ABC

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Theories Underpinning ABC

  • Realization that o/h do not just occur but are caused by activities but drive the costs.
  • Realizes that costs are not necessarily volume driven but driven by activities
  • Assumes that o/h can be analyzed and cost drivers identified
  • A cost pool is est. for a cost driver – a pool of costs
  • Indirect costs can not be assumed to be fixed
  • There is a need for a periodic attention-direction reporting system
  • Special studies are (last lesson) are almost impossible when you have got 100 or so products. E.g. to drop 1 product would not affect FC but drop 10 and it would. Therefore cannot assume decisions are independent


Benefits

  • High level of competition
  • Diverse product range
  • High level of indirect costs

Using ABC

It is distinguished from Full Costing by the

  • Greater number of Cost Centers
  • Greater number of second stage cost drivers
  • It based on the activity (product) and not department

Designing ABC

  • Look for what Kaplan and Cooper call L-t Variable costs like Set Ups, which vary with Volume
  • Identify the major activities
  • Assign costs to cost pools
  • Determine the cost driver for each activity
  • Transaction drivers – Purchase orders
  • Duration drivers – set up hours
  • Unit level activities – direct labor hours
  • Batch related hours – purchase orders
  • Product sustaining activities – Engineering
  • Customer sustaining - marketing
  • Facility sustaining – plant management and property costs

Cost v Benefit Considerations

  • ABC is expensive
  • Therefore if the cost of errors exceeds the cost of implementing ABC then go ahead and implement
  • ABC should be used where there is intensive competition
  • Non-volume related costs are high
  • Diverse range of products

Benefits of ABC

  • Provides more accurate costing data than absorption costing
  • Appropriate for establishing cots for diverse products or activities
  • Reduces the need for special studies to obtain relevant cost info

Criticisms of ABC

  • Identifying cost drivers is time consuming and costly
  • Like Full costing it does not use relevant costs for decision-making (ignores opportunity costs)
  • But it does provide l-t avg cost
  • Evidence that its use is declining
  • Allocations are always arbitrary in the end
  • Past data is out of date or no longer relevant
  • Is the emphasis on costs that important when cost plus pricing is rarely used
  • May overly focus on management by numbers
  • Companies have tried to determine too many cost drivers


See Resource Consumption Models

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