Activity Based Casting ( ABC )
Activity Based Casting is a projecting theoretical account that identifies the activities in an administration and assigns cost to the merchandise based on the activities involved. In comparison to traditional system, ABC system accumulate all the operating expenses involved and do a casting pool from where it assign cost to each person merchandises. Costss are delegating to single activities like planning, technology, or fabrication and so activities are associated to different merchandises or services. From this, an organisation can exactly gauge the cost of single merchandises and services so they can place and extinguish those that are unprofitable and lower the monetary values of those that are overpriced. ( 1 ) By and large, activity-based costing is most effectual when used over a long period of clip, as opposed to shorter-term solutions.
Apple is an electronic fabrication company. It manufactures different electronic merchandises from laptop to mobile phones. The utilizations of ABC system in apple aid this company of accurately mensurate its cost to happen suited monetary values. Thin production is besides achieved by utilizing ABC system by taking non-value added activities. Value added activities are so delegating cost drivers which are chosen on the footing of activities. Cost pools are so created and assign cost on the footing of these cost drivers.
2. Phases involve in ABC system
ABC technique is a complete accounting procedure which involves different stairss.These stairss are
Analysis of Activities
In this measure, the activities that are to be analysed will be included. Experts recommend the analysis of at least half a twelve organisational units with a common functional orientation to get down the plan. These activities are of import for delegating cost to the merchandise or services. The analysis of each activity will include
Whether that activity is a value adding or non-value adding
Whether it is a primary or secondary
Whether it is of import for the merchandise or non
Value adding activity is of import for the company because it add value to the merchandise or service whereas non-value adding activities are non of import. So this difference plays an of import function in delegating cost to the merchandise. Primary activities support company ‘s missions while non-value adding activity support primary activity. Primary activities are ever demands to be performed whereas secondary activities can be avoided.
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For apple, the activities those add values to its merchandises are the fabrication procedure, labor, technology technique, natural stuff etc.
Cost informations assemblage
Following measure is cost informations assemblage. In this measure the cost incurred for each activity is analysed. There are different cost those are associated with these activities. These costs are wages of people executing these activities, stuff cost, equipment cost ( fixed cost ) , and R & A ; D cost. These costs are figured and if they are non available, they can be estimated.
Tracing of cost to activity
Following measure is following of cost to activities. This measure affect in finding where the entire cost of each end product comes from. Every end product of an organisation was produced by one or more activities, each of which incurred costs when that activity is done. This measure aims to find where the costs are being incurred in bring forthing an end product, by finding which activities are needed to bring forth that end product and what costs are incurred in each of these activities. So the activity that are of import are retain in this measure.
Constitution of end product prosodies
The constitution of end product prosodies determine the entire cost of bring forthing an end product. It consists of the computation of the existent activity unit cost for each primary activity and the coevals of the measure of activities.A The activity unit cost of an activity is the entire input cost divided by the primary activity end product volume.A The entire input cost should include both the costs incurred by the primary activity and its associated secondary activities.A The measure of activities is the list of activities ( and their corresponding consumed sums ) needed to bring forth the end product. The entire cost of the measure of activities is the amount of each activity unit cost multiplied by its corresponding activity sum consumed.A A
Cost Analysis
Last measure is the cost analysis. In this measure each activity ‘s unit cost and measures of activities are analysed and so decided if the procedure need farther betterment. In this measure non-value adding activities are decently identified and take from the procedure so that to happen out accurate cost of the merchandise or service. ( 2 )
3. Importance of choosing the right cost drivers
Cost drivers for activities used in fabrication merchandises in Apple are of import in the sense that if proper cost drivers are non used, so cost of the merchandises will non be accurate. In implementing an activity-based costing ( ABC ) system, the choice of cost drivers is a major issue since truth must be traded off against the complexness of the ABC-system. On the one manus, a high truth in apportioning overhead costs frequently requires a high figure of cost drivers. On the other manus, a little figure of cost drivers are desirable to accomplish acceptable information cost and to do the ABC-system easier for direction to understand. ( 3 )
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Activity Based Projecting itself shows that it is based on activities. The choice of right cost drivers of each activity plays an of import function as if the right driver is non selected that the distribution of cost on all activities will non be accurate. This is more complex system so the traditional costing system but this is more accurate system as it is based on all the activities involved.
