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Nimbus Continuous Improvement Training :
             ABC Costing
           nandan@nimbusconsulting.net

                Phnom Penh, Cambodia
                   May 16-20, 2011

                      www.nimbusconsulting.net, Email: info@nimbusconsulting.net
Continues Improvement




Prasac MFI Ltd, Cambodia


          www.nimbusconsulting.net, Email: info@nimbusconsulting.net
Activity Based Costing

        What?
        Why?
        How?

         www.nimbusconsulting.net, Email: info@nimbusconsulting.net
Requirement of Cost Systems
• Valuation of inventory and measurement of
  the cost of goods sold for financial reporting.

 •Estimation of the costs of activities,
 products, services, and customers.

  •Providing economic feedback to
  managers and operators about process
  efficiency.

                        www.nimbusconsulting.net, Email: info@nimbusconsulting.net
Today’s businesses are working in an
increasingly complex environment.

Use of Advanced Technology

Product Life Cycle

Product Complexity
Channels of Distribution
Quality Requirements

Product Diversity
                       www.nimbusconsulting.net, Email: info@nimbusconsulting.net
Composition of Cost


100



  0
      1           2               3                 4
Direct Material       Labour       Overheads

                       www.nimbusconsulting.net, Email: info@nimbusconsulting.net
Conventional Costing
• Total Cost = Material + Labour+
  Overheads
• Overheads are allocated to the products on
  volume based measures e.g. labour hours,
  machine hours, units produced
Will this not distort the costing in the
new environment?


  ABC provides an Alternative.
                   www.nimbusconsulting.net, Email: info@nimbusconsulting.net
Conventional Costing   AB Costing
                                                    Economic
                                                    Element

  Expenses             Resources




                                                         Work
                       Activities                        Performed
  Cost Objects



                                                          Product or
                        Cost Objects                      service




                        www.nimbusconsulting.net, Email: info@nimbusconsulting.net
Activity-Based Costing

• Traditional allocation method
  Costs                                                    Products



• Activity-based allocation method

  Costs                  Activities                        Products


           First stage                   Second stage

                          www.nimbusconsulting.net, Email:9
                                                          info@nimbusconsulting.net
Basics of A B C
• Cost of a product is the sum of the costs
  of all activities required to manufacture
  and deliver the product.
• Products do not consume costs directly
• Money is spent on activities
• Activities are consumed by
  product/services

                   www.nimbusconsulting.net, Email: info@nimbusconsulting.net
Basics of A B C (contd.)
• ABC assigns Costs to Products by tracing
  expenses to “activities”. Each Product is
  charged based on the extent to which it used
  an activity

• The primary objective of ABC is to assign
  costs that reflect/mirror the physical dynamics
  of the business

                     www.nimbusconsulting.net, Email: info@nimbusconsulting.net
Basics of A B C (contd.)
• Provides ways of assigning the costs of
  indirect support resources to activities,
  business processes, customers, products.
• It recognises that many organisational
  resources are required not for physical
  production of units of product but to provide a
  broad array of support activities.



                     www.nimbusconsulting.net, Email: info@nimbusconsulting.net
ABC systems addresses the
       following Questions:
• What activities are being performed by the
  organisational resources?
• How much does it cost to perform activities?
• Why does the oranisation need to perform those
  activities?
• How much of each activity is required for the
  organisation’s products, services, and customers?


                      www.nimbusconsulting.net, Email: info@nimbusconsulting.net
Basics of A B C : How?
                                      Cost pools are groups or
                                      categories of individual
Steps:                                expense items

  1. Form cost pools
  2. Identify activities
  3. Map resource costs to activities
  4. Define activity cost drivers
  5. Calculate cost

                  www.nimbusconsulting.net, Email: info@nimbusconsulting.net
Identify Activities
In developing an ABC system, the
  organisation identifies the activities being
  performed:                    Activity Dictionary



•Move material               •Respond to
•Schedule                    customers
production                   •Improve products
•Purchase material           •Introduce new
•Inspect items               products
                             •Explore new markets
                        www.nimbusconsulting.net, Email: info@nimbusconsulting.net
Map resource costs to activities

• Financial accounting categorises expenses
  by spending code; salaries, fringe benefits,
  utilities, travel, communication, computing,
  depreciation etc.

