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4.5. The Steps to Implement ABC

Even a cursory review of the concepts of ABC will help you appreciate that several steps must be taken for a successful implementation:

1. STUDY PROCESSES AND COSTS - It is said that ABC is process oriented. Therefore, the first step in implementing ABC is a detailed study of all business processes and costs. This extensive study will usually involve employees from throughout the organization. Employee involvement is crucial to get the system dialed in correctly, and so that there will be acceptance of the measures produced by the system. Employees at all levels need to believe the results of the accounting system before they will truly rely on the results.

2. IDENTIFY ACTIVITIES - Once a business is understood, care should be used in selecting the business activities that will be central to the cost allocations. Too many activities and the system will become unmanageable; too few and the information will not be meaningful. It is helpful to think of activities at different levels:

o Unit-level activities are those activities that have a one-to-one correspondence with a unit of output. For example, a telescope manufacturer may have to perform some final calibration activity to each finished product (whether it be an entry level scope or an advanced device). Thus, calibration may be seen as an activity.

o Batch-level activities are those activities that must be performed, but can relate to one or more units of output. In some cases, shipping can be seen as an excellent example of a batch process. Assume that Nile is an online bookstore. Some customers order only one book while others may order a dozen books at a time. In each case the customer's books must be packaged and shipped. Roughly the same activity is required independent of how many books are put in a box.

o Product-level activities are carried out at the product level, no matter the volume of production. Product design, product marketing, and so forth are typically cited as activities that have a one-to-one correspondence with the number of end products.

o Customer-level activities can take many forms. These include technical support help lines, catalogs, sales calls, and so on. You would generally expect this category to grow as the customer base expands.

Other activity levels might be appropriate. Some businesses will identify market level activities. For example, most global companies' contract with an independent customs broker within each market served. Thus, the cost of customs brokerage services can be seen as a function of markets served. There is also entity sustaining activities. A public company in the USA must incur substantial costs to comply with the Sarbanes-Oxley legislation; this may cause the company to identify Sarbanes-Oxley compliance as a separate activity.

The identification of activities is unique to each company. The above "levels" provide a frame of reference that is helpful in considering the important activities of an organization. Consultants who specialize in ABC can also be very helpful in coaching a company as it searches for its important activities that will become central to an ABC system. As a general rule, these consultants advise to (1) develop a list of every conceivable activity, (2) segregate the activities according to level, and (3) look for logical ways to combine similar activities within each level (but not across levels as this will undermine the basis on which activity cost will eventually be allocated to cost objects).

3. IDENTIFY TRACEABLE COSTS - Whenever a cost is solely related to a specific cost object, that cost should be traced directly to the end object. The most obvious example of this is the direct material and direct labor that goes into an end product. But, there are other examples. The preparation of a product catalog can consume many hours of indirect labor and other internal resources that would be attributable to a related activity cost pool, but it may also involve an outside printer/ postage and that cost can be traced right to the "customer" cost object.

4. ASSIGN REMAINING COSTS TO ACTIVITIES - After sorting out the costs that can be traced to cost objects, the remaining costs are assigned to activities. Sometimes this is easy and logical, and it is sometimes challenging. As examples, there may be a separate industrial engineering group that does nothing but machine set up prior to a production run. The cost of this group is easily assigned to the machine set-up activity, which in turn will be reallocated to a variety of end products. However, it may be that the industrial engineers are messy and the janitorial group must always do a major cleanup after each machine set up. Perhaps 10% of the janitorial staff's time should be assigned to machine set up and the other 90% to general maintenance. You can see how quickly ABC can get complex!

There is also the problem of trying to put a "square peg in a round hole." Some resources are consumed and no one can agree as to the activity that consumed the resource. Someone perhaps decided that the entry gate to the factory should be nicely landscaped with seasonal flowers. What activity will absorb this cost, and more importantly, to what cost object shall this cost ultimately be attributed? If a product manager gets a bonus based on profitability for her unit, you can be sure she does not want her products to absorb any of the floral costs - no matter how much she enjoys looking at the flowers! And, the marketing manager for a region half way around the globe surely does not want his market to bear the cost - he and his customers have probably never seen the factory. Suffice it to say that the cost allocation decisions can be contentious, and some costs may never find a logical home. Therefore, ABC may leave some costs as unallocated.

Unallocated does not mean to "ignore". While it may be perfectly logical to leave some costs as unallocated for purposes of identifying the cost of a specific product or other cost object, it would be foolhardy to forget about those costs in overall management of the organization. After all, they must be recovered. To survive, prices need to be high enough to recover the allocated and unallocated costs!

5. DETERMINE PER-ACTIVITY ALLOCATION RATES - Once the costs for each activity

have been determined in the aggregate, it is then necessary to unitize the cost pool. For example, if the catalog preparation activity cost pool contained $500,000 and 200,000 catalogs were produced, then the allocated catalog cost would be $2.50 each.

6. APPLY COSTS TO OBJECTS - The final step is to utilize the activity-based rates in determining the amount of activity cost to allocate to each cost object. Continuing with the catalog illustration, we know that the allocated cost from the catalog preparation pool was $2.50 each. Of course, this is not the total cost, this is just the allocated amount. The total cost would also include the directly traceable amounts (printing, postage, etc.). This catalog cost, along with other customer-related costs would be compiled in some form of summary report. Managers would then have a measure of how much it costs to support one additional customer. Similarly, measures would be produced for each additional cost object.

The necessary steps to develop an ABC system are summarized as follows:

The necessary steps to develop an ABC system are summarized as follows:

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