APPLICATION OF ACTIVITY BASED COSTING IN EMIRTAES TECHNOLOGY SOLUTIONS

APPLICATION OF ACTIVITY BASED COSTING IN EMIRTAES TECHNOLOGY SOLUTIONS

Name Jamsheedali Mekkamannil

CMA Batch Number Country UAE

Date of Program Completed Title of Assignment Application of Activity Based Costing in Emirates Technology Solutions

Name of Current Employer Emirates Technology Solutions L.L.C

Designation Finance Manager

Name of Organization Analyzed for the Assignment Emirates Technology Solutions L.L.C

Activity Based Costing

Introduction

Activity based costing is another way of allocating overhead than traditional way. It allocates overhead costs based on activities, that contribute to overhead costs. In traditional way cost allocation, mainly used labor hours and machine hours for overhead allocation. ABC brought more insight into cost allocation and that brought more effective and accurate ways to find product or service profitability. That is very important for any organization to make management decisions. ABC method is more widely used in Developed countries than developed countries. That ABC technique mainly required a more complex ERP system than traditional methods of application.

Definition of Activity Based Costing

Activity-based costing is a costing method that identifies activities in an organization and assigns the cost of each activity to all products and services according to the actual consumption by each. Therefore, this model assigns more indirect costs into direct costs compared to conventional costing.

Concept of Activity Based Costing

Activity based costing is a way of method of accounting, which we can use to find the total cost of activities necessary to make a product or service. It is a costing method to identify all activities of a organization and assigns the cost of each activity to products or Services based on each activity used for each products or services.

ABC is a widely accepted accounting method to trace all indirect costs to a cost object, which is a product or services. It is used to improve the accuracy of cost analysis and cost reporting by way of finding the actual cost of a product or services of an organization, it enables the organization to make informed decisions on pricing of products or services.

ABC process allows you to track the progress of jobs/task in real time, so you can correct mistakes and inefficiencies before losing money to them. Companies can identify whats working and what is not via ABC. We also may be able to understand excessive spending activities in the process and we can control the expenditure accordingly. For Decision making process, the ABC can provide clear picture of what type of activities will be better for the companies and it enable to grow the business.

How It Works:

Identify What You Want to Find the Cost for:

It could be a product, service, or maybe a specific customer.

Break Down Activities

Figure Out the Costs

Associate each activity with its cost. Some activities might cost more than others.

Link Costs to What You Want to Find the Cost Of

Now, connect these activity costs to the specific thing you are interested in (like a product, Service, or a customer). This connection is based on what activities are involved in making or serving that thing. It helps us see exactly where the money is going. We can make better decisions because we know which activities are costing more.

Example:

If a company makes two products/services, ABC can show that Product A/ Service A costs more because it requires more complex activities, even though both products might look the same on the surface.

In short, cost objects are the things you want to find the cost for, and ABC helps you break down and connect the costs to specific activities, giving you a detailed understanding of where your money is really going.

Objectives of Activity Based Costing

To improve accuracy of overhead expenses

To find out high-cost activities and focus on high-cost activities.

To allocate overheads based on activities involved in the process.

To identify the opportunities for cost reduction of activities involved in the process.

To ensure accurate costing to make management decisions.

To use data to improve the product mix and pricing decisions.

Significant Terms in Activity Based Costing

Cost objects

Cost objects hold paramount significance in the realm of Activity-Based Costing (ABC), acting as pivotal elements for gauging profitability and facilitating strategic decision-making.

In the ABC framework, cost objects are representative entities to which costs are allocated through a cause-and-effect relationship. This allocation bifurcates into external activities, contributing value to customers, and internal activities within the organizational framework.

In essence, ABC, through its focus on cost objects, unravels a clearer picture of costs associated with different facets of an organization. In contrast to traditional costing methods, this approach enables more accurate insights into cost origins and facilitating astute decision-making.

Activities

Activity-Based Costing (ABC) is all about breaking down costs based on the things we do, like setting up machines, designing products, or getting goods ready for delivery. These things we do are called activities.

ABC takes a closer look at these activities, treating them as special cost spots that help us see where the money goes.

ABC helps us follow the money trail and figure out which tasks use up the most resources.

By seeing tasks as cost spots, ABC makes it easier to share costs more precisely. It's like giving each task its own bill based on how much it contributes to the overall cost. This helps businesses make smarter choices about where to put their resources.

Cost Driver

Cost drivers are the direct cost of a business expense. In a small business, one of the expenses will be the electricity bill. The amount of electricity we use (measured in units) is what we call a cost driver. In this scenario, cost driver is number of units of electricity used. It directly triggers the cost, which is electricity bill.

Understanding the cost driver help us to manage expense better, if we can control or optimize the use of electricity units, we can control or reduce your electricity bill. cost drivers are like the switches that control costs.

This is a way of figuring out how much things really cost. Instead of just looking at the big picture, ABC helps us see the details. It says that not all costs are the same for everything a company does.

Steps involved in Activity Based Costing

Identify activities.