In apple, the best manner of choosing activity thrusts is spliting the costs into value-added and non-value-added constituents, with cost drivers separated into volume-related and transaction-related classs. This will ensue in nearing cost drivers as a manner to pull off and command disbursals.
When choosing an activity driver, attention should be taken as non all cost drivers are volume related and sometimes the drivers associated with minutess have a greater cost than the cost drivers associated with volume. For illustration to doing a female parent board for a laptop, activities involve labour clip, natural stuff coating, machine handling. If proper drivers are non used like natural stuff coating is used on the footing of labour alternatively of machine hours so it will non ensue accurately.
Activity drivers merge the demands that cost objects topographic points on activities. The importance of choosing activity drivers accurately can non be over emphatic. This will impact on the truth of the costing of cost objects. ( 4 )
4. ABC oil good cementing company
ABC Oil Well Cementing Company, a cost Centre affiliated with a Chinese State-owned Oil Conglomerate, specializes in cementing oil Wellss and gas Wellss. In crude oil well building, cementing is the procedure used to do certain that oil or a gas well is steadfastly protected for the ulterior oil or gas geographic expedition work. This company utilize ABC system in its procedure to cipher the true cost of merchandise. In this company squad responsible for implementing ABC ( Activity Based system ) identifies six activity Centres of lime storage, good borings, transit, fix and care, research lab testing, and administrative coordination. In these six activities, the ABC squad finds that the transit activity operating expense cost is the most of import cost for company direction to command. The transit activity includes wadding, burden, and transporting the direct stuffs and the equipment needed for good borings from the company office to the oil good field. Cement trucks, armored combat vehicle trucks, water-tank Lorries, and force per unit area autos are needed for the transit activity. Cement trucks are viewed by the ABC Company as transit equipment, while armored combat vehicle trucks, water-tank Lorries, and force per unit area autos are viewed as transit and cementing equipment.
The resource ingestion or overhead cost for the transit activity includes labour cost, equipment related cost, installation related cost such as parking or rental fees, and other motor vehicle cost. Sing that driving the armored combat vehicle trucks, water-tank Lorries, and force per unit area autos from the company office to the oil field are needed both for the transit intent and the good boring intent, it is hard to make up one’s mind on the proportion of labor cost and equipment cost that should be assigned to the “ transit ” activity pool and the “ good borings ” activity pool.
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If these cost drivers are non selected justly based on the activities performed so the cost of happening oil of a certain reign will non be accurately measured. If for illustration transit activity pools ‘cost drivers ( figure of trucks involved in transit, figure of drivers etc. ) are non accurately used and alternatively drivers of good boring pools are used so the cost incurred in transit can non be accurately measured which in consequence of favorable or inauspicious discrepancy. ( 5 )
5. Importance of sorting cost hierarchy
A cost hierarchy is a classification of costs into different cost pools. Cost drivers are associated to each activity on the bases ( cost-allocation bases ) of activity.ABC systems normally use a four-part cost hierarchy to place cost-allocation bases:
5.1 Output unit-level costs
5. 2 Batch-level costs
5.3 Product-sustaining costs
5. 4 Facility-sustaining costs
The importance of these cost hierarchy is that they allocate cost to all the activities that are involved. The cost drivers included all the costs those are to be incurred in making that activity. In the hierarchy, first one is end product unit-level costs.
5.1 Output Unit-Level Costss
These are resources sacrificed on activities performed on each single unit of merchandise or service.
