The Activity-Based Costing (ABC) is a costing technique which identifies activities in a business and allocates the cost of every single activity with resource to all products and services based on the amount consumed by each. ABC is a costing model that assigns more indirect costs i.e. overheads such as heating, lighting, and marketing into direct costs compared to the traditional costing (The economist, 2009). ABC has made companies to attain great returns where there is stiff competition and increased product diversification, for example Ford and GM in the automotive industry.
The most prominent signs that ABC methodologies might be appropriately applied to a product costing for an automobile manufacturing company include need for accuracy in production costing and when significant quantities of indirect costs are being allocated using only one or two cost pools. Also, when the operations staff have significant disagreements with accounting staff about manufacturing and marketing costs of products and services.
Broad averaging refers to a costing approach which uses broad averages for assigning the cost of resources uniformly to cost objects when the individual product or services use those resources non-uniformly. Managers should be concerned about broad averaging of product costs because it can lead to incorrect and misleading cost data by ignoring variations in consumption of resources by different cost objects. Inaccurate and misleading cost data can have a negative impact on the marketing and operating decisions made according to the wrong information.
Based on Kwon and Zmud's six implementation stage, initiation is the first step to implement ABC within the company. During this stage, pressure to changes develops from the internal requirements or outside competitive threats, and a quest for solution begins. Adoption, which involves the choice of a suggested solution and the decision to put in resources to facilitate change is the second step. After adoption, adaptation follows. Unforeseen needs or shortcomings of the system are identified in the process of changing, hence need to adapt. Acceptance, the fourth step, reflects the least level of utilization and upkeep that the new technology needs to be sustained. Routinization, where the methodology becomes part of the normal lives or the routine is the fifth step, and lastly infusion which enhances the effectiveness of the technique (Anderson, 1995).
The four classifications of the ABC cost hierarchy are output unit-level costs, batch-level costs, product/ service-sustaining costs, and facility sustaining costs (Kuchta, & Troska, 2007). The output unit-level costs are expenses of activities performed on each individual unit of product or service, for example depreciation and maintenance costs of specific machines. The batch-level costs are costs of activities related to a group of units of a product or service such as setup costs. The product or service-sustaining costs are for activities undertaken to support individual products or services regardless of the quantity of units or batches in which the units are produced. For instance the cost for designing processes. Lastly, the facility-sustaining costs include expenses that managers cannot trace to individual products or services but which support the whole organization, such as plant rent and insurance.
A significant challenge in the implementation of ABC within the company is lack of senior management commitment. Ramsey (2005) lists lack of senior management commitment as one of the issues that affect implementation of ABC. Commitment of senior management in implementation of ABC is necessary because they will provide the needed resources to successfully execute ABC.
A significant opportunity in the implementation of ABC within a company is updated technology. This is because latest technology simplifies the complexities in ABC methodology, making it more effective.