Manufacturers & Distributors ARTICLE -

Activity-Based Costing Makes Accounting as Lean as the Plant

Target Audience: Manufacturing and Distributing Companies, M&D Industry Employees, Manufacturing Distributors

Lean manufacturing is becoming an industry standard practice, but it may not be suited for traditional accounting practices. As companies adopt lean manufacturing, they may also want to consider lean accounting methods, such as activity-based costing.

More accurate than traditional accounting, activity-based costing identifies the costs — including overhead — of every activity. By isolating the factors that drive overhead costs, activity-based accountants can then use formulas to allocate those costs to specific processes and procedures throughout the business.

Effective but complex

With an accurate road map of expenses tied to activities, management can reduce or eliminate waste, increase productivity and simplify processes. Activity-based costing is, in effect, a continuous improvement program that can affect everything from how you handle customer correspondence to how you sort inventory. Activity-based costing can be complex, however, and create confusion if it isn’t properly implemented. The goal is to assign all cost drivers to a product or service. That means someone must develop accurate and appropriate data with enough documentation to satisfy audit requirements, and then use the data to make policy decisions.

The process

• Activity-based costing is a multistep process. If you decide to adopt this method, expect to:

• Analyze activities — noting whether or not they are value-added. Non-value-added activities are those that add cost, create waste or delay, or don’t produce revenue. Establish the scope of the activities to be analyzed before beginning.

• Gather costs. These include items such as salaries, research, equipment, office furniture and materials. 

• Link costs to activities. Multiply the percentage of time a business unit spends on a particular activity by that unit’s input cost to arrive at the total input cost.

• Establish output measures. Activities may have multiple outputs, but only one measurable volume or quantity should be identified as the primary output. By dividing the total input cost by the primary output volume, activity-based accountants can calculate the total cost activity charging rate for a set of activities.

• Analyze costs to improve business processes. By identifying the activities that consume the majority of costs, you can begin to see where those activities can be changed. This activity also clarifies non-value-added costs that you can eliminate, as well as opportunities for efficiencies that you can implement.

Choosing an accountant

Activity-based costing can be a powerful business tool when it is executed with high professional standards, accurate and comprehensive data, and the requisite technical knowledge and ability. 

The person you select as the activity accountant should have management and analytical experience to supplement a technical accounting background. If those skills aren’t present in a single person, a team may be appropriate, although final decisions should be made by the designated activity accountant.

Simpler operations

Activity-based costing isn’t simple, but in the end it may lead to significantly simpler operations — as well as significantly greater savings.

Find out how our M&D accountants can add value to your business. Email us or call us at 1 (888) 875-9770.

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