1.

Activity-based Costing

1.
Activity-based costing is an attempt to get away from traditional standard costing,
in which the overheads, which often form the largest part of the total cost, may be shared
between different products in quite an arbitrary way. Oracle does support ABC, but it is
a limited implementation. Customers enquiring about it may in fact be advised to
implement a Pc-based package such as EasyABC, and then to import the costs derived
from that into Oracle. Note that ABC is a form of standard costing an it can run alongside
traditional standard costing. Customers can switch from one form to the other gradually if
required.
2. When creating an activity it is always possible to give it a cost. However there is no
point in doing so unless the basis of the cost is activity. Costs with a basis type of
activity can only be added to items as Material Overheads. If you create an activity with
a basis of item or lot, and that activity is then linked to resources on a route, those
resources will be costed in the same way as if the activity was not there. Putting an
activity code on a resource or an overhead makes no difference whatever to the cost of
that resource or overhead. It is more logical to identify new overheads purely for the
purposes of ABC and to link these to resources as replacements for more general
overheads. In many cases there is only ONE overhead. The whole point of activity-based
costing is to break down this general overhead into specific overheads which are only
incurred in specific departments.
3. If you do create an activity with a cost then in practice it operates like a material
overhead, but the calculation is different. You must enter a total cost and a number of
times used. The screen then divides one by the other and displays a the cost of doing the
activity once. For example, if you define an activity for receiving costs, you may calculate
that the cost of the Goods Inwards department is 120,000 currency units a year. Let us
assume that 1200 similar items pass through the Goods Inwards department in a year
which means that the cost of processing one item is 100 currency units. This value is
displayed on the screen.
4. When defining item costs, you may then enter costs for an activity based on the costs
input at (3 ). These are only available for the material overhead cost element. You can
select an existing material overhead or create a new one (with a default activity) for this
purpose. You will then be allowed to pick any activity. If you pick one where the basis
type is activity a pop-up window is opened. Here you enter the number of times this item
uses the activity, and the quantity of the item each time it uses the activity. The system
then calculates the cost per item. For example, let us say that item JPCOMP passes
through the Goods Inwards department 20 times a year. This is 20 of the total of 1200
entered at (3 ). The cost of this is 20 * 100 - the cost each derived at (3 ). So the total
cost of processing JPCOMP in Goods Inwards in 2000 currency units. However, each time
we receive JPCOMP, we receive on average 5 at a time. Therefore the activity cost of
receiving one JPCOMP is 400 currency units.
5. Remember that material overheads can be created for both inventory and rolled-up
costs. In the latter case, the material overhead is simply added on top of the rolled-up
cost.
6. A logical use of ABC is to determine the cost benefit of buying an item instead of
making it in-house. If general overheads are in use the real cost of both buying the item
and making it can be grossly misleading. For example, the real purchase cost cannot be
obtained simply by consulting the suppliers catalogue. To this must be added a part of

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1. Activity-based Costing

the cost of running the purchasing department (which can be expressed as the number of
purchase order lines entered in a year), the cost of running the Goods Inwards
department, the warehousing and financing costs etc. Each of these can be set up as
activity-based activities, and material overheads created for them. It may in fact be best
to create one material overhead per activity because this is where the GL code goes. If
several activities share the same material overhead their costs will not be identifiable in
the GL.
7.
By the same token the real costs of manufacture may not be known. New
activities can be set up for things like cleaning, maintenance and factory space and costs
can be created here. These costs should then be removed from the general overhead rate
and they should be applied only to the items which incur them. This can be done in the
same way as the above. Otherwise new overheads can be created for the cost drivers
which have been identified. An activity field is available on the overhead records. Note
that if this method is used, you may specify how the overhead will be charged using the
usual basis types - Resource Value etc. However you will not be able to access any costs
entered in the Define Activity screen. As noted at (2) above, these are only used by
material overheads.
8. Another way to implement ABC is to use the specification of the products being made
as the cost drivers. I have seen an implementation of it at a process control board factory.
The costs were based on simple algorithms to which the inputs were the dimensions of the
different parts of the process control boards, and in this case the factory had succeeded in
reducing the level of general overhead to 15%.

305844285.doc

Company Confidential - For internal use only

1. Activity-based Costing