Overview of Activity Based Costing
Activity-based costing (ABC) is a methodology for more precisely allocating overhead to those items that actually use it. ABC works best in complex environments, where there are many machines and products, and tangled processes that are not easy to sort out.
Problems with Activity Based Costing
Many companies initiate ABC projects with the best of intentions, only to see a very high proportion of the projects either fail, or eventually lapse into disuse. There are several reasons for these issues, which are:
▪ Cost pool volume. The advantage of an ABC system is the high quality of information that it produces, but this comes at the cost of using a large number of cost pools – and the more cost pools there are, the greater the cost of managing the system. To reduce this cost, run an ongoing analysis of the cost to maintain each cost pool, in comparison to the utility of the resulting information. Doing so should keep the number of cost pools down to manageable proportions. ▪ Installation time. ABC systems are notoriously difficult to install, with multi-year installations being the norm when a company attempts to install it across all product lines and facilities. For such comprehensive installations, it is difficult to maintain a high level of management and budgetary support as the months roll by without installation being completed. Success rates are much higher for smaller, more targeted ABC installations. ▪ Multi-department data sources. An ABC system may require data input from multiple departments, and each of those departments may have greater priorities than the ABC system. Thus, the larger the number of departments involved in the system, the greater the risk that data inputs will fail over time. This problem can be avoided by designing the system to only need information from the most supportive managers. ▪ Project basis. Many ABC projects are authorized on a...