Activity-Based Costing (ABC) delivers more accurate costs - this is the mantra pushed by advocates of this costing approach. How so? Here's we draw on a few practical examples to help bring clarity to this claim.
Example 1: Nanosolar
Our first example will consider the high-level production activities of Nanosolar, a leading manufacturer of solar cells and panels. (You can read more about the company here.) There are 4 high-level steps in nano-solar's solar panel production process: (i) production of nanoparticle ink, a fundamental ingredient in a solar panel's energy capturing potential; (ii) printing nanoparticle ink onto propriety aluminium foil; (ii) cutting foil and assembling them into solar cells; and (iv) assembling cells together to form solar panels (the finished product). Watch the process in action here.
After reading through the basic production process and watching the associated video, Think about the following:
After reading through the basic production process and watching the associated video, Think about the following:
- What are the significant costs incurred in this process? (Specifically identify as many as you can.)
- What proportion of these costs are likely to be directly traceable to eachpanel produced (high/low)?
- For the indirectly traceable costs, what proportion is likely vary with each panel produced (high/low)?
Example 2: Fine Dining
Have you ever bemoaned the cost of eating out, particularly when it comes to fine dining? Many have difficulty reconciling menu prices with what they receive on the plate. Amusingly, some people I know go as far as to sprout the theory that the price of a meal is inversely related to the amount of food one receives on the plate! Of course, this theory is based on the limited view that the cost one can see on the plate (the physical ingredients to the actual meal) accounts for all the costs. Some investigative journalism by the Sydney Morning Herald (see articles here and here) highlighted that there are many overheads that need to be taken into account, and that the margin being made on each meal may be far less than one thinks. Take for example the following meal from Canberra's Aubergine restaurant:
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| Would you pay $36 for this meal? (Source: Sydney Morning Herald). |
The above example shows the many indirect (otherwise known as shared or overhead) costs associated with this meal. Think about the following:
- What are the implications of this high proportion of overhead costs?
- Are there further implications from the fact that many of these overhead costs would not vary with each meal served?
The value of ABC
Reflecting on the above examples, the value of ABC comes in being able to identify more specific and robust logics for how overhead costs should be apportioned to things we want to estimate the cost of. This is particularly so where overhead is a higher proportion of total costs; many of those costs are driven by something other than volume of output (e.g. batches run, product lines maintained, or general facility-related concerns), and where, in a multiple product/service provision setting, different products/service draw on proportionately different levels of resources.
On the flip-side ABC can be quite expensive and resource intensive to implement. And it brings its own problems, uncertainties and motivational issues. What are your experiences with organisational uses of ABC systems. Have they been of benefit? What problems were encountered?
