Having covered

1. Cost Objects
and
2. Identifying Activities
3. Cost Drivers
4. Activity Drivers

Let's wrap up with:

ABC and Budgeting

Organizations can use ABC to do budgeting. They typically start with the expected sales volume or another requirement of the business and then determine the activity level necessary to support this volume. Once this activity is agreed on, historical activity-based cost fixes an initial budget. Next, known or expected increases of labor or purchased services are then factored into the activity cost. Finally, planned cost reduction opportunities, less the cost of resources that may be required to implement the cost reduction opportunity, are reflected in the budget. The final budget, therefore, includes the cost of activities the department has agreed to do, adjusted for inflation and quantified improvement targets. The steps are summarized below.
5. Expected sales volume, or other requirements of the business
6. Determine activity needed to support sales

Budget =

(Activity Based Costs + Expected increases in costs) - Planned reductions of cost

Example: ABC in Evaluating Outsourcing Opportunities

The manager of the payroll department in an a large company was asked to evaluate a bid to outsource the payroll function to a service company specializing in payroll activities. As a basis for evaluation and recommendation, this manager did an activity based evaluation of the payroll department. Appropriate staff defined and costed each activity, and the number of transactions (outputs) associated with the activities was determined. Once completed, this analysis was compared to the bid for payroll services.

The evaluation produced interesting results. First was that many of the departmental activities would not go away with outsourcing. Activities associated with the collection, review, and correction of time attendance records remained with the company. Next, while the costs of the payroll department were comparable, in terms of total dollars and by transaction, with those activities (preparing payroll checks, preparing payroll tax filings, maintaining payroll master file) included in the bid amount. The activity based analysis enabled the manager to make a comparison of similar activities available from the bid and to make a recommendation to keep the payroll function inside the company.

Even though the comparison of internal costs was about the same as the bid amount, the manager used the activity analysis to determine that the payroll department was not completely competitive and needed to improve. This was because the manager knew the service firm included a profit in the bid amount. Therefore, the estimated cost of performing the activities by the service firm was less than the payroll department. Also, the analysis surprised the manager by highlighting the amount of money being spent on activities like correcting errors. With this knowledge, the manager took action to focus efforts on improving the department activities.

[1]
Developing a Curriculum (DACUM) A system of analyzing a subject in a team by writing ideas on pieces of paper and posting them on the walls so they are visible to the whole group.

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