Implementing Activity Based Costing
All of us have used cost allocation, the process of assigning common costs to ending inventory and cost of goods sold (COGS), as part of our Financial Services offerings since it is required by GAAP. Our goal has been to either reduce taxes or increase reported earnings, depending on our client's needs and circumstances.
But what about cost allocation's other uses? Are we shortchanging our clients by not offering services in this area (usually referred to as cost or management accounting services)?
Managers’ use cost allocation for a number of reasons. First and foremost, cost allocation provides a methodology for assigning overhead costs of various activities, usually support departments, to products or services being produced and/or sold allowing upper management to assess and analyze their profitability. By knowing what the true "cause-and-effect" relationship is, managers are able to more accurately assess the true cost of a product or service and determine if carrying certain products and/or services contributes to overall profitability given the demand for and price these products/services sell for. This is especially important as it pertains to both operational decisions (such as calculating the maximum price a firm can charge, especially for a "commodity" product, determining the maximum cost a firm is willing to pay to provide this product or service, and in making special order and transfer pricing decisions) and capital/long-term decisions (such as make-or-buy component decisions, continue or discontinue a product line decisions, process further decisions, etc,).
Cost allocation can also be used to reduce wasteful spending and/or promote more efficient use of resources (especially PP&E) by evaluating needs and uses for the year to come as part of the planning/budgeting process. Managers can then be evaluated on their planning effectiveness, leading to better communication, sharing of resources, and cost efficiency. It can also used to manage product and process design. As allocations are broken down/determined, the use of resources becomes transparent from a process standpoint, allowing managers to improve operations as needed....
More at WikiCFO.com
But what about cost allocation's other uses? Are we shortchanging our clients by not offering services in this area (usually referred to as cost or management accounting services)?
Managers’ use cost allocation for a number of reasons. First and foremost, cost allocation provides a methodology for assigning overhead costs of various activities, usually support departments, to products or services being produced and/or sold allowing upper management to assess and analyze their profitability. By knowing what the true "cause-and-effect" relationship is, managers are able to more accurately assess the true cost of a product or service and determine if carrying certain products and/or services contributes to overall profitability given the demand for and price these products/services sell for. This is especially important as it pertains to both operational decisions (such as calculating the maximum price a firm can charge, especially for a "commodity" product, determining the maximum cost a firm is willing to pay to provide this product or service, and in making special order and transfer pricing decisions) and capital/long-term decisions (such as make-or-buy component decisions, continue or discontinue a product line decisions, process further decisions, etc,).
Cost allocation can also be used to reduce wasteful spending and/or promote more efficient use of resources (especially PP&E) by evaluating needs and uses for the year to come as part of the planning/budgeting process. Managers can then be evaluated on their planning effectiveness, leading to better communication, sharing of resources, and cost efficiency. It can also used to manage product and process design. As allocations are broken down/determined, the use of resources becomes transparent from a process standpoint, allowing managers to improve operations as needed....
More at WikiCFO.com
Labels: abc costing, activity based costing, managerial accounting, product costing
1 Comments:
I really agree on the need for clearer insights into an organization's cost structure. Valuable analytical insights derived from it can lead to competitive advantage and translate into profit and market share increases.
One thing I'd like to caution on is that costs are typically the measure of an outcome. When it comes to operations, and even management of support departments, performance should be measured at the process level with operational metrics that can be directly influenced by the people in charge.
This way we know we are managing the process with a lower likelyhood of merely gaming costs while potentially sub-optimizing processes.
...Just my 2 cents...
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