Activity Based Costing ABC and Activity Based Management ABM

■ Activity Based Costing (ABC)

The Activity Based Costing (ABC) is a cost calculation technique that has been worked out to solve the problem of how the indirect expenses contained in the traditional cost calculation should be allocated.

The cost can calculated by dividing it into direct cost and indirect cost. Direct costs refer to how much was spent for manufacturing the product, i.e. raw materials and materials cost, and indirect costs are the selling and administrative costs, physical distribution costs, research and development costs, etc. or those costs that cannot be directly measured. Depending on the nature of the business and products, the indirect costs incurred due to this allocation can exceed 50% of the total cost.

In order to strictly analyse the profit of each business or for each product/ customer, these indirect costs must be added to each business or product in a way that is as close to the actual costs as possible. Otherwise, large costs cannot be identified or the manner in which the profit has been obtained, which may lead to a problem that an erroneous decision is made by using figures that differ greatly from the actual costs incurred. By understanding how the resources have been used against the cost object such as the business, products or customers, in the course of work, in accordance with the actual activities, the result is reflected on the cost of products, which is called ABC.

Through Activity Based Costing, major work processes and activities that comprise the work are extracted, and the Cost Driver (activity action factor) that reflects each activity best is selected, by means of which the cost is grasped (Table 4-5-25).

Activity

Product cost

Materials procurement expenses

Indirect expenses

Direct expenses

Materials procurement process

Price \ \ Placing \ \ negotiations, > ^ order/delivery > etc. management

Packing/ transportation

Cost driver

Purchasing amount of raw materials/ materials

Cost

Number of arrangement sheets for raw materials/ materials

Results of packing expenses

management/ ,

Inventory management /

Number of cases of inspection request

Number of slips for inventory distribution

Purchasing amount of raw materials/ materials

Number of arrangement sheets for raw materials/ materials

Results of packing expenses

Number of cases of inspection request

Number of slips for inventory distribution

Table 4-5-25: Activity and allocation by means of activity indexes (example)

As a result of this, the difference in cost for each of the products can now be captured more accurately. For example,

1) When comparing new products with the conventional main line of commodities, a fairly long time is spent in researching the selling and administration of new products, but the cost has been allocated according to the ratio of sales, therefore more cost is allocated to the main line of commodities.

2) When small volume products are being compared with products of a to be produced in large volume, the small volume products require more time and labour for manufacturing them. However, the cost will have been allocated according to the ratio of sales, which means more cost is allocated to the large volume products.

3) In research and development costs, during which a specific product development project occupies the research equipment and may take longer than others, the equipment depreciation costs and its personnel costs are allocated according to the overall research and development ratio, and so they are much different from the expenses incurred by the actual time of occupation.

By applying the Activity Based Costing, the costs incurred by these activities can be grasped as those being closer to the actual ones, thus enabling us to grasp the profitability of the business and products more accurately.

However, while in the Activity Based Costing, activities are defined in detail, and by selecting the Cost Driver of each activity, the cost can be reflected more accurately, while the time and labor for capturing it increase. Therefore, it is important to clarify why the cost should be understood, and to grasp it by defining activities at a level that is suited to the purpose.

■ Activity Based Management (ABM)

Activity Based Costing analyses the cost by focusing on the work process and activities. By merging Activity Based Costing with BPR (Business Process Reengineering), considering the work regarded as indirect costs as value added ,and engaging in management to ensure that the work can be carried out efficiently at all times; this is called the Activity Based Management.

In the Activity Based Management, by analyzing the added value of the work process based on the cost information obtained by the Activity Based Costing, wasteful and redundant processes and activities are reduced and made more efficient, thus improving work performance. Moreover, it is set as a target that by incorporating within an organization a mechanism that can measure the indexes and results of such an increase in efficiency, the promotion of an increase in efficiency is made at all times. (Table 4-5-26)

Work process

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