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Activity Based Costing
Introduction
Activity based costing (ABC) is one of the accounting concepts where costs relating to operation processes are traced back to their causes. Costs are not directly assigned to the products instead they are assigned to activities that relates to their production in the company. The product costs are calculated from its usage of the activities involved (Jurek et al, 2012). ABC costing requires thorough knowledge of the business process that involves the ABC costing in order to calculate and determine the distribution of the costs (Garrison et al, 2009).
The ABC costing concept traces all the resources that have been channeled to the activities and later to the cost objects for accurate calculation of cost distribution. Each cost object represents a process or product while the individual activities are actions that must be executed to enable the creation of the cost objects. The resources in ABC are typically the objects that consumed in the manufacturing activities and ultimately results in such costs as labor, materials or equipment.
The concept of ABC in cost accounting is such that the cost objects in the manufacturing process consume activities that also consume the resources and later the consumption of the resources ends in costs (Weil and Maher, 2005).
ABC accounting provides the true costs of the finished products while also providing a detailed insight on the reasons of the current product costs. These details provide various aspects and opportunities to improve the products while also exploring ways of cost reductions.
The drivers in ABC cost accounting are applied in tracing the resources to particular activities while the activities are utilized to trace the resources to the cost objects. The resource drivers trace all the actual resources to the process activities while the activity drivers extend the trace to the cost objects. The drivers basically represent the actual causes of consumption hence permit accurate distribution of cost down the ABC chain. The drivers shown below in figure 1 represent some resources in ABC accounting and the activity drivers. The drivers must however be accurately correlated with the causes of production consumptions.
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ABC accounting is directly associated with values mostly in monetary terms, however in ABC costing the values can be modified to include additional measurements like environmental factors. ABC costing facilitates the dual calculations as it measures quantities of resources that have been consumed by the manufactured products. From the quantities calculated one can apply specific costs or the results of the environmental impact provided to calculate the required total cost. For example, in automobile production plant, a product can consume up to 4MWH of electricity amounting to $200 per MWH.
ABC Cost Calculations
| Monetary | |||
| Resource | Resource Amount | Specific Cost | Total Cost |
| Electricity | 4 (MWh) | 200 ($/MWh) | $800 |
The specific impact to the environment may be 20 kg CO2 for every MWH. Hence the products total cost both in monetary and environmental terms would amount to $800 and 80kg of CO2. The expansion of the ABC costing aspect is materially applied in the processing industry to analyze Life Cycle Assessments or analysis of the plant’s manufacturing processes.
ABC Environmental Calculations
| Environmental | |||
| Resource | Resource Amount | Specific Cost | Total Cost |
| Electricity | 4 (MWh) | 20 ($/MWh) | 80 (Kg CO2) |
The Paint Shop in Automotive Industry
The manufacturing processes in an automobile plant are divided into three important departments:
- The Paint Shop
- The General Assembly
- Body Shop
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The body shop utilizes and transforms the basic raw materials that make up a vehicle into the initial structure of a vehicle. The protective coating is applied in the paint shop while in the final assembly plant of the factory other components are fitted before the vehicle finally rolls over to the show room. These components are like wheels, engines, gear boxes, headlights among other components. Each of the above departments has also different departments. For example, the paint shop has the following departments;
- Application of ELPO
- Sealing Application
- Paint Booth
- Post paint repairs that also include cavity waxing.
- Pretreatment of the product
The pretreatment stage allows the cleaning of all the contaminants that have accumulated on the body of the vehicle. Phosphate is usually applied at this stage of production as primary coating to ensure a protective layer is evenly applied. The Electro Coat Primer Operation is applied to increase the vehicles paint effectiveness. Sealing and the other remaining processes are utilized to obtain a fine finishing of paint application. The other activities in the paint line are listed in table 1 below.
Activities in Paint line (Table 1)
| Activities |
| A1 – Air Abatement |
| A2 – Light Building |
| A3 – Air Conditioning |
| A4 – Liquid Heating |
| A5 – Manual Sealing |
| A6 – Moving Air |
| A7 – Moving Liquid |
| A8 – Moving Product |
| A9 – Operating Robot |
| A10 – Lighting Process |
| A11 – Repairing Product |
Each of the activities mentioned above have several other activities below them. The following are the activities under Air conditioning activities in the paint shop.
Example of Activity States (Table 2
| Level 1 | Level 2 |
| A3 – Air Conditioning | A3.1 – Startup Air Conditioning |
| A3.2 – Production Air Conditioning | |
| A3.3 – Setback Air Conditioning | |
| A3.4 – Maintenance Air Conditioning | |
| A3.5 – Shutdown Air Conditioning |
To conclude, ABC costing has a wide range of applications. Numerous studies have been successfully undertaken to determine the flexibility of activity based accounting including the environmental metrics. ABC accounting can be applied to any manufacturing process and can also be expanded to include other non-traditional costs that are only associated with cost accounting.
Reference
Garrison, R., Noreen, W. & Brewer, P. (2009) Managerial Accounting, New York, NY: McGraw-Hill Irwin. 65 -70
Jurek, P., Bras, B. Guldberg, T., D’Arcy Seon-Chan, O, and Biller, S. (2012) Activity Based Costing Applied to Automotive Manufacturing, http://www.manufacturing.gatech.edu/sites/default/files/uploads/pdf/Final%20version%20_Jan%2026%202012_.pdf
Weil, R.L. and Maher, M.W. (2005) Handbook of Cost Management, New Jersey, John Wiley & Sons.
Activity Based Costing
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