From the course: Activity-Based Costing
Understanding the ABC process
- In my years consulting I've heard many people say that they're confused by the ABC process, but the truth is with just a little preparation it's dead easy. Remember ABC is a cost accounting process that builds upon traditional accounting methods but does not replace it. So the foundations needed for ABC, that is system data, almost certainly already exist in your organization. I've seen ABC attempted to be explained in some very complex design maps, and once even a 10-stage process. But I'm going to make things really simple for you. ABC is performed by identifying overhead cost pools, then the outputs of your business, and finally, linking the two together using something called cost drivers. Now, let's take the time to understand these three steps a little further. To effectively produce an ABC, we firstly perform what's called a cost pool analysis. This is sometimes also called a resource or activity pool analysis. It is where we source and analyze the business's overhead groups. By this we mean what functions and activities are needed to support the delivery of the organization's products and services? We then conduct what's called a cost object analysis. It's sometimes been referred to as value streams. This is essentially the outputs of the business. This is the products produced or the services delivered. They are ultimately the things that we are trying to allocate cost to. And lastly, we define our cost drivers. These drivers are used to allocate the cost pools we identified in step one to the cost objects we captured in step two. This is by far the most important part of the ABC process, because it provides the critical link between overheads and the business's products and services. The benefits of ABC heavily rely on accurate cost drivers, so make sure you take the time to get this right. And that's it for the process. Once it's understood, and of course the benefits it can deliver, you are ready to start working on your ABC model.
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