193-044 Activity Accounting--Another Way to Measure Costs This approach, which is also called transaction-based costing, or activity accounting,focuses on what an organization does, the way time is spent, and the outputs of those processes.To do this requires at least four steps: 1. Identify activities; 2. Trace the costs of resources to the activities performed; 3. Identify activity measures (outputs) by which the costs of a process vary most directly; and 4. Trace activity costs to cost objects such as products, processes, and customers based on the usage of activities.By this method, the cost of support departments, which might otherwise be simply accumulatedas indirect costs and assigned based on volume in a traditional cost accounting system, areassigned to activities performed, such as setting up machines, receiving and handling material, andshipping finished products. Then, the expenses of each activity are assigned to products orcustomers based on their demand for the activities, such as the number of setups, the number ofinbound material shipments, or the number of separate shipments to the customer. ABC systems are similar to more traditional cost systems in that they capture costs, assignthem to cost centers (activity centers), and then assign those costs to products based on thedemand that the product or customer places on the activity itself. Some activities, such asmachine setup, will occur each time a production run is initiated. Other activities, such as productengineering, may have nothing to do with how many units or batches of the products areproduced. ABC systems differ from more traditional volume-based systems because they focus onwhat causes a cost to occur rather than on simply allocating what has been spent. In manyrespects, you can think of ABC systems as abandoning the traditional ideas that a cost can bevariable or fixed. Resources are consumed because something (activities) made a demand on them.The ABC system seeks to understand what that something (activities) is and to associate the costsof the resources consumed with whatever made the demand. The system creates the mechanismfor tracing resource consumption to whatever caused spending to acquire the resource. Proponents of introducing and using ABC systems usually concede that such systems aremore complex and more costly than the traditional cost systems that they replace. However, theyalso feel that three benefits of using ABC systems outweigh the costs of designing, installing, andusing such systems. First, ABC systems produce more accurate product costs, particularly in circumstanceswhere indirect costs are important in the total cost structure of the organization and where thereis great diversity in products or services, the processes of producing them, or customers. Withmore accurate costs, the risk of poor decisions is reduced, and the revelation of competitiveopportunity is likely to be more complete. Second, focusing on the consumption of resources rather than merely allocating costs toproduct or services raises questions about why resources are being consumed in the way that theyare. For example, if the cost of processing orders is high because each order has a specialcharacteristic, the savings possible by producing a standard line can easily be uncovered with anABC system. In addition, focusing on resources used can direct attention to reducing the cost(increasing the efficiency) of activities and business processes.2
Activity Accounting--Another Way to Measure Costs 193-044 Third, the need for special cost analyses when confronted with usual situations isfrequently reduced with more accurate cost information and managements improvedunderstanding of what causes costs to be incurred. Two HBS case studies, "Destin Brass Products" and "Siemens Electric Motor Works (A),"introduce basic techniques used in ABC systems. One should be aware, however, that each ABCsystem will differ from another because every system must be closely tied to the technology andeconomic characteristics of the organization it supports. Although only a relatively smallproportion of companies are using activity accounting systems to date, it is expected that manymore will be experimenting with them over the next decade. Organizations that have developedand used such systems express enthusiasm for them, and managers agree that ABC developmentshave been one of the most exciting events in the development of cost accounting during thiscentury. 3
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