Activity-Based Costing

- introducing process thinking into cost management-

Scholarly Paper

@

the

University of Applied Sciences Wildau

name:

Patrick Zeuner

course title:

Master of Aviation Management

module title:

Managerial Accounting

date due:

1st of December 2007

Table of contents

Table of contents II

Table of figures III

1. Introduction 1

2. Methodology 2

2.1 Internal setup within the organization 2

2.2 Conceptual implementation 4

3. Effects of cost allocation 8

4. Conclusion 10

References IV

II

Table of figures

Figure 1: primary use of ABC (BetterManagement, 2005) 2

Figure 2: implementation approach 3

Figure 3: process example of a leasing business 5

Figure 4: methodology of an ABC calculation (Mattfeld, B., 2003) 5

Figure 5: relation of resource and activity drivers (Mattfeld, B., 2003) 6

Figure 6: assigning activities to respective cost objects (based on Mattfeld, B., 2003) 7

Figure 7: calculation of unit costs per cost object 8

Figure 8: complexity effect (Coenenberg, A./Fischer,T., 1991) 9

Figure 9: product example for economies of scale (Coenenberg, A./Fischer, T., 1990) 10

Figure 10: main challenges implementing the ABC method (BetterManagement, 2005) 11

III

1. Introduction

Activity-based costing first gained publicity in the early 1980s. It was developed as a logical

alternative to traditional cost management systems that tended to produce insufficient results

when it came to allocating costs. Harvard Business School Professor Robert S. Kaplan was an

early advocate of the ABC system.1

Due to a changing business world and strong competition, the cost structure in many

companies changed, while facing an increased price pressure. When profit margins are

decreasing, companies are focusing not only on external but also internal opportunities to

improve their cost structures and to make hidden costs transparent. This leads to the

introduction of Activity-based costing (ABC) as a new approach of process thinking to make

the internal organization more flexible to react to changes in the production process and

allocation of costs as well as to deal with overcapacities.

ABC is therefore a method to develop cost estimates into quantifiable activities or work units.

Traditional costing systems, which are based on calculating direct costs and adding overhead

costs proportionally, can lead to wrong business decisions. Due to a relatively small

proportion of direct costs in today′s businesses and increased overhead costs, the cost

allocation does not work properly. ABC has been designed to cope with the deficiencies of

traditional costing systems and allows an organisation to determine the actual costs associated

with each product or service.2

Aiming at transparency, efficiency increase and improvement of the cost calculation system,

the ABC method enables management to optimize the enterprise with detailed information for

a thorough decision making process.

1 Cokins, G.(1998), p. 15.

2 Coenenberg, A.(1992), p. 12.

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