| ABC: What is it and how can reengineering teams use it? This article will provide some insight into ABC and its relevance to reengineering. |
| The equipment selection problem is essential in manufacturing today. It typically involves the selection of a set of equipment to be used in production based on technical and economical criteria. This paper will focus on an activity-based costing approach to the equipment selection problem for flexible manufacturing systems. pdf-file |
| |
| This study points out the changes that have taken place during the activity-based accounting process in one day-surgery unit. We show the benefits and advantages that have come true because of the ABC-process and discuss the problems connected to this process. pdf-file. 2005 |
| This paper presents the results of a Web-based survey that gathered evidence about the current status of activitybased costing adoption and implementation. Pdf-file |
| ... as an engineering management tool for manufacturers. Pdf-file |
| An ABC Initiative is only as effective as the software that supports it. Controllers must not only understand what data and information operations needs, but also find a package that can provide the data in ways everyone can understand. |
| This presentation is intended to show and perhaps correct some misunderstandings about Activity Based Costing |
| Getting Costing Information to Support Appropriate Pricing. pdf-file |
| Activity-Based Costing Approach to Equipment Selection Problem For Flexible Manufacturing Systems. Pdf-file |
| How to recognize and manage the key concerns of multinational ABC programs. |
| This guidebook provides empirical guidance and suggestions on the basics of how to plan for, implement, and apply activity-based costing in evaluating and analyzing process flows and in performing a functional economic analysis of alternative courses of action. |
| |
| This paper describes a procedure that allows small companies to smoothly switch from a traditional costing system to an Activity Based Costing system at low risk and with minimal investment. |
| Costing Organization Activities, Components of Activity Based Costing, Steps for Performing ABC |
Senin, 10 Desember 2007
Activity Based Costing (ABC)
Sabtu, 08 Desember 2007
Activity Based Costing (ABC)
| Activity Based Costing (ABC) is an alternative to the traditional way of accounting. Traditionally it is believed that high volume customers are profitable customers, a loyal customer is also a profitable one, and profits will follow a happy customer. Studies on customer profitability have unveiled that the above is not necessarily true. ABC is a costing model that identifies the cost pools, or activity centers, in an organization and assigns costs to products and services (cost drivers) based on the number of events or transactions involved in the process of providing a product or service. As a result, Activity Based Costing can support managers to see how to maximize shareholder value and improve corporate performance. Historically, cost accounting models related indirect costs on the basis of volume. Typical benefits of Activity-Based Costing (also: 'Activity Based Management') include:
With the costing based on activities, the cost of serving a customer can be ascertained individually. Deducting the product cost and the cost to serve each customer, one can arrive at customer’s profitability. This method of dealing with customer cost and product cost separately has lead to identifying the profitability of each customer and to position products and services accordingly. ABC implementation can help make employees to understand the various costs involved, which will in turn enable them to analyze the cost, identify the Value Added and Non Value Added Activities, implement the improvements and realize the benefits. This is a continuous improvement process in terms of analyzing the cost, to reduce or eliminate the Non Value Added activities and to achieve an overall efficiency. |
| ABC has helped enterprises in answering the market need of better quality products at competitive prices. Analyzing the product profitability and customer profitability, the ABC method has contributed effectively for the top management’s decision making process. With ABC, enterprises are able to improve their efficiency and reduce the cost without sacrificing the value for the customer. Many companies also use ABC as a basis for a balanced scorecard. This has also enabled enterprises to model the impact of cost reduction and subsequently confirm the savings achieved. Overall, Activity Based Costing (ABC) is a dynamic method for continuous improvement. With Activity Based Costing, any enterprise will have a built in competitive cost advantage and can continuously add value to both its stakeholders and customers. The implementation of Activity Based Costing is not easy - not an ABC. However special activity based costing software can be helpful. Furthermore, Robert Kaplan and Steven Anderson have suggested Time-Driven Activity-Based Costing. This is a new approach to sidestep the difficulties associated with large-scale ABC implementation (HBR November 2004). In this revised model, managers estimate the resource demands imposed by each transaction, product, or customer, rather than relying on time-consuming and costly employee surveys. The Time-Driven Activity-Based Costing method is simpler since it requires, for each group of resources, estimates of only two parameters: how much it costs per time unit of capacity to supply resources to the business activities (the total overhead expenditure of a department divided by the total number of minutes of employee time available) and an estimation of the unit times of activities -how much time it takes to carry out one unit of each kind of activity - (as estimated or observed by the manager). This Time-Driven ABC approach also overcomes a serious technical problem associated with employee surveys: the fact that, when asked to estimate time spent on activities, employees invariably report percentages that add up to 100. Managers should take into account time that is idle or unused. The method also supports time equations, a feature that enables the ABC model to reflect the complexity of real-world operations by showing how specific order, customer, and activity characteristics cause processing times to vary. |
Senin, 03 Desember 2007
Activity-Based Costing
Definition
Activity-Based Costing (ABC) is a method of allocating costs to products and services. It is generally used as a tool for planning and control. It was developed as an approach to address problems associated with traditional cost management systems, that tend to have the inability to accurately determine actual production and service costs, or provide useful information for operating decisions. With these defiencies managers can be exposed to making decisions based on inaccurate data. The higher exposure is for companies with multiple products or services.
