ABC Costing

Activity Based Costing is costing based on activity. It is a costing methodology that identifies activities in an organization and assigns the cost of each activity with resources to all products and services according to the actual consumption by each. This model assigns more indirect costs (overhead) into direct costs compared to conventional costing.

Logistics activities are oriented to create value to all the entities involved in process by supplying right quantity of material, at the right time, on the right place in right price. To realize the required level of customer service at the lowest total cost, it is fundamental to analyse the logistics activities presents in the company and the cost that these activities generate. Many logistics operations require cooperation among companies. The costs that the companies pay depends on the decisions that they take about the realization methods of their logistics activities. The cost recording and analysis system has to help the companies to identify the best collaboration methods, to correctly define economic advantage.

To reduce logistics costs and provide the level of customer service demanded, it is important to know the resources used in every activity through an efficient logistics cost analysis system. ABC introduction to Logistics can be subdivided in below operating phases:

  1. Identifying and classifying main logistics processes
  2. Breaking the processes down into activities
  3. Identifying the resources consumed in performing each activities
  4. Determining the costs of the activities through resource drivers
  5. Assigning the costs to the costs objects through activity driver and assigning the total cost

A firm may have more or fewer processes depending on the nature of the business and the level of outsourcing implemented. To correctly analyze the logistics cost, it is necessary to break down the processes down into activities, creating a map of the logistics activities for the company. An analysis of the resources consumed in each activity will identify inefficiencies caused by poor
logistics activities planning that generate an excessive consumption of the resources. Different kinds of resources are consumed according to the logistics activities presents in the company and the way in which they are used. To define for each activity the utilization of resources, ABC uses the concept of resource driver. For a specific activity the resource driver is simply a factor that
causes or influences costs. The activity focuses on the most important processes and sub processes carried out in the company involving several business functions.

Once the resources for the activities have been imputed, it is necessary to identify the factors that generate the demand for that activity from each cost object. The activity drivers measure the frequency and intensity of activity arising from each cost object. Through ABC for each activity, it is possible to identify at least one activity driver. Some costs may have numerous drivers, but only the most
relevant should be used. The selection of cost driver is an important phase because it influences the level of accuracy of the final object cost assessment. The most relevant drivers can often be determined by questioning those employees who are most familiar with the activity to indicate which factor causes an increase or decrease in the time and effort they spend on the activity. The cost drivers should have direct relationship with the amount of effort required by the activity. A cost driver is usually expressed on a cost per unit basis. To assess the total cost of an activity for an individual cost object, the ABC multiplies the usage amount of a cost driver in performing that activity by the unit cost of the driver.

Allocating resources directly to activities and specific cost objects that utilize those activities are the most important phases of the ABC system. Through the identification of the costs sustained for each operation, connected to specific cost objects, it is possible to value the cost differential between customers, products, market segments or distribution channels. The ability to trace the costs to specific cost objects has immeasurable benefits in corporate decision-making roles. Nevertheless the information related to costs sustained in each business activity might not be sufficient. To face up to important management decisions, it could be necessary to determine the
costs sustained from all of the companies in the supply chain to fully understand the logistics activities and the variations that these costs undergone in relation to changes in the collaboration relationship

Benefits

  1. ABC addresses to solve the problems concerning the use of traditional cost accounting system based on volume and the improvement of business profitability.
  2. The activity cost analysis provides managers with useful information about labor and other resources, including consumption for products, consumers and supplying channels, leading to the management and control of the overheads present in the company.
  3. Through the analysis of factors that determine the overhead consumed it is possible to make the logistics activities more efficient by eliminating redundant or unnecessary tasks, and optimizing resource allocations to activities adding more value to the product or customer.
  4. ABC permits the planning of more efficient collaborative relationships among the companies in the supply chain.
  5. The identification of costs reciprocally influenced allows for a choice of collaborations as a method which is more convenient for the whole partnership.
  6. Correct information about the differential costs arising from possible alteration of the collaboration relationships help companies to make those appropriate strategic decisions with their logistics activities. This in turn helps them realize, with other companies, how best to modify the object of the cooperation in order to make the whole supply chain more competitive.

Drawbacks

  1. Implications of the application of ABC to logistics activities are not always positive.
  2. Typical drawbacks include, the lack of perfect cost data; the reluctance of companies to communicate their data; and the loss of attention on the customers.
  3. It has long since been understood that no one cost analysis system could be considered perfect.
  4. ABC does not always allow allocation to every activity or every cost concerning the resources employed. To identify and measure some logistics activities requires a lot of time and work.
  5. Even if ABC helps to analyse the resources consumed and to highlight the real cost connected at every logistic activity, the managers have to know that, sometimes, the correct and complete information is not available, especially when in the process of
    making important strategic management decisions.
  6. ABC provides important information about the costs incurred by the companies in the realization of their logistics activities.
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