Activity Based Costing

Activity based costing (ABC) is a methodology by which all indirect costs are allocated to finished goods and services based on their utilization of a particular activity. Contrast this with a traditional costing system that allocates only some indirect costs by a simplistic method such as direct labor hours. The underlying theory is that activities drive costs and demands upon those activities warrant allocation of costs.

BENEFITS OF ACTIVITY BASED COSTING

Compared with traditional costing methods, ABC will provide your organization with a much clearer understanding of the costs incurred to bring your products and services to market.

THE PROCESS COSTING PROCESS

Gather departmental overhead and operating expenses for the period
Outline the activities that take place within the company as inputs are converted to outputs
Determine an appropriate metric that will serve as the basis for allocating costs
Break the departmental expenses down by percentage of effort spent on each activity
Total the company-wide costs for each activity and divide that by the company-wide totals for the corresponding metric
Compute the direct costs (materials and labor) for the item to be analyzed
Ascertain this same item's utilization of each activity based on the employment of the corresponding metric
Sum the total dollar sales amount for this item and compare to the costs incurred.
If the results are deemed unsatisfactory determine where unnecessary activities and costs can be reduced

FURTHER READING

These links elaborate on the topic at hand. They serve as a good starting point for those companies that would like to learn more or would like to address these topics “in house.” For those firms that prefer to continue to focus on their current responsibilities and would value the objective viewpoint of a professional from outside of the organization, click here.

Monte Carlo Simulation – Introduction
Excerpt: “Whenever you need to make an estimate, forecast or decision where there is significant uncertainty, you'd be well advised to consider Monte Carlo simulation -- if you don't, your estimates or forecasts could be way off the mark, with adverse consequences for your decisions! “

http://www.riskamp.com/files/RiskAMP%20-%20Monte%20Carlo%20Simulation.pdf
Excerpt: “This demonstrates the risk in the model. Based on this information, we might make different choices when planning the project. In construction, for example, this information might have an impact on our financing, insurance, permits, and hiring needs.“

ImperoCo Business Solutions - "Developing Organizational Success."