Designing and Implementing Activity Based Costing (ABC) System

Designing and Implementing Activity Based Costing (ABC) System:

Experts agree on several essential characteristics of any successful implementation of activity based costing system.

First, the initiative to implement activity based costing must be strongly supported by top management. Second, the design and implementation of activity based costing system should be the responsibility of a cross functional team rather than of the accounting department. The team should include representatives from each area that will use the data provided by the activity based costing system. Ordinarily, this would include representatives from marketing, production, engineering and top management as well as technically trained accounting staff. An out side consultant who specializes in activity based costing system serve as an advisor to the team.

The reason for insisting on strong top management support and a multifunction team approach is rooted in the fact that implementing activity based costing system is difficult in organizations unless those changes have the full support of those who are affected. Activity based costing changes ” the rules of the game” since it changes some of the key measures that managers use for their decision making and for evaluating individuals’ performance. Unless the managers who are directly affected by the changes in the rules have a say, resistance will be inevitable. In addition, designing a good activity based costing system requires intimate knowledge of many parts of the organization’s overall operations. This knowledge can only come from the people who are familiar with those operations.

Implementation of activity based costing system must be initiated by top management due to two reasons. First, without leadership from top management, some managers may not see any reason to change. Second, if top managers do not support the ABC system and continue to play the game by the old rules, their subordinates will quickly get the message that ABC is not important and they will abandon the ABC initiative. Time after time, when accountants have attempted to implement an ABC system on their own with top-management support and active cooperation from other managers, the results have been ignored.

For designing and implementing activity based costing system, management should carefully study the existing cost accounting system and review the articles in professionals and trade journals. In most of the organizations, the new activity based costing system supplement, rather than replace, the existing cost accounting system, which continues to be used for external financial reports.

The following chart explains the general structure of activity based (ABC) costing model.

The Activity Based Costing Model

Cost Objects
(e.g., products and customers)
¯
Activities
¯
Consumption of Resources
¯
Cost

Usually, company’s traditional cost accounting system adequately measures the direct material and direct labor costs of products since these costs are directly traced to products. In most of the organizations activity based costing study is usually concerned solely with the other costs of the company – manufacturing overhead and selling, general, and administrative costs.

The activity based costing implementation team should carefully plan about implementing activity based costing. Implementation process may be broken down into the following six basic steps.

You may also be interested in other relevant articles from “activity based costing system” chapter:

  1. Definition and Explanation of Activity Based Costing System
  2. Treatment of Manufacturing, Non-manufacturing and Idle Capacity Costs Under Activity Based Costing System
  3. Activity Based Costing And Top Management
  4. Activity Based Costing System and External Reports
  5. Designing and Implementing Activity Based Costing System
  6. Targeting Process Improvements (Activity Based Costing + Activity Based Management)
  7. Advantages or Benefits | Disadvantages or Limitations of Activity Based Costing System
  8. Activity Based Costing Example

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