A costing methodology designed to obtain the information Cost Accounting can't provide.
ABCosting was created with a practical approach to cost analysis for internal management. Conventional accounting was created more than 50 years ago. Things have changed quite significantly in the business world since then. If a company wants to survive these days they need much more accurate information than what conventional accounting and gut feelings provide.
Every organization in the world deals with:
Resources & Materials
Cost Objects (Products, services, clients, etc.).
The more profitable the Cost Objects are, and the less Resources, Materials and Activities they use to fulfill those Cost Objects, the better the company does, prolonging its existence and increasing the wealth of those involved. A “Win-Win-Win” as they call it. Costing done from the ACTIVITIES perspective.
But how does a company know if a Product or Service is profitable or not?
How do they know with a high level of accuracy how are Costs being distributed?
How can they perfect their Processes to eliminate or improve Inefficient Activities if they don’t measure them?
To produce a gallon of ice cream (Cost Object or CO) I need milk, flavor, sugar (Materials), but I also will need to make the ice cream (Activities) and by doing so I will incur in other expenses like employees’ salaries, electricity, machine maintenance, cold storage, shipping, etc. (Resources).
Conventional accounting only takes into consideration direct costs like Materials and salaries, and all other OVERHEAD expenses (Advertising, sales, electricity, machine maintenance, etc.) are bundled into one and then allocated equally to all Cost Objects. The problem is that nowadays Overhead Costs account for more than 50% of all costs, making profitability analysis and decision making much more difficult and dangerous through conventional accounting.
ABC/M makes cost analysis easy because it allocates Indirect Resources (Overhead Costs) to Activities and then those Activities are allocated to Cost Objects. Creating a framework of understanding where every expenditure can be accounted for. Allowing managers to make the necessary modifications to improve that Cost Object, Activity or Resource utilization. But it doesn’t stop there, Materials and Direct Costs are also properly allocated to Cost Objects, that with the Overhead Costs allocations provide a complete picture of the area that is being analyzed and facilitate such information in a timely manner to make the most out of it.
This way we can see the importance of ABC/M in any organization. Just like a ship’s captain needs the navigation map or a general contractor needs a building’s blue print, the manager needs to see the most accurate picture of the organization internal processes and costs allocations to make the best possible decisions. Today, managers are driving blind on a dangerous and treacherous road if they only use conventional accounting for decision making.
ABCosting Vs. ABManagement
ABCosting and ABManagement are the both faces of the same coin. ABC answers the question “What things costs?” and ABM answers the question “Why things have costs?”. ABC represents the traditional framework in which managers analyze costs by assigning them through Drivers to Activities and then again to Cost Objects. ABM is the new approach by which continuous improvement is achieved by analyzing processes costs and procedures to make changes that make these less costly and more efficient.
For more information on how Activity-Based Management / ABCosting can help your business achieve new levels of efficiency and profitability, please CONTACT US and we will be happy to answer all your questions.