PART 1 LESSON 7

COSTING SYSTEM

LESSON 7-COSTING SYSTEM

CONTENT
1. Job Order Costing
2. Process Costing
3. Life Cycle Costing
4. Activity Based Costing
5. Activity Based Management

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JOB ORDER COSTING
Job-order costing is concerned with accumulating costs by specific job. This method is
appropriate when producing products with individual characteristics or when
identifiable groupings are possible, e.g., yachts, jewelry

Job costs consists of

• Direct materials
• Direct labor
• Manufacturing overheads
• These are recorded in general ledger supported by subsidiary ledger that
maintains costs for each job. Each job is identified by a unique Job Number.

Job Cost Sheets:

• Job Cost Sheets act as subsidiary ledger for each job.

• A separate Job Cost sheet is prepared for each job initiated into production.
• Normally Job Cost sheets are prepared by the cost accounting department to
accumulate the job costs upon notification by production department that
production order has been issued for a particular job.
• The production order is issued based on sales order received.
• A Job Cost Sheet contains details of Direct Materials, Direct Labor and
manufacturing Overheads assigned to each that particular job.
• It also consists of cost summary of materials, Direct Labor and Overhead; Total
Cost and Unit Cost.
• Job order costing is used in manufacturing situation of job production.
• Printing, furniture manufacturing, machine tool manufacturing is examples of
typical job orders.

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A typical Job Cost sheet is reproduced below.

JOB-COST SHEET
JOB NUMBER DESCRIPTION
DATE STARTED DATE COMPLETED
NUMBER OF UNITS COMPLETED

DIRECT MATERIALS
DATE REQU # QUANTITY UNIT PRICE COST

Total

DIRECT LABOR
DATE CARD HOURS RATE COST

Total

MANUFACTURING OVERHEAD
POOL ACTIVITY BASE Pool/ LEVEL OF COST COST
Predetermined DRIVER
Overhead Rate

Total

COST SUMMARY

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TOTAL DIRECT MATERIAL
TOTAL DIRECT LABOR
TOTAL MANUFACTURING OVERHEAD
TOTAL COST
UNIT COST

Source documents:

Material Requisition:

• The production process starts with the transfer of materials from store room to
production (operation) (Assets transferred to operation).
• The transfer is based on a document called Material Requisition.
• This document authorizes the release of materials to production and helps trace
material costs to appropriate job cost sheets.
• Materials directly related to the job becomes the direct material of the job
• Material that cannot be directly traced to any particular job is indirect material

Labor distribution documents or Time Cards:

• Time tickets, time cards, or time sheets record hour-by-hour summary of activities
assigned to each employee.
• When working on a particular job an employee enters the job number on his time
sheet and notes the number of hours spent on each job.
• The time sheets are analyzed by accounting department to assign direct labor to
different jobs and also identify indirect labor that has to be allocated to different
jobs.

Manufacturing Overhead:

• Manufacturing overhead consists of various expenses like

1. Depreciation of factory buildings and equipment

2. Utilities and insurance

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3. Supplies, such as lubricants, cleaning supplies, small tools, and gloves
4. Indirect labor, such as material handling, supervision, idle time, and
overtime premiums (idle time is unproductive time, and includes rest breaks
and down time due to power failures etc)
5. Taxes, such as property taxes on manufacturing facilities and payroll taxes
6. Service department costs, such as plant accounting, personnel, research
and development, engineering, and equipment repair etc

(Source: Bierman, Dyckman, Hilton, 1990)

Job production involves

• Job production is a type of manufacturing where production is undertaken in

response to customer orders.
• Producing a one-off product for a specific customer.
• Job production is most often associated with small firms (making railings for a
specific house, building/repairing a computer for a specific customer, making
flower arrangements for a specific wedding etc.) but large firms use job
production too. Examples include:

• Designing and implementing an advertising campaign

• Auditing the accounts of a large public limited company
• Building a new factory
• Installing machinery in a factory

Accounting for Job Costs:

• A job is defined as a single unit or group of like units being produced to

distinct customer specifications
• Each job is treated as a unique “cost entity” or cost object
• Costs of different jobs are maintained in separate subsidiary ledger accounts
and are not added together or commingled in those ledger accounts

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• Application of manufacturing overhead is difficult because:

a) Manufacturing overhead is indirect cost and so it cannot be directly traced

to a Job Order
b) Manufacturing overhead includes assorted items
c) Manufacturing overhead tend to remain constant despite of variation in
production

