Activity based costing in Service Sector – Part II


Activity Based Costing (ABC) is a technique for calculating the expenditure associated with the performance of group of tasks within an organization.

  • Cost objects consume activities.
  • Activities consume resources.
  • This consumption of resources is what drives costs.
Activity Based Costing
Activity Based Costing

Activities know no boundaries of dept or division as some activities like loans depending on values go to higher levels for sanction. Costs increases or decreases as there are changes in the work load that affect the activity costs via their cost drivers. Work activities are triggered by events and the costs react as the effect.

Some definitions related with ABC

An Activity is defined as “a value adding process which consumes resources.

Cost driver is “an activity or factor which generates cost”, for example, a cost driver could be no. of material receipts in the stores dept which is measurable or it can be a natural disaster like earth quake or electrical short-circuit fire which cannot be expected or measurable in advance. We are concerned with measurable drivers.

Resource drivers:  Trace expenditures to work activities.

Activity drivers: trace work activity to cost objects.

An activity driver may be the number of times an activity is performed—transaction driver—or the length of time an activity is performed-duration driver or deep intensive operation -intensity driver.

The traditional report and activity based report are shown below(Table A & B). The General Ledger uses a chart of account whereas ABC uses a chart of activities as its language. When you translate those “chart of accounts” expenses into the “chart of activities” that consume the  financial general ledger’s expenses, a manager’s insights from viewing the activity costs begin to increase. His responsibility is defined and he will take interest in showing performance.

ABC is very work-centric whereas the General Ledger is transaction-centric. The General ledger view on the traditional view describes “what was spent” whereas the activity-based view describes “what for it was spent?”

Traditional Presentation of Costs (Table A)

Dept: X

Expense Head Amt in Rs.
Direct Labour cost

2600

Direct material

100

Direct expenses

100

Indirect expenses

500

Total costs:

3300

ABC Method of presentation of costs  (Table –B)

Dept: X

Departmental activities Cost No. of transactions Cost/Trans (actual Rs)
Sanctioning and opening loan a/cs – term loans

1000

10

100

Sanctioning and opening loan a/cs – project loans

1500

10

150

Follow up of term loans

50

10

5

Follow up of project loans

50

10

5

Transactions in term loans

300

15

20

Transactions in project loans

400

20

20

Total activity costs:

3300

The Six General Steps to Activity-Based Costing Implementation:

1. Identify Cost Centers or Strategic Business units: First identify the cost centers or SBU of the banks or service units.

2. Identify Activities: Next we should conduct an in-depth analysis of the operating processes. Each process may consist of one or more activities required by outputs. Activities may be subdivided into tasks if need be.

Some of the activities in a savings section of a bank which is a service sector are

  • Opening savings account
  • Cash collection
  • Cheque collection
  • Cheque payment
  • Electronic payment
  • Setting up internet account access
  • Cheque issue,
  • Customer complaint/enquiry processing
  • Pass book updating

Activity Dictionary is to be made department wise or cost centre wise which will help mapping up all activities and to avoid any overlapping of activities. If this is supported by codes will help to prepare a software wherein all costs/revenues can be captured as a routine and for identification activity wise.

3. Assign resource costs to activities: This is also referred to as “tracing,” assigning costs to cost objects determines why costs were incurred.

4. Identify outputs: Then we have to identify all of the outputs for which activities are performed and resources are consumed. Outputs can be products, services, or customers-persons or entities to which a bank is required to provide goods or services.

5. Assign activity costs to outputs: We can use activity drivers to assign activity costs to outputs based on individual outputs’ consumption of or demand for activities. For example, a driver may be the number of times an activity is performed—transaction driver—or the length of time an activity is performed-duration driver or intensity driver which emphasize about intensity or quality of the product.

6. Note and report un-necessary activities and unused capacity: We can note down and report un-necessary activities which consume resources but not benefit to customers and growth of bank and also report any underutilized capacity. These can be identified when we look into facets of activities and its importance in value chain of the bank.

For activities, there is one unwritten rule i.e.  “It is wise to pay heed to the “5% rule” which states that if any activity which does not account for 5% or more of the depts’s time, then it should probably be aggregated with another activity “. So in a department, there can be maximum of 20 activities.

C.R. Venkata Ramani

(AICWA)

(This article by Mr. C.R. Venkata Ramani is extracted from his article published earlier in “The Chartered Accountant” magazine.)

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