (1998) Advanced activity based. Management Accounting, 70, 5, 32. Gering, M (1999) Activity Based Costing focusing on what counts. Management Accounting, 77, 2, 20-21.

Drury, C (1997) Management Accounting for Business Decisions. London: Thomson Business Press. Innes, J & Mitchell, F (1991) Activity Based Costing: A review with case studies. Chartered Institute of Management Accounting. web / web / web / Activity Based Costing is a very widely available topic, searches on the world wide web will give returns in the thousands not the hundreds. This however is a good thing because it made the researching and completion of this project a lot easier than it could have been.

I found that pretty much anyone and everyone book or website seemed to have an opinion or definition of Activity Based Costing. Firstly the course text I found extremely useful, not only in providing the background reading Ch's 4, 5, and 6, but in providing the necessary exercises on which I could hone my ABC skills. However for the rest of my research, although all the books I have listed provided good reading on the subject of ABC as well as definitions, implementation advice, and general overviews, I found that the web had more than enough readily accessible information on the subject. The reason why I favoured the web over traditional literature was due to the fact that, information from the web in electronic form is so much easier to access, call up, flick through, and return to. Individual pages from completely separate sites can be flicked to instantly by electronically book-marking them, which is not possible with a pile of books. In particular I found the better management site to be one of the best in providing activity based articles and case-studies, along with the of tech site, both of which provided detailed information and definitions from a varied number of sources.

I genuinely believe that all of the listed books and sites would provide more than enough information for a manager researching the area of Activity Based Costing. All of them provide insightful and in-depth appraisals of the subject, providing proven examples, and professional definitions, the data available from this reading list should more than negate any normal persons thirst for information on the subject.