Contribution to new competitive companies
1. Introduction
Traditional cost accounting clearly responds to paradigms that are no longer valid for the current state of technology and the need to make decisions based on better information, given the high level of competitiveness.
Under traditional indirect cost distribution technology, cost apportionments are made from service centers to production centers; however, the costs accumulated in the productive centers are assigned to the products or processes, normally based on machine hours, man hours or units produced; but these bases do not accurately reflect the resources consumed by the different products or processes.
The Activity Based Costing methodology is based on the fact that a company needs to carry out activities to produce products or services, which consume resources, which is why the activities are costed first and then the cost of The activities are assigned to the different cost objects (product, services, customer groups and regions, processes, etc.) that these activities demand; in this way, a much greater precision in the determination of costs and the corresponding profitability will be achieved.
Accountants based on bibliography typical of the Taylorian era, and unfamiliar with manufacturing processes, continue by tradition and ease with a costing system that leads to incorrect decision-making and analysis. These inaccuracies generate errors in the setting of prices, calculations of profitability, detection of waste, costing of products and / or services, and determination of plans and budgets.
It is time to dismantle these traveling ideas and paradigms, to replace them with new conceptions that are appropriate both to new production and information technologies, as well as to new highly competitive situations.
Cost analysis is essential in preventing, detecting, reducing and eliminating waste.
To solve these problems and based on the development of new computer technology, we have the contribution given by the Activity Based Costing system, commonly called ABC (Activity Based Costing).
The ABC intervenes in the costing of the indirect costs, distributing them among the activities that consume said resources. The ABC is therefore an attempt to transform indirect costs into direct costs in the way of influencing each activity, which undoubtedly requires greater precision than in traditional costing practices.
New rules for calculating costs
In an economy subject to globalization, the correct calculation of costs for the purposes of their control and subsequent reduction is essential in order to be able to compete effectively with suppliers from other parts of the planet. This is also essential when generating valid strategies for the internal market.
Now, what are these rules:
- First: overcome the organizational barriers in terms of areas or sectors, to give preponderance to the processes. Second: it must help detect those activities and processes that do not generate added value for the client or the company, and therefore help to eliminate them.. Third: it focuses its attention more on the elimination of unnecessary activities, than on the reduction of the costs of the activities. Fourth: to allow the setting of competitive prices for its products and / or services in the market. Fifth: to avoid that activities Surpluses finance other deficits.
What is ABC?
ABC was generated as a method to solve a problem that occurs in most organizations that use the traditional costing system, consisting of:
1. The inability to report the costs of individual products to a reasonable level of accuracy.
2. The inability to provide useful feedback for the administration of the company for the purposes of operations control.
Due to these circumstances, the managers of the companies that sell a variety of products and services make crucial decisions for the organization's progress, such as the determination of prices, the composition of products and the process technology to be applied, based on a notoriously inaccurate and inadequate cost information.
Traditional cost systems base the "costing" process on the product. The costs are remitted to the product because it is assumed that each element of the product consumes the resources in proportion to the volume produced. Therefore, product volume attributes, such as the number of direct labor hours, machine hours, amount invested in materials, are used as "routers" to allocate indirect costs. These volume routers, however, do not account for product diversity in the form of size or complexity. There is also no direct relationship between production volume and cost consumption.
Contrary to the aforementioned, Activity Based Costing bases the costing process on activities; This implies that costs are traced from activities to products, based on the demand for products for these activities during the production process. Therefore, the attributes of the activities, such as hours of preparation time, or number of times involved, are used as “drivers” to allocate indirect costs.
Since the number of the activity measures the increases used, the ABC allows to better capture the economic factors underlying the operation of the company, which allows obtaining more accurate product costs.
Another important distinction between traditional cost systems and the ABC system is the scope of operations. Traditional systems, which are primarily dedicated to inventory valuation, only analyze costs incurred within the factory walls. ABC's theory holds that since virtually all company activities exist to support the production and delivery of current goods and services, they should be included in their entirety as product costs not for inventory purposes, but to decision makers. In other words, to make a correct decision we must not only take into account the cost of manufacturing a product, but also the costs of advertising, sale and delivery, among others related to it.Examples of these manufacturing and business support costs, which can be broken down and referred to individual products or family products, include:
- LogisticsProductionMarketingSalesServicesResearch and DevelopmentDistribution
Conventional economic theory and management accounting systems treat costs as a variable only if they change with short-term fluctuations in production. ABC's theory holds that many important cost categories do not vary with changes in production in the short term, but with changes (over several years) in the design, composition, and variety of the company's products and customers. These complexity costs must be identified and assigned to the products.