ABC allows managers to attribute costs to activities and products more accurately than traditional cost accounting methods. The activities responsible for the costs can be identified and passed on to users only when the product or service uses the activity. Some of the advantages ABC offers is an improved means of identifying high overhead costs per unit and finding ways to reduce the costs.
The way it works is first major activities are identified in the process system. Next cost pools are created for groups of activities that can be allocated together. Following this cost drivers are identified. The number of cost drivers used vary depending on the balance between accuracy and complexity. After determining the cost drivers, rates are calculated. The rates are then applied to the respective cost drivers for each product or service that is being considered. The overhead cost per unit is then derived by dividing the total cost for the product by the total product units.
The Issues
One of the basic issues surrounding ABC is the difficulty of implementation. Identifying activities or processes to be allocated properly is cumbersome and takes a lot of effort. It requires that processes are adequately mapped throughout the organization. For a company that has undertaken a quality effort, or an effort to reengineer business processes, a major part of the work may already be completed. But for those who have not it is likely to be a major undertaking.
Just as anything else, Activity-Based Costing is no panacea, nor should it be embraced as a religion, or a fad. It is an operational strategy that needs to be carefully reviewed for applicability. The best way to approach the situation is to first rationalize a facility and its processes, identify the opportunities, and then conceptualize a solution. If this fits, use it.
Pragmatic Applications
Activity-Based Costing makes a lot of sense for companies with multiple products or services who are suffering from inaccurate costing information and need to know which products are really winners and which are losers. For these companies the effort required to successfully implement ABC is worth the time and resources. ABC can identify high overhead costs per unit and find ways to reduce the costs, avoid decreases in head counts due to inaccurate allocation of costs, and measure profitability with higher accuracy than traditional costing that uses direct-labor hours as the only cost driver.
Our Approach: Tools from a Toolchest
Rockford Consulting Group applies concepts and technologies as the situation warrants, that will result in the ultimate benefit to our clients. We treat strategies, technologies, and methodologies as tools in a toolchest, and use them when they offer practical solutions and achievable results. We believe that each client situation is unique, with its own unique set of solutions.
Why Us?
Rockford Consulting Group, Ltd. can provide long-term assistance to many companies in a variety of industries. The firm has a cadre of the best management consultants in the world today, providing high quality professionalism through the use of experience and innovation. (Please see our consulting services Consulting Services )
We subscribe to the Institute of Management Consultants Code of Professional Conduct. All consultants engaged on projects adhere to its principles. Whenever possible we will use consultants certified in their particular specialty area. Certification assures that consultants have substantial prior experience in their specialty, and their competencies have been tested by the IMC, and verified by a number of clients. This assures our clients that we are assigning the highest qualified consultants in the profession.
We provide technical expertise, team facilitation, leadership, and direction in deciding how you will meet the challenge. We refer you to our Qualification Statement for further details on our background, areas of specialization, concepts and technologies applied, staffing, operating policy, approach, companies and industries served, case studies and references. Equally as important, we train our clients to sustain new methods of manufacturing and the consequential benefits over time. Your company will benefit directly from this training.
We have achieved an efficiency in our approach to assignments that allows us to provide high quality technical and managerial advice in a much shorter amount of time than could be accomplished years ago. We are able to do this because of the extensive consulting experience that each of our specialists has.
A Procedure for Smooth Implementation of Activity Based Costing in Small
Companies
Narcyz Roztocki
State University of New York at New Paltz / Department of Business Administration
75 South Manheim Boulevard, New Paltz, NY 12561
914-257-2930 (phone); 914-257-2947 (fax)
roztockn@matrix.newpaltz.edu
Jorge F. Valenzuela
José D. Porter
Robin M. Monk
Kim LaScola Needy
University of Pittsburgh / Department of Industrial Engineering
1041 Benedum Hall, Pittsburgh, PA 15261
412-624-9838 (phone); 412-624-9831 (fax)
kneedy@engrng.pitt.edu
This paper describes a procedure that allows small
companies to smoothly switch from a traditional costing
system to an Activity Based Costing system at low risk
and with minimal investment. The paper focuses on any
type of small company (less than 100 employees) for
which the standard implementation of Activity Based
Costing is too expensive and complex. The
implementation guide leads a company step-by-step
through Cooper’s two-stage activity based cost system
model. The complete implementation procedure consists
of eight major steps. At first, decision-makers choose
among three methods, educated guess, systematic
appraisal, or actual data collection, for obtaining cost
information. At this stage, the decision-makers determine
the level of accuracy that is needed and the amount of
money to be assigned to this project. Next, the overhead
expenses such as administration, rent, utilities, and
transportation are compiled into product cost information
using newly developed matrices. Using these matrices,
cost related calculations are simplified and thus the
overhead costs are easily traced to the cost objects in the
final step. The easy-of-use of the proposed procedure is
illustrated using actual data from a small tool & die
manufacturing company.