Energy
Machine
Depreciation
Repairs
As these costs straight related to the single merchandise, so as the figure of merchandise additions, this cost is besides additions. As the figure of ram card additions, the cost is besides addition. But as this is straight related to the merchandise, there is no excess cost incurred in the production of the merchandise.
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5.2 Batch-Level Costss
These are resources sacrificed on activities that are related to a group of units of merchandise ( s ) or service ( s ) instead than to each single unit of merchandise or service.
Setup-hours
Procurement costs
Importance of this cost is that it divided to the whole group of the homogenous merchandises. As each batch is produced, this cost is occurred one time and when the batch is produced, this cost is finished. Setup-hours and procurances costs are the two illustrations of this cost and these are merely related to that peculiar batch.
In Apple, the supervisor ‘s wage will remain same whether Apple produce 10 mother board or 100 female parent boards.
5.3 Product-Sustaining Costss
These are frequently called service-sustaining costs and are resources sacrificed on activities undertaken to back up single merchandises or services.
( 1 ) Design costs ( 2 ) Technology costs
Designing of Apple ‘s merchandises and its technology are the merchandise prolonging cost.Importance of these costs is that they are straight involved to the merchandise regardless of figure of units or batch green goodss. These costs are ever at that place and they support to bring forth single merchandise or service.
5.4 Facility-Sustaining Costss
These are resources sacrificed on activities that can non be traced to single merchandises or services but support the organisation as a whole.
General disposal
– rent
– edifice security
These costs are besides of import for that single merchandise or batches as these are the basic installations to bring forth merchandise.
Cost pools and cost drivers are the basic subject of ABC system. In cost hierarchy if cost pools are non design decently so right cost drivers can non be assign to the activity. So planing a cost pool is the first cardinal measure in utilizing ABC system. Cost pools will demo all the cost that can possible incurred in doing the merchandise. ( 6 )
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6. Example of Activity based coting system of Apple
Following is the illustration of ABC method which shows the execution procedure of ABC system.
The undermentioned information provides inside informations of the costs, volume and dealing cost drivers for a period in regard of Apple Pvt. Ltd:
A
Merchandises
A
A
Bacillus
C
Gross saless and production ( units )
90,000
30,000
15,000
Natural stuffs use ( units )
10
7
14
Direct stuffs cost ( ? )
30
40
15
Direct labor hours
2.5
3
1.5
Machine hours
5
3
7.5
Direct labor cost ( ? )
20
30
10
Number of production tallies
5
10
50
Number of bringings
18
7
50
Number of grosss
50
70
700
Number of production orders
45
25
60
Operating expense costs
?
Set up
75,000
Machines
1,000,000
Receiving
900,000
Packing
650,000
Engineering
750,000
Entire
3,375,000
To use the ABC method to the above illustration, we need to place cost drivers for two phases:
1 cost drivers following the costs of inputs into cost pools ; and
2 cost drivers following the cost pools into merchandise costs
The computations for each of the rates to be used are:
The machine hr rate is the lone rate that is what we might name a traditional rate. All of the other rates we are about to utilize affect a two phase procedure. We will see the elements of these two phases as we get to them.
Machine hr operating expense rate
?1,000,000 =
?1.5326
652,500 machine hours
A
This rate is used as normal.
For the set up costs, we foremost invent a rate to state us the cost per set up: sum set up operating expenses divided by the figure of set ups: in this instance, this is
?75,000 =
?1,153.85
65 production tallies
A
We will return to this rate shortly.
All of the other rates are calculated likewise. Hence they will be presented now without farther remark.
Receiving rate
?900,000
= ?1,097.56
A
820 grosss
A
Packing rate
?650,000
= ?8,666.67
A
75 bringings
A
Engineering rate
?750,000
= ?5,769.23
A
130 production orders
A
All of this information can now be put together into a cost per unit statement as follows.
The concluding phase in the whole ABC process, every bit far as merchandise cost finding is concerned is to happen out the costs per unit. The cost per unit statement follows, and so we will work through the computations.
