INTRODUCTION
The world, society, organizations, individuals and the environment tend to change rapidly, which is why all the things that surround these systems have to adapt to the rhythm of substitution of the norms that govern the new social, productive and business.
The allocation of costs to the different cost objectives, especially the final objective that are the finished products, is without a doubt the most important problem to solve of any cost system. In addition, it is an inescapable problem because the organization needs to have reliable, timely and as accurate information as possible about the cost of its products, for correct decision-making.
The cost calculation model for companies is of utmost importance, since these are the ones that determine the viability of the business, those that mostly determine the degree of productivity and efficiency in the use of resources, so a cost model it cannot be based solely on allocating costs on a certain factor, which for the business order may be insignificant or not very representative of what it actually symbolizes.
A clear explanation of the rationale and components of the Activity Based Costing system will be presented below.
BACKGROUND TO ABC COSTS
Johnson and Kaplan say that Activity Based Cost Systems (ABC) have meant nothing more than a return to the origins of Cost Accounting. This assertion is based on the fact that Cost Accounting was born scientifically, together with the Industrial revolution and as a consequence of the fact that production began to develop within the same premises and under the direct supervision of the entrepreneur.
The necessity of the entrepreneur to know the performance in the different tasks that he carried out to manufacture the products, made that, in its beginnings, the Cost Accounting was directed mainly to know the activities that were developed in the organization.
The increasing complexity of the production processes and the lack of technical and computer resources were the factors that caused Cost Accounting to worry less and less about the activities at the core of cost calculation and more about the different parts of the organization. in front of which were appearing responsible for the management. Thus justifying the traditional rise in costs by Departments.
WHAT IS ABC?
The ABC (acronym in English for "Activity Based Costing" or "Activity-Based Costing") was developed as a practical tool to solve a problem that is presented to most companies today. Traditional cost accounting systems were developed primarily to fulfill the function of inventory valuation (to satisfy "objectivity, verifiability, and materiality" standards), for external incidents such as creditors and investors. However, these traditional systems have many flaws, especially when used for internal management purposes.
Two especially important defects are:
- The inability to report the costs of individual products to a reasonable level of accuracy. The inability to provide feedback useful to the management of the company for the purposes of operations control.
Consequently, managers of companies that sell a variety of products make important decisions about pricing, product composition, and process technology based on 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 terms of size or complexity. Nor is there a direct relationship between production volume and cost consumption.
In contrast to this, the ABC costing model is a model that is based on the grouping into cost centers that make up a value sequence of the products and services of the company's productive activity. It focuses its efforts on managerial reasoning in an appropriate way the activities that cause costs and that are related through their consumption to the cost of the products. The most important thing is to know the generation of costs to obtain the greatest possible benefit from them, minimizing all the factors that do not add value.
The activities are related in groups that form the total of the productive processes, which are ordered sequentially and simultaneously, in order to obtain the different cost statements that accumulate in production and the value that they add to each process.
The processes are defined as "The entire rational organization of facilities, machinery, labor, raw materials, energy and procedures to achieve the final result." In the studies carried out on ABC, activities and processes are separated or described, the most common are listed below:
Activities
- Approve products Negotiate prices Classify suppliers Receive materials Plan production Issue orders Billing Collect Design new products, etc.
Processes
- PurchasesSalesFinancesStaffPlanningResearch and development, etc.
The activities and processes to be operational from the point of view of efficiency need to be homogeneous to measure them in the operational functions of the products.
Identification of activities
In the identification process within the ABC model, activities must first be appropriately located in the productive processes that add value, so that when operations begin, the organization has the ability to respond efficiently and effectively to the demands that the market imposes on it. After the activities in the company have been specified and grouped into the appropriate processes, it is necessary to establish the work units, the cost transmitters and the transformation ratio of the factors to thereby measure the productivity of the inputs and to transmit rationally the cost of inputs over the cost of outputs.
A study of the sequence of activities and processes, together with their associated costs, can offer the organization's managers an overview of the critical points of the value chain, as well as the relative information to carry out continuous improvement that can be applied in the value-creating process. Knowing the causal factors that drive the activities, it is easy to apply the efficiency inducers, which are those factors that decisively influence the improvement of some efficiency attribute of the activity, whose refinement will help to complete the harmony of the productive combination. These inductors tend to focus on improving the quality or characteristics of the processes and products, reducing deadlines, improving the critical path of core activities, and reducing costs.
Finally, it is necessary to establish a system of control indicators that continuously show how the activities and processes are functioning and the progress of the efficiency inducers. This control consists of comparing the real state of the action against the proposed objective, establishing the appropriate correctors to take them to the proposed value chain.
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.
ABC is a valuable system that directs the costs of an organization to products and services. These organizations use ABC as a method of improving operations by managing inducers of cost-generating activities, to support better decisions about product lines, market segments, and customer relationships, simulating the impact of improving the processes (Total Quality Management) using the financial and non-financial intermission of the ABC as a measurement system.