 •ABC collects expenses from this financial
 system and drive them to the activities
 performed.

                    www.nimbusconsulting.net, Email: info@nimbusconsulting.net
Mapping
                                                             ABC Records
                         Activities                 Salaries Depreciation lectricity Supplies Travel
                                                                        E                                 Total
 Accounting Records
Salaries      313,000    Business Development          20,000     25000       5000                 5000      55,000

Depreciation   155,000   Maintianing Present Business 80,000      60000      50000       5000     10000 205,000

Electricity    132,000   Purhcasing Material          125,000     50000      20000     20000      60000 275,000

Supplies        25,000   Set up Machines               25,000     10000       2000                           37,000

                         Running Machines              50,000     10000      50000                          110,000
Travel         100,000
                         Resolve Quality Problems      13,000                 5000                25000      43,000
Total          725,000
                         Total                        313,000 155000 132000            25000 100000 725,000

                                      www.nimbusconsulting.net, Email: info@nimbusconsulting.net
Activities: Types

      •   Head Office Level
      •   Branch Level
      •   Department Level
      •   Customer Level
      •   Field Staff Level




                   www.nimbusconsulting.net, Email: info@nimbusconsulting.net
Define activity drivers

• The linkage between activities and cost
  objects, such as products, customers, is
  accomplished by using activity drivers.
• An activity driver is a quantitative measure
  of the output of an activity.
• The selection of an activity driver reflects a
  subjective trade-off between accuracy and
  cost of measurement.


                     www.nimbusconsulting.net, Email: info@nimbusconsulting.net
Activities                               Drivers
Unit Level
Acquire and Use material for containers No. of Containers
Acquire and Use material for baby-care productsproducts
                                         No. of

Batch Level
Set up manually controlled machines             No. of batches of contain
Set up computer controlled machines             No. of batches of B. Prod

Product Level
Design and manufacture moulds                   No.of moulds required
Use manually controlled machines                Product type (containers)
Use conputer controlled machines                Product type (B.Products

Customer Level
Consult customers                               No. of consultations
Provide warehousing for customers               No. of cubit feet


Faciltiy Level
Manage workers                                  Salaries


                       www.nimbusconsulting.net, Email: info@nimbusconsulting.net
Activities                                      Drivers                    Activity Cost Activity Volume
                                                                                                        Activity Rate
 Unit Level
         Acquire and Use material for containers No. of Containers                40,000     1,000,000       0.04
Acquire and Use material for baby-care products No. of products                   80,000         8,000         10

Batch Level
         Set up manually controlled machines No. of batches of containers          3,000            10        300
        Set up computer controlled machines No. of batches of B. Produst          12,000            20        600

Product Level
               Design and manufacture moulds No.of moulds required                 5,000             5      1000
             Use manually controlled machines Product type (containers)           15,000             1     15000
             Use conputer controlled machines Product type (B.Products)           40,000             1     40000

Customer Level
                            Consult customers No. of consultations                 4,000            40        100
             Provide warehousing for customers No. of cubit feet                   2,000        10,000        0.2


Faciltiy Level
                               Manage workers Salaries                             3,000        15,000        0.2
                              Use main building Square feet                       48,000        16,000          3
                                                      www.nimbusconsulting.net, Email: info@nimbusconsulting.net
Ascertaining Cost
 Activities                                      A. Rate A.Volume     Containers   Baby Product
 Unit Level
         Acquire and Use material for containers     0.04   1,200,000       48,000
Acquire and Use material for baby-care products        10       7,000                     70000

Batch Level
         Set up manually controlled machines          300            12         3,600
        Set up computer controlled machines           600            16                         9600

Product Level
                Design and manufacture moulds        1000
                                                                      1         1,000
                                                                      4                         4000
             Use manually controlled machines      15000              1        15,000
             Use conputer controlled machines      40000              1                        40000