Unit of measurement costs
A
Bacillus
C
A
?
?
?
Direct stuffs
30.0000
40.0000
15.000
Direct labor
20.000
30.000
10.000
Machine operating expenses
7.6628
4.5977
11.4943
Set up costs
0.0641
0.3846
3.8462
Receiving costs
0.6098
2.5610
51.2195
Packing costs
1.7333
2.0222
28.8889
Technology costs
2.8846
4.8077
23.0769
Entire Costss
?62.9546
?84.3732
?143.5257
Workss:
Machine operating expenses are found by multiplying the machine hr rate by the figure of machine hours per merchandise per unit:
Machine hr rate ?1.5326 ten
machine hours
5
3
7.5
gives
?7.6628
4.5977
11.4943
The set up costs rate we have already is the rate per machine set up, the cost per unit is calculated by multiplying the rate per set up by the figure of set up per merchandise and so spliting the consequences by the entire figure of units per merchandise:
Set up cost per set up ?1153.85 ten
No of set ups
5
10
50
gives
?0.0010
0.0059
0.0592
Set up cost per set up ?1,153.85 ten
No of set ups
5
10
50
gives
?5,769.25
11,538.50
57,692.50
These values are so divided by the figure of units per merchandise to give us the cost per unit:
A
?0.0641
0.3846
3.8462
The receiving, packing and technology costs are all calculated in the same manner as the set up costs. There is no demand to reiterate these computations, but check that they are understood.
Drumhead 1: Entire costs per unit utilizing each of the three methods
A
Merchandise
A
A
Bacillus
ABC
62.9546
84.3732
Drumhead 2: Operating expenses per unit utilizing each of the three methods
A
Merchandise
A
A
Bacillus
ABC
12.9546
14.3732
Drumhead 3: Operating expenses as a per centum of entire costs
A
Merchandise
A
A
Bacillus
ABC
20.58 %
17.04 %
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7. Restriction of ABC system
Although ABC system is a really powerful system in delegating cost to the merchandise or services. But there are besides some restrictions in utilizing this system.
Implementing an ABC system is a major undertaking that requires significant resources. Once implemented, an activity based costing system is dearly-won to keep. Data refering legion activity steps must be collected, checked, and entered into the system. This is really ambitious and difficult to get by with.
ABC produces Numberss such as merchandise borders that are odds with the Numberss produced by traditional bing systems. But directors are accustomed to utilizing traditional bing systems to run their operations and traditional costing systems are frequently used in public presentation evaluations.So traditional system attract directors most so ABC system and due to bureau job, directors prefer traditional system so ABC system.
A Activity based bing informations can be easy mis-interpreted and must be used with attention when used in doing determinations. Costss assigned to merchandises, clients and other cost objects are merely relevant. Before doing any determination utilizing activity based bing informations, directors must place which costs are relevant for the determinations at manus.
Reports generated by these systems do non by and large accepted accounting rules ( GAAP ) . Consequently, an organisation involved in activity based costing should hold two cost systems – one for internal usage and one for fixing external studies.
External studies are less elaborate than internal studies prepared for determination devising. On the external studies, Individual merchandise costs are non reported. Cost of goods sold and inventory ratings are disclosed, but there is no dislocation of these histories by merchandise. If some merchandises are under-costed and some are over-costed, the mistakes tend to call off each other when the merchandise costs are added together.
It is frequently really hard to do alterations in a company ‘s accounting system. The official cost accounting system in most big companies are normally embedded in complex computing machine plans that have been modified in-house over the class of many old ages. It is highly hard to do alterations in such computing machine plans without doing legion bugs.
The hearers are likely to be uncomfortable with allotment that are based on interviews with the company ‘s forces. Such nonsubjective informations can be easy manipulated by direction to do net incomes and other cardinal variables look more favorable. ( 8 )
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