Scope
It provides a global appreciation of the design and implementation process of an ABC system. If the organization is large or small, manufacturing or service, the main outline can be used to develop an effective cost system. This assumes that you are familiar with the basic concepts of ABC.
An understanding of the responsibilities and roles of accounting managers in the ABC project helps convince the organization of the need to overhaul the system, to provide a better understanding of product or service costs, business processes, and activities as a more comprehensive means of business decision making.
FUNDAMENTALS OF THE ABC METHOD
The ABC (Activity Based Costing) method analyzes the activities of the indirect (support) departments within the organization to calculate the cost of finished products. And it analyzes the activities because it recognizes two simple but evident truths:
- It is not the products but the activities that cause the costs; it is the products that consume the activities
The ABC method is to allocate manufacturing overhead to products by following the steps outlined below:
- Identifying and analyzing separately the different support activities that the indirect departments provide, assigning to each activity the costs that correspond to it, thus creating homogeneous cost groups in the sense that the behavior of all the costs of each group is explained by the same activity. Since all activities have been identified and their respective costs grouped together, then 'activity measures' must be found that best explain the origin and variation of manufacturing overhead.
ACTIVITY MEASURES
They are competitive measures that serve as a connection between activities and their respective manufacturing overhead, and can also relate to the finished product. Each "measure of activity" must be defined in perfectly identifiable units of activity.
The measures of activity are known as "COST DRIVERS", a term whose approximate translation in Spanish would be "origin of cost" because it is precisely the "cost drivers" that cause manufacturing overhead to vary; that is, the more activity units of the specific cost driver identified for a given activity are consumed, then the higher the indirect costs associated with that activity.
As an example of cost drivers we can mention »
Number of providers
- Number of production orders made Number of material deliveries made.
In this way, a higher cost is assigned to those products that have demanded more organizational resources, and there will no longer be distortions in the cost of products caused by the averaging effects of a traditional cost allocation system that fails to study the real causes of the behavior of manufacturing overhead and, therefore, apportion them using arbitrary allocation bases such as direct labor hours.
The traditional system did not identify, study, or analyze the root causes of origin and variations in manufacturing overhead.
The ABC method holds that each line of manufacturing overhead is tied to a specific type of activity and is therefore explained by a different 'Measure of Activity'. In other words, what explains the behavior of the costs of indirect departments (considered most of them as fixed according to traditional accounting thinking), are the different transactions or activities that the finished products consume in their elaboration.
PURPOSE OF THE ABC METHOD
It is making Senior Management and the entire organization in general aware of the important role that indirect departments play in the production process and how the manufacturing indirect expenses incurred in said departments contribute to the success of any company.
The role of accounting managers
ABC systems cannot be successfully implemented without full support from accounting managers who have the right background to approach the ABC system from its inception. His vision contributes to the identification of the appropriate units of analysis (product, processes, etc.) and the probable causes of failure of the cost system.
In the ABC project, accounting managers have the information to judge the level of detail that the system should study and the best understanding of the flow of costs through the organization and the ability to detail the necessary flow of information to support the system when is implemented.
Accounting managers must lead the ABC project towards its successful implementation through their enthusiasm, technical knowledge, conceptual understanding, creativity, innovation, persistence, ability to overcome reality and remove obstacles.
Collection of information
The information required for an ABC project is of two types:
- Conceptual and Statistics
Conceptual information is necessary to develop the overall design plan, statistical information is necessary to simulate the flow of cost through the model, it also serves as real data to validate conceptual information.
The objective of the collection is to accumulate the necessary information to:
- Identify the activities carried out in the organization (to assign the cost and visualize the process) Identify the elements of the cost (to visualize the allocation of the cost) and measure performance (to visualize the process) Determine the relationship between the activities and the elements of the cost (to view cost allocation)
Identify and measure cost drivers that determine workload (to visualize the process) and make cost flow to activities and in turn flow to other activities or to the organization's products and services (to visualize allocation of the cost)
ABC system information sources
- There are three primary sources of information necessary for the development of an ABC system: people, balance, and the organization's computer system. The people who perform the job are the primary source of information. They provide data about the organization's activities, the consumption of resources and the performance measurements used. The balance provides information about the elements of the organization's cost and the outputs made.
The organization's systems should contain information about cost objects and cost drivers. For example, the number of canceled invoices (a potential cost driver) should be obtained through the payment of system bills.