Keywords
Activity-Based Costing, Small Business
Introduction
Manufacturing firms face ever-increasing competition in
today’s global marketplace. Companies must react
quickly and manufacture high quality, low cost products to
be successful in this new environment. To make proper
decisions, senior managers must have accurate and up-todate
costing information. Traditional costing systems
based on volume-based allocation of overhead have lost
relevance in a manufacturing environment that has seen a
sharp increase in overhead and a subsequent decline in
direct labor. These traditional costing systems tend to
distort product costs and lead to poor strategic decisionmaking
(Johnson and Kaplan, 1987; Johnson, 1987;
1991).
One innovative costing method designed to deal
with the deficiencies of traditional costing systems is
Activity Based Costing (ABC). ABC, pioneered by Robin
Cooper, Robert Kaplan, and H. Thomas Johnson (Cooper,
1988a; 1988b; 1990; Cooper and Kaplan, 1988; Johnson,
1990), is a costing methodology used to trace overhead
costs directly to cost objects, i.e., products, processes,
services, or customers and help managers to make the
right decisions regarding product mix and competitive
strategies. According to Turney, ABC can radically
change how managers determine the mix of their product
line, price their products, identify the location for sourcing
components, and assess new technology (Turney, 1989).
Although the literature has reported numerous
implementations of ABC in large manufacturing firms,
there has been limited accounting of ABC being embraced
by small manufacturing firms (less than 100 employees)
(Needy and Bidanda, 1995; Bharara and Lee, 1996). Upon
closer examination, there appears to be several factors
preventing small manufacturing firms from implementing
an ABC costing system including lack of data, technical
resources, financial resources, and adequate
computerization. Perhaps the main obstacle, lack of data,
centers on the problem of collecting and processing the
needed data in the correct format at a reasonable cost.
Because the information needed for ABC is costly and
small manufacturing firms are typically constrained
financially, these companies need to be very selective in
the type of data and analysis that they use to determine
overhead costs. Moreover, small businesses operate
uniquely, a condition referred to as resource poverty, that
requires specialized cost management approaches (Welsh
and White, 1981). Thus, a methodology that will enable a
small company to obtain accurate product cost information
yet minimize financial effort is needed.
Exhibit 1. Relationship among expense categories, activities, and products.
In this paper, an efficient and inexpensive
method for implementing ABC in small business
environments is proposed. This procedure systematically
provides the decision-maker with accurate cost
information to establish corporate strategies, determine
product cost, and improve the cost structure.
Activity Based Costing
Cooper describes two stages in the ABC model (Cooper,
1987a; Cooper, 1987b). In the first stage, costs are
assigned to cost pools within an activity center, based on a
cost driver. There is no equivalent step in a traditional
costing approach. In the second stage, costs are allocated
from the cost pools to a product based on the product’s
consumption of the activities. This stage is similar to a
traditional costing approach except that the traditional
approach uses solely volume related characteristics of the
product without consideration for non-volume related
characteristics. Some examples of cost drivers not related
to volume include setup hours, number of setups, ordering
hours, and number of orders. Allocating non-volume
related costs using volume-based methods distorts the
product costs.
Methodology
In the ABC model, overhead expense categories such as
administration, rent, transportation, and insurance are
identified. This cost data can be obtained easily from
accounting. The next step is to determine the main
activities that simplify the tracing of cost information.
This can be accomplished by grouping actions into
activities and activities (or cost pools) into activity centers
using the ABC approach. Some examples of activities for
a small manufacturing company are receiving a customer
inquiry, customer quotes, production supervision, and
shipping products. Expenses are going to be assigned to
the previously defined activities via the first stage cost
drivers. Following the second stage, activity cost drivers
are determined to allocate overhead to individual products.
Exhibit 1 illustrates the hierarchical relationship among
expense categories, activities, and products.
The proposed methodology assumes that the
overhead cost and its categorization are available,
generally from accounting. Expense categories refer to
the traditional way in which a company divides
manufacturing overhead. This information will assist the
company in validating that the total overhead calculated at
the beginning of the process matches the total obtained
when summing the overhead that is assigned to each
individual product using ABC.
Identifying activities or cost pools
In order to implement ABC, the complete business
process should be divided into a set of activities. A
flowchart of the process is a commonly used tool for
identifying these main activities. Each box represents
activities and arrows denote the flow of the system. Thus,
in order to establish the needed activities for ABC,
homogeneous processes must be grouped together. In
other words, product driven activities and customer driven
activities must be separated in order to establish two
individual homogeneous activities. Examples of activities
for manufacturing companies are quote preparation,
production supervision, and material handling.
Activities and first stage cost drivers
Once the main activities have been defined, a total cost of
each activity can be calculated. First, the expense
categories related to each activity are identified. For
example, the activity cost for “quote preparation” includes
costs from various expense categories such as salary, rent,
utility, and office supplies. To properly trace the expenses
to each activity, cost drivers, also called first stage cost
drivers, have to be identified for each expense category.
