Activity Based Costing – Rajawali Adikarya

What Is?

The Activity Based Costing solution can be thought of as a more accurate method of apportioning overheads, the aim being to associate elements of overhead cost to those products which actually cause the cost.

When using traditional costing methods, each part has material and labor costs. The labor costs are made up of direct costs based on the time spent for each operation, and fixed and variable overhead costs. It is these traditional overhead costs that activity based costing is designed to supersede. These traditional overhead costs often comprise a significant portion of the total cost of a product and, therefore, increased accuracy in the cost recovery allows improved accuracy in calculating product profitability.

The traditional costing method of loading overheads against a product according to the labor content is obviously inaccurate when processing a diverse range of products, particularly where disparate overhead usage is involved.

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SYSPRO Solution

The Activity Based Costing system enables you to more accurately attribute overhead costs to specific products by associating elements of overhead cost to those products actually causing the cost burden and by enabling you to apply these costs at the points of transition in the procurement, manufacturing and sales cycles.

ABC is not another SYSPRO inventory costing method (e.g. Average, Standard, FIFO, LIFO and Last) but, rather, it provides you with a different method of calculating these costs. The traditional costing method of loading overheads against a product according to the labor content becomes increasingly inaccurate when processing a diverse range of products, particularly where disparate overhead usage is involved. Because these overhead costs often comprise a significant portion of the total cost of a product, ABC allows increased accuracy in calculating the cost recovery and thereby improved accuracy in calculating product profitability.

The overhead costs are accumulated against items as they are purchased, manufactured and sold, by attaching elements of cost to each transition point (i.e. at the actual point of purchasing, manufacturing, or selling an item). You may configure costs to be fixed per batch, or based on the quantity being handled. You can recover pre-production costs such as buying, expediting and goods-in, as items are received into stock from purchase orders. You can recover manufacturing costs at the time of receipt into stock of goods from Work in Progress. The recovery of these ABC overhead costs may be over-and-above the overheads recovered using traditional methods (e.g. labor postings into Work in Progress). You can recover post-production costs, such as marketing, credit control, inspection, packing and shipping through cost of sales as the final item is invoiced.

The above instances allow you to define the activity during which each element of cost is incurred. Each ABC incidence is calculated by adding the elements for that part/incidence. The element cost is calculated by multiplying the driver quantity by the element calculation rate.

You configure the system for accurate calculation of ABC costs by establishing the elements of your costs and where and how they occur and then defining the relevant driver quantities based on measures of relative importance. To assist in maintaining consistency, narrative comments can be attached to elements when they are added and a Recoveries Estimate Report is provided to calculate a divisor which you can use against estimated cost to establish a unit rate.

The system facilitates a migration approach whereby you can progressively recover more overheads using the ABC driver approach and less by the traditional labor usage method. This is achieved by you setting up separate ABC costs that you can run in parallel with traditional costing methods. You can then analyze these while the company’s day-to-day costing and accounting procedures remain unaffected. As confidence increases, overhead costs for the areas to be recovered via ABC can be removed from the traditional labor-based overhead rates and the system integrated with the company’s accounting procedures.

Process Flow

Traditional cost accounting involves attributing costs to individual products on the basis of an overhead absorption base related to some proxy such as direct labor hours or machine hours. You can apply this approach with varying degrees of sophistication but it is unlikely to give an unambiguous result in modern circumstances.

In the current manufacturing environment a high proportion of costs are indirect and the only meaningful way to attribute such costs to individual products is through a study of the activities that give rise to them. You are seeking an approach to product costing that reflects the manner in which costs are actually incurred and the question is whether or not traditional absorption costing offers such an approach for both decision making and performance evaluation purposes.

Performance evaluation is split into three:

Are production overheads significant relative to total full absorption cost?
Is there any fundamental link between the occurrence of these production overhead costs and production volume, and hence products?
Are there fundamental links between the occurrence of production overhead and particular products that are not volume-related?

Process Flow for Activity Based Costing

Transaction Analysis and Cost Drivers

Overhead in traditional systems is absorbed by products using volume-related measure. The activity based approach, where appropriate, seeks explanations other than volume for the level of overhead. It is therefore recognized that overhead costs are incurred in carrying out a number of different types of transactions. They can be summarized as follows:

Logistical transactions, those activities that relate to the organization of the flow of materials and other resources throughout the production process;
Balancing transaction, those that relate to ensuring that the supply of resources is matched with the demand for them;
Quality transactions, those concerned with ensuring output conforms to requirements;
Change transactions, those concerned with meeting customers’ requirements for altered specifications, product designs, delivery dates etc.

Traditional Product Costing System

Activity Based Costing System

Activity based costing identifies the activities that cause cost to be incurred, and searches for the fundamental cost drivers of these activities. Once the activities and their drivers have been identified, this information can be used to attach overhead to those cost objects (e.g. products) that have actually caused the cost to be incurred.

Favorable Conditions for Activity Based Costing

The purpose of moving from a traditional costing system to an activity based costing system must be based on the premise that the new information provided will lead to action that will increase the overall profitability of the business. This will occur when the analysis provided under the activity based costing system differs significantly from that which was provided under the traditional system, which is most likely to occur under the following conditions:

When production overheads are high relative to direct costs, particularly direct labor

Where there is great diversity in the product range

Where these is considerable diversity of overhead resource input to products and

When consumption of overhead resources is not driven primarily by volume.

Establishing an Activity Based Product Cost

A simplified description of the various steps associated with the operation of the basic activity based costing approach, and a comparison with the traditional costing approach is shown below:

Identify the main production related activities of the organization.
Identify the cost pool of each of the activities identified in step 1
Determine the cost driver for each activity identified in step 1.
Select the activity cost pools and cost drivers that will be used within the system.
Calculate a cost driver rate for each activity cost pool in the same way as an overhead rate is calculated in a traditional system.
Apply the activity cost driver rates to products (cost units) to arrive at an activity based product cost.

Integration

Activity Based Costing cannot run standalone and integrates with other solutions in the SYSPRO system. The other SYSPRO solutions to which it integrates include:

Bill of Materials

The BOM Cost Implosion program calculates the costs at all levels in the bill of material. Having established that the calculated costs are correct, the Transfer BOM Costs to Wh Costs program imports costs into the accounting system.

Inventory

Stock codes must be flagged as Activity Based Costing items. This ensures element structures can be setup against the stock code.

Purchase Orders

Purchase orders can be flagged as pre-production elements. Any overhead costs associated with processing a purchase order for an ABC stock item are recorded.

Sales Orders

Sales orders can be flagged as sales elements. Any overhead costs associated with processing a sales order for an ABC stock item are recorded.

Work in Progress

Jobs can be flagged as manufacturing elements. Any overhead costs associated with manufacturing an ABC stock item are recorded.

General Ledger

If you are running General Ledger Integration, a ledger code is defined for AB Costing variance.

Activity Based Costing Integration to other SYSPRO solutions

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