• Because of these problems,

o Manufacturing overhead rates are assigned in indirect manner through
allocation techniques.
o The manufacturing overhead is thus estimated using one of the costing
techniques which may be Actual Costing, Normal costing or standard costing

Steps in job costing:

a) Step 1: Identify the job that is chosen cost object. Each job is identified by
job number
b) Step 2: Identify the Direct Cost for the job
c) Step 3: Identify the Indirect Cost Pools Associated with the Job.
d) Step 4: Select the Cost-Allocation Base to Use in Allocating Each Indirect
Cost Pool to the job
e) Step 5: Develop the Rate per Unit of the Cost-Allocation base used to
Allocate Indirect Costs to the Job

Accounting entries for Job Costing

Raw materials purchased

Raw Materials xxx
Accounts payable xxx

Direct materials issued to production

Work in Process xxx
Raw materials xxx

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Indirect materials issued to production

Manufacturing overheads xxx
Raw materials xxx

Direct labor Identifiable with jobs xxx

Work in process xxx
Wages payable

Indirect labor
Manufacturing overheads xxx
Wages payable xxx

Cash expenses
Manufacturing overheads xxx
Cash xxx

Manufacturing expenses allocated to production at predetermined rate

Work in process xxx
Manufacturing overhead xxx

Finished goods transferred from production to finished goods stores

Finished goods xxx
Work in process xxx

Finished goods sold

Cost of goods sold xxx
Finished Goods xxx

Cash xxx
Sales xxx

Valuation Techniques:

Actual Costing Normal Costing Extended Standard

Normal Costing Costing
Direct Costs Actual direct Actual direct Budgeted direct Standard
rate x Actual rate x Actual rate x Actual direct rate x
quantity of quantity of quantity of Standard
direct cost input direct cost input direct cost input inputs allowed
for actual

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outputs
achieved
Overhead Actual indirect Budgeted Budgeted Standard
(Indirect) costs rate x Actual indirect rate x indirect rate x indirect rate x
quantity of Actual Actual Standard
cost allocation quantity of quantity of inputs allowed
base cost allocation cost allocation for actual
base base outputs
achieved

The four basic methods of valuation are Actual, Normal, Extended Normal and standard
costing. When a company uses the actual costs of direct materials, direct labor, and
overhead to determine the cost of work in process inventory, that company is employing
an actual cost system.

Companies modify the actual cost systems by using predetermined overhead rates rather
than actual overhead costs. This combination of actual direct materials and direct labor
cost with predetermined overhead rates is normal costing.

In Extended Normal costing, budgeted rates are used to value the actual quantity of direct
cost input in addition to using budgeted indirect rate to value overheads

In standard cost system, unit norms or standards are developed for direct material and
direct labor quantities and costs. Overhead is applied to production using a predetermined
rate, which is considered

PROCESS COSTING
Process costing is one of the most common methods of costing. Its main object is to
provide an average cost of a product. Average costs are calculated by accumulating for a
period the relevant labor, material and factory overhead and dividing the total dollar
amount by the units produced within that period.

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 In addition to giving the unit cots per period, a process costing system can also
provide:
 The cost of operating each department period by period
 The charge to be made for transfers from one process to another and to finished goods
account.
 Process costing system is used in industries like chemicals, petroleum, food
processing, glass, paints, rubber, steel etc where relatively homogenous products are
mass produced in continuous fashion. The difference between process costing and job
costing is the extent of averaging used to compute unit costs.
• In job costing each units use different amounts of inputs so it would be incorrect
to average the manufacturing costs among all the units produced.
• Whereas in mass production, similar units are produced with each unit using same
amount of inputs. So, in process costing unit cost are arrived at by dividing total
cost of production by number of units produced.

Steps in Process Costing

1. As a first step it will be necessary to decide the extent and number of departments.
• A department may perform a number of operations. To make the costing
efficient, a further sub division of each department into cost centers may be
necessary.
• Whether or not a cost centre should be created is a matter to be determined by
reference to use to which the costs, separately accumulated, are to be put.
Normally, process costing will call for division according to operations or
processes.
• Cost canters can be further divided into production departments and service
departments
a) Where costs in a department can be traced directly to products such a
department is a producing department.
b) A service department is a department whose costs cannot be traced
directly to products.

