Review and Research into Activity Based Costing


With the rapid development of information technology, the competition of market is increasingly severe. In this scenario, cost effectiveness is a significant factor that supports the survival and success of any company. To compete and qualify, companies need to improve their quality, reliability, and authenticity while consistently reducing their costs. Overhead costing is a major problem in most of the industries. Activity based costing (ABC) is one of the major techniques that help organizations to control cost. "ABC is a powerful management concept that can be developed and used by any organization to gain a competitive advantage through greater understanding of product or services costs, process costs, and the organizations overall cost behavior." (DoughlasT Hicks 2nd Edition P-17) The main aim of ABC is to develop cost information in such a way that it will reflect the current relationship between costs, activities and products or services. However the common perception of ABC is that it is a complex set of mechanics that needs to be integrated on to organizations day to day reporting systems. Another misconception is that ABC is for large organizations only because of its initial cost. But the fact is that ABC can be easily implemented in any company irrespective of its size. Any organization can make an efficient economic model of its business with ABC and it will support all kinds of management decisions in the company.

Lady using a tablet
Lady using a tablet


Essay Writers

Lady Using Tablet

Get your grade
or your money back

using our Essay Writing Service!

Essay Writing Service

Although there are many literatures and articles pointing out the overheads in companies because of the traditional costing methods and the advantage of popular cost mechanism systems like ABC; many industrial areas are still using the old practices. Land transportation is one such field. One of the main difficulties in land transportation companies is to determine and evaluate true cost of their operations and services. "If used and implemented properly, ABC can be very helpful for transportation companies to determine cost of their operations with higher correctness." (AdilBaykasog˘lu and VahitKaplanog˘lu) In this paper, an application of ABC to a land transportation company that is located in Turkey is presented in detail. In order to improve the effectiveness of the ABC an integrated approach that combines ABC with business process modeling and analytical hierarchy approach is proposed. In this paper, an application of ABC-based costing model to a land transportation company is presented. In the case study most of the costs elements of the transportation company are evaluated through the ABC- based model. In the costing model, SIMPROCESS is used for process modeling and AHP methodology is employed to determine cost driver parameters similar to Schnieder- jans and Garvin (1997). The results obtained from the ABC-based model are compared with the results of traditional cost accounting method currently used by the company.

Literature Review

"Activity-based costing (ABC) has become a major cost estimation and accounting methodology. Using ABC for cost estimation of manufactured parts is being practiced today with acceptable rate of success. Cost estimation of the design activity on the other hand, has been nebulous and hard to implement" (Activity-based cost management for design and development stage David Ben-Arieh and Li Qian )

ABC has been revealed recently and used rarely by the service sectors especially by the logistics sector. ABC has appeared during the 1980s' with the studies of Cooper (1988a, b), Cooper and Kaplan (1988) and Johnson and Kaplan (1987). (Tsai and Kuo, 2004) cited that "cost calculation of the products and/or services in traditional costing is based on the determination of direct costs and indirect costs and then summing them to find the individual cost of each element. Traditional costing involves collecting indirect costs from departments and then allocates them to products or services".

The advantage of ABC over traditional system was that it allows precise estimation of direct and indirect cost. Activity based costing was evolved in the mid 1980s but survived over 25 years. Its longevity proves the credibility of ABC as an innovative and potentially valuable costing methodology that acts as a value adder to performance management systems. One of the appealing factors of ABC is that it combines estimates with hard data. There were many changes in ABC method over time. "The ABC hype cycle has six phases of evolution: (1) technology trigger, (2) peak of inflated expectations, (3) trough of disillusionment,(4) slope of enlightenment, (5) the plateau of productivity, and (6) the post-plateau phase" (Peter B.B. Turney).

Lady using a tablet
Lady using a tablet


Writing Services

Lady Using Tablet

Always on Time

Marked to Standard

Order Now

"The main difference of ABC from traditional cost system is that traditional cost systems use actual departments or cost centers for define cost pools to accumulate and redistribute costs." (Robert S Kaplan 5th edn P-138) Embarking on an ABM project is not a trivial exercise. The success of an ABM project depends on every function that it uses for delivering the model outputs both from a process and functional perspective. Some of the main difficulties encountered during ABM projects are1) the ease with which data is available, 2) the relevance of data, 3) possibility of data extrapolation with current systems, 4) ensuring that the staff in data collection are available and knowledgeable, and 5) having a project team till the project ends.

