Activity-Based Costing for Accurate Business Decisions
Costing Methods for Decision Making
Key Considerations:
- The challenge with traditional costing methods (Absorption and Direct) lies in distributing fixed costs to the product cost.
- Raw materials should always be allocated directly to the product or process.
- Regarding labor, its allocation depends on the company type. If the business is labor-intensive, it is typically allocated directly to the product or process.
- Furthermore, these traditional methods often function merely as accounting procedures, disconnected from business strategy, and do not inherently guarantee the improvement of production processes.
Implementing a Costing Method
The implementation should involve a multidisciplinary team. The auditor’s role includes:
- Analyzing the production process according to the product life cycle and establishing control points for registration and accounting, in accordance with Generally Accepted Accounting Principles (GAAP) and International Accounting Standards (IAS).
- Analyzing the company’s various activities with the same purpose.
- Determining what information to collect, generating reports, and establishing the timing, responsibility, and method for recording this information.
- For implementing new costing methods, it is recommended that companies start with Activity-Based Costing (ABC).
Activity-Based Costing (ABC)
Background
To produce products or services, a company undertakes activities that consume resources.
- Activities are funded first.
- Then, the cost of these activities is assigned to different cost objects (e.g., products, services, customer groups, regions) that require those activities.
This approach achieves greater accuracy in determining costs and profitability.
Scope
ABC typically includes the activities of all core business processes.
However, implementation can begin with factory activities to obtain information for financial reporting purposes, later expanding to other process activities for management decision-making information.
ABC allocates the cost of resources used to perform activities to products/services, aiming for accurate cost and profitability determination.
- Activities are tasks identifiable with a verb: to do, ask, produce, record, design, transfer, etc.
- Resources are allocated to activities.
- Activities are assigned to cost objects based on their usage.
- Cost objects include products, services, customers, channels, business units, processes, among others.
The information provided focuses on how resources were spent, not just what they were spent on.
- What resources were spent refers to categories like salaries, depreciation expenses, purchases, etc.
- How resources were spent involves actions like monitoring, controlling, creating, collecting, etc.
Implementing ABC Costing
Team and Setup
Like any project, establishing and training a multidisciplinary team responsible for all phases is crucial. Support from senior management is essential.
Steps per Analysis Area
For each process area or unit of analysis, follow these steps:
- Define the cost objects
- Define the activities
- Define cost drivers (for both resources and activities)
- Design reports
Implementation Process Details
For each process, identify and analyze the resources, activities, and cost objects. Determine if this process supports or participates in other processes and how, establishing the network of relationships within the organization.
The next step involves answering relevant analytical questions (details not provided in the original text).
Report Design
Reports should be designed for each functional unit, containing:
- The activities performed for each cost object.
- The resources obtained and how they were assigned to each activity.
- How costs were allocated to each cost object, along with their respective performance measures.
For each report, define:
- The periodicity, timeliness of processing, delivery schedule, and recipients.
- The method for obtaining data, and those responsible for data delivery and processing.
- The delivery format and the means used for dissemination.
Information Generated by ABC
Comparison with Traditional Costing
ABC provides traditional cost information but adds significant value:
- Profitability analysis by customer type, service, etc.
- Activity-based budgeting.
- Costs for decision-making with approximately 95% accuracy.
- Activity performance measurement.
- Target costing capabilities.
Information for Decision-Making
- Strategic: Profitability analysis; contribution to value addition.
- Operational: Performance measurement of activities; administration of costs.