Activity Based Costing (ABC)
Background:
It is evident that at present time more and more universities and higher education
institutions use advanced technology medium such as the web to disseminate pertinent
information about their services, conduct research, deliver instruction etc. The way this
information is presented or obtained could add or destroy value for end users. For example,
uninformative web pages with broken links, and poor quality hardware have greater potential
of destroying IT value. A presentation of services using IT requires a careful study.
As much as it is necessary to evaluate the content and the technical factors of IT services, it
is also necessary to evaluate the cost associated with the services. Before conducting any of
these evaluations, it is important to see if the services being considered will help meet
institutional goals and parallel with the “mission” of the University.
Universities need a costing system to perform the functions of understanding the costs of
activities, products, services and customers and providing feedback and insights to
management on what causes costs. Activity Based Costing (ABC) is an alternative
accounting system that will deliver data for understanding the costs.
What is ABC?
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It is an accounting system that assigns costs to products/services based on the
resources they consume.
In an ABC system the cost of all activities and overhead are traced to a particular
product or service rather than spread across all product lines or services. This
enables resources and overhead costs to be more accurately assigned to the product
and the services that consume them.
An ABC system gives visibility to how effectively resources are being used and how
all activities contribute to the cost of a product or service.
Example:
Traditional
ABC
Salaries $100
Clean door $40
Equipment $80
Paint door $75
Supplies $20
Inspect door $75
Overhead $45
Send door to assembly $55
TOTAL $245
TOTAL $245
As you can see in the example, ABC provides information about how costs are actually
consumed. ABC did not eliminate or change costs. Using the ABC system then a manager
could evaluate the costs for each activity and may decide to combine some of the steps in
order to lower costs.
Why ABC is important to University IT:
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It is a means for justifying activities performed and the funding required for
supporting these activities.
May provide more accurate data that may serve to justify the investment or to
identify the need to withdraw or modify services.
Provides data that can assist in decision related to transferring of resources across
services.
Serves to highlight efficiencies and inefficiencies
In a service Level Agreement (SLA) environment, it can also provide valuable
costing data that will assist in 1) negotiation and re-negotiation and 2) advancing
arguments for a centralized model of support against a devolved
ownership/responsibility model (or, possibly even vice-versa)
Assists in decision making relating to the protection of core vs. non core
Ensures that expenditure of activities is consistent with organizational goals,
objectives and strategies
Provides opportunities for benchmarking
May assist with information to assist in outsourcing decisions.
Relationship of services to resources in an ABC syste m:
The relationship between services (cost objects) and the resources that are consumed by the
services is displayed below.
Resources =>resource drivers =>activities =>activity drivers =>cost objects
Examples of Resources are people and machines.
The resource driver is the measure of the frequency and intensity of the demands placed on
resources by activity.
Activities are the processes performed by people and machines.
Activity drivers measure the frequency and intensity of the demands placed on activities by
cost objects enabling costs to be assigned to cost objects.
Cost objects are the products, services produced.
Cost drivers are the factors that affect the cost of an activity, e.g. poor quality.