Identify all the activities in the organization to complete a job or service. These can be related to production, sales, administration, or any other aspect of the business.

Assign costs to activities.

Identify and allocate the cost to each activity including direct and indirect costs. Direct cost can be traceable directly to an activity while indirect costs are shared among multiple activites.

Identify cost drivers.

Determine the factors that drive the cost of each activity. Cost drivers are the variables that caused the cost to be incurred. Examples like Machine hours, Labor hours, No. of call made etc.

Link cost drivers to activities

This linkage helps establish a cause-and-effect relationship between activities and the costs incurred.

Collect Activity Data:

Collect data on the usage of each cost driver. This may involve tracking the time, resources, or other factors associated with each activity.

Calculate Activity Rates:

Calculate the cost per unit of each cost driver by dividing the total cost of the activity by the total quantity of the cost driver. This gives the activity rate.

Allocate Costs to Products/Services:

Assign costs to products or services based on their consumption of the identified cost drivers. This step helps in accurately attributing costs to the specific products or services that drive those costs.

Evaluate and Implement:

Review the results of the Activity based costing analysis and assess its accuracy and usefulness. Refine the system as needed to improve the allocation of costs and better reflect the true cost structure of the organization. Execute the revised costing system and monitor its performance over time. Regularly update and adjust the system to accommodate changes in the business environment.

Application of Activity Based Costing in Emirates Technology Solutions

Company Profile

Emirates Technology Solutions (Etek)

Emirates Technology Solutions (Etek) specializes in delivering state-of-the-art information technology-enabled solutions and services required to enable the business transformation of its clients. Etek adds value to its clients as their trusted Information Technology Partner to enable a successful business and IT transformation through its innovative solutions and wide range of customized services.

The service offerings of Etek include Software Solutions, Implementation of large scale IT infrastructure with worldwide connectivity, Mobile Application Development, Cloud offerings, Data Analytics Solutions, Document Management Solutions, RFID-based Asset Management Solutions, Managed Services and Outsourcing services in addition to emerging technologies like RPA and Artificial Intelligence. 'Etek' also assists clients through its Consulting services for Business Progress through Digital Transformation.

Etek partner with Industry leaders across technology domains, work with them closely to bring an extended level of customer experience in terms of technology and best practices.

Being a government owned entity, Eteks vision and mission are aligned to ensure the highest standard of service to all its clients.

Etek is headquartered in Fujairah, UAE having its offices at 1502, Al Hilal Business Tower, Al Hilal city, Fujairah. To seamlessly support its clients, Etek also has offices in Abu Dhabi and Dubai in the UAE.

Major Clients

Emirates Telecommunications Corporation (ETISALAT)

RAK International Corporate Centre (RAKICC)

RAK Economic Zone (RAKEZ)

Federal Authority for Nuclear Regulation (FANR)

Government of Sharjah

Federal Tax Authority (FTA)

Lootah BCGasAl Dhaheri Capital Investment

Dubai Municipality

Mohammed Bin Rashid Housing Est.

Ministry of Human Resources & Emiratization

Government of Fujairah

Fujairah Culture & Media Authority

Fujairah Oil Industry Zone (FOIZ)

Fujairah National Group (FNG)

Fujairah Foundation for Region Development (FFRD)

Department of Culture and Tourism

Last 2023 financial year, Etek has more man power outsourcing projects. So we are trying to applying ABC methods to Emirates technology solutions as its an service sector entity.

Etek face unique challenges in developing effective cost accounting systems due to distinct operational characteristics compared to normal manufacturing firms. While traditional cost accounting models have been tailored for manufacturing environments, they often fall short in accurately capturing costs and profitability in service settings.

Challenges in Cost Accounting for Etek:

Misalignment with Manufacturing Models

Service firms often model their cost accounting systems after those used in manufacturing, which prioritize valuing inventory and calculating standard costs for direct materials and labor.

However, service firms lack tangible inventory, and direct materials and labor constitute minor cost components, making it challenging to apply standard cost methodologies effectively.

Inadequate Cost Categories:

Unlike manufacturing firms, where direct materials and labor play significant roles in cost determination, service firms typically incur costs associated with overhead, personnel, technology, and other intangible resources.

Standard cost calculations are impractical in service sector due to the variability and complexity of service delivery processes, making it difficult to establish consistent benchmarks for cost evaluation.

Despite the challenges, service firms like Etek require accurate cost information for conducting product profitability analysis to:

Identify profitable products/services.

Determine areas of emphasis and resource allocation.

Analyze trends in product profitability over time.

Establish pricing strategies based on product costs and market dynamics.

While application of ABC in Etek, we assigned costs to specific activities involved in delivering services, offering a more accurate reflection of resource consumption.

By linking costs directly to activities and resources, ABC enables service firms to identify cost drivers and allocate overhead more precisely.

Time-Driven Activity-Based Costing (TDABC):

TDABC enhances traditional ABC by incorporating time as a key cost driver, allowing for a more granular analysis of resource utilization.

By quantifying the time required for various activities, service firms can better understand cost dynamics and optimize resource allocation.