Value-Added Activity Based Costing

Value-added Activity Based Costing and

Economic Value Added Measure

And Their Impact on Process Improvement & Business Profitability

Value-Added Activity Based Costing and

Economic Value Added Measure

And Their Impact on Process Improvement & Business Profitability

In today=s technologically advanced and global economic environment, Value-Added Activity Based Costing and Economic Value-Added Measure, afford businesses a more detailed, broader, and realistic view of their actual costs, as well as an in-depth knowledge of the use activity of their resources, resulting in valuable information managers need to make decisions that will improve the business operating processes and increase profitability.

The introduction and implementation of advanced Information Systems and Information Technology have significantly impacted and changed the way we live our lives today, and how business is conducted. In addition, it has given the business world the opportunities for a more global economic reach, which has resulted in greater competition. In order for businesses to be successful today, they must take advantage of the advanced technologies available, and design an infrastructure that fits their organization and provides them with competitive advantage in their field of business.

Businesses no longer have to settle for the short-term estimated business plans of traditional costing standards, but can achieve greater, more realistic, long-term benefits of an activity-based costing system (ABC), with increased business and customer profitability, as well as, quality control management. As stated by (Tarr, 2004, p1), AFinally, today, we have high tech, high speed data collection and reporting tools. With the proper system, gathering and manipulation of

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data in multiple complex ways is no longer an issue. With these tools at the disposal of a business organization, why still use a cost accounting system that was developed over 70 years ago?@ (Tarr, James D., 2004) ( p1)

A traditional standard cost system allocates costs to the product using an allocated base, such as direct-labor or machine hours. This is an inexpensive and simplistic cost system, however, its results can be inaccurate, leading to problems of undercosting and overcosting of products. Activity-based costing systems, on the other hand, improve on the traditional cost system by first assigning costs to activities, and then to goods and services, based on how much each good or service uses the activities, resulting in much more accurate and actual costs information, as well as, identifying areas where resources are being wasted. (Hilton, Maher & Selton, 2009) (pp 148 & 149)

The business environment and situation for which the traditional cost system was originally designed, is no longer in place today. AStandard cost accounting was designed for a company that had: 1) homogeneous products, 2) large direct costs compared to indirect costs, 3) limited ability to collect data and 4) low "below the line" costs. Today's company typically has 1) a wide variety and complexity of products and services, 2) high overhead costs compared to direct labor, 3) an overabundance of data and 4) substantial non product costs that can dramatically affect true product, distribution channel and customer profitability. The typical manufacturing company is

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still arbitrarily attaching overhead to products using Direct Labor as the driver. They are often allocating the largest cost (overhead) based on the smallest (direct labor). Because of product variety and product line complexity, one homogeneous overhead rate is no longer an appropriate average.@ (Tarr, 2004) (p 1)

Unlike the traditional cost system, AThe primary task of activity-based costing is to break out indirect activities into meaningful pools which can then be assigned to processes in a manner which better reflects the way costs are actually incurred. The system must recognize that resources are consumed by processes or products in different proportions for each activity.@ (Tarr, 2004)

(p 1)

An ABC system operates in four steps. The first step identifies and classifies activities related to products, which makes analyzing all the resources and activities needed to produce and support a company=s products and services easier, by recognizing that these resources and activities support different levels of the company. The second step estimates the costs of the activities identified in the first step. The third step calculates a cost-driver rate for the activity, which is estimated based on the cost of resource consumption per unit of cost driver (a characteristic of an activity or event that causes that activity or event to cause costs) for each activity. This cost-driver base is used to trace or assign costs to activities. The fourth step assigns activity costs to products, based on the cost-driver rate for a particular period and the actual cost volumes for that period. (Hilton, Maher & Selton, 2009) (pp 149 - 157) With the use of this costing method,

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organizations can make informed decisions based on how costs are accumulated, manage shared service cost allocations, streamline processes by identifying activities that don=t add value, learn how and why activities impact budgets, and increase quality control, which in turn, increases revenue growth and reduces costs across the organization.

Organizations that implement an activity-based costing system receive the full benefits when they also implement