How to Understand Activity Based Costing

Activity based costing presumes an understanding of cost parameters and dynamics that are associated with industries and organizations which have moveable parts.

Instructions

Difficulty: Moderately Easy

1. Activity based costing begins with the analysis of worker organizations and division or department wide components, and it begins with the description of an activity as it relates to such entities. Ultimately the larger departments of an organization are those that receive the largest number of services. Ultimately those services that are larger thereby receive the greatest cost attention. An activity based cost begins then with the consideration of the new project in terms of both the cost to other parts of the organization from the perspective that it will cause greater activities for resources disposed to other activities.
2. Once this consideration is made the new project must be assessed in terms of how much will it take additionally to provide services for the new addition. If it supplies a new service and relates to several departments what are the costs of provisioning these services. If it relates to additional modifications or enhancements of existing services, then again what are they vis-a-vis what exists in the environment at the time. An Accounting Department project may affect controlling, treasury and each division within the entity because it adds work to those reporting to it.
3. That one understands that cost implications add or reduce net value from a new service or an individual service within an organization one is ready to
   assess individual projects and offices in terms of their activity based cost and benefit. The typical example for an analysis involving this approach is that of a hospital. A hopsital while complicated to assess practically serves the visual purpose of establishing an understanding of services beyond a financial analysis centered or experienced audience. A better example is a medium sized business manufacturer. Such an entity produces parts of various types as outputs. Factory a produces product a and factory b produces product b. Together these produce when assembled the final output. A service center provides services or tools for each factory in terms of delivery drivers and machinery services or managers, administrative and other personnel costs. Expansion causes costs that increase at each service level. Ultimately, costs of buying a customized accounting or other professional service may need to be considered in terms of integrating collaboratively with each factory. Cost y for factory 1 may be twice for implementation what it is for factory 2 meaning while beneficial for one too costly and in the long run not worth investing in for the company.