Activity Based Costing And Value Addition- An Academic Matter

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General Costing vs. Activity based costing- Academic matter

Today’s discussion would cover the costing concepts in organizations. Generally while doing costing or cost accounting we normally put different earning and spending on generic terminology, we call heads. This is generally accounting procedures and standards that everybody does understand. But, while analyzing business performances we better check out activities that really matters in order to identify who is doing what in terms of contribution to profits or revenue earning.

This sounds clumsy, but it is not. If check the following table it would be clear as ever. Say for example- we spend money to pay the salaries of staff, paying fringes for small expenditures, or pay for supplies, and there are fixed costs too. This is generic. The same total 590,345/– would be segregated in different names or according to activities, that’s why it is called activity costing. The heads would be different in names or calling, but the total figure would remain be the same. Such as-

Activity based costing at ABC Corporation

Traditional Accounting                      Activity Based Costing

                                                Salaries                       Fringes            Supplies          Fixed Costs

Salaries

$ 371,917

Fringes

$ 118,069

Supplies

$ 76,745

Fixed Costs

$23,614

Total $ 590,345

Processing sales order                                                  144,646

Sourcing parts                                                              136,320

Expediting Supplier orders                                            72,143

Expediting internal processing                            49,945

Resoliving supplier quality                                             47,599

Reissuing purchase orders                                             45,235

Expediting customer orders                                           27,747

Scheduling intracompany sales                          17,768

Requesting engineering change                          16,704

Resolving problems                                                       16,848

Scheduling parts                                                           15,390

Total                                                                           $590,345

The advantages the activity costs have are numerous. The managers could pin point the contributions and could commensurate accordingly. Normal complaining about getting less or more would be evaporated. Staff would be motivated and equitable justice could be ensured.

Economic Value Addition and investment – in a layman sense

Managers have many responsibilities in running a company. In short they could be summarized as:

Based on Responsibility:

Philanthropic Responsibility

Ethical Responsibility

Legal Responsibility

Economic Responsibility

While doing business or setting up of business goals or objectives the managers must implement the responsibilities upward turn, rather than downwards. It means the main responsibility not sole responsibility is economic responsibility, which refers the Investors interests must be fulfilled first, otherwise, the investment would be deemed as waste; while pursuing this legal aspects must not be forgotten in doing or choosing business and processes, thirdly moral and ethical aspects are also related to human development and human resource development of the organization for the sustainability. Philanthropic is the last options to fulfill, after all others being done successfully.

While economic responsibility matter- the following interested parties and their objectives too must be considered. While computing the objectives managers must check the corporate objectives first, although in people’s case- individuals will consider their own objectives first and so one.

Based on Operations: 

Individual objectives

Departmental objectives

Divisional objectives

On the basis of economic value addition or deduction investors do consider their portfolios, where to put their money and not. The following examples would clarify the matter more explicitly. Here two companies for example- Anheuser Busch and Spiegel. In doing business one is creating value and the other is not. Although after tax operating profit is bigger and the other is smaller, where should the investor put their money is easily understandable.

Example of Affecting Value for Investors:

Anheuser-Busch                                   Spiegel

After tax operating profit                                   $1,139 mill.                                          $119 mill.        

minus               

cost of capital   (Equity +debt)                          $904 bill.                                              $178 bill.

= Value Created/ (Destroyed)                           $235 mill.                                             $59 mill.

Source: Fortune September 20, 1993.

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