Customer Level
                           Consult customers          100
                                    Containers                        2           200
                                    B.products                       40                         4000
            Provide warehousing for customers         0.2
                                    Containers                    8,000         1,600
                                    B.products                    2,000                          400
Faciltiy Level
                             Manage workers           0.2
                                    Containers                    4,000           800
                                    B.products                   10,000                         2000
                            Use main building           3
                                    Containers                    5,000        15,000
                                    B.products                    7,000                        21000
Total Cost                                                                     85,200        151,000
                                                 www.nimbusconsulting.net, Email: info@nimbusconsulting.net
Building an ABC Model
            Identify           Identify               Identify
           Resources          Activities            Cost Objects




           Define                                      Define
           Activity                                   Resource
           Drivers                                     Drivers



 Enter          Enter                Enter
                                                              Calculate
Resource      Resource              Activity
                                                               Costs
 Costs        Driver Qty.          Driver Qty.

                       www.nimbusconsulting.net, Email: info@nimbusconsulting.net
Activity
Any event, action, transaction, or
 work sequence that causes a cost
 to be incurred in producing a
 product or providing a service.




              www.nimbusconsulting.net, Email: info@nimbusconsulting.net
Activity Cost Pool
The overhead cost allocated
 to a distinct type of activity
 or related activities.




           www.nimbusconsulting.net, Email: info@nimbusconsulting.net
Illustration 4-2


Activities and Related Cost Drivers




             www.nimbusconsulting.net, Email: info@nimbusconsulting.net
Reasoning for ABC




      www.nimbusconsulting.net, Email: info@nimbusconsulting.net
Cost Driver
Any factor or activity that has a direct
  cause-effect relationship with the
  resources consumed.
In ABC cost drivers are used to assign
  activity cost pools to products or
  services.


                 www.nimbusconsulting.net, Email: info@nimbusconsulting.net
Illustration 4-3




www.nimbusconsulting.net, Email: info@nimbusconsulting.net
Activity-Based Costing (ABC)
Calculate unit cost
• Identify activities
• Identify cost driver
• Compute overhead rate
• Assign overhead costs

           www.nimbusconsulting.net, Email: info@nimbusconsulting.net
Benefits of Activity-Based Costing
More accurate product costing
which necessitates:
 éMore cost pools used to assign
 overhead
 éEnhanced control over
 overhead
 éBetter management decisions
               www.nimbusconsulting.net, Email: info@nimbusconsulting.net
Limitations of Activity-Based Costing

      éCan be expensive to use.
      éSome arbitrary allocations
      continue.




               www.nimbusconsulting.net, Email: info@nimbusconsulting.net
Activity-Based Management

• Natural extension of ABC
  – Why are activities performed?
     • Are they necessary?
     • Are they consistent with organizational goals?
  – How are they performed?
     • Are they performed efficiently?
     • Can they be redesigned or eliminated?




                        www.nimbusconsulting.net, Email:33
                                                        info@nimbusconsulting.net
“You Get What You Measure”




         www.nimbusconsulting.net, Email: info@nimbusconsulting.net
ABM for Process Improvement

• Focus on problems, opportunities
• Prioritize opportunities for improvement
  – Most critical
  – Greatest potential for cost savings




                      www.nimbusconsulting.net, Email:35
                                                      info@nimbusconsulting.net
ABM for Process Improvement

• Determine and explain causes for problems
  and opportunities
  – Cannot improve the system without first
    understanding it
• Select specific improvement projects




                     www.nimbusconsulting.net, Email:36
                                                     info@nimbusconsulting.net
ABM for Process Improvement

