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Implementing activity based costing

You will find implementing Activity Based Costing a powerful tool in measuring performance.Activity-based costing is used to identify, describe, assign costs to, and report on agency operations.Traditional accounting is not as accurate for use as a cost management system.Activity based costing identifies opportunities to improve the business process and efficiency by determining the ‘true' cost of a product or service.

You can use activity based costing to focus management attention on the total cost to produce a product and to determine the basis for full cost recovery.You will find that support services are well suited for activity based resourcing because they produce measurable units of output.

Activity-Based Costing is:

  • Is a management tool that provides better allocation of resources
  • Is applicable to both appropriations and revolving funds
  • Relates total cost (resources consumed) to work accomplished (outputs produced)
  • Aligns costs to outputs, thereby increasing cost visibility
  • Is useful in forecasting financial baselines

Activity based costing assigns costs to resources and products to produce units of cost.A unit cost is the "average total cost" of producing one unit of output. You calculate the unit cost by dividing the total cost of production by the total number of units of output produced.

For example, if make or produce 50 houses for a total cost of $12,500,000, then the cost-per-unit (house) is $250,000.

When you make a clear connection between the costs and outputs you have a true financial picture.You will see the costs are move visible and explicit which will help you make good decisions when allocating resources.

Total cost visibility takes into account all of the costs associated with producing or delivering a product.For example, if you have a family member working in your business and you pay them by providing them a vehicle.Your family member's labor is not free and you must calculate the cost of the vehicle into your total costs.
You have four steps in activity based costing:

  1. Identify activities-perform an analysis of the operating process of each segment used to create the product.You may need to be very detailed depending on your business.
  2. Assign costs to activities-you must determine all the costs in each activity.You must include administrative costs all the way to materials and labor.
  3. Direct-costs that can be traced directly to one output.For example, the material costs (varnish, wood, and paint) to build a chair.
  4. Indirect-costs that cannot be allocated to an individual output; in other words, they benefit two or more outputs, but not all outputs. Examples: maintenance costs for the saws that cut the wood, storage costs, other construction materials, and quality assurance.)
  5. General and Administrative-costs that cannot reasonably be associated with any particular product or service produced (overhead). These costs would remain the same no matter what output the activity produced. Examples: salaries of personnel in purchasing department, depreciation on equipment, and plant security.
  6. Identify outputs-identify all of the outputs for each segment in the operating process. Outputs can be products, services, or customers.
  7. Assign activity costs to outputs-assign activity costs to outputs using activity drivers. Activity drivers assign costs to outputs based on the outputs' use of resources. For example, a driver may be the number of times an activity is performed (transaction driver) or the length of time an activity is performed (duration driver).

Activity based costing encourages managers to identify which activities are add value.Those activities that will best accomplish a mission, deliver a service, or meet a customer demand. Activity based costing improves efficiency and improves the decision making process by focusing on the actual costs.

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