Activity based costing – costs per unit

As we have already discussed, activity based costing lets you measure the expenses certain process generates. This in turn helps in assessing either any alternative is necessary in terms of materials, methods or entire procedure. It also helps in determining the sales price for end or byproduct.

Although you may have the expenses measured in total, say on maintenance we used before 10,000 EUR, it still needs to be split onto measurable units. Now this part is way trickier than collecting all related expenses together. In order to do this, you need to follow the next steps.

First off you need to decide on your products – either groups or separate unique ones. Defining them may become a huge challenge in case there are hundreds of variations like, depending on the product obviously, color, thickness, surface, extra add-ons etc. Eventually it all affects the end result as well. In case of many what would seem similar products and with no real cost difference, they can be easily grouped together. Having fewer products makes building up the model for ABC costing way easier.

Now that we have expenses collected, products decided, we move onto splitting the expenses. Before we can do it however, it may also be possible (making things easier in my opinion) to have sub products, which helps in splitting the expenses. If it is not possible, you can skip this part, however, the method of splitting stays the same nevertheless.

Generally speaking expenses for certain period are simply divided onto units produced in this very same period. Depending on the size and consumption, some steps of the production process may give different contribution to the cost price of the product (i.e. a bigger chair with leather surface instead of cloth surface may require more attention hence is more expensive). Having sub products may help in determining the price better in some phases as the material inflow to the process has a determined price already.

Building up the ABC model is lots of work, however once done, is a real tool to make the production more effective, decide on the better selling price etc.

2 thoughts on “Activity based costing – costs per unit

  1. Bill Clark

    The difficulty and amount of work required for building up any ABC model is directly dependent upon its intended use. The cost accounting model you build should address a need or solve for a distinct problem. What you build and, more importantly, the complexity of your design must be directly linked with the level and intricacy of your management information needs.

    Any successful ABC implementation starts with the end in mind. What is your organization trying to achieve? How does it hope to get there (profitably!)? Are you looking to outsource an activity? How should you prioritize products to better maximize profits? What’s the nature of your business; are you a limited product manufacturing firm or a multi-faceted entity with many products? Which customers are profitable? How can you re-price for those who aren’t? All these questions should be a starting point when considering activity-based costing and building your model. And to get the right answers, sr. management must be engaged and committed to act on the results.

    An effective ABC tool addresses these questions. Model complexity is aligned with current and ongoing needs for cost accounting information. Even within activity-based costing, there are several build options. If you’re looking at a one-off, one-time calculation of cost for an outsourcing decision, then a rapid proto-type, perhaps even in MS Excel, may be your best approach. If you’re a small manufacturing firm with a limited number of products, you don’t need an ABC tool; you already know your all-in product costs. If your organization is transaction oriented, with very clear and established procedures, then a time-driven ABC (TDABC) tool may be the right solution. Should both product and customer costs be an issue, then a multi-faceted, multi-tiered tool that answers both is optimal.

    Your options and choices are limitless. How you proceed must begin with your strategy.

  2. Karl Post author

    Thank you for your comment, that’s indeed a really good thought.

    Everything you do in accounting, especially the complexity and detail you use, is dependant on the defined need. With ABC you can get an input for pricing your products, segmenting your clients or building a more efficient production. Answering the question of “Why do we want the ABC tool?” is the starting point afterwhich comes the source of information available, building the structure etc. At the end of the day the time (and money) invested should be for a purpose of helping your business.

    Thank you again.

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