• Use ABC/ABM data to test potential impact
  of changes
• Make changes
• Iterate
  – Process of continual improvement




                    www.nimbusconsulting.net, Email:37
                                                    info@nimbusconsulting.net
Implications of ABC/ABM
• Shifts focus from managing costs to
  managing activities
• Aids in recognizing, measuring and
  controlling complexity
• Promotes understanding of why costs
  are incurred
• Provides better cost allocation
  information

                    www.nimbusconsulting.net, Email:38
                                                    info@nimbusconsulting.net
Implications of ABC/ABM
• Useful for planning future operations
• Fosters continuous improvement
• Likely to meet with substantial
  resistance
  – Analysis of why and how activities are
    performed




                       www.nimbusconsulting.net, Email:39
                                                       info@nimbusconsulting.net
Thank You


Nandan S. Bisht
Director: Nimbus Consulting Pvt. Ltd.
nandan@nimbusconsulting.net
www.nimbusconsulting.net,




                            www.nimbusconsulting.net, Email: info@nimbusconsulting.net
                                                                                         40

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9. presentation2 abc

  • 1. Nimbus Continuous Improvement Training : ABC Costing nandan@nimbusconsulting.net Phnom Penh, Cambodia May 16-20, 2011 www.nimbusconsulting.net, Email: info@nimbusconsulting.net
  • 2. Continues Improvement Prasac MFI Ltd, Cambodia www.nimbusconsulting.net, Email: info@nimbusconsulting.net
  • 3. Activity Based Costing What? Why? How? www.nimbusconsulting.net, Email: info@nimbusconsulting.net
  • 4. Requirement of Cost Systems • Valuation of inventory and measurement of the cost of goods sold for financial reporting. •Estimation of the costs of activities, products, services, and customers. •Providing economic feedback to managers and operators about process efficiency. www.nimbusconsulting.net, Email: info@nimbusconsulting.net
  • 5. Today’s businesses are working in an increasingly complex environment. Use of Advanced Technology Product Life Cycle Product Complexity Channels of Distribution Quality Requirements Product Diversity www.nimbusconsulting.net, Email: info@nimbusconsulting.net
  • 6. Composition of Cost 100 0 1 2 3 4 Direct Material Labour Overheads www.nimbusconsulting.net, Email: info@nimbusconsulting.net
  • 7. Conventional Costing • Total Cost = Material + Labour+ Overheads • Overheads are allocated to the products on volume based measures e.g. labour hours, machine hours, units produced Will this not distort the costing in the new environment? ABC provides an Alternative. www.nimbusconsulting.net, Email: info@nimbusconsulting.net
  • 8. Conventional Costing AB Costing Economic Element Expenses Resources Work Activities Performed Cost Objects Product or Cost Objects service www.nimbusconsulting.net, Email: info@nimbusconsulting.net
  • 9. Activity-Based Costing • Traditional allocation method Costs Products • Activity-based allocation method Costs Activities Products First stage Second stage www.nimbusconsulting.net, Email:9 info@nimbusconsulting.net
  • 10. Basics of A B C • Cost of a product is the sum of the costs of all activities required to manufacture and deliver the product. • Products do not consume costs directly • Money is spent on activities • Activities are consumed by product/services www.nimbusconsulting.net, Email: info@nimbusconsulting.net
  • 11. Basics of A B C (contd.) • ABC assigns Costs to Products by tracing expenses to “activities”. Each Product is charged based on the extent to which it used an activity • The primary objective of ABC is to assign costs that reflect/mirror the physical dynamics of the business www.nimbusconsulting.net, Email: info@nimbusconsulting.net
  • 12. Basics of A B C (contd.) • Provides ways of assigning the costs of indirect support resources to activities, business processes, customers, products. • It recognises that many organisational resources are required not for physical production of units of product but to provide a broad array of support activities. www.nimbusconsulting.net, Email: info@nimbusconsulting.net