Activity Based Budgeting (ABB) is a part of the Activity Based Management System (ABM) that draws its conclusions from Activity Based Costing. ABB analyzes the products or services to be produced, what are the necessary activities to produce those products or services, and finally what resources need to be budgeted to perform those activities. In other words, ABB is the reversing of the ABC process to produce financial plans and budgets. Activity Based Budgeting differs from traditional budgeting in that it concentrates on the factors that drive the costs and not merely historical expenditure. (Julie Mabberley, Activity Based Costing in Financial Institutions, 2nd edn p-35) The action taken by the manager on the basis of an ABC study to improve the efficiency of activities and profitability of products is known as Activity Based Management (ABM). Julie Mabberley states that the objective of Activity Based Management is to determine the importance and costs of activities within the value chain, giving management the opportunity to focus resources on adding value and on continuous improvement in effective use of resources. In the beginning there were some difficulties in conventional ABC software solution regarding scaling of enterprise models. Companies built separate models for product and customer analysis. Because of the proliferation of models across units the companies could not take a holistic view of cost and profitability. (Time Driven Activity Based Costing Robert S Kaplan P-7). The solution for these problems was Time Driven Activity Based Costing (TDABC). In 1997 Akorn built the first Time Driven Activity Based Costing System (TDABC). By 2006 the model has been successfully implemented in more than 200 companies including enterprise wide applications in mid size and fortune 1000 companies. (Time Driven Activity Based Costing Robert S Kaplan)

According to Nachtmann and Al-Rifai(2004), ABC helped many manufacturing and service organizations to improve their competitiveness by enabling them to make

better decisions based on an improved understanding of their product cost behavior.


The way we measure our company affects our company. In different parts of the worlds different measurement criteria are used. Business experts believe that Activity Based Costing (ABC) is probably the best method for measuring business. Accounting software products like SAP, Syspro IMPACT Encore, and Deltek offer strong ABC accounting. The basic idea behind ABC is to segregate a project in to its activities and find a cost estimate typically prepared for each activity. The cost estimate contain raw-materials, labor cost, machinery and subcontracting costs, including overhead, for each activity. Summing up all activity costs provides the overall cost estimate for the entire project. In the recent years there was an increasing interest in ABC. It was mainly fueled by the new evidences of financial benefit, modern software supporting ABC and the use of internet and business intelligent systems to report the success stories of ABC to decision makers. Peter B.B. Turney argues that ERP systems and BI tools made it easier to build and modify advanced ABC models and report the information to management. An example is SAS® Profitability Management which offers increased analytic power and faster results from ABC.

ABM models can be built on spread sheets, but only the most basic type of analysis can be undertaken in this way. (Brian Plowmann). Database tools provide a lot of functionalities to undertake ABM analysis. Today there are many softwares available in the market that provides detailed profitability analysis of specific customers, orders, and products. This includes Acorn Quick ABC software, ICMS, Leeds Software, IRIS Accounting Software, ABM toolkit with CMS-PC 4.0 etc. It is better to select proprietary ABM software used and managed by ABM experts. Irrespective of the software, the ABC methodology or concept is providing the optimum solutions for a business.

Lady using a tablet
Lady using a tablet

This Essay is

a Student's Work

Lady Using Tablet

This essay has been submitted by a student. This is not an example of the work written by our professional essay writers.

Examples of our work

ABC can be defined by the following equation:

C/A = HD + M + E + S

where C/A = Estimated cost per activity

H = Number of labor hours required to perform the activity one time

D = Wages per labor hour

M = Material costs required to perform the activity one time

E = Equipment costs to perform the activity one time

S = Subcontracting costs to perform the activity one time

ABC methodology is used when a project can be divided into defined activities. The project should be divided into the lowest functional level activities so that costs can be tracked at a basic level and performance can be evaluated. Based on the project organization, the activity may coincide with an element of the work breakdown structure (WBS) or may combine one or more elements of the WBS. But by defining the activities separately we can prevent overlapping. Once activity is defined clearly, unit of work can be decided. The unit work estimate is done by using cost estimating relationships, obtaining outside quotes for equipment, etc. The activity cost should include all costs including overhead and profit.

An estimator should be aware about the amount of time for preparing ABC because at times people develop an extremely accurate cost estimate by defining smaller and smaller activities but it may not justify the increased accuracy as the preparation of ABC takes a large amount of time. The total estimated project cost may be sufficiently accurate if 10 activities are used instead of 15. Apart from this, reliable cost information may not be accessible if the activity categories are too general. So activity should be carefully selected as it is the basis of the estimation.

Case Study:

The main services of the company where the case study was performed consist of export services from Gaziantep to European countries and import from European countries to Turkey. Transit services are also provided by the company. The company was established in 1936. The company presented a sharp growth rate after year 2000. The company owns 122 trucks and it is presently one of the biggest logistics company (land transportation service provider) in the southeast of Turkey. In the present case study, costs of the transportation services of the company are tried to be determined for a 9-month time period. Twenty-eight different services including both exports and imports that were performed within the time period of 9 months are identified. The transportation services which are provided by the logistics company are assumed as truckloads. Therefore, the volumes of the loads consolidated into the vehicles are neglected. As a result the cost calculation is made so as to find standard costs of each route (it is whether export or import). In other words the cost objects of this case study are the truckloads of the logistics company. Belgium export, Belgium import, Germany export, etc. are some examples of the cost objects. Direct cost required for the total transportation for the 9-month duration had been recorded. In this case study, direct costs represents the fuel consumptions and other transportation costs.