For instance, the expense category “rent” associated with
the activity “quote preparation” may be driven by square
Activity 1 Activity 2 Activity 3
Cost driver Cost driver Cost driver
Expense 1 Expense 2 Expense 3
Product 1 Product 2
Cost driver Cost driver Cost driver
FIRST
STAGE
SECOND
STAGE
feet, whereas, the expense category “salary” may be driven
by the amount of time the employee spends on this
activity.
Second Stage Cost Drivers
In the second stage, activities are traced to products using
second stage cost drivers. As with first stage cost drivers,
data needed for second stage drivers may not be readily
available to represent the proportion of cost pools that
correspond to the products. For instance, mileage can be
difficult to trace to individual product. In the absence of
actual data there becomes a need to estimate the amount of
activity cost consumed by each product.
Information Gathering Procedures
Gathering information is essential in order to achieve
accuracy of final product costs. An important part of the
required data is the proportions needed in each stage of an
ABC costing system. Each activity consumes a portion of
an expense category. Similarly, each product consumes a
portion of an activity. As discussed previously, a
proportion usually represents this portion. For instance,
the activity “quote preparation” consumes 0.1 (10%) of
administration expenses. There are many ways to obtain
these proportions and the selected procedure will impact
the desired accuracy. Three levels of data accuracy can be
used in estimating these proportions: educated guess,
systematic appraisal, and collection of real data.
Educated guess
In the case where real data can not be obtained or data
collection efforts can not be financially justified, an
educated guess can be made in order to obtain proportions.
These guesses should be done collaboratively by
management, financial organizers, and operational
employees associated with the costing center of interest.
This team can provide an educated guess of the
proportions of costs allocated in both stages of an ABC
costing methodology. The level of accuracy obtained is
based on a combination of the teams’ diversity and their
knowledge of the cost center of interest.
Systematic Appraisal
A more scientific way to obtain the proportions for tracing
costs is using a systematic technique such as Analytic
Hierarchical Process (AHP) (Saaty, 1982; Golden, Wasil,
and Harker, 1989). AHP is a suitable tool for pulling
subjective individual opinion into more representative
information. For example, assuming that the allocation of
a gasoline expense is needed between three cost pools
namely sales, delivery and maintenance. By questioning
the departments that consume this resource and by asking
them to evaluate what percentage of mileage they
accumulate in a certain period of time, AHP can generate
the percentage of this expense and allocate it to the
appropriate cost pool.
A second area in which AHP can be used is to
allocate the expense from the cost pool to each individual
product. At this step it is important to determine an
appropriate cost driver in order to achieve the desired
level of accuracy. For example, suppose we wish to trace
the sales cost pool to each product. One approach is to
estimate the level of sales activity needed for each of the
individual products. Let assume the following scenario: a
company produces five products. Product A is a very well
established product requiring minimal effort from the
sales representatives when they talk to potential
consumers. On the other hand, products B, C and D are
in the middle of their life cycle. Finally, product E, is a
new product that consumes a lot of time from the sales
representatives. Instead of allocating an equal amount of
sales expenses to each one of the products, AHP can
provide an estimation that can allow the company to more
accurately trace this cost to the products. The methodology
followed by AHP requires first determining factors that
account for cost relationship between activities and
products. In this specific illustration, locations of travel for
sales and time spent with the client discussing each
individual product may be some examples of these factors.
Secondly, the sales representative assigns a ranking
among products according to the distance needed to
support them. A second raking among products is
established in proportion to the time spent with the
customer. Finally, the subjective rankings of sales
representatives are combined by AHP and ratios for sales
expenditure among the five products are obtained.
Actual data collection
The most accurate and most costly procedure for
computing proportions is the collection of real data. In
most cases, a data collection procedure must be developed
and data collection equipment may need to be purchased.
Moreover, collection of the data will need to be timely and
skilled collectors may be required. The results often have
to be analyzed using statistical methods. For example, job
sampling can be used to estimate the time proportion
dedicated to supervise the manufacturing of a particular
product. In this case, the supervising engineer is asked, at
random time intervals, to specify the product being
currently supervised. Based on this data the needed
information can be obtained.
Proposed procedure for tracing overhead expenses to cost
objects
Step 1. Get the expense categories
The initial step is to examine the expense categories
included in the income statement of the company.
Step 2. Identify main activities
Step 2 can be performed in parallel with Step 1.
Step 3. Relate expenses to activities by establishing an
EAD matrix.
In this step, the activities that contribute to each expense
are identified and the Expense-Activity-Dependence
(EAD) matrix is created. The expense categories
represent the columns of the EAD matrix, whereas the
activities identified in Step 2 represent the rows. If the
activity i contributes to the expense category j, a checkmark
is placed in the cell i,j.
Step 4. Replace check-marks by proportions in the EAD
matrix.
Each cell that contains a check-mark is replaced by a
proportion which is estimated using any of the procedures
previously mentioned. Each column of the EAD matrix
must add up to 1.
Step 5. Obtain dollar values of activities.
To obtain the dollar values of each activity the following
equation is applied.
å ´
M
j = 1
TCA(i) = Expense (j) EAD (i, j) (1)
Where:
TCA(i) = Total cost of activity i
M = number of expense categories
Expense (j) = Dollar value of expense category j
EAD (i, j) = Entry i, j of Expense-Activity-
Dependence matrix
Step 6. Relate activities to products by establishing an
APD matrix.
