editing work less than 3hrs
quicksmart
uses_of_activity_based_costing.docxUses of Activity Based Costing
The fundamental advantage of using an ABC system is to more precisely determine how overhead is used. Once you have an ABC system, you can obtain better information about the following issues:
· Activity costs. ABC is designed to track the cost of activities, so you can use it to see if activity costs are in line with industry standards. If not, ABC is an excellent feedback tool for measuring the ongoing cost of specific services as management focuses on cost reduction.
· Customer profitability. Though most of the costs incurred for individual customers are simply product costs, there is also an overhead component, such as unusually high customer service levels, product return handling, and cooperative marketing agreements. An ABC system can sort through these additional overhead costs and help you determine which customers are actually earning you a reasonable profit. This analysis may result in some unprofitable customers being turned away, or more emphasis being placed on those customers who are earning the company its largest profits.
· Distribution cost. The typical company uses a variety of distribution channels to sell its products, such as retail, Internet, distributors, and mail order catalogs. Most of the structural cost of maintaining a distribution channel is overhead, so if you can make a reasonable determination of which distribution channels are using overhead, you can make decisions to alter how distribution channels are used, or even to drop unprofitable channels.
· Make or buy. ABC provides a comprehensive view of every cost associated with the in-house manufacture of a product, so that you can see precisely which costs will be eliminated if an item is outsourced, versus which costs will remain.
· Margins. With proper overhead allocation from an ABC system, you can determine the margins of various products, product lines, and entire subsidiaries. This can be quite useful for determining where to position company resources to earn the largest margins.
· Minimum price. Product pricing is really based on the price that the market will bear, but the marketing manager should know what the cost of the product is, in order to avoid selling a product that will lose a company money on every sale. ABC is very good for determining which overhead costs should be included in this minimum cost, depending upon the circumstances under which products are being sold.
· Production facility cost. It is usually quite easy to segregate overhead costs at the plant-wide level, so you can compare the costs of production between different facilities.
Clearly, there are many valuable uses for the information provided by an ABC system. However, this information will only be available if you design the system to provide the specific set of data needed for each decision. If you install a generic ABC system and then use it for the above decisions, you may find that it does not provide the information that you need. Ultimately, the design of the system is determined by a cost-benefit analysis of which decisions you want it to assist with, and whether the cost of the system is worth the benefit of the resulting information.
Problems with Activity Based Costing
· Cost pool volume. The advantage of an ABC system is the high quality of information that it produces, but this comes at the cost of using a large number of cost pools – and the more cost pools there are, the greater the cost of managing the system. To reduce this cost, run an ongoing analysis of the cost to maintain each cost pool, in comparison to the utility of the resulting information. Doing so should keep the number of cost pools down to manageable proportions.
· Installation time. ABC systems are notoriously difficult to install, with multi-year installations being the norm when a company attempts to install it across all product lines and facilities. For such comprehensive installations, it is difficult to maintain a high level of management and budgetary support as the months roll by without installation being completed. Success rates are much higher for smaller, more targeted ABC installations.
· Multi-department data sources. An ABC system may require data input from multiple departments, and each of those departments may have greater priorities than the ABC system. Thus, the larger the number of departments involved in the system, the greater the risk that data inputs will fail over time. This problem can be avoided by designing the system to only need information from the most supportive managers.
· Project basis. Many ABC projects are authorized on a project basis, so that information is only collected once; the information is useful for a company’s current operational situation, and it gradually declines in usefulness as the operational structure changes over time. Management may not authorize funding for additional ABC projects later on, so ABC tends to be “done” once and then discarded. To mitigate this issue, build as much of the ABC data collection structure into the existing accounting system, so that the cost of these projects is reduced; at a lower cost, it is more likely that additional ABC projects will be authorized in the future.
· Reporting of unused time. When a company asks its employees to report on the time spent on various activities, they have a strong tendency to make sure that the reported amounts equal 100% of their time. However, there is a large amount of slack time in anyone’s work day that may involve breaks, administrative meetings, playing games on the Internet, and so forth. Employees usually mask these activities by apportioning more time to other activities. These inflated numbers represent misallocations of costs in the ABC system, sometimes by quite substantial amounts.
· Separate data set. An ABC system rarely can be constructed to pull all of the information it needs directly from the general ledger. Instead, it requires a separate database that pulls in information from several sources, only one of which is existing general ledger accounts. It can be quite difficult to maintain this extra database, since it calls for significant extra staff time for which there may not be an adequate budget. The best work-around is to design the system to require the minimum amount of additional information other than that which is already available in the general ledger.
· Targeted usage. The benefits of ABC are most apparent when cost accounting information is difficult to discern, due to the presence of multiple product lines, machines being used for the production of many products, numerous machine setups, and so forth – in other words, in complex production environments. If a company does not operate in such an environment, then it may spend a great deal of money on an ABC