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1. This department is not concerned with producing, but with the
rendering of services to producing departments.
2. Thus the stores, purchasing, maintenance and personnel
departments are all service departments
• Separate accounts for each service and producing department are kept and at the
end of each accounting period the balances in the services departments’ accounts
are transferred to the producing departments. The service received by each
producing department would become the basis for determining how the service
costs are apportioned.

2. The second step is to record the costs. The journal entries for a process cost accounting
system are like those for a job order costing system. In a process that consists of mixing,
shaping and heating, direct materials, direct labor, and factory overhead are recorded as
follows:

To purchase materials and incur direct labor and factory overhead:

Materials Inventory
Accounts Payable
Factory Wages
Wages Payable
Factory Overhead
Accumulated Depreciation
Property Tax Payable
Accounts Payable, and so on
To requisition materials, assign direct labor cost, and assign factory overhead cost
to the Mixing Department:
Work in Process Inventory- (Mixing)
Materials Inventory
Work in Process Inventory-(Mixing)
Factory Wages

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Work in Process Inventory-(Mixing)
Factory Overhead
To transfer cost from the Mixing Department to Shaping Department:
Work in Process Inventory-Shaping
Work in Process Inventory-Mixing
To record the additional labor and overhead cost of the Shaping Department
Work in Process Inventory-Shaping
Factory Wages
Work in Process Inventory-Shaping
Factory Overhead

Entries for the Heating Department parallel those for the Shaping Department:
To transfer cost of goods completed from the Heating Department to Finished
Goods:
Finished Goods Inventory
Work in Process Inventory-Heating
To account for cost of goods sold:
Cost of Goods Sold
Finished Goods Inventory

Conversion Costs:
Conversion costs are all manufacturing costs other than direct materials costs. The
conventional method of classifying costs is threefold: direct materials, direct labor, and
indirect manufacturing costs (overhead). However, this threefold category is becoming
les and less important in relation to total manufacturing costs because of increasing
automation. A two fold category is often used i.e. (1) Direct Materials (2) Conversion
costs. In many companies direct labor has vanished as a major category

Steps in Process Cost Accounting:

Step 1: Summarize the flow of production in Physical Units

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Step 2; Compute Output in Terms of Equivalent Units of Production
Step 3: Summarize Total Costs to Account for
Step 4: Compute Equivalent Unit Costs
Step 5: Apply Total Cot to Units Completed and to Units in Ending Work in Process
Inventory

Equivalent Production
Computing Unit Costs:
This involves some basic steps:
1. Identify individual processing centers: Processing center are locations in the
factory where work is done directly on the goods being produced.
2. Accumulate material and processing costs: Cost accumulation is simpler in a
process costing situation than in a job order costing situation. “The reason is that
costs only need to be identified by processing center- not by separate jobs
3. Measure the Output of the period: After materials and processing costs have
been accumulated for a period, the period’s output must be computed so that
appropriate costs can be determined. If a processing center has no work to process at
the beginning or at the end, this is simple task. The periods output will simply equal
the completed units
4. If a processing center has work in process at the beginning or at the end it needs
to be valued on the basis of equivalent units
5. Compute Unit Costs: Once costs have been accumulated by the processing
centers, and the period’s output has been determined, unit costs can be computed.
Generally, this is simple task of dividing the accumulated costs by periods output:

Costing of completed units or EQUIVALENT PRODUCTION (Work-in-Process,

Finished Goods) in Process Costing:

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1) Both the completed and the uncompleted units must be estimated at the end of
each process or operation
a) Those units still in process will require estimates to be made regarding
stage of completion in terms of cost, or time, for conversion into cost
b) The physical flow of units through a cost center and the manufacturing
effort is usually in following order:
• Units started in the previous period and finished in the present
period
• Units started in the present period and finished in the present
period
• Units started in the present period and not finished in the present
period
c) Because of these mixed manufacturing efforts, production must be
measured by method other than counting whole units.
2) Cost accountants use a concept known as Equivalent Units of Production (EUP)
for this purpose.
a) In production processes, materials, labor, and overhead are applied to the
product at different rates.
• Material is often added at discrete points of time
• Labor and overheads are applied throughout the productive process
b) At the end of accounting period there remains in each stage of production
process certain amount of partially completed units which are called
WORK IN PROCESS
c) Process costing uses the concept of equivalent units to measure the cost of
partially completed units
d) IMA defines Equivalent Units as ‘The number of units of completed
output that requires the same costs as actually incurred for production of
completed and partially completed units during a period

