At first, a company developing an ABC system has
to identify the resources consumed by the company and their cost.
Note that a resource is an economic good consumed in performing
activities. For example, Friends Company, a manufacturer of valves, has the
following resources: manufacturing equipment, supplies, utilities, wages,
office expenses, furniture, etc.
In addition to
identifying available resources, the company has to determine the
activities that consume the company’s resources, or in other words, resource-consumption
cost drivers. Resource-consumption cost drivers can be divided into two
categories: Transaction drivers and Duration drivers.
Transaction
drivers count the number
of times an activity occurs (e.g. number of orders processed, number of orders
shipped, number of items inspected). Transaction drivers can accurately measure
the activity rate when the activity requires the same amount of time. For
example, the amount of bills processed would be an accurate activity measure
when it takes the same amount of time to process each bill. However, a more
accurate type of activity measure is a duration driver.
Duration
drivers measure the time
required to perform an activity. For example, duration drivers measure the
amount of time required to inspect items, to process bills, to process orders,
etc. Duration drivers are more accurate measurement of the consumption of
resources.
To determine
resource-consumption cost drivers, the company collects data concerning the
activities performed in a manufacturing process. Such information can be
gathered from the company’s records and documents as well as from observations,
interviews of personnel, and surveys. Some of the questions often asked are:
What activities do you do? What resources are necessary to perform these
activities? How much time do you spend performing these activities?
Besides collecting data
regarding activities, the company ranks activities according to their level of
resource consumption.
Activity levels of
resource consumption:
A unit-level activity is an activity performed on each individual product or service. At this level,
the cost drivers will be volume-based since the amount of activity will
proportionally depend on the number of units produced. For example, for Friends
Company, a manufacturer of valves, the unit-level activities include inserting
piston into piston valves, inspecting each unit, and providing power to run
processing equipment.
A batch-level
activity is an activity performed on each batch of products or services
regardless of how many units are in the batch. For instance, the cost of
setting up equipment is the same whether the batch has ten or thousand units. Examples
of batch-level activities are: placing purchase orders, setting up machines
(i.e. per batch and not per individual product), conducting inspections by
batch, arranging for deliveries to customers, etc. At this level, examples of
cost drivers are: orders processed, number (or duration) of set-ups, number of
inspections, etc.
A product-level activity (also called, a product- or service-sustaining activity) is an activity
performed to support production of a specific product or service regardless of
how many batches are run or how many items are produced. Examples of
product-level activities are: purchasing product parts, designing, modifying
(re-engineering) and testing products, managing inventory, advertising a
product, maintaining a product manager, etc. At the product-level, examples of
cost drivers are: number of categories of product parts, design and testing
time, number of engineering orders, number of inventory categories, etc.
A customer-level
activity is an activity that relates to specific customers, not specific
products. Examples of customer-level activities are: IT-support, sales calls,
sales visits, catalog mailings, etc. We will talk in greater detail about
customer-level costs when we will learn about customer cost and customer
profitability analyses.
A facility-level
activity (also called, a business/organization sustaining activity) is an
activity that supports business operations in general and cannot be traced to
individual units, batches, or products. Examples of facility-level activities
are: managing factory, heating factory, providing factory safety and security,
maintaining general-purpose equipment, cleaning executive offices, arranging
for loans, closing books each month, preparing annual reports to shareholders,
providing a computer network, etc.
Note, that the activities
can be traced in the ascending order and not vice versa. For example, a
unit-level activity can be traced to a batch-level activity, and a batch-level
activity can be traced to a product level activity, but not vice versa. In
addition, within each group of activities, the activity cost centers that use
the same cost driver are combined into homogeneous cost pools (e.g. Customer
Orders, Customer relations).
