Activity-based costing seeks to relate all relevant expenses to the value adding activities performed. For example, costs are assigned to a customer or product to reflect all relevant activity cost independent of when and where they occur. The fundamental concept of activity-based costing is that expenses need to be assigned to the activity that consumes a resource rather than to an organizational or budget unit. For example, two products produced in the same manufacturing facility, may require different assembling and handling procedures. One product may need an assembly or packaging operations that requires additional equipment or labor. If total equipment and labor costs are allocated to the products on the basis of sales or units produced than both items will be charged for the additional assembly and packaging operations required by only one of them.
In case of logistics, the key event is a customer order and related activities and relevant costs that reflect the work required to fulfill the order. In other words, activity based costing in logistics must provide managers the insights needed to determine if a specific customer, product, order, or service is profitable. This requires matching specific revenue with specific costs. The guiding criteria for effective logistical activity-based costing are relevancy and consistency. Relevancy is important in the sense that the costs assignment helps managers to better understand the major factors affecting logistics expenses. Consistency is important in terms of comparing related activities over time. In the final analysis, activity based costing in logistics has to make sense only to the managers who are using it as a guide to decision making.
(I) Cost Identification:
All costs associated with the performance of logistics function should be in the activity- based classification. The total cost associated with fore casting and order management, transportation, inventory, warehousing, packaging must be isolated. Typical logistics costs can be categorized under two headings – direct and indirect costs, cost of capital and overheads.
- Direct Costs: These costs are those expenses specifically caused by the performance of logistics work. Such costs are difficult to identify. For example, the transportation costs for an individual truckload order can be directly attributed to a specific order. Likewise only minor difficulty is experienced in isolating the direct administration cost of logistical operations.
- Indirect Costs: These are more difficult to isolate. For example, the cost of capital invested in real estate, transportation equipment, and inventory- just a few of the areas within the capital structure of logistics- must be identified to arrive at a comprehensive total cost. The manner by which total costs are attributed to logistics activities are determined by managerial judgments. One approach is to allocate the overhead cost on the basis of the average cost per unit. All expense paid to support capital investment in logistical operations are relevant to activity-based costs. The judgment applied in arriving at cost of capital will greatly influence logistical system design. Thus procedures and standards used to calculate indirect logistical costs are critical. They are also essential for potential outsourcing.
- Cost of Capital: Capital investment Expenses for logistical activities are relevant to logistical activity- based costs. Cost of such capital also needs to be included in your logistical cost.
- Overhead: An enterprise incurs considerable expenses on behalf of all organizational units, such as for light and heat in various facilities. Judgement is required to determine how and to what extent various types of overhead should be allocated to specific activities. One method is to directly assign total corporate overhead on a uniform basis to all operational units. At the other extreme, some firms withhold all overhead allocations to avoid distorting the ability to measure direct and indirect logistical activity- based costs.
(II) Cost Time Frame
A basic concern in activity based costing in logistics is to identify the period of time over which costs are accumulated for measurement. Accounting principles call for accrual methods to relate revenues and expenditure to the actual time period during which services are performed. Expenses associated to raw material procurement through finished product distribution and almost all other logistical operating costs are incurred in anticipation of future transactions, making accrual methods difficult to administer.
To overcome the time problem, accountants attempt to break costs into 2 groups- costs assigned to a specific product and costs associated with the passage of time. Using this classification an attempt is made to match the appropriate product and time period costs to specific periods of revenue generation. From a logistical perspective, a great many of the expenses associated with procurement and manufacturing support can be assigned and absorbed into direct product cost.
In situations where a considerable period of time elapses between production and sales, such as in highly seasonal businesses, significant costs of maintaining inventory and performing logistical operations may not be associated with revenue generation.
(III) Cost Formatting
The typical way to format activity-based costs is to assign expenses to the event being managed. For example, the object of analysis is a customer order, than all costs that result from the associated performance cycle contribute to the total activity cost. Typical units of analysis in activity based costing in logistics are customer orders, channels, products and value added services. The cost analysis will vary depending on which analysis unit is selected for observation Logistical expenses can be presented in a number of ways for managerial use. Three common ways are;
- Functional Grouping: To format costs by functional grouping requires that all expenditures for direct and indirect logistical services performed for a specified operating time be formatted and reported by master and sub account classifications. Thus ,a total cost statement can be constructed for comparison of one or more operating periods .It is important to identify as many cost accounting categories as practical and to develop a coding system that will facilitate assignments to these cost accounts.
- Allocated Costs Grouping: This consists of assigning overall logistical expenditures to a measure of physical performance. For example, total logistical cost can be generated on a per ton, per product, per order, or on some other physical measure that is useful for comparative analysis of operating results.
- Fixed Variance Grouping: This is the most useful for identifying the logistics cost implications of current or alternative operating practices. This method of formatting consists of assigning costs as either fixed or variable to approximate the magnitude of change in operating expenditure that will result from different volumes of logistical throughput. Costs that do not directly vary with volume are classified as fixed. In the short run, these expenses would remain if volume were reduced to zero. Costs influenced by volume are classified as variable. For example, the cost of a delivery truck is fixed, however gasoline to operate the truck is variable.