Activity Based Costing (ABC) is an accounting technique you can use to determine the actual cost associated with each order your sales representatives enter. In order to achieve your major business goals, you need to fully understand the cost, time, and quality of the activities your employees or machines perform. The more work a customer causes your sales representative to perform, the less money you make. For example, if a customer orders a product and then changes his mind, the time spent entering that product on the sales order is wasted.
Use the ABC system to designate specific, traceable activities that occur during the customer order cycle. As your employees process the orders, the system tracks each activity as it occurs and records it in a database. You can then use the inquiry and reporting features to review the activities associated with each customer's orders and compare the actual profit levels for each customer. Based on this information, you may want to assign customers to price classes that will keep your profit margins at acceptable levels.
Many activities are associated with entering, shipping, and invoicing an order. During a normal business day, your employees spend time performing these activities, which translates into an expense that can be measured. Examples of costed activities include:
Entering an order.
Making changes, such as quantity, shipping dates, or product, to an order.
Picking the line items on an order.
Scheduling an order.
Delivering and invoicing an order.
Handling cash receipts.
Your system is set up with a pre-defined set of activities, but you can add additional activities, as needed.
The system uses auto group codes—pre-defined triggers built into programs—to log most activities. However, users can also enter log entries, if needed. During system setup, each expense activity the system tracks is assigned to an auto group code. Each activity code you define must be assigned to an auto group code. You cannot define auto group codes, as they are hard coded into the package.
The system uses G/L pools to link activities to the G/L accounts where the associated expenses, such as employee salaries, paper, utilities, or delivery expenses, are posted. When you assign a G/L pool to an expense account, you can designate the percentage of the expense to apply to the pool. The system uses this information to assign costs to activities so that you can determine the cost of doing business with your customers.
After you determine the activities to track and the costs associated with each one, the system calculates the activity-based costs.
You can then use inquiries and reports to review activity and cost information in a summary or detail format and identify the activities that make doing business with a customer expensive. With accurate cost information, you can adjust the way you do business with that customer and improve your profitability.
You need to collect ABC data for a year in order for the ABC cost calculation program to produce accurate results. During that time, you use estimated costs for each activity.
To generate the data required for the ABC inquiries and reports, you need to set up the activity codes as follows:
Assign ABC G/L pools to activity codes to calculate the cost per activity for each activity code.
Assign ABC expense categories to activity codes to summarize information presented in the inquiries and report.
Assign ABC extensions to activity codes to associate multiple activities with the same auto group code.
Click here for a printable version of the Activity-Based Costing documentation.
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