Explain Logistics Activity Based Costing

Logistics Activity Based Costing

The fundamental concept of activity – based costing is that expenses need to be assigned to the activity that consumes a resource rather than to a budget unit. Activity based costing is based on the concept that business activities are made up of a series of process that cause or consume costs. Managers can determine the costs of possible alternative action by tracing the costs to their origin.

Example:

• Two products, produced in the same manufacturing facility, may require different assembly and handling procedures.
• Out of the two products, one may need additional equipment or labour for assembly or packaging operations.
• If total labour and equipment costs are allocated to the products on the basis of sales or the number of units produced then both the items will be charged for additional assembly and packaging operations require by only one of them.
• This will reduce the profitability of that product which did not require additional equipment or labour because this product will be paying for the operations it did not need.

In the case of logistics, the key event is ultimately the customer. In other words, in logistical activity –based costing, we determine if specific customer, order, product or service is ultimately profitable to the company. This earns that the revenue has to be matched with the specific costs. That is the logistics managers have to identify whether it is worth incurring the costs in relation to the amount of revenue earned with regard to specific products.

The logistics manager can use the results of activity based costing system to weigh possible alternatives, improve decision making and also to improve efficiency and competitiveness of the firm.

Assumptions made in ABC (Activity Based Costing) system:

Two primary assumptions that accompany an ABC system are:

(i)                 Individual costs in each part of the activities must be fairly homogeneous activities

(ii)               Costs are proportional to the activities being measured.

Both these assumptions must be kept in mind when the system is designed. Further, the success of entire system depends on the accurate tracing of costs to activities. If the firm can accurately trace the costs to specific causes such as products, customers, supply channels and logistics activities, the results of the ABC system can be more insightful and effective in implementation.

Features of Activity Based Costing

1. It out performs more traditional approaches by providing better operational performance.
2. It develops information about cost drivers and the causal relationship these drivers have with overhead resource consumption.
3. It gives a more accurate picture of expenses and helps management to make strategic decisions about cost centers such as general marketing or integrated logistics.
4. It identifies potential areas for process improvement within cost areas such as labour, equipment and supervision.
5. It can significantly enhance the effectiveness and efficiency of internal audit operations.
6. It helps managers to assess the performance of a business unit by examining productivity, flexibility, quality, order cycle time and customer satisfaction.