Activity costs account ABC (Activity Based Costing) also the calculation of ABC, defines the structure and principles of indirect costs calculation, thus it is used to accurately determine the amount of indirect costs per product. According to the ABC concept, indirect costs are accounted for in the cross-section of activities and processes generating these costs, not in the cross-section of production entities (e.g. departments).
This account is a new method of measuring and calculating costs. According to it, indirect costs are settled on products using a number of different basis of settlement (cost drivers). Some of them may be proportional to the volume of production, while others do not have to have a direct causal relationship with the quantity of products produced.
The basis for cost settlement is used to allocate indirect costs to products, caused by various internal activities or processes (activities), necessary for the production and sale of certain products included in the company's production program. These bases are also used to measure the size of specific activities. They should be proportional to the costs generated by specific activities, the costs of which are subject to settlement.
In practice, you can define a large number of business processes leading to the creation of a product on the "exit", starting from general activities and ending with activities on a microscale. The ABC type calculation, defined as a calculation based on actions or elementary processes, is an opposite method to traditional costing systems.
Premises for ABC calculation
The turbulent change in the environment and the high degree of complexity of manufacturing processes make traditional cost accounting systems not always provide adequate information for decision-making needs. In principle, they do not provide information on the costs and efficiency of processes. Their accuracy is not sufficient to meet the information needs of the management. Traditional calculation methods pre-grouped indirect costs according to the place of their creation and then they settled them into the settlement basis, which is usually the direct costs of products (materials, labor). Such a settlement of indirect costs was always superficial. When using the traditional method, these costs are attributed to too small a portion of these costs to specific products whose indirect costs of generation and delivery to customers are high. This results in too high valuation of typical products and too low valuation of special products.
The answer to the need for more detailed information on the costs incurred is the activity costs account. The most important motivations for enterprises to implement the ABC account include recognition of activities that do not bring goodwill. Activity costs account allows a completely different view of the costs incurred and increases the possibility of their analysis and limitation. It focuses on a more accurate settlement of indirect costs, and direct costs are referred to products and services based on accounting documents.
What is the use of the ABC activity costs account useful for?
Activity-based costing is necessary in those enterprises in which:
- fixed costs represent a significant share of total costs
- production is complicated, multi-assortment, and the size of production series is subject to frequent changes
- managers often negate information about costs
- products are exposed to strong price competition
When should you use the ABC system?
R. Cooper and RS Kaplan, who have developed the action cost account, formulated two principles that should be followed when deciding to implement it, they are:
- principle of high indirect costs - this principle suggests the introduction of an ABC account in those companies where indirect costs and auxiliary costs represent a high share of total costs
- the principle of great diversity - it suggests the introduction of the ABC system in companies characterized by a large variety of customers, a wide range of production, the use of various technologies and a large variety of economic processes
Presuppositional of the operating costs account - ABC
The ABC concept is based on the following assumptions:
- Expenses incurred to acquire various resources necessary for the operation of the enterprise are expressed by costs,
- Different activities lead to the consumption of these resources,
- Each company is a collection, a series of processes and activities,
- Clients contribute to the company's processes and activities
- Costs arise as a result of processes and activities; is therefore considered as a result of activities and processes taking place in the company, not their cause,
- The specified number of actions is expressed using the appropriate unit of measure for this activity,
- First, the costs are grouped in the cross-section of activities, and then the individual products are accounted for according to the unit costs for each measure of the measure,
- The purpose of taking action is to meet customer needs, which means that activities are consumed by cost objects such as products and services as well as customers and sales channels.
Phases of the activity costs account
The ABC concept is subordinated to the structure of the cost accounting system, which is formed by the following phases:
- identification of relevant activities (activities) occurring in the business entity,
- determination of the volume measurement unit of each activity (cost driver),
- determining the costs of each separate operation (cost pool),
- settlement of indirect costs of individual actions for the types of products manufactured,
- determination of unit costs of products,
- settlement of indirect costs (grouped in activity areas) between work products. For this purpose, the general areas of activity should be divided into two groups, which include:
- indirect costs increasing the value of work products, representing the actual consumption of factors of production (value-added activity),
- indirect costs that do not increase value, being costs of maintaining production capacity in readiness for operations (non value-added activity)
The ABC system clearly distinguishes resources acquired from resources used in the economic process. The ABC system measures changes in the level of resource consumption. The final costs are borne on the manufactured products. Not the products directly, but the actions are the reason for their formation.
Tools resulting from the ABC concept
- ABM (Activity Based Management) - focuses on the management of processes and activities in order to increase the value received by the client and the achieved profit by creating this value. It provides an opportunity for the company to achieve the same or better results using fewer resources, and consequently to reduce costs.
- Time-Driven ABC (TD ABC) - allows to obtain precise information on the costs of operations and the profitability of cost objects: customers, products, orders, distribution channels, market segments. It also allows you to obtain detailed information on the pool of costs involved in the implementation of specific activities, so you can accurately determine their profitability and indicate what is caused by high profitability or lack thereof.
- ABP (Activity Based Pricing) - is the domain of using information from the ABC / M system in the process of shaping prices and rebates of the company. It informs managers that the cost of the product depends not only on the organization, but also on the purchasing behavior of customers purchasing the product.
- ABB (Activity Based Budget) - is an approach to the budgeting process, focusing on identifying the costs of activities occurring in every activity of an enterprise. ABB was established as a response to the criticism of traditional budgeting methods. The conventional way of budgeting is based on repetitive negotiations between heads of centers of responsibility for costs and management. The concept of ABB differs from the cost budget in that it is primarily associated with activities and allows for a more factual basis, and less in the strength, influence and ability of discussion. Thanks to this, it is possible to create financial forecasts more accurately and thus encourages the organization to make the most effective use of its resources.
Benefits and shortcomings in the ABC account
Benefits of using ABC:
- an information that costs should not be the target of control, but the factors that cause them
- change of management in the field of operation control
- a cost brakdown that takes into account their actual impact on the cost of the product (goods)
- answering the questions about whether activities are profitable, profitable or cost-intensive
Shortcomings in ABC:
- too much difficulty in implementation and application
- the information provided by this cost account is only a modification of the previous ones
- there is no need to provide such accurate data
- currently, cost accounting systems do not play a key role.
- Kaplan, R. S., & Anderson, S. R. (2003). Time-driven activity-based costing. Available at SSRN 485443.
- Cooper, R., & Kaplan, R. S. (1991). Profit priorities from activity-based costing. Harvard business review, 69(3), 130-135.
- Gosselin, M. (1997). The effect of strategy and organizational structure on the adoption and implementation of activity-based costing. Accounting, organizations and society, 22(2), 105-122.