Activity-Based Costing Methodology and Implementation

Activity-Based Costing (ABC)

Indirect cost allocation distinguishes between the following systems:

• Based on sections (full cost, charge, or cost-wise variable)
• Based on activities (ABC)

ABC claims that indirect costs are allocated more accurately and consistently with the current characteristics of companies. It posits that it is not the products that consume resources; instead, activities consume resources, making them the primary cause of costs. ABC identifies the cause of resource consumption (activities) to then determine the activities consumed by products.

The Methodological Basis of the ABC Model

The development of the ABC model involves two successive calculation processes:

1. The allocation of costs to the activities that caused them; that is, those that utilized production factors (costs are considered consumed by the activities).
2. Costs previously grouped into activities are then applied to the relevant product through the use of cost generators (cost drivers).

The development of these two phases is calculated using a previous classification of direct and indirect costs, so that activities receive only indirect costs.

Defining Activities and Processes

Activity: A set of actions or tasks aimed at obtaining an output (product or service), consuming a number of factors or inputs to do so. This consumption will depend on how well the tasks are designed and their frequency. Examples include: placing an order, receiving goods, quality control of incoming materials, storage, etc.

Process: A set of interdependent activities with a common purpose (purchases, sales, finance, personnel, planning, etc.).

Attributes for Identifying Activities

• The tasks that comprise them, performed by any person or equipment, are readily apparent.
• They require specific know-how.
• There is uniformity in the behavior of costs and performance measures.
• The aim is to obtain an output.
• They are carried out to meet the requirements of a customer (internal or external).

Implementation Requirements for ABC

ABC begins by identifying activities based on the above attributes, but also considers the following:

• It is necessary to measure the level of activity (the level of output obtained by the activity), which requires defining the unit of activity.
• It is desirable to have a detailed description of the inputs consumed in the activity (type, source activity, unit of measurement, customary or sporadic, etc.).
• Whenever possible, you should set the measure of potential activity.
• We must establish a set of indicators or benchmarks to analyze and assess how the activity is performed (in terms of cost, deadline for compliance, quality, etc.).
• It is necessary to understand the induction of activity (the cause, which also acts as the cost generator) to manage and rationalize costs.