What gave rise to the ABC System?
Many managers intuitively understand that their accounting systems distort product costs, and make informal adjustments to compensate. However, few managers can predict the magnitude and impact of the adjustments they should make.
ABC was first developed as a solution to these problems by two Harvard University professors, Robin Cooper and Robert Kaplan. They identified three independent but simultaneous factors as the main reasons that justify the need and practice of ABC:
The cost structure process has changed dramatically. At the turn of the century, direct labor accounted for approximately 50% of total product costs, while materials accounted for 35% and overhead 15%. Now, overheads typically amount to about 60% of the cost of the product, with materials in the order of 30% and direct labor at just 10%.
Obviously, the use of direct labor hours as an allocation basis made sense 90 years ago, but it is not valid within the current cost structure.
The level of competition that most firms face has increased markedly. The rapidly changing and global competitive environment is not a cliche, it is a disturbing reality for many firms.
Knowing the real costs of products is essential to survive in this new competitive situation.
The cost of measurement has come down as information processing technology improves. Even twenty years ago, the cost of accumulating, processing, and analyzing the data necessary to run an ABC system would have been prohibitive.
Today, however, these activity measurement systems are not only financially accessible, but much of the data already exists in some form within the organization. Therefore, ABC can be extremely valuable to an organization because it provides information on the scope, cost, and consumption of operating activities.
What benefits and strategic uses can be derived from this information?
First, we have more accurate product costs, which leads to better strategic decisions regarding:
a) Determination of the price of the product.
b) Product combination.
c) Determine the convenience of buying or producing.
d) Investments in research and development.
Secondly, the greater visibility of the activities carried out allows a company to focus on improving high-cost activities, and on the other hand, detect and eliminate non-value-adding activities.
We can summarize the advantages and benefits of applying the ABC in the following points:
1) It allows research into the causes of the activities and, in turn, the costs.
2) It does not pose implementation difficulties in any type of organization.
3) It is compatible with the method of Total Costs, or Full Costing, since in fact it is based on the calculation of the total cost.
4) It allows its adaptation to both historical costs and standard costs.
5) Facilitates the elimination of those activities that do not generate value.
6) It allows the calculation “a priori” of activities that you want to incorporate, as well as the impact that they would produce if carried out to term.
7) It facilitates strategic decision making since it shows the real level of competitiveness of the company, as well as the possibilities of success or failure compared to the competition.
In relation to point 5, it should be noted that of multiple western companies that audit their activities, it has been determined that between 50 and 70 percent of said activities are not valued by their clients.
This data reflects the importance of the analysis of the activities and the added value that they generate.
Principles of the ABC method
The two fundamental ideas from which the methodology in question starts are:
1) Products do not consume costs but activities.
2) Activities are those that really consume resources. Costs are the quantified expression of the resources consumed by the activities.
From this it is derived first of all that the cost management should focus, mainly on the activities that originate them, leading to the optimal management of the same generating the reduction of the costs that are derived from them.
Secondly, a cause / effect relationship must be established between activities and products or services. From this it is derived that to greater consumption of activities corresponds the imputation of higher costs and vice versa.
Finally and thirdly, we have the greatest objectivity in the allocation of costs, resulting from knowing the resources consumed in each activity. Therefore, the imputation to the product or service will be based on the activities that it has produced or consumed.
Activity and volume produced
A criterion as usual as negative that is lavished in the traditional cost system is the consideration of dividing the indirect costs based on a determined volume, which can be production, sales, etc. The result is that when small amounts are produced from a product, small amounts of indirect costs are therefore absorbed, regardless of what they have actually consumed.
Sometimes, it is not taken into account that functions such as: launch of production orders, design, research, preparations and changes of tools, and purchasing management, among others, cause activities that are not contemplated, much less imputed. This criterion can generate growth in indirect costs, which must either be borne by the rest of the products or services, or will obviously cause a drop in profitability.
The ABC grants the possibility of analyzing the information not on the costs that have been imputed to them based on a certain criterion but to detect those unnecessary works that must be the source of reduction and even elimination.