  • 13. ABC systems addresses the following Questions: • What activities are being performed by the organisational resources? • How much does it cost to perform activities? • Why does the oranisation need to perform those activities? • How much of each activity is required for the organisation’s products, services, and customers? www.nimbusconsulting.net, Email: info@nimbusconsulting.net
  • 14. Basics of A B C : How? Cost pools are groups or categories of individual Steps: expense items 1. Form cost pools 2. Identify activities 3. Map resource costs to activities 4. Define activity cost drivers 5. Calculate cost www.nimbusconsulting.net, Email: info@nimbusconsulting.net
  • 15. Identify Activities In developing an ABC system, the organisation identifies the activities being performed: Activity Dictionary •Move material •Respond to •Schedule customers production •Improve products •Purchase material •Introduce new •Inspect items products •Explore new markets www.nimbusconsulting.net, Email: info@nimbusconsulting.net
  • 16. Map resource costs to activities • Financial accounting categorises expenses by spending code; salaries, fringe benefits, utilities, travel, communication, computing, depreciation etc. •ABC collects expenses from this financial system and drive them to the activities performed. www.nimbusconsulting.net, Email: info@nimbusconsulting.net
  • 17. Mapping ABC Records Activities Salaries Depreciation lectricity Supplies Travel E Total Accounting Records Salaries 313,000 Business Development 20,000 25000 5000 5000 55,000 Depreciation 155,000 Maintianing Present Business 80,000 60000 50000 5000 10000 205,000 Electricity 132,000 Purhcasing Material 125,000 50000 20000 20000 60000 275,000 Supplies 25,000 Set up Machines 25,000 10000 2000 37,000 Running Machines 50,000 10000 50000 110,000 Travel 100,000 Resolve Quality Problems 13,000 5000 25000 43,000 Total 725,000 Total 313,000 155000 132000 25000 100000 725,000 www.nimbusconsulting.net, Email: info@nimbusconsulting.net
  • 18. Activities: Types • Head Office Level • Branch Level • Department Level • Customer Level • Field Staff Level www.nimbusconsulting.net, Email: info@nimbusconsulting.net
  • 19. Define activity drivers • The linkage between activities and cost objects, such as products, customers, is accomplished by using activity drivers. • An activity driver is a quantitative measure of the output of an activity. • The selection of an activity driver reflects a subjective trade-off between accuracy and cost of measurement. www.nimbusconsulting.net, Email: info@nimbusconsulting.net
  • 20. Activities Drivers Unit Level Acquire and Use material for containers No. of Containers Acquire and Use material for baby-care productsproducts No. of Batch Level Set up manually controlled machines No. of batches of contain Set up computer controlled machines No. of batches of B. Prod Product Level Design and manufacture moulds No.of moulds required Use manually controlled machines Product type (containers) Use conputer controlled machines Product type (B.Products Customer Level Consult customers No. of consultations Provide warehousing for customers No. of cubit feet Faciltiy Level Manage workers Salaries www.nimbusconsulting.net, Email: info@nimbusconsulting.net
  • 21. Activities Drivers Activity Cost Activity Volume Activity Rate Unit Level Acquire and Use material for containers No. of Containers 40,000 1,000,000 0.04 Acquire and Use material for baby-care products No. of products 80,000 8,000 10 Batch Level Set up manually controlled machines No. of batches of containers 3,000 10 300 Set up computer controlled machines No. of batches of B. Produst 12,000 20 600 Product Level Design and manufacture moulds No.of moulds required 5,000 5 1000 Use manually controlled machines Product type (containers) 15,000 1 15000 Use conputer controlled machines Product type (B.Products) 40,000 1 40000 Customer Level Consult customers No. of consultations 4,000 40 100 Provide warehousing for customers No. of cubit feet 2,000 10,000 0.2 Faciltiy Level Manage workers Salaries 3,000 15,000 0.2 Use main building Square feet 48,000 16,000 3 www.nimbusconsulting.net, Email: info@nimbusconsulting.net
