Activity Based Costing (ABC)
Activity Based Costing was introduced as the answer for an improved full-cost product-cost calculation as the model grew into a more full-fledged costing system for hierarchies of activities and cost objects. Activity Based Costing is a two-stage procedure where cost of resources in the first stage are allocated to activities to construct Activity Cost Pools, which in second stage are allocated to cost objects based on these objects’ use of the different activities. It is also a tool for cost and performance measurement towards activities, resources and cost objects (for example products and services). Activity Based Costing is knows as a “horizontal” or cross-functional cost view and it can provide fact-based insight into the spending and profitability of products, services and customers.
There are three guidelines to support cost allocation in Activity Based Costing. The first would be ‘Direct-cost tracing to product’. Trace the cost of flexible resources towards individual products that are exclusively related. These are cost of direct material and direct labour. There are also some capacity-related costs that will need to be included in the exclusively used for one product. The second guideline is the ‘Indirect-cost allocating to product’. There are three indirect costs that need to be allocated. The first would be the ‘Multipurpose resource costs’. It occurs when resources are consumed by multiple products. These are the overheads that need to be allocated into the products. Secondly is the ‘Cost Centers’ where only the three-step allocation process uses the cost centers to allocate costs of a group of consumables or indirect resources necessary to operate cost centers and it also includes major production machines and human resources. The third indirect cost is the ‘Activity Costs (cost pools). The principal of allocation of this indirect cost is to separate activity cost if the cost or productivity of resources is different and if the pattern of demand is different across resources. Every one of the activity cost has a cause and effect relationship with the cost driver. Lastly the third guideline is the ‘Activity cost drivers’. Cost drivers should relate to way in which activity costs are consumed. For example, setup cost is assigned to a product consuming a setup activity-based on setup time if setup time drives the costs. In a simpler term, Activity Based Costing is a costing system that improves and helps the organization to identify activities and allocate the cost to each respective activity.
Activity Based Costing can provide more accurate and reliable cost data to the managers and decision makers so that they can decide which one is suitable for their decisions. Most companies that use Activity Based Costing have seen improvement in their performance with the reduction in costs and improvements in making the right decisions. The product cost should be allocated evenly and it is essential in determining the performance of the company in the current competitive environment.
Activity Based Management (ABM)
Activity Based Management is derived from Activity Based Costing itself with additional component to describe any application of Activity Based Costing data to management decisions. Activity Based Management focuses on managing activities or business processes in order to achieve organizational objectives. Activity Based Management also reduces cost drivers and transfers resources to economic value to create activities or business processes which customers wants and willing to spend money for it. It also measures performance for cost, time, quality and outcomes so that the users of the information would understand how their activities would contribute to the mission and strategy of the company. Activity Based Management supports Balanced Scorecard in creating performance measurements. One of the perks of Activity Based Management is it improves company’s cash flow, and increases the quality of the information produced and also reduction in cycle time. It can also be used as a foundation for a Business Process Redesign and supports gain sharing amongst the individual involved.
Activity Based Management able to support businesses growth by providing information to monitor long-term strategic decisions. It allows product designers to have a clearer view and understand the impact of different designs on cost and the flexibility therefore; designers may modify their designs appropriately. It opens the choices to the management by supporting quest for continuous improvement by gaining new insights into activity performance by concentrating on the source of demand for activities and by allowing management to create incentives based on behavior to improve single or multiple aspects of the business.
Activity Based Management helps organizations to be more competitive by identifying key aspects that needs to be improved in the business process. Activity Based Costing would first identify all the activities that start from customer order up until the shipment of products to customers and after that, Activity Based Management would be used to focus on ways to reduce the non-value added activities, thus these shortened down the process duration. The question is are Activity Based Costing together or separate from Activity Based Management? The answer would be it is working together as Activity Based Costing would focus on reducing costs while Activity Based Management would focus on the improving processes so that both systems would improve the company’s performance and profitability and also improvement in qualitative and quantitative basis.