Activity-based costing for product cost estimative and productivity improvement

Activity-based costing for product cost estimative  and  productivity improvement  
Activity-based costing (ABC) is a new method for calculating the cost
of product thereby replacing traditional cost.  Give accurate product
cost and provides insight information of operation for managers.   
            For the past two decades, the traditional cost method has
failed to provide such accurate costing of products for companies
(Tsai, 1995).  Traditional cost assigns overhead cost to only one cost
driver such as direct labor cost, direct labor hour, direct material. 
Overhead cost was a small portion of the overall product cost, while
nowadays overhead cost tend to takes up a much larger portion.  ABC provides managers with rich information to make better decisions.  By allocating overhead costs to activities that the product consumed, activity-based costing provides managers with accurate cost of products and financial information             Traditional costing lay in the concept that overhead costs can be
allocated from one cost driver such as direct labor hour, direct labor
cost, and direct material cost.  The overhead cost will be calculated
by multiplying the direct cost by a mark-up constant, which is assigned
by managers depending on their experience.  In the past, the
traditional costing was adequate because of major two reasons (Andrade
et. al, 1999; Cokins, 1999): (1)   The fraction of total product
cost due to the direct cost component was substantially larger than
overhead component.  Therefore, imprecise estimate overhead cost would
not cause a big distortion in the cost of product. (2)   Overhead
cost component as and is inherently more expensive to determine than
the direct cost component.  Spending time and money to allocate small
amount of overhead would not be worth.   Activity-Based Costing (ABC) requires the execution of the following steps:            
  To identify firm resources is to identify all direct and indirect
costs of operation (e.g., cost of material handling between machine A
and machine B).  Then these costs will later be attached to specific
activities (e.g., material handling).  This suggested that mapping firm
activities that should be performing at the same time.  Activities need
to include ones that directly operate to produce products and ones that
are indirect such as general management and administrative activities.
                The second step, after managers have information of
resources and activities, trace those costs from resources to
activities to identify cost drivers.  Identification of proper cost
drivers is one of the greatest challenges of the ABC method (Goldsby,
& Closs, 2000).  The third step of ABC method is to trace
costs from activities to cost objects.  For example, product A requires
20 setups.  The cost of driver results from the second step equal $200
per setup.  Therefore cost of setup for product A equal to $200x20
setups =$4,000.  Four thousand dollars is then assigned to product A
for setup activity. Activities in ABC method can be can be
categorized in four types.  Each type of activity behaves differently. 
These four types of activities are (Gunasekaran, & Sarhardi, 1998;
Lere, 2000) (1)      Unit-level activities bases, which assume
the cost of a unit-level activity changes in direct proportion to
change in the number of units produced.  Costs are occurred in response
to unit-level activities behave like variable costs.  Thesame amount of
cost must be incurred each time an activity is performed and the same
amount of activity must be performed for each unit of a product
manufactured. (2)       Batch-level activities bases, which
assume that cost of a batch-level activity changes in direct proportion
to change in the number of batch produced.  Each batch contain
different numbers of units, the cost of batch-level activities will
vary with the number of batches produced, not the number of unit.
(3)      Product-level activities bases, which assume that cost of a
product-level activity, is necessary to support the production of each
different type of product.  The example can be seen in book printing,
the correction of an error on a plate is consist to be product-level
activity, because this plate will be use in printing books until it
wears out, another error was discovered, or books go out of print. 
Therefore, this type of activity will be assign as product-level
activity. (4)      Facility-level activities bases, which
associated with providing the capacity necessary to undertake the
manufacturing operations, marketing operations, or administration.  The
examples of these costs are such as depreciation, property taxes, and
insurance.  These costs behave like fixed costs under the traditional
cost behavior classification but be smaller amount compare to
traditional fixed costs because they present only the portion that are
not vary by unit-level, batch-level, or product-level activities.            
            Basic benefits for companies that have ABC in place can be
summarized below (Gunasekaran, & Singh, 1999; Cooper, 2000):
(1)   ABC gives a more accurate product costing.  The company then can
be aware of the real cost of the product.  ABC might reveal the product
that company thought was profitable was actually losing money. 
(2)   ABC provides non-financial information.  Besides giving
information on a financial basis, ABC gives companies the information
on how each activity generates product cost.  (3)   ABC
encourages improvements.  Because ABC provides insight information of
operation, managers can see where most of the cost comes from, and how
much each activity costs when it is performed and how it relates to
certain types of products.