Before the implementation of ABC system, the following factors need to be considered:
 

• It’s implementation needs very strong top management support. Without leadership from top management, some managers may not see any reason to change. Without top management support, the ABC implementation will be seen as unimportant,

•  There should be cross-functional involvement. Since ABC affects people across departments, it should involve these people and be fully supported by them. If the accounting department alone attempts to impose ABC on others, skepticism and resistance are inevitable,

• A well designed ABC system requires intimate knowledge of many parts of an organization. This knowledge can only be learned from employees familiar with the various parts of an organization’s operations,
• ABC data should be linked to how people are evaluated and rewarded. If traditional non-ABC data continues to be used to evaluate employee performance, it sends the signal that ABC data is unimportant and can even be ignored.

The following are the basic steps to implement ABC system:

1. Identify the major activities in the organization,
2. Determine the significant factors or the costs drivers affecting the cost for each activity identified in 1,
3. Determine the activity cost and collect them into cost pools. A cost pool is a bucket in which costs that relate to a single activity are accumulated,
4. Prepare a total activity budget in each activity area. For example, total machine hours, total deliveries, total setups,
5. Calculate an activity cost driver rate,
6. Charge overheads to products based on their usage of the activities at the rates calculated in step 5 above.
7. Prepare management reports.

The activities are often identified and defined by interviewing the employees that work in the respective overhead departments. The lengthy list of activities that emerges from this process is usually reduced to a handful by combining similar activities.

A common framework for combining activities in manufacturing companies is as follows:

• Unit-level activities are performed each time a unit is produced. For example, providing power to run processing equipment would be a unit- level activity,

• Batch-level activities are performed each time a batch is handled or processed, regardless of how many units are in the batch. For example, setting up equipment and shipping customer orders are batch-level activities.

• Product-level activities relate to specific products and must be carried out regardless of how many batches are run or units produced and sold. For example, designing or advertising a product would be product-level activities,

• Customer-level activities relate to specific customers and are not tied to any specific product. For example, sales calls and catalog mailings would be customer-level activities.
• Organization-sustaining activities are carried out regardless of which customers are served, which products are produced, how many batches are run, or how many units are made. For example, heating a factory and cleaning executive offices are organization-sustaining activities.

When combining these activities, they should be grouped together at the appropriate level. Batch-level activities should not be combined with unit-level activities, and so on.

Furthermore, activities should only be combined within a level if they are highly correlated with each other.

Each combined group of activities forms what is called an activity cost pool which is defined as a “bucket” that accumulates costs related to a single allocation base.

• Product-level activities relate to specific products and must be carried out regardless of how many batches are run or units produced and sold. For example, designing or advertising a product would be product-level activities,

•  Customer-level activities relate to specific customers and are not tied to any specific product. For example, sales calls and catalog mailings would be customer-level activities.

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Related Entries

• Activity-Based-Costing System (ABC): Introduction And When It is beneficial
• Overview Of Activity-Based Costing System
• Activity Based Costing As a One Step Attribution System Compared To Other Traditional Systems
• Limitations of Activity-Based Costing (ABC) System
• Types of Activity Measures & Activity Cost Pool And Corresponding Activity Measures