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Accounting students have difficulty in understanding the concept of equivalent units.
Produced here below is an extract from article of Don Etnier, published in the research

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journal The Accounting Review, 1961, page

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Cost of Production Report:
1) In order to compute Equivalent Production, it is necessary to prepare Cost of
Production Report.
2) A Cost of Production report is a process costing document that details
manufacturing quantities and costs, shows the computation of cost per EUP, and
indicates the cost assignment to goods produced during the period

PROFORMA COST OF PRODUCTION REPORT

PRODUCTION DATA EQUIVALENT UNITS CALCUATIONS:

QUANTITY
CONVERSION
SCHEDULE
DIRECT DIRECT FACTORY
(Units Introduced) MATERIALS LABOR OVERHEAD
Beginning Work in Process
Started into Production
Total Units into Production

(Units Reconciled)

To Finished Goods
Ending Work in Process
Total Units Reconciled
COST DATA COST CALCULATIONS:

CONVERSION
Total Costs DIRECT DIRECT FACTORY
MATERIALS LABOR OVERHEAD

Cost of beginning work in process

Current period cost

Total cost to account for

Divided by EUP

Cost per EUP

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COST ASSIGNMENT

Transferred
Ending inventory

Methods of valuation computation and valuation of Equivalent Units of Production:

(FIFO or Weighted Average)
1. The cost method of computation of Equivalent Units and the costs assigned to
them differ according to the cost flow assumptions
2. Broadly there can be two kinds of cost flow assumptions FIFO or Weighted
3. The cost of production report format shown above can be used in any kind of cost
flow assumption- whether FIFO or Weighted Average
4. The method of computation of cost of Equivalent Units can be best described
through illustration

Illustration (1): FIFO method

Kalamazoo chemicals manufacture a single industrial chemical. In one of its processes it
uses Chemical X as an input to produce Chemical Z. The production and cost data reveals
the following:
Beginning Work In Process (40%) complete as to conversion 1500, tons started during
current period, 98500, tons of Chemical Z produced and transferred to finished goods
97500, ending work in process 80% complete as to conversion 2500 tons. The cost of
Direct Materials in the beginning work in process is $98800, direct labor applied to the
beginning work in process was $45925, and overheads applied were $43600. The cost of
direct material introduced during the current period was $9043260, the cost of direct
labor applied during the current period was $6997900, and the overheads applied were
$7014460. Compute the cost of Equivalent Production using FIFO method

FIFO method

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Total Units Rec onc iled 100,000 100,000 197,000 197,000

COSTCALCULATIONS:

COSTDATA CONVERSION
Total Costs
DIRECT FAC TORY
DIRECTLABOR
M ATERIALS OVERHEAD

$188,325.00 $98,800.00 $45,925.00 43600.00

Cost of beginning inventory
Current period c ost $23,055,620.00 $9,043,260.00 $6,997,900.00 $7,014,460.00

Total c ost to ac c ount for $23,243,945.00 $9,142,060.00 $7,043,825.00 $7,058,060.00

Divided by EUP 100,000 197,000 197,000

Cost per EUP $163.00 $91.42 $35.76 $35.83

COSTASSIGNMENT(FIFO method)
Transferred 15,892,868 $8,913,508.50 $3,486,157.04 $3,493,202.28
Ending inventory 371,718 $228,551.50 $71,510.91 $71,655.43
$16,264,585.67

Illustration (2): Weighted Average Method:

Kalamazoo chemicals manufacture a single industrial chemical. In one of its processes it uses
Chemical X as an input to produce Chemical Z. The production and cost data reveals the that
Beginning Work In Process (40%) complete as to conversion 1500 tons started during current
period,98500 tons of Chemical Z produced and transferred to finished goods 97500, ending
work in process 80% complete as to conversion 2500 tons. The cost of Direct Materials in the
beginning work in process is $98800, direct labor applied to the beginning work in process was
$45925, and overheads applied were $43600. The cost of direct material introduced during the
current period was $9043260, the cost of direct labor applied during the current period was
$6997900, and the overheads applied were $7014460. Compute the cost of Equivalent
Production using Weighted Average approach

Weighted average method:

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PRODUC TION DATA EQUIVALENT UNITS C ALC UATIONS:

Q UA NTITY
C O NV ERSIO N
SC HEDULE
DIREC T FA C TO RY
(Units Introduced) DIREC T LA BO R
M A TERIA LS O V ERHEA D
Be ginning Work in Pro c e ss
(40% c o mp le te )
1,500
Sta rted into Pro duc tio n 98,500
To ta l Un its into Pro d uc tio n 100,000

