a review of activity based cost management principles
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A Review of Activity Based
Cost Management Principles
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E N T E R P R I S E P E R F O R M A N C E O P T I M I Z A T I O N
It is a means of identifying the resources - money,people, assets - consumed by each activity that isperformed in an enterprise.
It identifies theevents or driversthat cause eachactivity to beperformed.
These drivers and their relationship to products, servicesand customers are used to assess product, service andcustomer cost and profitability.
What is Activity BasedCosting?
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E N T E R P R I S E P E R F O R M A N C E O P T I M I Z A T I O N
Definitions
Definition Example
Function An area of related skillssupporting one area in thebusiness
Accounts Receivable
ActivityA series of related taskscarried out repeatedly
Chase a customer for
late payment
Driver An event or factor whichcauses an activity to beperformed
Unpaid Invoices
Process A series of activitiesrequired to achieve anoutcome
Invoicing Process
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E N T E R P R I S E P E R F O R M A N C E O P T I M I Z A T I O N
Traditional (Standard) Costing
- Direct Labour- Machine Time- Direct Cost Ratio- Floor Area- etc., etc.
Customer, Productor Service costs
Standard costing fails to applycost in the way it is reallyincurred!
It produces a result that isprecisely wrong
Indirect costs
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E N T E R P R I S E P E R F O R M A N C E O P T I M I Z A T I O N
Activity Based Costing
Activities and
their driverscreate ameaningfullink betweenproducts,
customers,and theresourcesthey eachconsume.
Customer A
Customer A
Customer A
Customer A
Customer A
Customer A
Product 1
Product 1
Product 1
Product 1
Product 1
Product 1
Cost Driver 1
Cost Driver 1
Cost Driver 1
Cost Driver 1
Cost Driver 1
Cost Driver X
Activity 1
Activity 1
Activity 1
Activity 1
Activity 1
Activity 1
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E N T E R P R I S E P E R F O R M A N C E O P T I M I Z A T I O N
Customer A
18Kgross
margin
0debtchases
0incurred
cost
18Kadjustedmargin
Example of Activity Drivers
Customer B
20Kgross
margin
12debtchases
3Kincurred
cost
17Kadjustedmargin
ABC cost ofdebt chasing:
250,000
Number of debtchases: 1000
Average unitdriver cost:250/chase
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E N T E R P R I S E P E R F O R M A N C E O P T I M I Z A T I O N
Receive customer orderValidate customer orderInput order to systemProduce order confirmationSchedule orderProduce picking documentsPick order in warehousePack orderProduce despatch documents
Despatch and deliver orderProduce and mail invoiceReceive payment
Activity driven bya Customer Order
Customer A
Margin 100K
Monthly Order
12 orders/year
Customer B
Margin 120K
Weekly Order
52 orders/year
Do these customerscost the same to
deal with ?
Example of Activity Drivers
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E N T E R P R I S E P E R F O R M A N C E O P T I M I Z A T I O N
Assigning Base Costs toActivities
Activity-specificcosts
Costs from chartof accounts
ActivityAnalysis
Allocation methods
Employment costs:Hours worked per activity or %age oftime spentOccupancy costs:Square or cubic meters (or feet)Network costs:Log-on time, Processing time etc.
Activity relatedcosts areassigned toindividualactivities on thebasis of rationalallocationmethods
For example:
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E N T E R P R I S E P E R F O R M A N C E O P T I M I Z A T I O N
Costs
Activity Analysis
Internalsupportactivity
Sustainingactivity with no
link
Activity driven byproducts, services
& customers
AllocationMethods
AllocationMethods
AllocationMethods
e.g., Personnel, IT,Office services
Activity directlydriven by
front-line delivery
Flow of Costs
e.g., Managementaccounting, Strategydevelopment,Corporate planning
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E N T E R P R I S E P E R F O R M A N C E O P T I M I Z A T I O N
Costs
Activity Analysis
Internalsupportactivity
Sustainingactivity with no
link
Activity driven byproducts, services
& customers
AllocationMethods
AllocationMethods
AllocationMethods
ProductsServices
Customers
Sustainingcost
Activity costs taken toproducts,services,customers using thedriver volume of eachactivity by service or
customer
# Driver
Flow of Costs
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# of domestic customers# of export customers# of orders placed# of orderlines - domestic# of orderlines - export# of machine set-ups# of production defects
# of schedules placed# of units processed# of new products introduced# of supplier late deliveries# of schedule changes# of supplier defects
# of order lines - goods In# of inspections
# of cash payments in# of new accounts set-up# of account closures# of customer claims made# of refunds# of invoices processed# of customer returns
# of customer enquiries# of customer complaints# of telephone calls received# of policies issued# of cheques processed# of direct debits
# of late payments# of terminals connected
Some Examples of Drivers
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Activity specificcosts
Costs
Non-specificcosts
From chart of accounts
Product,customer,
service orchannel
specific costs
Some costs might relate tospecific customers orservices and not be relatedto activity... e.g. rawmaterials
Other costs may have noreasonable direct
relationship to activities,products or customers...e.g. changing thecorporate logo
Costs Not Related to Activities
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E N T E R P R I S E P E R F O R M A N C E O P T I M I Z A T I O N
Activity specificcosts
Costs
CustomersServicesProducts
Non-specificcosts
Unabsorbedcost
From chart of accounts
Activity analysis
Drivers or%age
allocations
Drivers or%age
allocations
Product,customer,service orchannel
specific costs
Drivers or%age
allocations
Final Flowchart of Costs
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E N T E R P R I S E P E R F O R M A N C E O P T I M I Z A T I O N
Revenue from Customers/Products
less Service/Product Driven Costs
Customer Driven Costs
Channel/Distribution Driven Costs
ABC Contribution
less Unabsorbed Sustaining Costs
Profit (or Loss)
True Overhead
Profit and Loss from aDifferent Perspective
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