Activity Based Costing is a technique for accumulating cost for a given cost object (i.e., product, service, or customer) that represents the total and true economic resources required or consumed by the object. Activity Based Costing occurs in two phases. First, cost data is reorganized into activity cost pools. In other words, costs of significant activities are determined. This first phase is sometimes referred to as activity based process costing. Then, the amounts in the cost pools are assigned to products, services or other cost objects. The second phase is referred to as activity based object costing.
The goal of ABC is to model the causal relationships among resources, activities, and entities in assigning overhead costs. "The fundamental belief behind this costing approach is that cost is caused and causes of cost can be managed. The closer you can come to relating the costs to their causes, the more helpful your accounting information will be in guiding the management decisions of your business," states the Ernst & Young Guide to Total Cost Management (Ernst & Young, 1992).
Enterprises use resources to conduct activities. Resources perform activities to benefit products and services. The key to understanding cost dynamics in any enterprise is modeling the relationship between activities and their causes; and the relationship between activities and costs. If cost dynamics are not modeled (which is usually the case with traditional management accounting information systems), the performance information provided is incomplete or misleading.
The architecture of SIMPROCESS provides an integrating framework for ABC. The building blocks of SIMPROCESS (processes/activities, resources, and entities) bridge ABC and dynamic process analysis. ABC embodies the concept that a business is a series of inter-related processes, and that these processes consist of activities that convert inputs to outputs. The modeling approach in SIMPROCESS manifests this concept, builds on it by organizing and analyzing cost information on an activity basis.
One of the major challenges in successful implementation of ABC is finding the appropriate level of detail for the business process analysis. The organization of business processes is critical to reorganizing the cost data into activity pools. The hierarchical modeling approach of SIMPROCESS facilitates this organization and accommodates varying levels of detail for ABC analysis.
Another significant value of the ABC analysis in SIMPROCESS comes from the dynamic analysis of costs based on the event-driven simulation. Because SIMPROCESS keeps track of resource interdependencies and captures the random nature of processes, the cost statistics provided by SIMPROCESS are far more accurate than results obtained from static analysis.
Go to Cost Calculations.