Activity-Based Costing

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* Activity-Based Costing (Encyclopedia of Management)
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Activity-based costing (ABC) is an accounting method that allows businesses to gather data about their operating costs. Costs are assigned to specific activitiesuch as planning, engineering, or manufacturingnd then the activities are associated with different products or services. In this way, the ABC method enables a business to decide which products, services, and resources are increasing their profitability, and which are contributing to losses. Managers are then able to generate data to create a better budget and gain a greater overall understanding of the expenses that are required to keep the company running smoothly. Generally, activity-based costing is most effective when used over a long period of time, as opposed to shorter-term solutions such as the theory of constraints (TOC). Activity-based costing first gained notoriety in the early 1980s. It emerged 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. While mainly used for private businesses, ABC has recently been used in public forums, such as those that measure government efficiency. HOW ACTIVITY-BASED COSTING WORKS

Activity-based costing programs require proper planning and a commitment from upper management. If possible, it is best to do a trial study or test run on a department whose profit-making performance is not living up to expectations. These types of situations have a greater chance of succeeding and showing those in charge that ABC is a viable way for the company to save money. If no cost-saving measures are determined in this pilot study, either the activity-based costing system has been improperly implemented, or it may not be right for the company. The first thing a business must do when using ABC is set up a team that will be responsible for determining which activities are necessary for the product or service in question. This team should include experts from different areas of the company (including finance, technology, and human resources) and perhaps also an outside consultant. After the team is assembled and data on such topics as utilities and materials is gathered, it is then time to determine the elements of each activity that cost money. Attention to detail is very important here, as many of these costs may be hidden and not entirely obvious. As Joyce Chutchian-Ferranti wrote in an article for Computerworld: "The key is to determine what makes up fixed costs, such as the cost of a telephone, and variable costs, such as the cost of each phone call." Chutchian-Ferranti goes on to note that even though in many instances technology has replaced human labor costs (such as in voice-mail systems), a business manager must still examine the hidden costs associated with maintaining the service. Nonactivity costs like direct materials and services provided from outside the company usually do not have to be factored in because this has previously been done. Once all of these costs are determined and noted, the information must be input into a computer application. Chutchian-Ferranti explains that the software can be a simple database, off-the-shelf ABC software, or customized software. This will eventually give the company enough data to figure out what they can do to increase profit margins and make the activity more efficient. After a business has had enough time to analyze the data obtained through activity-based costing and determine which activities are cost effective, it can then decide what steps can be taken to increase profits. Activities that are deemed cost prohibitive can then be outsourced, cut back, or eliminated altogether in an effort to make them more...
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