Activity Based Costing

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Last updated on
16th May, 2022
Published
12th Dec, 2012
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Activity Based Costing

Activity based costing is a different way of looking at an organization’s costs in order to optimize profit margins. Activity based costing is more effective when used long-term rather than in short-term.

Implementation in an Organization:

When it comes to implementing activity based costing in an organization, commitment of senior management is a must. Activity based costing requires visionary leadership that should sustain long-term. Therefore, it is required that the senior management has comprehensive awareness of how activity based costing works and management’s interaction points with the process.

Before implementing activity based costing for the entire organization, it is always a great idea to do a pilot run. The best candidate for this pilot run is the department that suffers from profit making deficiencies.

Although one might take it as risky, such departments may stand an opportunity to succeed when managed with activity based costing. Lastly, this would give the organization a measurable illustration of activity based costing and its. success. In case, if no cost saving occurs after the pilot study is implemented, it is most likely that the model has not been properly implemented or the model does not suit for the department or company as a whole.

Having a Core Team is Important:

If an organization is planning to impalement activity based costing; commissioning a core team is of great advantage. If the organization is small in scale, a team can be commissioned with the help of volunteers who will contribute their time on part-time basis. This team is responsible for identifying and assessing the activities that should be revised in order to optimize the product or service.

The team should ideally consist of professionals from all practices in the organization. However, hiring an external consultant could be also become a plus.

The Software:

When implementing activity based costing, it is advantageous for an organization to use computer software for calculations and data storage. The computer software can be a simple database that will store the information such as customized ABC software for the organization, or a general purpose off the shelf software.

The Procedure:

Following is the procedure followed for successful implementation of activity based costing in an organization.

  1. Identification of a team that is responsible for implementing activity based costing.
  2. The team identifies and assesses the activities that involve in products and services in question.
  3. The team selects a subset of activities that should be taken for activity based costing.
  4. The team identifies the elements of selected activities that cost too much money for the organization. The team should pay attention to detail in this step as many activities may shield their cost and may look innocent from the outside.
  5. The fixed costs and variable costs related to activities are identified.
  6. The cost information gathered will be entered to the ABC software.
  7. The software then performs calculations and produce reports to support management decisions.
  8. Based on the reports, management can then, identify the steps that should be taken to increase profit margins in order to make the activities more efficient.
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