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ACTIVITY BASED COSTING

ACTIVITY BASED COSTING

Discuss ACTIVITY BASED COSTING within the Management accounting and Cost accounting forums, part of the Upload / Download Banking and Insurance Projects and Notes category; ACTIVITY BASED COSTING 1. INTRODUCTION Activity Based Costing (ABC) is a method for developing cost estimates in which the project ...

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ACTIVITY BASED COSTING
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faaiz
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Thumbs up ACTIVITY BASED COSTING - January 4th, 2008

ACTIVITY BASED COSTING
1. INTRODUCTION
Activity Based Costing (ABC) is a method for developing cost estimates in which the
project is subdivided into discrete, quantifiable activities or a work unit. The activity
must be definable where productivity can be measured in units (e.g., number of samples
versus manhours). After the project is broken into its activities, a cost estimate is
prepared for each activity. These individual cost estimates will contain all labor,
materials, equipment, and subcontracting costs, including overhead, for each activity.
Each complete individual estimate is added to the others to obtain an overall estimate.
Contingency and escalation can be calculated for each activity or after all the activities
have been summed. ABC is a powerful tool, but it is not appropriate for all cost
estimates. This chapter outlines the ABC method and discusses applicable uses of ABC.
2. ACTIVITY BASED COSTING METHODOLOGY
For many years, construction firms and industry trade groups have collected cost data
from a multitude of different construction projects. The amount of work associated with
that cost was also collected with the cost data. For example, collected data included the
cost of the paint, labor, equipment, and overhead to paint a room, the amount of surface
area painted, and the manpower required to paint the room. This practice allowed
construction professionals to obtain a cost per area and manpower per area. These costs
are based on an activity, such as painting, and are known as ABC. ABCs are discussed
in detail in the following sections.
A. Activity Based Costing Definition
ABC can be defined by the following equation:
C/A = HD + M + E + S
where C/A = Estimated cost per activity
H = Number of labor hours required to perform the activity one time
D = Wages per labor hour
M = Material costs required to perform the activity one time
E = Equipment costs to perform the activity one time
S = Subcontracting costs to perform the activity one time
24-2 DOE G 430.1-1
03-28-97
The total cost for performing the activity will be based on the number of times the
activity is performed during a specific time frame.
Cost estimators have assembled large databases of activity based cost information.
The R.S. Means Company updates its published cost references on a yearly basis,
and they are an excellent source of ABC information for the construction industry.
B. Use of Activity Based Costing Methodology
ABC methodology is used when a project can be divided into defined activities.
These activities are at the lowest function level of a project at which costs are
tracked and performance is evaluated. Depending on the project organization, the
activity may coincide with an element of the work breakdown structure (WBS) or
may combine one or more elements of the WBS. However, the activities must be
defined so there is no overlap between them. After the activity is defined, the unit
of work is established. All costs for the activity are estimated using the unit of
work.
The estimates for the units of work can be done by performing detailed estimates,
using cost estimating relationships, obtaining outside quotes for equipment, etc. All
costs including overhead, profit, and markups should be included in the activity
cost.
C. Identification of Activities
When defining an individual activity, the cost estimator must balance the need for
accuracy with the amount of time available to prepare the estimate. An estimator
may be able to develop an extremely accurate cost estimate by defining smaller and
smaller activities; however, the amount of time required to prepare ABC estimates
for each of these activities may not justify the increased accuracy. The total
estimated project cost may be sufficiently accurate if 10 activities are used instead
of 15. On the other hand, reliable cost information may not be accessible if the
activity categories are too general. Since the activity is the basis for the estimate, it
is very important that the activity be selected correctly.
D. Example of an Activity Based Costing Estimate
To get a better understanding of how an ABC estimate is developed, assume that
you have been asked to prepare a cost estimate for a site evaluation. To verify that
there is no contamination at the site, subsurface soil samples will have to be
collected. The area of the site is known, and the guidelines for the number of
samples per unit area has also been given.
1. Site: Atlas Metals (now out of business)
DOE G 430.1-1 24-3
03-28-97
2. Objective: Collect and analyze subsurface soil samples to determine if
contamination exists from past usage of the 1,000 square-foot-yard area.
3. Sampling Requirements: One sample per 100 square feet, and sample depth is
5 feet.
The following activities would be involved:
mobilize equipment and personnel,
drill hole for sample,
collect sample,
decontaminate equipment between samples,
prepare all samples for analysis,
demobilize equipment and personnel,
analyze samples.
Equipment needs are as follows:
Hand-held auger for sample collection
($100.00/day flat rate)
Safety equipment for site personnel
(gloves, safety glasses, and protective equipment at
$10.00/person/day)
Material needs are as follows:
Sampling containers and labels
($1.00/sample)
Water to clean the auger between samples
(5 gallons/sample at $.30/gallon)
The auger requires two people to operate it. Site mobilization and demobilization
will take a total of 1 hour. Local labor rate is $15.00/hour for all disciplines. A 2-
person crew can prepare 10 samples for analysis in one hour. The laboratory
charges $1,000.00/sample for analysis.
24-4 DOE G 430.1-1
03-28-97
Number of hours required to perform the activity = 12 hours
Wages per labor hour = 2 x $15.00 x 2.5 = $75.00/hour
Labor cost per sample = (12 x 75) 10 = $90.00/sample
Materials costs = (10 x $1.00 + 2 x (2 x $10.00) + 10 x 5 x $.30) x 1.2 =
$78.00
Materials cost per sample = $7.80/sample
Equipment costs = (2 days x $100.00/day) x 1.2 = $240.00
Equipment cost per sample = $24.00/sample
Subcontractor cost per sample = ($1,000.00 x 1.15) = $1,150.00
C/A = (HD + M + E + S)/sample
C/A = $90.00 + $7.80 + $24.00 + $1,150.00 = $1,271.80/sample
If the area requiring sampling increases or decreases, the number of samples can be
recalculated using this ABC.
3. APPLICATION OF ACTIVITY BASED COSTING
As can be seen from the example, ABC can be a useful cost estimating tool for nonconventional
and construction projects. However, there are some activities that are more
appropriately estimated using other cost estimating techniques. For example, site
security may always be required at some facilities regardless of the number of employees
at the facility or work being conducted at the facility.
ABC estimating is especially useful in instances where the number of activities is
uncertain or may change during the estimate process. Referring back to the ABC
estimate example, if the number of samples changed, it would be fairly easy to
recalculate the cost of the sampling.
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Re: ACTIVITY BASED COSTING
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blueholics
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Re: ACTIVITY BASED COSTING - May 4th, 2008

thank u for posting it...
now i understand it pretty well...
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Re: ACTIVITY BASED COSTING
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Varssha M
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varssha
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Bombay, Maharashtra
 
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Location: Bombay, Maharashtra
Re: ACTIVITY BASED COSTING - December 2nd, 2008

thanks 4 so much info!
its really helpful!
gr8 job.
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