In this step, the activities consumed by each product are
identified and the Activity-Product-Dependence (APD)
matrix is created. The activities represent the columns of
the APD matrix, whereas the products represent the rows.
If the product i consumes the activity j, a check-mark is
placed on the cell i,j.
Step 7. Replace check-marks by proportions in the APD
matrix.
Each cell that contains a check-mark is replaced by a
proportion which is estimated using any of the procedures
previously mentioned. Each column of the APD matrix
must add up to 1.
Step 8. Obtain dollar values of products.
To obtain the dollar values of each product the following
equation is applied.
å ´
N
j = 1
OCP (i) = TCA (j) APD (i, j) (2)
Where:
OCP(i) = Overhead cost of product i
N = Number of activities
TCA (j) = Dollar value of activity j
APD (i, j) = Entry i, j of Activity-Product-
Dependence matrix
The procedure described can be easily implemented using
common standard spreadsheet software.
Application Example
In this section the overhead costs of a typical small
manufacturing firm are traced using the proposed
methodology. The example uses the average of actual
costs tabulated from several small-manufacturing
companies to represent the costs of a ‘typical’ small
business enterprise. Moreover, this approach also
preserves the anonymity of the companies.
Tool & Die Inc. is a small manufacturing
company in Western Pennsylvania that manufactures three
main products and supplies to multiple customers. Ongoing
engineering work is prominent because of the use of
CNC machines to manufacture products. Ten main
customers are responsible for more than 80 percent of the
total business. Since its foundation 20 years ago, the Tool
& Die Inc. has growth by adding three to five new
employees per year. Currently, its total work force is
nearly one hundred employees. Despite the growth in
company size and business volume, the profitability has
declined during the last few years. In the last two years,
the company experienced losses for the first time in its
history. Management believes that costing by intuition or
by applying traditional methods is no longer appropriate.
Therefore, they decided to introduce an ABC costing
system to the company. Because the data required for the
ABC system does not already exist and the cost to collect
all of it would be prohibitive for this firm, management
decided to use educated guesses, systematic appraisal, and
actual data.
The initial step was to examine the expense
categories included in the income statement of Average
Inc and to select cost drivers. Exhibit 2 shows this
breakdown. In the second step, Tool & Die Inc. identified
its main activities and their respective second stage cost
drivers as shown in Exhibit 3. Exhibit 4 illustrates a
hierarchical tree relating expense categories, activities and
products. The third step determined which activities
contributed to each expense category. For example, the
activities contributing to the expense category “Transport”
are material receiving and product shipment.
Exhibit 2. Expense categories and their respective cost drivers
Expense category Cost ( $) Cost drivers
Administration 270,000 Time (hours)
Depreciation 180,000 Dollar use of resources ($)
Rent and utilities 150,000 Space (ft2)
Office expenses 70,000 Level of use of office resources (%)
Transport 50,000 Distance (miles)
Interest 45,000 Cost of the activity ($)
Product shipment 45,000 Weight (Lb)
Business travel 45,000 Distance (miles)
Business insurance and legal expenses 40,000 Cost of resource used by the activity ($)
Advertising 40,000 Level of benefit (%)
Entertainment 20,000 Level of importance of customer (%)
Miscellaneous expenses 45,000 None
Exhibit 3. Main activities and their second stage cost drivers
Activity Cost driver
Customer contact Number of customer contacts
Quote preparation Number of quotes
Engineering work Engineering hour
Material purchasing Number of purchase orders
Production preparation Number of production runs
Material receiving and handling Number of receptions
Production management and supervision Product complexity
Quality assurance Product complexity
Product shipping Distance
Customer payment administration Number of payments
General management and administration Intensity of activities
Exhibit 4. Expense categories (hierarchical tree)
Overhead Allocation
Administration
$ 270,000
Depreciation
$ 180,000
Rent & Utilities
$ 150,000
Office Expenses
$ 70,000
Transport
$ 50,000
Interest
$ 45,000
Product Shipment
$ 45,000
Business Travel
$ 45,000
Business Insurance
$ 40,000
Advertising
$ 40,000
Entertainment
$ 20,000
Miscellaneous
$ 45,000
Overhead
$ 1,000,000
Customer contact
Quote preparation
Engineering work
Material purchasing
Production preparation
Material receiving
Production management
Quality assurance
Product shipment
Customer payment
General management
Product 1 Product 2 Product 3
Expense categories
Activities
Products
Exhibit 5. Expense-Activity-Dependence (EAD) matrix
Activities
Expense category
Administration
Depreciation
Rent and utilities
Office expenses
Transport
Interest
Product shipment
Business travel
Business insurance
and legal expenses
Advertising
Entertainment
Miscelaneous expenses
Customer contact ä ä ä ä ä ä ä
Quote preparation ä ä ä ä
Engineering work ä ä ä ä ä ä
Material purchasing ä ä ä ä ä
Production preparation ä ä ä ä
Material receiving and handling ä ä ä ä ä ä
Production management ä ä ä ä
Quality assurance ä ä ä ä ä
