Steps in the implementation of ABC

In ABC the hidden weaknesses and high cost segments are identified for maximum effectiveness of cost accounting system. The process of designing and implementing an ABC system for support, departments usually by way of interviewing the concerned departmental heads to have an insight into the departmental operations and into the factors that trigger departmental activities. Subsequent analysis traces these activities to specific products. Suppose the inventory control department is responsible for raw materials and purchased components.

The relevant questions that could be asked are:

1. How many people work in the department?
2. What do they do? What determines the time required to process an incoming shipment?
3. Does it matter if the shipment is large or small?
4. What other factors affect your department’s workload?
5. Do you usually disburse the total amount of material required for a production run all at once or does it go out in smaller quantities?

After the interview the system designer can use the number of people involved in each activity to allocate the departments costs. ABC calls for high level costing policy, cost technology and modules for activities effectiveness in a competitive economy for survival and prosperity.

Since allocation of indirect costs to various products or departments on a reasonable basis is a complicated job, activity based costing technique helps a cost accountant to find out product cost to a greater accuracy.

Following steps are involved in implementing ABC to achieve the desired results:

1. Identifying the functional areas (like material management, production, quality control etc.) involved.
2. Identifying the key activities involved in each functional area.
3. Allocating the common indirect costs to various activities in each functional area.
4. Identifying the most suitable cost driver in each activity under functional areas for better allocation of indirect costs to get accurate cost information. A cost driver is any factor that influences cost. A change in the cost driver will lead to a change in the total cost of a related cost object.
5. Preparing the statement of expenditure activity wise and comparing it with the value addition activity wise to know the activities which are to be eliminated or need improvement for better performance of the organisation.

Functional areas may be as follows:

(a) Material Management

(b) Stores Management

(c) Production Management

(d) Quality Control Management

(e) Personnel Management

(f) Sales Management

(g) Repairs & Maintenance

(h) Administration

(i) Public Relations