Implementing an activity-based costing model

Activity-based costing (ABC) is a forward-looking product costing method. Unlike traditional volume-based approaches, which are historically oriented, ABC concepts guide managers in seeking the best strategies to pursue in the future. This product costing method can be a valuable tool in planning and managing costs not only in the manufacturing area, but also in all aspects of business operations, from product design to distribution. Although its main advantage is its ability to provide more realistic product cost information for financial reporting purposes, use of ABC can lead to a better understanding of the strategic linkages existing between the various cost areas in the organisation. It enables managers to have a holistic view of cost management. ABC was developed to better understand, manage and control the overheads. The brief fundamental of ABC is: Products consume activities, activities consume resources, and resources consume costs. Based upon this fundamental principle, ABC can trace the cost from resources to activities that are consumed by product manufacturing processes as well as from activities to products. ABC investigates the transactions that trigger cost instead of concentrating solely on measures of physical volume or a certain amount of labour hours. Compared to the traditional costing systems, ABC can not only answer how much product cost is but also tell executives the factors triggering costs and the way to manage costs. ABC helps managers make better decisions about product design, pricing, marketing, and mix and encourages continual improvement. Unlike the traditional method, instead of using the single pre-determined overhead rate to absorb the indirect cost to products, ABC uses actual incurred cost to v determine the product cost. By tracing the absorption process of indirect cost, ABC would provide more information to management and help it find better ways to manage costs. However, the cost drivers used in ABC are constants but the cost driver rates are continually changing. ABC still uses predetermined cost drivers so it has the same fundamental problem as the traditional methods for estimating.