Activity Based Costing

Research Paper (undergraduate), 2004

14 Pages, Grade: 2



2 Introduction

3 Designing ABC systems
3.1 Identifying activities
3.2 Assigning costs to activity cost centres
3.3 Selecting appropriate cost drivers
3.3.1 Transaction Drivers
3.3.2 Duration Drivers
3.3.3 Intensity Drivers
3.4 Assigning the cost of the activities to products

4 Strategic benefit of ABC approach
4.1 Activity based costing (ABC)
4.2 Activity based management (ABM)
4.3 Activity based budgeting (ABB)

5 Failure in implementation
5.1 Resistance
5.2 A high degree of inherent difficulty in implementation
5.3 The threat of redundancy
5.4 Expertise not held by the company
5.5 Data-collection problems

6 Conclusion

7 References
7.1 Books
7.2 Journal
7.3 Internet

2 Introduction

(CIMA 2001a) During the last decades there was a change in organisations from managing vertical to managing horizontal. The organisations started to become process orientated instead of function orientated, and new management styles, like total quality management, just in time, benchmarking, or business process reengineering appeared. Which lead into an increase of overheads.

(Drury 2004a) The most important cost factors changed from direct costs like labour costs or materials, into indirect costs like set-up costs or administration costs. Therefore the traditional costing systems became more or less useless, because they presented poor cost information, which leads into decision errors.

Therefore the ABC- system of cost calculation seems to be a solution. The most important difference between traditional systems, and the ABC system, is the breakdown of overheads. In traditional costing systems, they are divided into cost centres, and accumulated products by using direct cost drivers. In the ABC system, they will be assigned to activities, which creates a greater number of cost centres with different cost drivers. They will be accumulated to products in the percentage of usage of an activity.

3 Designing ABC systems

(Drury 2004b) To design an ABC-system, a process including four stages is required. At first the relevant activities must be identified, then the relevant overheads, which are caused by this activity must be identified. In the third step, a relevant cost driver must be found, before finally the costs of the activities can be assigned to the products.

3.1 Identifying activities

To identify the activities can be seen as the most important, and also most difficult stage in creating an ABC approach. Therefore it is very important, to carry out this stage very carefully. Activities consist of different tasks, which can be added together. Certainly each task can be seen as one activity, but this would create a too high amount of data. To cursorily activities will not be able to present usable cost information. So it is important to find the right size

Activities can be carried out by activity analysis. As a useful starting point can be seen a plan of the workplace, and a payroll listing, to identify how all work space is used, and which personnel is taken into account. Afterwards the managers and employees must be interviewed to identify which tasks they carry out, and how they can be summed up to certain activities. The most important factor in summing up different tasks to one activity is a single cost driver, to be able to assign the costs caused by this activity to different products.

3.2 Assigning costs to activity cost centres

After the activities and their cost drivers have been identified, the relevant costs, which are caused by this activity over a certain time, must be ascertained. The aim should be to find out how much an organisation has to spend for this single activity. Therefore some resources can be directly attributed, and some must be shared with other activities, and therefore indirectly determined. This costs should be assigned to activities by using cause-and-effect cost drivers, or interviews of staff, to find out how much an activity requires frm a certain resource.

3.3 Selecting appropriate cost drivers

Cost drivers in this stage are also called activity cost drivers, there are several requirements to this cost drivers. They should provide a good explanation of costs in each cost pool. They should be easily measurable, this data should be easily to obtain and should be linked to products. There exist three types of cost drivers.

3.3.1 Transaction Drivers

Transaction drivers count the number of times an activity is carried out. For example, number of purchased orders or number of undertaken set-ups. They assume, that the same amount of resources is required, when an activity is carried out, so they are very accurate as long as there is not a high variation in the amount of required resources by certain cost objectives.

3.3.2 Duration Drivers

Duration drivers represent the amount of time, which is needed to carry out a certain activity. If for example different products require different set-ups hours, the transaction drivers will not deliver an accurate result. Because the product, which a longer set-up hour will be undercosted, while the product with the shorter set-up hour will be overcosted. Using now set-up hours will solve this problem, but increases measurement costs.

3.3.3 Intensity Drivers

Intensity drivers charge the resources directly, if an activity is carried out, and do not use an average rate for splitting up overheads like duration drivers. For example, if an activity requires both unskilled and skilled personnel, the duration drivers would average them, while the intensity drivers would calculate them separately. It is also possible, to weight them by a certain factor instead of creating two different drivers. But it may become difficult to locate the right factor.


Excerpt out of 14 pages


Activity Based Costing
Glyndŵr University, Wrexham known as NEWI  (Business school)
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ISBN (eBook)
ISBN (Book)
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Activity, Based, Costing
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DI (FH) Andreas Leitner (Author), 2004, Activity Based Costing, Munich, GRIN Verlag,


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