Product shipment ä ä ä ä ä ä ä
Customer payment ä ä ä ä ä
General management ä ä ä ä ä ä ä ä ä
Exhibit 6. Expense-Activity-Dependence (EAD) matrix
Activities
Expense category
Administration
Depreciation
Rent and utilities
Office expenses
Transport
Interest
Product shipment
Business travel
Business insurance
and legal expenses
Advertising
Entertainment
Miscelaneous expenses
Customer contact 0.06 0.01 0.24 0.63 0.64 0.58 0.09
Quote preparation 0.10 0.05 0.14 0.09
Engineering work 0.10 0.70 0.12 0.08 0.14 0.09
Material purchasing 0.08 0.09 0.09 0.80 0.09
Production preparation 0.04 0.11 0.03 0.09
Material receiving and handling 0.05 0.09 0.06 0.40 0.11 0.09
Production management 0.20 0.13 0.01 0.09
Quality assurance 0.10 0.30 0.20 0.02 0.09
Product shipment 0.05 0.12 0.05 0.60 1.00 0.23 0.09
Customer payment 0.04 0.01 0.08 0.46 0.09
General management 0.18 0.07 0.20 0.20 0.23 0.20 0.36 0.42 0.09
To systematically describe the contribution of
activities to expense categories, the Expense Activity
Dependence (EAD) matrix was used. The EAD matrix
for Tool & Die Inc. is shown in Exhibit 5. A “ä” at the
entry i,j denotes that the activity i generates expense in
category j.
In step four, the costs of each expense category
are traced to activities. Each expense category is divided
among activities according to the proportion of
contribution. For instance, the expense category
“Transport” is divided into two activities (material
receiving and product shipment), and the ratio of
contribution is 0.4 and 0.6, respectively. In this case, 0.4
and 0.6 as shown in Exhibit 6 replaces the corresponding
check marks of the EAD matrix. Note that each column
will sum to one, implying that the entire expense category
is spread across the activities. The ratios presented in
Exhibit 6 were obtained by using the three procedures
described previously: actual data, systematic appraisal
(AHP), and educated guesses. When data was available
the ratios were determined according to the first stage cost
driver. For instance, Tool & Die Inc. tracked the miles
consumed by the activities material receiving and
handling and product shipment (miles is the first stage
cost driver for “Transport”). The records showed that
40,000 miles and 60,000 miles were consumed by
material receiving and handling and product shipment,
respectively. Accordingly, the ratios for the expense
category “Transport” were 0.4 and 0.6.
On the other hand, Tool & Die Inc. did not keep
track of the distance for business travel (distance is the
first stage cost driver for the category expense “Business
travel”). The activities that cause business travel expenses
were customer contact, engineering work and general
management. In this situation the ratios were estimated
using AHP. Employees at Tool & Die Inc. involved in
these three activities were asked to estimate the relative
distance (cost driver) used by each activity. For example,
the following three questions were asked:
· How was the total distance traveled due to customer
contact compared with engineering work?
· How was the total distance traveled due to customer
contact compared with general management?
· How was the total distance traveled due to
engineering work compared with general
management?
The answers to these questions were translated into
numbers using the scale measurement table shown in
Exhibit 7, and then they were input into the software
package Expert Choice (Expert Choice is a decision
support software developed and distributed by Expert
Choice, Inc.) to estimate the ratios.
Exhibit 7. Scale measurement table
Numerical values Definition
1 Equally important
3 Slightly more important
5 Strongly more important
7 Very strongly more important
9 Extremely more important
2,4,6,8 Intermediate values
In step five, every entry i,j of the EAD matrix
was replaced with the resulting dollar value by
multiplying the cost of the expense category j and the ratio
i,j. The new matrix gives the dollar resource consumption
of each activity. The total cost for each activity was
obtained by adding each row. Exhibit 8 depicts the new
EAD matrix for Tool & Die Inc. with the resulting dollar
resource consumption of each activity.
In step six, activity costs were traced to each
product after the total cost of each activity was
determined. The procedure is similar to the one used for
tracing cost in the first stage; however, second stage cost
drivers allowed Tool & Die Inc. to determine or estimate
activity consumption by product. In this stage the APD
matrix is used. The APD matrix for Tool & Die Inc. is
shown in Exhibit 9. In a similar fashion, a “ä” at the
entry i,j denotes that product i consumes activity j.
In step seven, the check marks were replaced by
the corresponding ratios.
As before, the ratios were calculated using educated guess,
systematic appraisal (AHP), and actual data. For
example, the three products consume the activity material
purchasing. To estimate the appropriate ratios, the
employees involved in production were asked the relative
number of purchase orders (cost driver for material
purchasing) required for each product. The following
questions were asked to obtain information needed for
AHP:
· How was the total number of material purchase orders
for product 1 compared with product 2?
· How was the total number of material purchase orders
for product 1 compared with product 3?
· How was the total number of material purchase orders
for product 2 compared with product 3?