  • 22. Ascertaining Cost Activities A. Rate A.Volume Containers Baby Product Unit Level Acquire and Use material for containers 0.04 1,200,000 48,000 Acquire and Use material for baby-care products 10 7,000 70000 Batch Level Set up manually controlled machines 300 12 3,600 Set up computer controlled machines 600 16 9600 Product Level Design and manufacture moulds 1000 1 1,000 4 4000 Use manually controlled machines 15000 1 15,000 Use conputer controlled machines 40000 1 40000 Customer Level Consult customers 100 Containers 2 200 B.products 40 4000 Provide warehousing for customers 0.2 Containers 8,000 1,600 B.products 2,000 400 Faciltiy Level Manage workers 0.2 Containers 4,000 800 B.products 10,000 2000 Use main building 3 Containers 5,000 15,000 B.products 7,000 21000 Total Cost 85,200 151,000 www.nimbusconsulting.net, Email: info@nimbusconsulting.net
  • 23. Building an ABC Model Identify Identify Identify Resources Activities Cost Objects Define Define Activity Resource Drivers Drivers Enter Enter Enter Calculate Resource Resource Activity Costs Costs Driver Qty. Driver Qty. www.nimbusconsulting.net, Email: info@nimbusconsulting.net
  • 24. Activity Any event, action, transaction, or work sequence that causes a cost to be incurred in producing a product or providing a service. www.nimbusconsulting.net, Email: info@nimbusconsulting.net
  • 25. Activity Cost Pool The overhead cost allocated to a distinct type of activity or related activities. www.nimbusconsulting.net, Email: info@nimbusconsulting.net
  • 26. Illustration 4-2 Activities and Related Cost Drivers www.nimbusconsulting.net, Email: info@nimbusconsulting.net
  • 27. Reasoning for ABC www.nimbusconsulting.net, Email: info@nimbusconsulting.net
  • 28. Cost Driver Any factor or activity that has a direct cause-effect relationship with the resources consumed. In ABC cost drivers are used to assign activity cost pools to products or services. www.nimbusconsulting.net, Email: info@nimbusconsulting.net
  • 30. Activity-Based Costing (ABC) Calculate unit cost • Identify activities • Identify cost driver • Compute overhead rate • Assign overhead costs www.nimbusconsulting.net, Email: info@nimbusconsulting.net
  • 31. Benefits of Activity-Based Costing More accurate product costing which necessitates: éMore cost pools used to assign overhead éEnhanced control over overhead éBetter management decisions www.nimbusconsulting.net, Email: info@nimbusconsulting.net
  • 32. Limitations of Activity-Based Costing éCan be expensive to use. éSome arbitrary allocations continue. www.nimbusconsulting.net, Email: info@nimbusconsulting.net
  • 33. Activity-Based Management • Natural extension of ABC – Why are activities performed? • Are they necessary? • Are they consistent with organizational goals? – How are they performed? • Are they performed efficiently? • Can they be redesigned or eliminated? www.nimbusconsulting.net, Email:33 info@nimbusconsulting.net
  • 34. “You Get What You Measure” www.nimbusconsulting.net, Email: info@nimbusconsulting.net
  • 35. ABM for Process Improvement • Focus on problems, opportunities • Prioritize opportunities for improvement – Most critical – Greatest potential for cost savings www.nimbusconsulting.net, Email:35 info@nimbusconsulting.net
  • 36. ABM for Process Improvement • Determine and explain causes for problems and opportunities – Cannot improve the system without first understanding it • Select specific improvement projects www.nimbusconsulting.net, Email:36 info@nimbusconsulting.net
  • 37. ABM for Process Improvement • Use ABC/ABM data to test potential impact of changes • Make changes • Iterate – Process of continual improvement www.nimbusconsulting.net, Email:37 info@nimbusconsulting.net
  • 38. Implications of ABC/ABM • Shifts focus from managing costs to managing activities • Aids in recognizing, measuring and controlling complexity • Promotes understanding of why costs are incurred • Provides better cost allocation information www.nimbusconsulting.net, Email:38 info@nimbusconsulting.net
  • 39. Implications of ABC/ABM • Useful for planning future operations • Fosters continuous improvement • Likely to meet with substantial resistance – Analysis of why and how activities are performed www.nimbusconsulting.net, Email:39 info@nimbusconsulting.net
  • 40. Thank You Nandan S. Bisht Director: Nimbus Consulting Pvt. Ltd. nandan@nimbusconsulting.net www.nimbusconsulting.net, www.nimbusconsulting.net, Email: info@nimbusconsulting.net 40