ABC Advantages
- One of the most important advantages derived from an activity-based management system is that it does not directly affect the functional organizational structure since ABC manages the activities and these are arranged horizontally throughout the organization. This is precisely the advantage that changes in the organization are not reflected in the system. It helps to understand the behavior of the costs of the organization and, on the other hand, it is a management tool that allows financial projections to be made since it simply must report the increase or decrease in activity levels. The ABC perspective provides us with information on the causes that generate the activity and the analysis of how tasks are carried out. An exact knowledge of the origin of the cost allows us to attack it from its roots.It allows us to have a real vision (horizontally) of what is happening in the company. Without a horizontal vision (without knowing the participation of other departments in the process that is executed) we really lose the vision of the need for our work for the client to whom we must justify the price that we invoice.This new management system will allow us to know measures of a non-financial type, very useful for decision-making. Once this system is implemented, the ABC will provide us with a quantity of information that will reduce the costs of special studies that some departments support or complement the traditional cost system. So the effect is twofold,on the one hand, it increases the level of information and, on the other hand, it reduces the costs of the cost department itself. The difficult thing about a system is that it be simple and transparent, and the ABC is so because it is based on real events and is totally subjective in such a way that it does not can be manipulated in any way given that it is based on activities
Disadvantages of ABC
- There is a clear acceptance by all experts that the ABC consumes a significant part of resources in the design and implementation phases. Another aspect to keep in mind that can make the implementation of the ABC difficult is the determination of the perimeter of performance and level of detail in the definition of the activity. A third aspect is that if we can make it difficult to define the activities, where we are really going to have a greater number of problems is in the definition of the “inductors” or factors that trigger activity. To determine the inductors, we must use the cause-effect method in order to analyze the immediate causes until obtaining the true cause that triggers the accumulation of activities.Finally, it is true that any change in a system is always accompanied in the early stages of an adaptation process and to avoid that the new implanted system becomes complex in use and does not involve a traumatic process, users should be educated to They maintain the information and the people who use it for decision making.
When should an activity cost management system be implemented?
- When the percentage of indirect costs over the total costs of the company has a significant weight, although it is true that its implementation would not make sense if the company manufactured a single product for a single client. A second case of application of ABC is in companies where they are subjected to strong price pressures in the market and wish to know exactly the composition of the cost of products, since traditional management systems usually incorporate indirect manufacturing costs based on volumes of units produced or sold and therefore some of the products may be subsidizing the cost of others and, ultimately, prices may be incorrectly defined.A third case in which the implementation of ABC could be advised is in companies that have a high range of products with different manufacturing processes and where it is very difficult to know the proportion of indirect costs affected by each product.
Lastly, the recommendation to implement the ABC could even be raised in companies with high levels of structural spending and subject to major strategic-organizational changes.
THE RELEVANCE OF INDIRECT EXPENSES
Direct costs have decreased their share dramatically within the total cost of products, while manufacturing overhead has also increased. This has an immediate impact on cost systems: direct labor no longer explains the behavior of manufacturing indirect costs and therefore ceases to be a valid basis for apportioning them.
As an example of this, it is enough for now to mention that in highly automated factories, the proration rates based on the hours of direct labor exceed 100 or 200%, reaching up to 1000%, which in itself only shows that the cause-effect relationship between direct labor and manufacturing overhead has ceased to exist.
The low cause-effect relationship between direct labor and manufacturing overhead, direct labor hours continue to be a very frequent apportionment basis in companies. This base assumes that those products that consume more hours of direct labor in their production consume equally more indirect resources and, therefore, must absorb a greater portion of their cost.
The above reasoning is valid in a 100% labor intensive productive environment, but when this is not the case and there are products whose production process has been technified, continuing to use direct labor hours as a basis of apportionment introduces distortions. in product costing, that is, the proration rate is inflated by technology costs.
This rate applies to all products, whether or not they have used the new automated production technology.
The result is that products that are labor intensive are incorrectly assigned part of the costs originated by automation, because they were not benefited from it, while on the other hand, technology intensive products absorb less indirect costs of manufacture of what corresponds to them.
With a manufacturing overhead allocation system such products benefiting from automation are subsidized by those labor intensive. Based on the above reasoning, it is concluded that there is currently a manufacturing indirect cost allocation system that does not identify or attack the various causes that explain the behavior of the different manufacturing indirect costs and that, therefore, cannot assign them appropriately.
CONCLUSION
In conclusion, traditional cost accounting measures what it costs to do a task, while activity-based accounting also records the cost of not doing, such as the cost of machine unavailability, waiting for a tool, inventory, reprocessing, etc. These costs of not doing often equal and sometimes exceed the costs of doing.
For all these reasons, the ABC system can be considered the most appropriate for our work.
- This system provides the possibility of moving from a static to a dynamic budget. Most alternative systems do not offer the adequate structure to capture the relevant information on the cost of quality (Statistical Process Control, rework, demotivation, delays). ABC allows Obtain additional strategic information through product tracing. With ABC, the effects of quality failures are revealed, allowing the company to focus on reducing these hidden costs. ABC improves perception of the cause of costs.
Once the ABC costing system was defined, the activities and their corresponding cost generators were analyzed.
To finish, and as a complement to what has already been explained in this document, we leave you with a series of videos through which you will have the possibility of deepening your learning about the ABC Costing System. In the first, Professor Jorge Ignacio Lardizabal, from Austral University, makes a conceptualization of said system, explains its essence and presents some of its characteristics. In the following two, the consultant Carlos Castilla Florián makes a practical approach based on an example with which he makes clear how it is applied and what are the benefits of Activity-Based Costing. (3 video - 38 minutes)
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