The evolution of the concept of Activity Based Costing (ABC) has materially changed the cost accounting and management systems. It has enabled the management to predict the cost behavior related to individual units of products, which in turn has made it possible for the management to get away with the less profitable products and look into the pricing of the products. This paper covers the technical aspects of the activity based costing with reference to share made by each customer in the profits of an organization. Moreover, the study also highlights how activity based management comes in action after ABC has identified the information necessary for decision making.
Unlike other costing methods, ABC is a technical concept which enables the management to make sure the efficient running of the organization’s operations. The concept of ABC is applied evenly throughout the organization’s activities and operations. In this paper, the application of the ABC for the analysis of customers’ contribution in costs and profits of the organization has been focused. The application of the knowledge gained by management through ABC analysis is called Activity Based Management (ABM).
The concept of activity based costing equips the managers with a tool, which helps them in identifying each customer’s contribution in profits. In the world of business, every organization wants to give its best to the customers who show confidence in it and help in making good profits. But there is a problem. One cannot simply say that who is/are the best customer(s). Neither can anyone say that the one who adds major figures to the revenues of an organization is the best. The solution lies in ABC analysis, which helps managers to rate their customers in terms of their individual contribution to the profits of the organization. Apart from this, the analysis also helps managers to identify activities and spread their respective costs over the products manufactured and services rendered by the organization (Economist).
How it Works?
In order to find out the costs associated with each customer, the activities pertaining to every customer, which are called “cost drivers”, are chosen and their respective costs are calculated. These cost drivers are than analyzed in order to identify as to what portion of these drivers are associated with each of the customer. Henceforth, these cost drivers are split into individual activities (Offtech).
While carrying out these procedures, managers are required to make sure that the identified activities are related to the customers and can be analyzed with ease. The relatedness of the activities to the customers refer to the direct and indirect costs (Offtech).
Going Ahead: From ABC to ABM
ABC and ABM (Activity Based Management) go together. Once analysis through ABC is underway, ABM also comes in action in the form of decisions made by management on the basis of the analysis. The ABC analysis is meant to equip management with a comprehensive knowledge and understanding of the business processes of the organization. Managers than apply this understanding while planning for the business strategies and designing operational strategies (Roztocki).
Following are the significant outputs for managers which are achieved by performing ABC techniques in the organization:
- Generates information: The fundamental idea of applying ABC is to generate information for management’s decision making.
- Identifies wastes: Those processes which do not add value to the item being produced but increase cost are termed as waste. The ABC analysis helps management in identifying wastes.
- Identifies activity performance: Apart from generating information related to business activities, ABC also enables managers to identify activity performance.
- Accurate information: ABC techniques produce accurate information in terms of costs of products and services. This output of ABC analysis is considered to be the most important one, because it allows managers to select markets for competition and effective pricing (CIMA).
ABC analysis does not only provides techniques to managers for improving decision making processes but also at the same time gives a concise knowledge about the costs required to manufacture a product or render a service. These provisions in turn improve the efficiency with which an organization operates.
CIMA. “Activity-based Management – An Overview.” 2001. Web.
Economist. “Activity-based costing.” 2009. Web.
Offtech. “What is Activity Based Costing and how does it work?” 2011. Web.
Roztocki, Narcyz. “Activity Based Costing.” 2011. Web.