Monday, December 19, 2011

Cost Accounting

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Activity-based costing (ABC) is a cost management approach that identifies the processes involved in supplying a product or service and the resources that these processes consume. It uses this information to assign costs, eliminate waste, and improve processes. ABC is a powerful tool to understand the components of a company’s costs and their underlying causes. By focusing on the causal factors or cost drivers, ABC can help identify opportunities for cost reduction.

Activity-based management (ABM) is a discipline that focuses on the management of activities to improve continuously the value that customers receive. It draws on ABC as a major source of information. ABM complements a continuous improvement philosophy by highlighting waste and opportunities for cost reduction.

When is ABC Appropriate?

ABC is recommended when one or more of the following situations occur

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• The products are diverse.

• Overhead costs are relatively high.

• Production volumes vary significantly.

• Operating managers do not believe their product costs.

• Managers want a better understanding of their cost structure.

An Implementation Approach

There are many ways to implement an activity-based accounting system. Each organization must determine the right approach given its informational needs, the available resources, and the company culture. The following steps may be used to approach an ABC implementation.

1. Identify the purpose. ABC can be used for different purposes. It is important to identify the specific purposes for which the model will be used. The project team should design a model that satisfies these objectives.

. Perform an activity analysis. The project team analyzes all the significant activities of the organization and classifies these activities according to the characteristics of the data.

. Trace resources to activities. Each organizational unit has an assigned set of resources. Some resources are unique to a particular activity; others are used in multiple activities. The challenge in this step is to identify the resources involved in performing each activity.

4. Select the appropriate activity measure. All activities have inputs, which trigger transactions, and outputs, which are the products of an activity. These input-output measures must be identified and collected for each activity. These measures will be used as a basis for cost assignment.

5. Calculate the activity cost. Once the resources are identified, these resources must be costed. This step involves restating costs into an activity view.

6. Trace activity costs based on usage. This step ties the cost directly to the consumption of the activity by the product or service. The input or output measures determined in item 4 will be the basis of the cost assignment.

7. Establish performance measures. This step ensures that the performance measures support company objectives and moves the organization in the direction that management desires. These measures can be financial and nonfinancial indicators.

There is no one right way to implement an activity based information system. Key elements for a successful implementation are top management support and cross-functional involvement in the system design and implementation.

Products do not consume cost directly. Money is spent on activities, which in turn are consumed by products/services (cost objects). This new costing methodology and the two-stage allocation method (now known as ABC) made its first public appearance in articles published in the Harvard Business Review.

The roots of ABM [activity-based management] lie in product costing. People did not begin to grasp the value of using activity information to support and drive improvement initiatives and understand its applicability to industries other than advanced manufacturing until the early 10s. It was this understanding that led to the birth of ABM.

In essence, ABC does the arithmetic to provide accurate cost information. Activity-based management is focused on using the information to manage activities. Activities are universal to all organizations, including service companies, schools, governments, and not-for-profit organizations.

Activities and processes, the common denominator of the horizontal organization, must be managed and improved to remain competitive. Activity management is fundamental and basic to organization success.

What does all this mean?

The demand for ABC/M information continues to grow across industries as managers see the benefits of leveraging ABC/M information beyond profitability analysis into areas such as budgeting, planning, and performance management. This broader use of ABC/M information requires continuing improvements in the areas of both integration with ERP and Data Warehousing systems and in the ability to analyze, report, and deploy ABC/M results across the organization.

Survey Highlights at a Glance

• Product/service costing was mentioned most often as the primary objective for implementing an ABC/M system.

• Six out of 10 said that the ABC/M system must integrate with the ERP system.

• Two-thirds of the respondents update and report the information at least quarterly.

• The majority said they share the information with 10 to 4 people.

• The average number of locations that currently use ABC/M is .4 per organization, with a median of .

In confronting the process of change, many organizations will first consider their current competitive weaknesses and take action to improve them. Employee empowerment, activity-based management, decentralization, knowledge-based networks�these improvement programs are all on offer from the consultant’s toolbox. But managers cannot simply cherry-pick items from the third wave menu and put them into their existing second wave mixing bowl. Successful change involves much more than this.

Most firms fail to consider the whole when they attempt to introduce and implement new management ideas. Still imbued with a mechanistic approach to business performance, they expect to make a change here and a change there, assuming that all other aspects of the working machine will adapt to these “foreign bodies” and that improvements will quickly flow.

Major business change will not work unless the culture also changes. Countless numbers of restructuring, reengineering, quality, and empowerment initiatives have failed because this lesson has not been learned.

Culture, according to [author] John Kotter, refers to norms of behavior and shared values among a group of people. Norms of behavior are common or pervasive ways of acting found within a group. They persist because group members tend to behave in ways that teach these practices to new members, rewarding those who fit in and sanctioning those who do not. Shared values are important. Concerns and goals shared by most people in a group tend to shape group behavior and often persist over time even when group membership changes.

Not only do managers have to cope with the practical problems of implementing change within business, but their efforts at inculcating such ideas and attitudes receive little support from the education establishment.

Third wave companies will not only need better education for their people, they will require it. All employees must understand the common purpose and learn how to find problems as well as solve them. Equally, specialists must be given more time to pursue and improve their specialties. And CEOs can link with their peers around the world in a sort of open forum of strategic thinking that can only benefit the future of their organizations.

The principles of good management are teachable and cannot begin too soon. If previous generations had been told that they were working for customers who paid their wages rather than bosses who held their contracts of employment, and that their compensation depended on the quality of their work, who knows what the economic consequences might have been? Imagine the benefits that would flow if young people were entering the workplace with these disciplines already deeply ingrained.

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