Use of Activity-Based Costing for Concurrent Assessment and Tracking of Costs

Activity-based costing is a very important tool that manufacturing companies use to minimize its production cost. Its idea was introduced in 1960 when General Electric made an attempt to link manufacturing activities with their costs. Concurrent engineering is an approach to product realization where all the elements of product production are incorporated into one continuous feedback- driven the designed process (Congress, U. S.1992). The process starts from purchase of raw materials through manufacturing to disposal. The main aim of concurrent engineering in manufacturing is to minimize cost throughout the life cycle of a product without reducing the product quality. Environmental sustainability is very important and this makes different product manufacturing companies consider a whole product life cycle which involves production to recycling (Emblemsvag and Bras, 1994). To solve this problem of cost minimization and waste reduction, it is important to introduce activity-based costing which can identify activities that are used in product lifecycle and finally assign appropriate costs associated with them.

The main function of cost model is to provide information to the design department and product realization to make accurate cost/revenue design changes. Although there are different costing methods that can be used in designing environmentally design products and processes, ABC becomes the most convenient method that can be used also for cost assessment of a product lifecycle and other environmental issues (Keoleian and Menerey, 1994). It is, therefore, the most efficient costing method that can be used in cost assessment in designing product lifecycle. ABC has the capacity to provide effective decision support in life cycle design because it can assess and trace costs and revenues of a product, it can also use both direct and overhead costs and can work in situations where there are uncertainties (EPA, U.S, 1993b). This, therefore, makes it more appropriate in concurrent assessment and tracking of costs in a manufacturing sector of a product.

Activity Based Costing

There are very important manufacturing costing methods used in estimating the value of inputs and output during the production process. Through cost estimation and ascertainment, the production department can determine the cost per unit of a product and other performance indicators. Costing information is very important in decision making and therefore the management requires such information in determining production level, pricing, and future investment (Thurston and Blair, 1993). Costing information is usually essential for internal use. Currently, most companies search for ways in which they can minimize cost and maximize profits. The business organization can achieve this through the use of activity-based costing. It is a costing method which identifies all the business operations and the costs related to these activities. Activity-based costing method then assigns the cost related to these activities directly to the pricing of the output of that activity instead of finding their averages across all outputs. This costing method is very useful to production managers in using all the cost associated with the product to determine the most appropriate price.

History of Activity Based Costing

This costing method was introduced in 1980 when companies were looking for costing method that can minimize production cost and also get accurate product cost data that managers can use to generate more informed decisions about process enhancement, price determination and improving good customer association. In activity-based costing, all costs including fixed costs, overhead costs, and variable costs are assigned to specific activities associated with them. These costs, therefore, are essential in identifying the drivers. This costing method was designed for two main reasons (Greenwood and Reeve, 1992). The first reason was to eliminate cost distortion and the second to reduce wastages. The distortion of the cost is achieved in activity-based costing through assigning a cost to specific drivers. A cost driver is a factor that alters the activity cost and therefore it is the main element of activity-based costing.

The Difference between ABC and traditional costing method

Activity-based costing makes use different levels in the cost hierarchy. It uses output unit-level cost, batch level cost, sustaining cost and facility sustaining costs. Output unit level cost is costs of an activity that are executed on a single unit of a product while batch level cost is the cost of operation of a multiple product or services. The product sustaining costs are a cost incurred to support a unit product or service without considering the number of products in which units are generated. In the contrary, facility sustaining cost is the cost of business operations that cannot be traced by managers to unit product or services but helps the business organization achieve some of its business operations. Activity-based costing method is, therefore, a very important too that business organization depends on to ascertain and allocate product costs pragmatically. It also offers the means in which the business organization can cut off and determine the individual cost associated with a given activity.

