Activity Based Costing/Management
Activity Based Costing can be defined as a costing system that easily determines specific activities of an organization and allocates the costs to these activities in relation to the products and services taking into consideration the actual consumption by each. It involves assigning of overhead or indirect costs into direct costs. This gives an organization an opportunity to determine the position of the costs of its products and services for the sole objective of detecting and doing away with those products and services that are not profitable.
Taking such measures also assists in the reduction in the price of the same products and services that may be overpriced. In 1930’s when security and exchange acts placed a greater emphasis on financial accounting, cost accounting was split off as a separate accounting surviving in the mainstream of accounting (Taney, 1998). The application of ABC system of costing and management involve the allocation of resource costs in line with its activities to the products and services.
It is a vital tool used to undertake the important policies such as outsourcing, pricing, improvement of products and services and finally determining procedures that if undertaken could lead to the improvement of the delivery of such products and services to the customers. In the past, accountants applied techniques that were not very effective in price reduction and lacked means of identifying numerous bottlenecks in the achievement of customer satisfaction. The two decades of the 1970s and 1980 saw the further application of ABC as a system of costing especially in the manufacturing segment of the economy.
The traditional forms of costing do not often attain accurate costs of production and other costs in the service delivery. ABC deviates from the application of broad arbitrary fractions in the determination of actual costs and further goes ahead to locate connections that exists between these costs (Baker, 1998). Upon the identification of costs of an activity, the actual costs of each activity are linked to each product or service that makes use of this activity.
ABC therefore assists in detecting the loopholes of excess overhead costs per unit and creates the opportunity for finding solutions to problems of using excess amounts in the production line (Hicks, 2002). These systems of management can be traced back to early 1980s when the manufacturing industry extensively used them. Technological advancement in the manufacturing sector has led to massive direct costs in labour and raw materials while leading to an upward surge in indirect costs.
A good example is the use of automated machines that has considerably led to a decline in costs of labour but has led to the increase in costs of depreciation. The cross- product- cross -customer subsidies can be made into use by both the manufacturing firms and the financial institutions. The term cost deriver, which refers to the determination of the level of use of a common activity by each product estimates costs involved in shared activities (Richard, Crawford and Rebishcke, 1990).
Before the invention of Activity Based Management, it was hard to determine costs linked to the process of developing a product and its final delivery and thus calculating actual figures in profits was not easy. Activity Based Management takes a deep examination into costs-both direct and indirect, the process and even the type of activity. These indicators then assist in ascertaining the actual expenses system and management improvement (Plowman, 2001).