The ratios were then placed into the APD matrix,
as shown in Exhibit 10. In step 8, the overhead costs for
each product was computed. The resulting APD matrix,
shown in Exhibit 11, gives the total overhead costs for
each product as well as their origin.
Conclusion
The implementation of a new cost system involves
investment in time and money. A cost system based on
ABC requires organizational changes, employee
acceptance, investment in software and hardware,
equipment for data collection, and so on. Although, ABC
has been successfully used in many large companies it
does not guarantee a payback in a short period of time. By
using the proposed method for implementing an ABC
costing system, the risk of switching from a traditional
costing system to an extensive ABC system can be reduced
significantly. The proposed method is more suitable for
smaller companies because it provides a smooth transition
from a traditional costing system to ABC, it does not
require a high investment in sophisticated data collection
systems, and it does not require a serious organizational
restructuring. Therefore, the proposed method can be used
as an intermediate step for gradually implementing a full
ABC system where the estimated data is replaced by
actual data. In addition, the EAD and APD matrices assist
in the comprehension of how overhead costs are
generated. These matrices can also be used for
recognizing improvement opportunities. As a future step a
software package based on this methodology can be
developed that would trace overhead cost to products
accurately, at low cost, and in short time.
Exhibit 8. Expense-Activity-Dependence (EAD) matrix ($ 10,000)
Total Expenses $27.00 $18.00 $15.00 $7.00 $5.00 $4.50 $4.50 $4.50 $4.00 $4.00 $2.00 $4.50
Activities
Expense category
Administration
Depreciation
Rent and utilities
Office expenses
Transport
Interest
Product shipment
Business travel
Business insurance
and legal expenses
Advertising
Entertainment
Miscelaneous expenses
Total Cost
Customer contact $ 1 .62 $ - $ 0 .15 $ 1 .68 $ - $ - $ - $ 2.84 $ - $ 2.32 $ 0 .18 $ 0.405 $ 9.19
Quote preparation $ 2 .70 $ - $ 0 .75 $ 0 .98 $ - $ - $ - $ - $ - $ - $ 0.18 $ 0.405 $ 5.02
Engineering work $ 2 .70 $ 12.60 $ 1.80 $ 0 .56 $ - $ - $ - $ 0.63 $ - $ - $ 0.18 $ 0.405 $ 18.88
Material purchasing $ 2 .16 $ - $ 1 .35 $ 0 .63 $ - $ 3.60 $ - $ - $ - $ - $ 0.18 $ 0.405 $ 8.33
Production preparation $ 1 .08 $ - $ 1 .65 $ 0 .21 $ - $ - $ - $ - $ - $ - $ 0.18 $ 0.405 $ 3.53
Material receiving and handling $ 1 .35 $ - $ 1 .35 $ 0 .42 $ 2 .00 $ - $ - $ - $ 0.44 $ - $ 0.18 $ 0.405 $ 6.15
Production management $ 5 .40 $ - $ 1 .95 $ 0 .07 $ - $ - $ - $ - $ - $ - $ 0.18 $ 0.405 $ 8.01
Quality assurance $ 2 .70 $ 5.40 $ 3.00 $ 0 .14 $ - $ - $ - $ - $ - $ - $ 0.18 $ 0.405 $ 11.83
Product shipment $ 1 .35 $ - $ 1 .80 $ 0 .35 $ 3 .00 $ - $ 4 .50 $ - $ 0.92 $ - $ 0.18 $ 0.405 $ 12.51
Customer payment $ 1 .08 $ - $ 0 .15 $ 0 .56 $ - $ - $ - $ - $ 1.84 $ - $ 0.18 $ 0.405 $ 4.22
General management $ 4 .86 $ - $ 1 .05 $ 1 .40 $ - $ 0.90 $ - $ 1.04 $ 0.80 $ 1 .68 $ 0 .18 $ 0.405 $ 12.31
Exhibit 9. Activity-Product-Dependence (APD) matrix
Products
Activities
Customer contact
Quote preparation
Engineering work
Material purchasing
Production preparation
Material receiving and handling
Production management
Quality assurance
Product shipment
Customer payment
General management
Product 1 ä ä ä ä ä ä ä ä ä
Product 2 ä ä ä ä ä ä ä ä ä
Product 3 ä ä ä ä ä ä ä ä ä ä
Exhibit 10. Activity-Product-Dependence (APD) matrix
Products
Activities
Customer contact
Quote preparation
Engineering work
Material purchasing
Production preparation
Material receiving and handling
Production management
Quality assurance
Product shipment
Customer payment
General management
Product 1 0.00 0.00 0.20 0.14 0.21 0.12 0.34 1.00 0.32 0.21 0.33
Product 2 0.53 0.60 0.10 0.34 0.27 0.41 0.27 0.00 0.26 0.38 0.33
Product 3 0.47 0.40 0.70 0.52 0.52 0.47 0.39 0.00 0.42 0.41 0.34
Exhibit 11. Activity-Product-Dependence (APD) matrix ($ 10,000)
Activity Cost $ 9.19 $ 5.02 $ 18.88 $ 8.33 $ 3.53 $ 6.15 $ 8.01 $ 11.83 $ 12.51 $ 4.22 $ 12.31
Products
Activities
Customer contact
Quote preparation
Engineering work
Material purchasing
Production preparation
Material receiving and handling
Production management
Quality assurance
Product shipment
Customer payment
General management
Total Cost
Product 1 $ - $ - $ 3.78 $ 1.17 $ 0.74 $ 0.74 $ 2.72 $ 11.83 $ 4.00 $ 0.89 $ 4.06 $ 29.92
Product 2 $ 4.87 $ 3.01 $ 1.89 $ 2.83 $ 0.95 $ 2.52 $ 2.16 $ - $ 3.25 $ 1.60 $ 4.06 $ 27.15
Product 3 $ 4.32 $ 2.01 $ 13.21 $ 4.33 $ 1.83 $ 2.89 $ 3.12 $ - $ 5.25 $ 1.73 $ 4.19 $ 42.88
References
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About the Authors
Narcyz Roztocki is an Assistant Professor of Business
Administration at the State University of New York
(SUNY) at New Paltz. He received his M.S. degree in
Mechanical Engineering from the Technical University
Hamburg-Harburg, Germany and his Ph.D. in Industrial
Engineering from the University of Pittsburgh. His
research focus is in the area of Strategic Management,
Activity Based Costing, Economic Value Added, Decision
Support Tools and Information Systems. He is a member
of ASEM and IIE.
