CAM-I Model of ABC & Need of ABC

CAM-I Model of ABC & Need of ABC

Part 1: The CAM-I Model

The foundation stone for ABC was laid in the US manufacturing sector during 1970s and 80s. And this was further formalized by the Consortium for Advanced Management-International (CAM-I).

So, to better understand ABC we must understand the CAM-I Cross.

CAM-I Cross

The vertical view is called the ‘Cost Assignment View’ as it tells how the cost is assigned. It answers the following questions:-

Element	Question Answered by it
Resources	What we spend?
Resource Driver	Why we spend it?
Activities	What we do?
Activity Drivers	Why we and how much we do it?
Cost Object	Who/for what we do the activities?

The Process View answers why things have cost i.e. why cost exists and what causes it to fluctuate.

Part 2: Need of ABC

Being initially introduced by CAM-I for the manufacturing industry, ABC is often mistaken to be useful only for manufacturing industries. But, this is certainly not the case. Why so?

To understand this let us first know why the need of ABC arose, what was so wrong with the good old traditional costing that it needed a replacement.

Over the years, as the businesses evolved, the component of Overhead Costs in the Total Cost of the business has increased.

The overhead costs result from O/H activities which aren’t linked to production or sales volume. These are linked/dependent upon the diversity and complexity of products (or services/ channels/ customers).

Traditional costing allocated costs primarily on the basis of volume. As the overheads costs were not based on volume, allocating them on volume basis resulted in incomplete, in appropriate or unprocessed allocation.

The allocation needed a more logical approach, a better cause and effect relationship between the Resources (Cost) and the Cost Objects.

ABC filled this gap. It first converted the Cost into Activity Cost, the activities could be better linked to Cost Objects. Thus Activity Cost was allocated to various Cost Objects using the particular activity. Also, each activity has a different driver which defined the quantum of cost to be allocated.

To summarize ABC added a layer ‘Activity’ to the traditional costing method thus providing a more logical allocation method.

P.S. Manufacturing as a sector was the first to mature with regard to complexity and diversity in products offered, the service sector followed it. This sounds like the reason why manufacturing was the first to use ABC and hence the myth that ABC is for manufacturing sector.

ABC - An Introduction

Hi All…

My first blog..!!!

Before I pen down further just a disclaimer :P…

You may not find anything new in here but I being an amateur in ABC will start things from the scratch. This I guess will be helpful for people like me to get through this fancied concept of ABC (Activity Based Costing) and the related stuff.

So here we begin…

What is ABC?? – A Primary Introduction

Shakespeare says ‘What is in the name?’ but I disagree. If we look precisely at the name ‘Activity Based Costing’, the name certainly bears the meaning of what it is.

ABC as the name suggests is the costing system which is based on activities performed by an organization.

First, why do we need costing?

Ans. The first and primary need of costing is to correctly calculate the cost of product/ service (to be precise the cost of ‘cost object’) of our organization so as to find the right price for the same.

Cost Object is anything for which or whom the work is done is called a cost object i.e. the reason for which or for whom the cost are incurred are cost objects. Ex. Product / service / customer / internal customer etc.

What do I mean when I say costing ‘Based on Activities’?

Normally, what we are used to doing in traditional costing is to directly allocate the expenses to the cost object. This method fails when we try to allocate indirect expenses i.e. the expenses which are not directly attributable to a cost object.

In ABC, we first convert the expenses into the cost of various activities performed and then we link these activities to various cost objects. This way we just add a layer to our allocation process of allocating the expenses to the cost objects. But this layer helps create a proper cause and effect relation between the expenses and the cost objects and thus adds greater transparency and accuracy to the whole costing system.

Example:-

Let’s say we have an employee ‘A’ who has a weekly wage of Rs.100 and produces two types of products ‘X’ and ‘Y’.

What we normally do is something as follows:-

Allocating the weekly wage to the two products on the basis of ‘Number of Units Produced’ for each type of product.

-	Product X	Product Y
Number of Units Produced	10	30

The same case will be handled in ABC as follows:-

1.       Find the activities done by this employee.

To keep it simple, let’s assume he does only 2 activities viz. ‘Setup Machine’ and ‘Assemble Product’.

2.       He has 40 hours per week out of which he took 10 hours in machine setup and 30 in assembling the products.

3.       This way we have converted the expenses into activity cost.

4.       We will now allocate this activity cost to the two products on the basis of the quantum of activity done for each product.

Assuming the quantum of activity was as follows:-

-	Product X	Product Y
Setup Hours	4	6
Assembling Hours	5	25

5.       So, the activity cost allocation will be as follows:-

-	Product X	Product Y
Setup Cost	= 25*(4/10) = Rs.10	= 25*(6/10) = Rs.15
Assembling Cost	= 75*(5/30) = Rs.12.5	= 75*(25/30) = Rs.62.5
Final Product Cost	= 10 + 12.5 = Rs.22.5	= 15 + 62.5 = Rs.77.5

Thus we can say, there is a difference in the cost allocated to the two products in traditional costing and in ABC costing. The difference may seem small in our example but the same difference when multiplied by the scale of a company’s activity will be huge.

This was a first and a very raw look at the concept of ABC. Next we will uncover this concept through the CAM-I model.