Integral Logistics Management — Operations Management and Supply Chain Management Within and Across Companies

16.4.2b Allocating Fixed Costs Using Activity-Based Costing, and Introducing ABC

Intended learning outcomes: Explain allocating fixed costs using activity-based cost accounting. Describe the steps to introduce activity-based costing into the company.

Continuation from previous subsection (16.4.2)

Figure shows several examples of processes (activities) and process variables (activity cost drivers) in the areas of purchasing and production.

Fig.       Allocating fixed costs using activity-based cost accounting.

Examples of process cost rates associated with the process variables in Figure are

  • x dollars per order
  • y dollars per item in receiving
  • z dollars per component in assembly
  • u dollars per run time unit in
    the testing process

The separation of tooling costs from fixed internal manufacturing costs described in Section 16.1.4 is one example of activity-based costing. There, the (ABC) process of tool utilization is considered separately. The activity cost driver may be the same as the tool utilization time or even, as suggested, simply the use of that tool to manufacture one unit of the batch.

To introduce activity-based costing into the company, the following steps are necessary:

1.    Determine the areas in which activity-based costing is to be used.

2.    Determine the ABC processes, broken down into subprocesses (activities). A meaningful ABC (sub-)process has at least the following characteristics:
- The costs of the process are significant.
- The process corresponds to a specific task within the process organization.
- The various products (cost objects) should use the process to varying degrees (different process quantities).

3.    Determine the process variable (activity cost driver) for each process. A good process variable has at least the following characteristics:
- It is so closely related to the process costs that the process quantities can be based upon this unit variable.
- It is self-explanatory to the people concerned within the organization, since it appears to be a natural variable within the operational process.
- It should also appear to be a natural variable when options for different design variants or production methods are compared against one another.
- The process quantities and cost rate per unit (process cost rate or process rate) can, as far as possible, be automatically calculated from the operational data.

4.    Determine the process cost rate for each ABC process. This is done by dividing the fixed costs resulting from the process by the likely future process quantities.

5.    Specify the ABC process plan for each product and the process quantity for each ABC process in the ABC process plan.

6.    Calculate the process costs for the product by analyzing the ABC process plan (and the bill of material, of course) with the same algorithm used for production or procurement costs calculated using the traditional order costs or job order costing technique (see Section 16.2).

7.    Job-order costing and analyzing variances: As in conventional costing, the volume variance can now be calculated for a particular order by recording the actual usage of process variables. Activity-based costing should thus identify any deviation from planned unit cost rates and compare actual process costs against the budgeted costs. This type of measurement is rather illusory, however, since small process quantities would take much too long to measure.

Course section 16.4: Subsections and their intended learning outcomes