Navigating Chapter 10: Activity Based Costing and Management

Together with the team Vincent sets the strategy and manages the content planning, go-to-market, customer experience and corporate development aspects of the company. All organizations want to perform optimally and avoid or reduce mistakes as much as possible. Along with this, the value generated from each activity has to be quantified so that it can be compared to the costs, which further allows the evaluations of the activity. In other or­ganisations such as government departments, hospitals, universities, colleges, fast-food restaurants, utilities one may find a large number of non-value added activities.

Step 3: Determining the cost driver for each activity

• By identifying these drivers, businesses can focus their efforts on reducing costs in areas that have the most significant impact.
• Regardless of its size or scope, any company within the service industry will benefit significantly from implementing activity-based management strategies for their operations’ improved effectiveness.
• When different products consume resources at rates that are not accurately reflected in their relative numbers (volumes), a traditional cost allocation approach will result in product cost cross-subsidization.
• By identifying activities, determining cost drivers, and allocating costs accordingly, businesses can make informed decisions to optimize operations and improve profitability.

The company discovered that it was spending too much time assembling its products and not enough time on quality control. By optimizing the production line and reallocating resources, the company was able to increase profits and improve customer satisfaction. Using ABC, the company determines activity based management that the testing and quality control activities drive the cost of producing its chemicals.

( Making Activity Analysis:

Taking action to reduce or eliminate non-value-added activities is given top priority. By doing so, the organization permanently reduces the cost it incurs without reducing the product’s value to customers. However, management should be making sure that the eliminations are not affecting other value-added activities. It focuses on managing the business based on the organization’s activities and assumes that such activities consume costs.

Table 1: Existing cost data

Companies can use ABM to develop a strategic plan based on their operations’ costs and performance. This helps managers to analyze how they can improve profitability by upgrading operational efficiency. It is crucial as it helps organizations understand their cost structure better and make informed decisions about resource allocation. The process may involve eliminating unnecessary activities, redesigning processes, or reallocating resources to more valuable activities. Activity-based costing (ABC) is a cost accounting method that assigns costs to specific activities or processes based on their consumption of resources.

How ABM made a difference: lessons from case studies

One of the major things that ABM does is that it helps in identifying a business’ significant activities. This becomes important because a business is involved in several activities on a daily Basis and one of the most important areas that affect the business both positively and negatively is finances. Understanding what influences costs is essential for sound financial decision-making. Categorizing these drivers helps pinpoint cost variations and develop strategies to manage them. The provider took more of an active role in this pilot since the product-based language of management information systems sometimes hinders activity identification.

Armed with this knowledge, they can implement strategies to reduce setup time, such as investing in automated setup equipment or implementing lean manufacturing techniques. Implementing ABC/M may seem daunting at first, but there are a few tips that can help ease the process. Firstly, it’s important to identify and define the activities within your organization.

• With the activity rates determined, the next step is to allocate costs to the products or services based on their consumption of each activity.
• By doing so, the organization knows clearly what activities should improve should to eliminate.
• ABM establishes relationships between overhead costs and activities so that the costs of products, services or customer segments can be calculated more accurately.
• In the case of ABC however, it is then necessary to apportion the costs of each activity to the products using the cost driver information.

In addition, ABM emphasizes the importance of understanding the costs of individual activities and how they contribute to the overall cost of the organization’s products or services. To illustrate the benefits of activity-based costing, let’s consider a case study of a consulting firm that provides various services to clients. In the traditional costing approach, the firm allocated costs based on the number of hours worked by each consultant.

ABM analyzes the costs of employees, equipment, facilities, distribution, overhead, and other factors in business to determine and allocate activity costs. ABM is focused on identifying and managing the activities that create value for customers and eliminating or reducing activities that do not add value. It is a proactive approach to management that involves continuously monitoring and improving processes and activities to achieve better outcomes.

Through this analysis, the company realized that certain products required more setup time and material handling, leading to higher costs. Armed with this information, the company was able to optimize its production processes, reduce costs, and improve profitability. Activity-based costing (ABC) is a costing method that provides a more accurate and detailed view of how costs are incurred within an organization.

Key takeaways:

A consulting firm wanted to gain a better understanding of the cost drivers for its various projects. By implementing ABC, the firm identified activities such as proposal development, client meetings, and project research. Costs were allocated to each activity based on the time spent by consultants and support staff. The analysis revealed that certain projects required extensive research and client meetings, leading to higher costs. Armed with this information, the firm was able to refine its pricing strategy, improve resource allocation, and enhance project profitability. Implementing activity-based costing in your organization can provide valuable insights into the true costs of your products or services.

By understanding costs and profitability at the activity level, it becomes easier to identify areas for improvement and optimization. Embracing activity-based costing can significantly improve your organization’s financial performance. By accurately allocating costs to activities and using appropriate cost drivers, you can gain valuable insights into the cost structure of your business and make informed decisions. Remember to regularly review and update cost drivers and communicate the results to stakeholders for maximum impact.