(Units completed)

Be ginning Invento ry C o mp le te d 1,500 900 900

C urre nt Pd Pro dc tn C omplete d 96,000 96,000 96,000 96,000

To tal C o mp le te d 97,500

2500 2000 2000

Ending Wo rk in Pro c e ss 2,500

To ta l Un its Re c o n c ile d 100,000 98,500 98,900 98,900

C OST C ALC ULATIONS:

C OST DATA C O NV ERSIO N

To ta l C o sts
DIREC T FA C TO RY
DIREC T LA BO R
M A TERIA LS O V ERHEA D

$188,325.00
C o st o f be ginning inve nto ry
C urre nt pe rio d c o st $23,055,620.00 $9,043,260.00 $6,997,900.00 $7,014,460.00

$23,243,945.00
To ta l c o st t o a c c o unt fo r
Divided by EUP 98,500 98,900 98,900

Cost per EUP $233.49 $91.81 $70.76 $70.92

LIFE CYCLE COSTING

In order to know about the life cycle costing, we should know the meaning of PLC.

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The product life cycle (PLC) spans the time from initial R & D to the time at
which the support to customers is withdrawn. Under life-cycle budgeting, managers
estimate the revenues and costs attributable to each product from its initial R & D to its
final customer servicing and support in the market place. Life cycle costing tracks and
accumulates the actual cost attributable to each product from start to finish i.e. from
cradle to grave.
Life Cycle Reports:
• Product Life Cycle reports do not have calendar basis. Life cycle reports are
prepared for different phases of product life.
• Product life cycle reporting offers 3 benefits
o Revenues and costs associated with each product become clear
o Differences among products in total costs incurred at early stages in the
life cycle are highlighted
o Interrelationships among business function cost become clear. Example
companies that cut back their R & D and product design cost may
experience major increases in customer service costs in subsequent years.
• Management of environmental costs is one of the areas of application of Life
cycle costing principles.
o The enactment of strict environmental laws has introduced tougher
environmental standards and increased the penalties and fines for polluting
the air and contaminating subsurface soil.
o Compliance of these regulations costs money to the firms.
o In addition, in order to design environmentally safe products, companies
have to spend more money on R&D in order to design environmentally
safe products and incur costs on recycling the products after their useful
life.
o Companies have to incur high cost on disposal of waste.
o Environmental costs are locked into the product costs at the design stage.

ACTIVITY BASED COSTING

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1. A cost object can be anything for which it is worthwhile to compile costs, such as
a department, a product, or activity.
2. Under Activity based costing (ABC) the focus is on activities.
3. Activities are the cost objects and uses cost of activities as building blocks for
compiling cost of products and other cost objects.
4. ABC is generic and can be used in conjunction with Job order costing system or
Process costing system that is divided into departments.
5. Activity-based costing (ABC) is a costing approach that assigns resource costs to
cost objects such as products, services, or customers based on activities performed
for the cost object.
6. ABC approach is based on the premise that a firm’s products or services are the
result of activities and activities use resources which incur costs.
7. Costs of resources are assigned to activities based on the activities that use or
consume resources and costs of the activities are assigned to cost objects based on
activities performed for the cost objects.
Activity:
An activity is a specific task or action of work done. An activity can be a single action or
an aggregation of several actions.
Resource:
A resource is an economic element needed or consumed in performing activities.
Supplies are an example of resource needed in manufacturing activities.
Cost driver:
A cost driver is a factor that causes a change in the cost of an activity. Cost drivers are
used as bases for allocating resources to the activity.
Resource consumption cost driver:
A Resource consumption cost driver is a measure of the amount of resources consumed
by an activity. It is the cost driver for assigning a resource cost consumed by or related to
an activity to a particular activity or cost pool

Activity consumption cost driver:

