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Activity-based costing refers to a method for the attribution of manufacturing costs to the right source as opposed to a general attribution of costs in an equal manner to various sources during the manufacturing process. The relationship between activity-based costing and activity-based management is derived from the fact that activity-based management can be influenced by the information derived during the analysis of the activity-based costing process. In order to properly understand the link between activity-based costing and activity-based management, it is necessary to understand what the two accounting terms mean.
Usually, when manufacturers try to attribute the cost of the production of the various items in the manufacturers’ product line, they do this by looking at the volume of the production process for that particular item without considering other factors that might render this statistic inaccurate. For example, the calculation of the production cost for product A and product B by the same company can be used to illustrate the concepts of activity-based costing and activity-based management. Assuming the manufacturer already knows the directly attributable costs resulting from the manufacture of product A and product B but it is still trying to figure out the overhead costs for the production of the two items, this process will require the application of activity-based costing in order to arrive at the right conclusion since such overhead costs may be misleading without proper analysis. In this case, the overhead costs for the production of both product A and product B could involve overhead costs like the inspection of the raw materials before production and the use of a predetermined number of employees as part of the production process.
Where the manufacturing process for product A utilizes less input from the factory workers due to the nature of the product, even if the workers are available for the production process, this will serve as a factor in the computation of the activity-based costing. If product B utilizes all of the factory hands during the production process, even if the volume of products generated is less than that from the production of product A, this will also be reflected in the calculation of activity-based costing as a contributing factor, making product B the more costly. The connection between activity-based costing and activity-based management is related to the way in which such information can be used to better manage the manufacturing process for more cost-effectiveness.
Activity-Based Costing (ABC) and Activity-Based Management (ABM) are really a “one and the same” cost accounting methodology.
Think of it as a continuum, where the success of one depends on the other. We don’t run without first learning to walk. Consider ABC the first steps; while ABM is the gallop.
The CAM-I ABC Expanded Model, or CAM-I Cross, offers a great visual of this inter-relationship. The cross’ vertical component, where ABC begins, takes a cost assignment view. Resources and activities are assigned here, through the use of drivers, to products, customers, etc. ABC gets at cost, profit, and revenue. It provides an answer to what things cost. The CAM-I Cross’ horizontal component, or ABM, takes a
process view, using cost drivers and performance metrics, to answer why things have cost.
ABM is where the power lies. It’s decision-making, it’s competitive advantage, it’s product pricing, it’s determining tradeoffs, it’s deciding to outsource. Think of a cost management tool that directs and supports your strategy, and there you have ABM. And yet, the only way to get there is through the detailed analytics and costing in ABC. To bridge the gap between ABC and ABM, you’ll need executive support, effective change management, some spot-on training, and time. Nonetheless, if you have an ABC costing system, with a little work, you’ll have an even more powerful ABM tool.