Jorge F. Valenzuela received his B.S. in Electronic
Engineering from Northern Catholic University in Chile
(1984). He obtained a M.S. degree in Statistics at CIENES
and a M.S. degree in Industrial Engineering at Northern
Illinois University in 1985 and 1996, respectively.
Currently he is a Ph.D. student at the University of
Pittsburgh.
Jose D. Porter received his B.S. in Mechanical
Engineering from Universidad Autonoma de Nuevo Leon
in Mexico in 1991. He obtained a M.S. degree in
Manufacturing Systems at I.T.E.S.M. (Mexico) in 1994.
Currently he is a Ph.D. candidate at the University of
Pittsburgh.
Robin M. Monk received her B.S. in Industrial
Engineering from the University of Pittsburgh in 1996.
She obtained a M.S. degree in Industrial Engineering at
the University of Pittsburgh in 1998. Currently she is
working for PPG Industries in Pittsburgh, PA.
Kim LaScola Needy is an Assistant Professor of
Industrial Engineering at the University of Pittsburgh.
Ph.D. in Industrial Engineering from Wichita State
University. She has obtained nine years of industrial
experience at PPG Industries and The Boeing Company.
Her research interests include Activity Based Costing,
TQM, Engineering Management, and Integrated Resource
Management. Dr. Needy is a member of ASEE, ASEM,
APICS, IEEE, IIE, SME and SWE. She is a licensed PE
in Kansas.
What is Activity Based Costing and how does it work?
What is Activity Based Costing and how does it work? |
| Activity-based costing is a costing model that identifies the cost pools, or activity centres, in an organisation and assigns costs to products and services (cost drivers) based on the number of events or transactions involved in the process of providing a product or service. | Source | ||||||||||||||||||||||||||||||||||||||||||||||||
| It's an unwritten rule respected by many in the business world that you generally treat your best customers the best. The problem is, do you really know who your best customers are, or do you think you know? The majority of business people have the false perception that the best customer is the one that accounts for the largest portion of your income every year. This is not always the case for the simple reason that the same customer may be responsible for the biggest part of your expenses also. There is a solution to the problem and it is as simple as Activity Based Costing.
Activity based costing is a costing method that provides managers with useful information they need regarding the contribution that each customer makes to overall profitability. Also, ABC allows managers to see how to maximise performance and implement sound profit-growth strategies. ABC also makes it very clear that integrated costs associated with the services that the customer demands play a crucial role in determining each customer's contribution to net profit. Studies have shown that 20% of all customers virtually provide all the profits of a company. Another 60% break even and the remaining 20% only reduce the bottom line. Wouldn't it be nice if you had the names of that 20% of headache-inducing customers that are literally more trouble than they're worth?
To determine how much a customer is costing you, you must first identify the activities that relate to each customer and determine the total cost absorbed by those activities. These activities or "cost drivers" should be considered then to measure the level of activity absorbed by each customer. The ultimate purpose of implementing ABC is to separate these activities into individual cost drivers. Then, all you have to do is measure each customer's participation in the specific cost.
When choosing cost drivers, make sure they are relevant and easy to measure. Relevancy relates to the direct or indirect relationship it bears to the cost of doing business and ease of measurement means that you must be able to allocate to each customer the portion attributable to the activities consumed. Cost drivers might include, but not be limited to, inside/outside sales, order processing, credit, delivery, telephone expenses, training, application expertise, after-hour service, design time, machining etc. To describe how to determine the total cost of each of these cost drivers and how that cost should be allocated to each customer is beyond the scope of this article. But help is available. Contact OffTech Computing Pty Ltd and one of our consultants will be more than happy to assist you with any questions that you may have. Take control of your business today and start saving immediately by implementing Activity Based Costing methods. The following chart diagram will help you to see how Activity Based Costing works :
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