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An activity consumption cost driver measures the amount of an activity performed for a
cost object.
The Two-Stage Cost Assignment Procedure
1. A two stage cost assignment procedure assigns resource cost such as factory
overhead cost to cost pools and then to cost objects to determine the cost of cost
objects.
2. Volume based costing systems assign factory overhead costs first to plant or
departmental cost pools and next to products or services.
a. This system is convenient because accounting systems accumulate cost
information by department which can easily be aggregated to plant level.
b. In the second stage, a volume based rate is used to apply overhead to each
of the cost objects.
3. Activity based costing systems differ from volume based costing systems by
tracing uses of resources to activities and linking activity costs to products,
services, or customers.
a. The first stage assigns factory overhead costs to activities or activity cost
centers (activity cost pools) by using appropriate resource consumption
cost drivers.
b. The second stage assigns the costs of activities or activity cost pools to
cost objects using appropriate activity consumption cost drivers that
measure the demands cost objects place on the activities.
4. Thus, activity-based costing systems differ from volume based costing systems in
two ways.
a. First, the ABC system defines cost pools as activities rather than
production plant or department cost centers.
b. Second, the cost drivers that the ABC system uses to assign activity costs
to cost objects are drivers based on an activity or activities performed for
the cost object.

Steps in Activity Based Costing:

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Step 1: Identify Resource Cost and Activities
a. Resource costs are recorded in specific accounts of the firm. Examples
include supplies, purchasing, material handling, warehousing, office
expenses, furniture and fixtures etc
b. Activity analysis is necessary to determine activities of the firm. This is
done by collecting data through questionnaires, surveys, interviews with
key employees etc. At the end of activity analysis an Activity dictionary is
prepared.
Levels of activity:
Activities can be classified according to the way they consume resources. The activities
may be:
1. Unit level activity at each individual unit of product or service of
the firm. Example Direct Material, Direct Labor etc
2. Batch level activity performed for a batch or group of products of
services. Examples Setting up of machinery, placing purchase orders,
scheduling production etc
3. Product level activity supports production of specific product or
service. Examples include designing the product, engineering changes to
specific products, administering parts required for specific products etc
4. A facility level activity supports operations in general.
5. These are not caused by product or customer service needs and
cannot be traced to individual units, batches or products. Example
providing security and safety, maintenance, incurring factory taxes etc
Step 2: Assign Resource Costs to Activities
a. Activity-based costing uses resource consumption cost drivers to assign
resource costs to activities.
b. Activities drive the cost of resources used in operations, so a firm chooses
resource consumption cost drivers based on cause and effect relationship.
c. Typical resource consumption cost drivers include the number of
i. labor hours for labor intensive activities;
ii. employees for payroll related activities

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iii. setups for batch related activities;
iv. moves for material handling activities;
v. machine hours for machine repair and maintenance; and
vi. Square feet for general maintenance and cleaning activities.
Step 3: Assign Activity Costs to Cost Objects
d. The final step is to assign costs of activities or activity cost pools to cost
objects based on the appropriate activity consumption cost drivers.

BENEFITS:
Firms adopt activity based costing to reduce distortions in product costs found in volume
based costing systems. The major benefits of ABC are:
a) Better profitability measure: ABC provides more accurate and informative product
costs, leading to more accurate product and customer profitability measurements
b) Better decision making: ABC provides more accurate measurements of activity-
driving costs, helping managers to improve product and process value by making
better product design decisions, customer support decisions, and taking up value
enhancement projects
c) Process improvement: The ABC system provides the information to identify areas
where process improvement is needed
d) Cost estimation: Improved product costs lead to better estimates of job costs for
pricing decisions, budgeting, and planning
e) Cost of unused capacity: Since many firms have seasonal and cyclical fluctuations
in sales and production, there are times when plant capacity is unused. The costs
are incurred at batch, product and facility level activities but are not used. ABC
systems provide better information to identify unused capacity.

Activity Based Management:

1. Activity-Based Management (ABM) manages activities to improve the value of
products or services to customers and increase the firm’s competitiveness and
profitability.

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2. ABM draws on ABC as its major source of information. Using ABM,
management can pinpoint avenues for improving operations, reducing costs, or
increasing values to customers.
3. By identifying resources spent on customers, products, and activities, ABM
improves management’s focus on the firm’s critical success factors and enhances
its competitive advantage

ABM applications can be classified into two categories:

• Operational ABM
• Strategic ABM.
1. Operational ABM enhances operation efficiency and asset utilization and lowers
costs; its focuses are on doing things right and performing activities more
efficiently.
2. Strategic ABM attempts to alter the demand for activities and increase
profitability through improved activity efficiency.
a. Strategic ABM focuses on choosing appropriate activities for the
operation, eliminating nonessential activities and selecting the most
profitable customers.
b. Strategic ABM applications use management techniques such as process
design, customer profitability analysis, and value chain analysis.

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