ABC cost model concept
The ABC Activity Based Costing system (Activity Based Costing) is a model that allows the assignment and distribution of the different indirect costs, according to the activities carried out, since these are the ones that really generate costs. This system arises from the need to solve the problem that standard costs normally present, when they do not faithfully reflect the added value chain in the production of a specific product or service, and therefore, it is not possible to adequately determine the price.
The ABC cost model allocates and distributes indirect costs according to the activities carried out in the product or service development process, identifying the origin of the cost with the necessary activity, not only for production but also for its distribution and sale; the activity is understood as the set of actions whose purpose is to incorporate added value to the product through the manufacturing process. Complementing the definition of activity, it should be mentioned that the ABC Model is based on the fact that products and services consume activities, and these in turn are the generators of costs.
History of the ABC cost model
In the mid-1980s, the ABC cost model appeared, or also called “Activity Based”, which had Cooper Robin and Kaplan Robert as promoters.
This model is considered, to date, one of the most effective as it allows greater accuracy in the allocation of company costs, and also allows them to be viewed by activity. The ABC cost model allows greater accuracy in the allocation of company costs and allows them to be viewed by activity.
Both Robin and Robert justify its application in an attempt to respond to the limitations posed by traditional cost accounting systems from a management point of view, such as the uncertainty created by the internationalization of markets, the continuous technological evolution and the shorter life cycle of the products, etc… These limitations had as a consequence a modification of the cost structures of the companies that make the traditional cost systems invalid.
Phases to implement the ABC Cost Model
The ABC cost 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 the reasoning of adequately managing 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 the costs to obtain the greatest possible benefit from them, minimizing all the factors that do not add value.
The activities are related in sets that form the total of the productive processes, which are ordered sequentially and simultaneously, in order to obtain the different states of cost that accumulate in production and the value that they add to each process. The processes are defined as “All the rational organization of facilities, machinery, labor, raw material, energy and procedures to achieve the final result”. In the studies that are done on the ABC, the activities and processes are separated or described, the most common are listed below:
Activities
Homologize products
negotiate prices
Classify providers
Receive materials
plan production
ship orders
Check in
Collect
Design new products, etc.
processes
Shopping
Sales
Finance
Staff
planning
research 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 operational functions of the products.
Identification of activities
In the identification process within the ABC model, activities must first be properly located in the productive processes that add value, so that when operations begin, the organization has the capacity to respond efficiently and effectively to the demands imposed by the market. 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 measure the productivity of the inputs and to transmit rationally the cost of the inputs over the cost of the outputs.
A study of the sequence of activities and processes, together with their associated costs, will be able to offer the company’s management a vision of the critical points of the value chain, as well as the relative information to carry out a continuous improvement that can be applied in the value creation process. Knowing the causal factors that trigger the activities, it is easy to apply the efficiency drivers (Perfomance drivers) which are those factors that decisively influence the improvement of some efficiency attribute of the activity whose refinement will contribute to complete the harmony of the productive combination. . These drivers tend to focus on improving the quality or characteristics of 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 working and the progress of the efficiency drivers. 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.
ABC Instrumentation
Having identified and established the activities, processes and factors that measure the transformation of the factors, it is necessary to apply a cost operational phase to the model since it is known that every activity and process consumes a cost, as well as products and services. consume an activity. In this model, the costs directly affect the raw material and labor compared to the final products, distributing the rest among the activities, since on the one hand resources are consumed and on the other they are used to obtain outputs.
As the activities have a direct relationship with the products, with the cost system based on activities it is possible to transform the indirect costs with respect to the products into direct costs with respect to the activities, which leads to a more efficient form of transformation. factor cost in the cost of products and services.
After carrying out the previous steps, the costs of the activities must be grouped according to their level of causality for obtaining the products and services in:
Activities at the internal level of the product (Unit level)
Activities related to production orders (Batch-level)
Activities related to product maintenance (Product-level)
Activities related to production maintenance (Product-sustaining)
Activities related to research and development (Facility-level)
Activities aimed at the continuous process of customer support (Customers-level)
Allocation of costs
In an ABC cost system, the cost is assigned first to the activities and then to the products, achieving greater accuracy in the imputation.
Stages for allocation
First stage: In this stage, the costs are classified into a set of general costs or pool for which the variations can be explained by a single cost-driver.
Second stage: In this stage, the cost per unit of each pool is assigned to the products. It is done using the pool ratio calculated in the first stage and the measurement of the amount of resources consumed by each product. The calculation of the costs assigned from each cost pool to each product is:
General costs applied = Pool ratios * Cost-driver units used
The total overhead costs allocated in this way are divided by the number of units produced. The result is the unit cost of general production costs. Adding this cost to the unit cost for materials and direct labor, the unit cost of production is obtained.
Allocation factors
The allocation factors are directly related to the stages in front of their design and operation. These factors are the choice of cost pools, the selection of means of allocating overhead costs to the cost pools, and the choice of a cost driver for each cost pool. These factors represent the basic mechanism of an ABC system.
Purpose of the ABC model
Scholars of this system have various theories about the purpose of the model, among the most utilitarian they can be extracted:
Produce useful information to establish the cost per product.
Obtaining information on costs by production lines.
Ex-post analysis of profitability.
Use the information obtained to establish management decision-making policies.
Produce information that helps in the management of production processes.
Establishment of an ABC costing system in the company
Benefits of the ABC Cost System
Facilitates fair cost per production line, particularly where non-volume related overhead costs are significant.
Analyzes other cost objects besides products.
It unambiguously indicates the long-run variable costs of the product.
It produces financial and non-financial measures, which are used for cost management and for the evaluation of operational performance.
It helps cost identification and behavior and thus has the potential to improve cost estimation.
Limitations of the ABC cost system
There is little evidence that its implementation improves corporate profitability.
There are no known consequences in terms of human and organizational behavior.
The information obtained is historical.
The selection of cost-drivers and costs common to various activities are not satisfactorily resolved.
ABC is not a generic purpose system whose outputs are adequate without qualitative judgments.
In the areas of control and measurement, its implications are still uncertain.
As a final conclusion, it should be taken into account that the cost system based on activities is established as a philosophy of business management, in which all the individuals that make up the company must participate, from the workers and workers of the plant, to the more senior managers, since by having all the productive sectors covered, the company is led to achieve competitive and comparative advantages over entities that carry out the same activity.
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