The Activity Based Costing (ABC) module enables you to more accurately apportion overhead costs to specific products; the aim being to associate elements of overhead cost to those products that actually cause the cost.
AB Costing allows for the accumulation and recovery of costs associated with the purchase, manufacture and sale of items, resulting in improved accuracy in calculating product profitability.
AB Costing is not another SYSPRO Inventory costing method (e.g. Average, Standard, FIFO, LIFO and Last Cost), but rather, it provides you with a different method of calculating these costs.
When using traditional costing methods, each part has material and labor costs. The labor costs are made up of direct costs based on the time spent for each operation, and fixed and variable overhead costs. It is these traditional overhead costs that activity based costing supersedes. These overhead costs often comprise a significant portion of the total cost of a product and, therefore, increased accuracy in the cost recovery allows improved accuracy in calculating product profitability.
The traditional costing method of loading overheads against a product according to the labor content becomes increasingly inaccurate when processing a diverse range of products, particularly where disparate overhead usage is involved.
For example: If you were manufacturing two products - both consuming the same time and production facilities (e.g. washers, where one is manufactured from mild steel and the other from gold) then the overhead costs would be carried equally between the products. By implication, therefore, when using traditional costing methods the cost of the mild steel washers would have excessive overheads, while the overheads of the gold washers would be subsidized (in that the overhead costs of safes, security guards, etc, are only there because of the gold washer). This would lead to the reported cost of the mild steel washers being too high and the gold ones too low. This in turn could lead to the setting of inappropriate selling prices of the products with adverse effects on the company's sales and profit.
ABC costing attempts to more accurately attribute overhead costs to specific products by applying them at the points of transition in the procurement, manufacturing and sales cycle.
Overhead costs are accumulated against items as they are purchased, manufactured and sold, by attaching elements of cost to each transition point (i.e. at the actual point of purchasing, manufacturing, or selling an item). These costs may be fixed per batch, or based on the quantity being handled.
- Pre-production costs such as buying, expediting, goods-in, etc. can be recovered as items are received into stock from purchase orders.
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Manufacturing costs may be recovered at the time of receipt into stock of goods from Work in Progress.
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The recovery of these ABC overhead costs may be over-and-above the overheads recovered using traditional methods (i.e. labor postings into work in progress).
- Post-production costs, such as marketing, credit control, inspection, packing, shipping, etc, can be recovered through cost of sales as the final item is invoiced.
The above instances allow you to define the activity during which each element of cost is incurred. Each ABC incidence is calculated by adding the elements for that part/incidence. The element cost is calculated by multiplying the driver quantity by the element calculation rate.
The accurate calculation of ABC costs depends on establishing various criteria:
- What are the elements of cost?
- Where do they occur? (pre-production, manufacturing, or sales)
- How do they occur? (once per batch as in placing a purchase order; in batch mode as in goods receiving; or individually as in 100 % inspection of goods)
For each element of cost it is necessary to define a driver quantity, allowing some measure of relative importance as the cost is defined against a particular product.
For example: If the cost element represents picking items from stock then the driver quantity for the element (stores issuing) could indicate the number of items in the bill of materials. However, when buying items the purchasing element driver quantity could be the reliability of the supplier on a scale of say 1 to 10.
It is important that whenever a product is assigned an element driver quantity that the same relative measure is used. To assist in maintaining consistency, narrative comments can be attached to elements when they are added.
Unlike traditional costing, which has a relatively simple driver (labor hours per cost center) the sheer diversity of potential drivers in the ABC system would make the calculation of a recovery rate extremely difficult. To assist in this, a Recoveries Estimate Report is provided to calculate a divisor which can be used against estimated cost to establish a unit rate.
The system allows you to adopt a migration approach whereby progressively more overheads may be recovered using the ABC driver approach and less by the traditional labor usage method. This is achieved by providing separate ABC costs that can be run in parallel with traditional costing methods. These ABC costs can then be analysed while your company's day-to-day costing and accounting procedures remain unaffected. As confidence increases, overhead costs for the areas to be recovered via ABC can be removed from the traditional labor-based overhead rates and the system integrated with the company's accounting procedures.
You would typically implement Activity Based Costing if the information it provides will lead to action that will increase the overall profitability of your business. Analysis provided by activity based costing will differ significantly from that provided under the traditional system under the following circumstances:
- when production overheads are high relative to direct costs, particularly direct labor costs
- where the product range is diverse
- where there is considerable diversity of overhead resource input to products
- when consumption of overhead resources is not driven primarily by volume
This section describes how to implement Activity Based Costing.
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Define the activity based costing setup options (Bill of Materials Setup - AB Costing tab).
You can only activate AB Costing if you have installed the Inventory and Bill of Materials modules and inventory costs are not held in a unit of measure other than stocked (Inventory Setup).
