What is activity-based costing?
Posted on Jan 04, 2022 at 12:01 PM
Reaching the goals requires doing the necessary activities and utilizing the resources that these activities need to achieve the desired goal, which means that the Organization can set an activity-based balance to predict the costs of achieving the goals.
Activity-based costing is defined as a system that researches, records, and analyses the activities of the organization and the resulting consumption of resources.
Advantages of activity-based costing:
The activity-based costing contributes to the planning of the various activities of the organization, thus bringing the balance into line with the organization's plans. To identify ways to integrate the balance with the organization's strategic plans, you can take integrating budgeting, forecasting and business planning training.
That is, activity-based costing is suitable for new projects that do not have a previous budget, and organizations that have fundamental changes such as change of workplace or change of product, as it does not take into account costs in the previous period.
The activity-based costing links cost and output, as it focuses on the added value provided by the activity. Thus, it is possible to identify which activities are the most profitable to allocate resources to the most appropriate and to focus on which activities are necessary for the functioning and implementation of the plans.
In which balancing is appropriate for the self-employed, as they usually know the value of their time. The activity-based costing allows for control of the organization's costs, especially fixed costs while avoiding excessive cost reductions, so that cost reductions do not lead to poor performance of obligations or a reduction in profitability.
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Activity-based costing flaws:
Activity-based budgeting is not the only way to predict the costs of the Organization, but it has proved to be distinguished by offering a variety of advantages to the Organization compared with the traditional method of costing.
However, activity-based costing is costlier in terms of time and resources than traditional budgeting, as the process of obtaining information requires time and effort.
In addition, the potential accuracy of the balance sheet may be weakened, as it may require reliance on management vision and assumptions. Therefore, activity-based costing is no longer appropriate because of its high cost to non-activity-driven, stable, and non-changing organizations.
Activity-based costing steps:
There are three basic steps for activity-based budgeting:
- Definition of cost causes for different activities:
Identifying activities, dividing them according to the relevance and priority of the activity to the organization, its contribution to achieving its objectives into major activities and secondary activities, since it is the core activities that are necessary to achieve the objective of the organization and cannot be discarded, while the secondary activities are activities that add value to clients and are often costly.
Once activities have been identified, it is important to identify the cost factors affecting the level of consumption of resources by the activity, such as wages of workers, which are classified into three classifications:
Repeat: It is important to take into account the number of repeats of activity, to calculate the average cost of the activity.
Duration: It's the time the activity takes.
Resources: the number of resources the activity needs at a time.
- Predict the number of units required in each cause of cost:
Once activities have been identified, and because of their cost, the resources that the activity may require in particular units are predicted to distribute resources between these activities. For example, manufacturing may require three workers, which means 240 hours per week.
- Cost-per-unit calculation in cost causing:
Activities are examined and the resources that each activity may consume are predicted to eliminate or minimize activities that do not provide greater cost-benefit and to find a way to increase the efficiency of activities.
The activity-based costing is revalued every time the activity or routine is changed or adjusted, and the activity-based balance may also be revalued annually, to better control financial changes, thereby reducing the cost to increase profits from sales.
Conclusion:
The fact that the budget is a financial reflection of the organization's strategic plan supports the achievement of strategic objectives, and the greater the linkage between the budget and the strategic plan, the easier the oversight of financial matters related to activities, the ability to examine and control their output and costs, and therefore the activity-based balance is distinct from the traditional budget.
However, on the other hand, activity-based budgeting is costlier than conventional budgeting, as it requires gathering information on different activities and analyzing them across three steps, initially by identifying activities and cost factors, then predicting the number of units in activities, and ultimately calculating the cost of the activity.
