Activity Based Costing and Activity Based Management

Cost-Conscious Culture

Creating a mindset within the organization where everyone is motivated to reduce costs and technology is utilized to achieve cost reductions.

Activity-Based Costing (ABC)

An approach to costing that traces resource consumption and costs to final outputs based on activities and cost drivers.

Direct Product Profitability (DPP)

Involves attributing purchase price and indirect costs to each product to determine net profit for better cost analysis and pricing decisions.

Customer Profitability Analysis

Analyzing revenue streams and service costs associated with specific customers or customer groups to understand profitability.

Distribution Channel Profitability

Evaluating the profitability of different distribution channels to ensure that the chosen channel contributes positively to the business.

Activity-Based Budgeting (ABB)

Budgeting method based on activities to align budgeting with the organization's activities and cost drivers for better financial planning.

Activity-Based Budgeting (ABB)

A budgeting approach that focuses on budgeting for activities by identifying cost drivers for each activity and estimating activity costs.

Cost Driver

A factor that causes a change in the cost of an activity, which is used to allocate costs to cost objects.

Overhead Activities

Costs that are not directly tied to a specific product or service but are necessary for the overall operation of the organization.

Responsibility Centre

A segment of an organization for which a manager is held accountable for the performance, including costs, revenues, or investments.

Zero-Based Budgeting (ZBB)

A budgeting approach where budgets are prepared from scratch for each budgeting period, requiring managers to justify all expenses.

Total Quality Management (TQM)

A management approach that focuses on continuous improvement of processes and products to enhance customer satisfaction.

Budget Holder

An individual responsible for managing and controlling the budget of a specific area within an organization.

CGMA Cost transformational model

• Engendering cost conscious culture

• Managing risks that may arise from a cost conscious culture

• Connecting products with profitability

• Generating maximum value through new products

• Maintaining the sustainability to optimize profits

• Understanding cost drivers

Steps to ABC

1. Group the production overheads into activities

2. Identify cost drivers for each activity i.e what causes these activity costs to be incurred

3. Calculate cost driver rate

4. Absorb activity costs into products

5. Add all the costs that you found to give full production cost or profit or loss

When is ABC better than traditional costing

a) when production overheads are high relative to direct costs, particularly direct labour

b) where there is great diversity in the product range

c) where there is considerable diversity of overhead resource input to products

d) when consumption of overhead resources is not driven primarily by volume

Unit level activities

They are consumed in direct proportion to the number of units produced.

Batch related activities

The cost of batch-related activities varies with the number of batches made, but is common (or fixed) for all the units within the batch.

Product sustaining activities

They are performed to enable different products to be produced and sold, but the resources consumed are independent of how many units or batches are being produced.

Facility-sustaining activities

Some costs cannot be related to a particular product line, instead they are related to maintaining building and facilities. Examples would be maintenance of the building, plant security and business rates.

How does ABC help in decision making?

Helps in long term decision making. Given the inherent uncertainty involved in strategic decision making, management may use this information in decision-modelling and sensitivity analysis to assist in the making of such decisions.

DPP software systems require which key variables to analyze?

a) Buying and selling prices

b) Rate of sale

c) Inventory

d) Product size

e) Pallet configuration

f) Ordering costs

g) Distribution routes

Customer profitability curve

When an organization analyses the profitability of its customers it is not unusual to find that a Pareto curve exists. That is 20 per cent of customers provide 80 per cent of the profit.

Problems with implementing ABC/ABM

• Resistance to change from employees and management

• Complexity in identifying and measuring activities

• High initial implementation costs

• Difficulty in integrating with existing systems

• Potential data overload and analysis paralysis

• Misalignment with traditional accounting practices

• Need for continuous monitoring and updating of activity data