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Define the ABC costing variance ledger code (General Ledger Integration - Inventory tab).
Postings are made to this account only if the value of the total cost of a receipt differs from the value of the new unit cost multiplied by the receipt quantity. (The total receipt cost is calculated as the quantity received multiplied by the unit cost, to which are added the total ABC costs. The new unit cost is calculated as the total receipt cost divided by the quantity received.)
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Add elements of cost using the Browse on Element Descriptors program.
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Against each stock item for which you require ABC costing, you must select the Activity based costing required option (Stock Code Maintenance - Other tab).
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Link elements of cost to the required stock items using the Browse on Element Structures program.
During this phase, the incidence (pre-production, manufacturing or post-production) and driver quantity must be entered. You can define more than one incidence code for the same element against an item.
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Run the ABC Recoveries Estimate Report program to establish probable driver units to be produced in a period, and a rate per element from which to recover the estimated costs in that period. These rates are entered using the Browse on Element Descriptors program.
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Run the Cost Implosion program to calculate the costs at all levels.
The ABC costs are accumulated separately, the cost of each element accumulated and added into the appropriate incidence field. The pre-production and manufacturing incidence are accumulated up to the next level (parent part), while the post production incidence only occurs for that level. The sales elements are not carried from component to parent. The cost of the sale of a part cannot affect the cost of selling the part of a higher level since it has already been sold.
If you selected Yes at the setup option: Activity based costing required (Bill of Materials Setup - AB Costing tab), then in addition to the above steps, you need to perform the following:
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Having established that the calculated costs are correct, run the Transfer BOM Costs to Wh Costs to import costs into the accounting system.
A stock revaluation journal is produced.
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Run the AR Invoice Register program to calculate the ABC sales costs held against stock codes which have been invoiced using the AR Invoice Posting and Sales Order Entry programs.
The following files are updated with the new costs:
- customer movement
- inventory movement
- sales transaction
- ABC analysis
- sales distribution
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Process stock items (i.e. purchase order receipts, receipts of parts from work in progress, stock issues, etc,) and generate the Inventory Journal Report and GRN Journal Report for audit trail purposes.
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If the option: Create GL journal is not selected for Inventory (General Ledger Integration), then run the Inventory GL Integration and GRN GL Integration programs to ensure that all the General Ledger journals for transactions processed are created.
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If the option: Post GL journal is not selected for Inventory (General Ledger Integration), then use the GL Journal Entry program to post the journals into the General Ledger.
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Run the Analysis Report program to analyse the results.
If you selected Yes, but costs not updated at the setup option: Activity based costing required (Bill of Materials Setup - AB Costing tab), then
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Run the ABC Recoveries Estimate Report report to assess the recoveries that would have been made had the ABC system been integrated.
This section gives a breakdown of the apportioning of ABC costs within the system.
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| Pre-production | Debit | Credit |
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| Warehouse control account [quantity x warehouse cost] |
Interface entry (GRN suspense) [quantity x (warehouse cost - pre-production ABC cost] |
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| Each applicable ABC element ledger
code [pre-production ABC cost] |
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| ABC variance account [balance, if any] |
| Manufacturing | Debit | Credit |
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| Warehouse control account [quantity x warehouse cost] |
Work in progress control account [quantity x (warehouse cost - manufacturing ABC costs)] |
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| Each applicable ABC element ledger
code [manufacturing ABC cost] |
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| ABC variance account [balance, if any] |
| Sales | Debit | Credit |
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| Cost of sales ledger account [quantity x (warehouse cost + sales ABC costs)] |
Warehouse control account [quantity x warehouse cost] |
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| Each applicable ABC element ledger code [sales ABC cost] |
Refer to Activity Based Costing Integration for additional information and examples of AB costing integration to the General Ledger.
Overhead costs in traditional systems are generally absorbed by products using a volume-based measure. The activity based approach, where appropriate, seeks reasons other than volume to apportion overhead costs. AB Costing attempts to more accurately attribute overhead costs to specific products by applying them at the points of transition in the procurement, manufacturing and sales cycle.
Overhead costs are incurred in carrying out a number of different types of transactions. These include:
- Logistical transactions - activities relating to the flow of materials, products and other resources through the production and distribution process.
- Balancing transactions - activities relating to ensuring that the supply of resources and products is matched to their demand.
- Quality transactions - activities concerned with ensuring that output conforms to specified requirements.
- Change transactions - activities concerned with meeting customer requirements for altered specifications, product designs, delivery dates, etc.
Activity based costing identifies the activities that cause a cost to be incurred and searches for the fundamental cost driver for each activity. Once the activities and their drivers are identified, this information can be used to attach the overhead costs to the appropriate products (cost objects).