ABC got its name from the activities it performed to get a product. The product cost is derived from activities performed when producing a product. ABC is different from traditional costing in a number of ways. It is different on the assumption that each unit of a given product use resources while ABC has the assumption that products do not use resources directly but use activities (EPA, U.S, 1993a). It, therefore, means that the cost of a product in ABC is a sum of the cost of all activities that are executed to get a product. In the contrary traditional costing rely on unit level cost driver of a commodity that is proportional to the quantity of product produced. The cost of labor, materials, and overheads are examples of unit level which are used when determining the unit cost of a product in a traditional costing method. ABC does not use unit level costs but uses cost drivers for example batch level hours and the number of setups. Due to the fact that product uses activities and all the allowances for batch and product level costs, drivers prove that ABC is vital in modeling and tracking of costs than traditional costing methods.

ABC is selected due to the fact that it is good for cost tracking, separation of direct and indirect costs, increase accuracy and can blend into the ABM which most companies are using. ABC can be used in ecological context to identify plants and products which controls the environmental expenditure. This costing method is used by many business organizations despite the fact that it has some issues such as how to offer efficient and effective decision support when designing and how uncertainty can be included.

Integration of Uncertainty in a cost Model

Since there are very many people who have conducted research on ways environmental impacts can be mitigated, a little has been done on the accuracy of data used and how the result is sensitive to changes in the output data. This is so important when handling ecological issues where uncertainty is required because of the absence of hard data. For example car manufacturing companies designed for a recycling, the correct economic and ecological impacts can be quantified from the date of manufacturing to the date of disposal. This only happens in Europe but other countries it is used until it becomes wreckage. This law is very important in making the environment clean. In cases where there is no probability, it is important to use uncertainty which can be created in different ways based on the nature in which it should be modeled. The following below are the possibilities: Uncertainty can be modeled using historical information through the application of statistical analysis through following Gaussian statistics. It can also be made through following experience in fuzzy numbers but ensure all the problems are determined numerically. When designing using historical data, it is always very hard to get historical data thus the method where Gaussian statistics is not a good method and may not work in some way. For that matter, the best method to use requires the use of Fuzziness which is based on experience where mean and standard deviation is used. It, therefore, means that there will be no accurate data but they will be based on guesswork.

The uncertainty will, therefore, be created by assigning distributions to all the numbers in the model with the uncertainty. This allows for the creation of uncertainty in a cost model and it is necessary to find out their effects in relation to cost. To make it more effective Monte Carlo simulation need to be applied to determine the cost uncertainty generated from the assumptions. The use of this method is very simple but has a great impact on determining uncertainties because it is working on the controlled and viral experiment (Hines and Montgomery, 1990). Despite the fact that there are other simulation methods, it has been found useful because it uses crystal Ball software which makes it more efficient and appropriate. It supports the description of the assumptions and cell projections in a spreadsheet. It also allows for a situation where a forecast is looked upon as a response variable and assumption cells are observed as source variable.

There are some situations where the cost of a product is used as a simple linear function representing material and labor cost. On this basis, the association of product cost can be determined using either assumption cell or spreadsheet cell. Monte Carlos simulation method is therefore useful in generating simple random samples of numbers found only on the assumption cells. The numbers selected are required to propagate along the equation in the model while forecast cells are determined by appropriating the equations. The determination of uncertainty in the cost model allows for cost tracking and assessment so that the effect of ABC can be determined by the user. It is anticipated that ABC is cost effective and can minimize waste. All these effects can only evaluate the use of simulation methods called Monte Carlo simulation. Other simulation methods cannot work effectively because they are very complex and require expert knowledge. For example, the projected product cost is the summarization of random values for materials and direct labor. After conducting all the required tests the value of anticipated cell generates another statistical distribution. As a result of its randomness, the figure which has been propagated within the model can be applied in normal statistical evaluation in the same way as a real experiment. This helps in the creation of confidence interval and carries out T-tests. Immediately the values and their corresponding uncertainties have proliferated in the cost model and another cost associated with design solution is acknowledge, identifying an appropriate design solution is also not easy.

Assumption cell Forecast cell

Statistical distribution of a forecast cell

Trials

$4

$8

$20

Selected statistical distribution for an assumption cell

Trials

Results

$10

$20

$35

Trials

$4

$8

$15

Direct labor Propagate through the model

Direct Material

Monte Carlo simulation

In...