Activity based costing

1. Activity based costing • Activity based costing – ABC • Created as an answer to criticism of traditional costing(1987 - Cooper R., Kaplan R. S., How Cost Accounting Systematically Distorts Product Costs) • Disadvantages of traditional costing • An assignment of product costs based on the size of production (unit-based cost system, volume-based cost system) • Calculation is more exact when more costs can be accounted for directly • Typical costs drivers include quantities connected to production size • A grouping of costs according to functions based on organizational structure of the enterprise • General productions costs are settled proportionally to the sum of direct costs and department costs

2. Enterprise Market ing/Sales Develop ment Person el Production Order Fulfillment Product Development Customer Service Marketing Sales Person el Production Develop ment Activity based approach of the enterprise Disadvantages of traditional costing: • Lack of customer-orientation • Rigid organizational structure, hierarchy • Non-continuous flows • Excessive supervision and coordination systems • Too much documentation • More possibilities to make mistakes • Higher costs

3. Process flows in the organizational structure • An employee completes his/her part of the process. Who controls the whole process?

4. Department centered thinking... Multi-level hierarchy… Too-detailed division of labour… Excessive asset-orientation… ....thinking about the whole system, beyond departments ....flat organizational structures ....increased scope of activities and responsibilities ....result-oriented From functions to activities Activity-based costing Functional-based costing

5. Market Information purchase sale transport invoice Key word: process (1) • „A process is a collection of activities demanded at an input entry phase and producing a valuable to the client result at the end ” /M. Hammer, J. Champy/ • „A process describes the flow and transformation of materials, information, operations and decisions” /T. H. Davenport/ • A business process is a flow of sequenced activities, having a beginning and an end, and precisely and clearly defined input and output, leading to a particular effect that has a value to the client

6. Dane materiałowe Dane dostawców Zrealizowano Przygotować Zrealizowano zamówienie transport dostawę Realizować zamówienie Przekazano do produkcji KLIENT PRZEDSIĘBIORSTWO DOSTAWCA Produkt Zapotrzebo- wytworzyć wanie wystąpiło Przygotować zlecenie Zaopatrzenie Produkt Zlecenie wytworzony gotowe Dokumentacja techniczna Dane produktu Dane klienta Zaopatrzenie Opracować Odlewnia Zlecenie Produkt zlecenie przyjęto przesłać Przedsta- wiciel handlowy Opracowanie zlecenia Wytwarzanie Dane klienta Dane produktu Zbyt Towar Towar Towar przyjęty przyjąć nadesłano Zbyt LEGENDA Jednostkiorganizacyjne Zasoby Funkcje Dane Key word: process (2)

7. Level of the mail processes: Inventory /Stock / Supply Level of the partial processes: Purchase of raw materials Level of activities: Transport receipt Purchase order Choice of supplier Invoice payment Poziom czynności: • Analysis of the supplier market • Questions to offerers • Analysis of the offers • Negotiating conditions • Agree on the schedule and conditions of freight • Signing an agreement • Order confirmation • Order delivery • Quality inspection of deliveries • Storeroom documentation prepared • Invoice control/ inspection • Documentation of operations • Settlement of payables Process levels

8. Changing concepts in organisations • BPR – Business Process Reengineering (1900s) • „Business Process Reengineering is a fundamental rethinking and radical reengineering of processes in an enterprise, leading in a dramatic way to breakthrough improvements according to modern, critical measures such as cost, quality, service, and speed ” /M. Hammer, J. Champy, 1993/ • BPO - Business Process Orientation (currently) • a concept of changes leading to systemic organization, analysis, and assessment of economic processes in order to obtain improvements in measures of these processes such as time, cost and quality • BPM - Business Process Management (currently) • a systemic approach to analysis and continuous improvement of activities in an enterprise. The important elements of a concept are: actual documentation of processes, organizational structure process-oriented, processes' aims and measures, information systems about processes, motivation system”

9. Process- approach in management • Processes are starting point for: • Internal changes in an organization • Defining the value chain inside the organization • Defining the value chain among organizations • Implementing IMS • Obtaining ISO 9000:2000 certificate • E- business • Use of activity based costing(ABC) • Activity based management • Implementation of Customer Relationship Management and Knowledge Management concepts

10. Amortization Materials Energy Foreign services Social insurance Employee benefits Taxes, charges and fees Labour Costs incurred Materials Employees Equipment Space Resources required Activity 1 Activity 2 Activity 3 ... Activity N Need to do activities Product A Product B Product C Product D ... Product Z Activity based costing - process approach

11. ABC's definition • Activity Based Costing – ABC • A method of measuring costs and an effectiveness of activities, resources, products, and clients as well as other cost objects, consisting of relating resources to activities and activities to other cost objects based on the degree of use of an activity and also understanding of the casual relations among cost-raising variables and activities /Cooper R., Kaplan R. S./ • Resources of an enterprise are used by activities (processes), not by products or organizational units • The main part of general and overhead costs does not depend on the product volume, but rather changes with the intensity of conducted activities

12. Amortization Materials Energy Foreign services Social insurance Employee benefits Taxes, charges and fees Labour Assigning simple costs to compound costs Materials Employees Equipment Space Resource cost drivers Activity 1 Activity 2 Activity 3 ... Activity N Activity cost drivers Product A Product B Product C Product D ... Product Z Model calculation in ABC

13. Concept of resources in ABC

14. Concept of cost driver • Cost driver • The main cost-creating variable used as a settlement driver (a key) of cost object on other objects • Shows an origin of the costs • Resource cost driver • A variable measuring the usage of a resource in an activity • Activity cost driver • Describes the main origin of the costs in an activity • Presents a casual relation between activities and other objects • Main types of activity cost drivers: • Time • Transaction • Intensity

15. Examples of activity cost drivers

16. Accounting Delivery Prepare an offer Check the invoice Make payment Order materials Main process Cost per driver Part of the process Part of the process Part of the process Part of the process Number of lines Number of In the invoice invoices Activity cost driver Number Number of offers of orders CostperCost line in the invoiceper invoice Rate of the process costs Cost Cost per offer per order Calculating costs under ABC • Phases of calculating costs under ABC: • Where do costs originate - an analysis of activities and variables • Defining the costs of activities based on resource costs • Choice of the cost driver and calculation of cost per cost driver unit • Assigning activity costs to products