When you receive an item into stock (Inventory Movements - Receipt) then any pre-production elements assigned to the item are calculated and added to the receipt cost entered.
The calculation of ABC elements is performed as follows: driver quantity x element rate (single-based and batch-based) driver quantity x element rate x transaction quantity (item-based).
Costs are apportioned as follows:
| Inventory Receipt | Debit | Credit |
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| warehouse control account (quantity x warehouse cost) |
interface entry [quantity x (warehouse cost - pre-production ABC cost)] |
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| each applicable ABC element ledger
code (pre-production ABC cost) |
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| ABC costing variance account (if the value of the total cost of a receipt differs from the value of the new unit cost multiplied by the receipt quantity) |
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The Use single type ABC elements option (Inventory Movements) enables you to indicate whether pre-production elements defined with a calculation method of single must be included in the calculation of costs. |
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When you receive a finished item back into stock (Inventory Movements - Backflushing) then any manufacturing elements assigned to the item are calculated and added to the receipt cost.
The calculation of ABC elements is performed as follows:
- driver quantity x element rate (single-based and batch-based)
- driver quantity x element rate x transaction quantity (item-based)
Costs are apportioned as follows:
| Backflushing Receipt | Debit | Credit |
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| warehouse control account (quantity x warehouse cost) |
interface entry [quantity x (warehouse cost - manufacturing ABC cost)] |
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| each applicable ABC element ledger code (manufacturing ABC cost) |
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| ABC costing variance account (if the value of the total cost of a receipt differs from the value of the new unit cost multiplied by the receipt quantity) |
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When processing a purchase order receipt for a bought-out item and a cost is entered manually, then the pre-production elements are calculated and added to the cost entered. If using the last cost, no ABC costs are added.
If you are using standard costing (Inventory Setup) then the value of stock is increased by the inventory cost, while the merchandise content is calculated by deducting the pre-production elements of cost held against the item.
If you are using Average or FIFO costing, then the value of stock is increased by the new merchandise cost multiplied by the quantity plus the appropriate ABC elements.
The calculation of ABC elements is performed as follows:
- driver quantity x element rate (single-based and batch-based)
- driver quantity x element rate x transaction quantity (item-based)
Costs are apportioned as follows:
| Purchase Order Receipt | Debit | Credit |
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| warehouse control account (quantity x warehouse cost) |
interface entry [quantity x (warehouse cost - pre-production ABC cost)] |
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| each applicable ABC element ledger
code (pre-production ABC cost) |
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ABC costing variance account (if the value of the total cost of a receipt differs from the value of the new unit cost multiplied by the receipt quantity) |
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When processing a job receipt, the manufacturing elements are calculated and added to the cost entered.
If you are using Average, Last or FIFO costing, then the value of stock is the entered cost plus the appropriate ABC elements. The value of work in progress is reduced by the entered cost.
If you are using standard costing, then the entered cost is the last cost and will not include the ABC elements of the part or assembly. The value of work in progress is reduced by the standard cost less the manufacturing cost elements held against the item.
The calculation of ABC elements is performed as follows:
- driver quantity x element rate (single-based and batch-based)
- driver quantity x element rate x transaction quantity (item-based)
Costs are apportioned as follows:
| Job Receipt | Debit | Credit |
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| warehouse control account (quantity x warehouse cost) |
interface entry [quantity x (warehouse cost - manufacturing ABC cost)] |
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| each applicable ABC element ledger
code (manufacturing ABC cost) |
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| ABC costing variance account (if the value of the total cost of a receipt differs from the value of the new unit cost multiplied by the receipt quantity) |
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You use the AR Invoice Register program to calculate the ABC sales elements held against stock items that have been invoiced within the Sales Order Entry program.
The calculation of ABC elements is performed as follows:
- driver quantity x element rate (single-based and batch-based)
- driver quantity x element rate x transaction quantity (item-based)
Costs are apportioned as follows:
| Sales | Debit | Credit |
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| cost of sales ledger account [quantity x (warehouse cost + sales ABC costs] |
warehouse control account (quantity x warehouse cost) |
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| each applicable ABC element ledger code (sales ABC cost) |
This section indicates the reporting and querying programs for AB Costing.
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You use the Costing Report program to print a report listing the ABC elements of cost associated with a range of selected stock items.
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You use the BOM-Inventory Cost Comparison program to print a report listing the total cost of a range of selected stock item. It includes the direct costs of each item, as well as the pre-production and manufacturing ABC costs.
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Within the Costing Query program you can select the ABC Elements function to view the ABC elements of cost associated with the stock item.
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Within the Production pane of the Inventory Query program you can view the pre-production, manufacturing and sales costs for a stock item, as well as the cumulative pre-production and manufacturing costs. Values are displayed in these fields once you have run the Cost Implosion program.