Steps needed to implement an ABC system
The steps that the company would need to take if it was to introduce an ABC system are as follows:
Employees involved in collating activity and cost information and their analysis should be educated about the process. Even though training employees requires resources and costs, starting an ABC system without proper education may result in collection of incorrect data and its wrong interpretation. Also educating employees about the benefits of an ABC system will help them overcome their initial inertia. Without proper understanding of the benefits of an ABC system, the demand for additional resources for data collection and associated additional costs can make the process painful (Weil & Maher, 2005: pg. 233).
Identify the cost objectives and activities.
The objective of implementing an ABC system is to establish costs of services being delivered by the company to various government bodies. To meet this objective the company needs to identify activities involved in completing those services. A process flowchart is a good tool for identifying main activities (Rozrocki et. al, 2004, pg. 20).
Identify cost drivers.
The company should select cost drivers on the basis of the following criteria:
A reasonable cause-effect relationship between the cost-driver unit and consumption of resources.
Availability of quantifiable and measurable data on the cost drivers.
Collection of relevant data concerning costs.
The company should collect all costs associated with the above identified activities and divide them by the cost driver units to arrive at cost per cost-driver unit.
Calculate service costs.
The cost per cost-driver unit should be multiplied with number of cost driver units required for completing each activity used in a service. Summing the above costs for each activity in a service will give the cost of each service provided by the company.
Allocation, apportionment and absorption rates
Allocation of an expense takes place when it can be specifically charged to a cost centre. Apportionment of an expense happens when it cannot be identified to a specific cost centre. The main difference between allocation and apportionment of costs is that the allocation deals with the entire costs but apportionment deals with proportion of items of costs. This means that allocation is a direct method whereas apportionment is an indirect method as it uses some indirect basis to allocate costs. As an example, the salary of a worker in a maintenance department will be allocated fully to the maintenance department. But as the maintenance department services are used by other departments, the salary of a maintenance worker will be apportioned to those departments.
The absorption rate is a rate used in an accounting period to charge overheads to the production in that period. Absorption rates are calculated by dividing the overhead expense by the total production of goods or services.
Costing most suitable for the company
The choice of a costing system by the company should be based on cost versus benefit considerations. There could be a number of cost drivers because of the nature of activities performed in providing various services to government bodies. Adding all unallocated costs in to a cost pool and then absorbing them on the basis of some method will not result in true representation of costs. Instead the service firm should use ABC to analyse different causes of the additional costs incurred and allocate costs on the basis of these cost drivers. An ABC system will generate more accurate data for pricing of company’s services in an increasingly competitive environment. Establishing cost drivers will not only help in proper costing of different services but also reducing costs through benchmarking of standard activities.
As the company is a medium sized business, the costs of implementing an ABC system are not prohibitive in relation to this size. It also has the manpower resources as employees working in different departments have process knowledge and can be trained and assigned to record cost data without causing a significant business disruption. Hence in light of intensifying competition, the company should implement an ABC system to maintain or increase its competitive edge.