ABC in action
Activity-based cost management (ABC) systems place overhead costs on the specific activities that cause them, thereby providing a safer product cost. Four key concepts differentiate activity-based cost accounting systems from traditional cost accounting systems, allowing activity-based systems to provide more accurate product cost data:
I. Activity accounting. In an activity-based system, the cost of the product is the sum of all the costs required to manufacture and deliver the product. The activities that a company carries out consume its resources, and the availability and use of resources create costs. Activity accounting breaks an organization down into an activity structure that provides a reasoned cause and effect analysis of how fundamental objectives and their associated activities create costs and result in products. According to Brimson, an effective activity accounting system uses the following method:
A. Determine the fundamental activities that must be carried out to satisfy the objectives of a company. The activities allow the identification of how a company deploys its resources to achieve its basic objectives.
B. Determine the causal relationships that allow products (result) to be attributed to inputs (resources). A large number of these relationships will be based on non-volume related measurements such as the number of parts in a new design.
C. Check the output of an activity in terms of a measure of the volume of activity through which the costs of a business process vary more directly (for example, number of machine configurations required for a complex design).
D. Relate activities to products (or other objects) and determine how much of each activity is devoted to them. A cost structure, known as an activity list, is used to describe each pattern of activity consumption of the product.
E. Determine the fundamental success factors through which the company's activities can be aligned with the strategic objectives set. This step indicates how effectively the desired operation is carried out through the activities that the company undertakes.
F. Take action, with the philosophy of continuous improvement, on the productivity opportunities identified in steps AE. Since the cost of activity is the ratio of resources consumed by an activity to the measure of the activity's output, a means of evaluating effectiveness and efficiency (i.e. productivity) is available to managers. Various alternatives for realizing desired changes in activity patterns can now be realistically evaluated through investment or organizational means.
II. Cost drivers. A cost driver is an event that affects the cost / performance of a group of related activities. Family cost drivers include the number of machine configurations, number of engineering change notices, and number of purchase orders. Cost drivers reflect the demands placed on activities at the activity and production levels. By controlling the cost driver, unnecessary costs can be eliminated, resulting in an improvement in product cost.
III. Direct identification. Direct identification implies attributing costs to those products or processes that consume resources. Many hidden overhead costs can be effectively identified to products, thereby providing a more accurate product cost.
IV. Added costs without any value. In production processes, customers may perceive that certain activities do not add value to the product. By identifying cost drivers, a company can accurately determine these unnecessary costs. Activity-based cost systems identify and place a cost on executed activities (which add value and do not add value) so that management can determine the expected changes in resource requirements for each activity. In contrast, traditional cost systems accumulate costs by budget line item and by item.
These four basic concepts are included in activity-based cost accounting systems and lead to more accurate cost accounting information. Furthermore, activity-based cost accounting systems provide more flexibility than traditional systems because they produce a variety of cost figures useful for technology accounting, product cost accounting, and life cycle analysis. In addition, these cost figures can be applied in making various special decisions, including inventory determination, budgeting / forecasting, product line analysis, make / buy decisions, and cost design.
conclusion
In order to compete in today's business environment, companies need to have information on costs and total profitability of the business that allows them to make strategic and operational decisions in the right way. Having this type of information accurately and in a timely manner serves as a basis for the top management of a company to seek to maximize business performance.
While there is a strong need to manage and allocate overhead, traditional cost accounting systems are no longer effective.
The implementation of the ABC serves the purposes of achieving cost reduction, increasing profits, improving performance and making continuous improvement feasible.
It is necessary to keep in mind:
1. Not all costs originate exclusively from a volume of production, as opposed to the Taylor theory. In our days, and given the increasing complexity that occurs in companies, some costs appear that are due to the growth of the services that customers demand, such as customer service, logistics, infrastructure, among others.
2. Not all costs are really fixed. A very important part of them are, or can be constituted in variable costs.
In order to analyze the possibilities of improvement that the implementation of the method may bring you, it is necessary to thoroughly know each organization. In order for companies to reach the level of competitiveness that the current environment requires only a methodical, rigorous and motivating implementation, this system can be really useful.
Bibliography
An ABC Manager's Primer - Gary M. Cokins - Edit. John Wiley & Sons, Inc. - 1992
ABC / ABM Models - Samuel Cogan - Qualitymark Editor - 1997
Custos e Preços. Formaçao e análise - Samuel Cogan - Editorial Pioneira - 1999
Activity Based Costing for Small and Mid Sized Businesses - D. Hicks - Edit. John Wiley & Sons - 1995
Activity Accounting - James A. Brimson - Editorial Marcombo - 1995
