The Activity Based Costing – ABC system accumulates the cost of various important activities and assigns this accumulated cost to products and services according to the treatment of activities. Through ABC the overall resources of an organization can be allocated to higher yielding products rather than high cost products ABC differs from traditional costing method in the treatment of costs and activities related to resources in an organization.
The ABC system is applied to Wal-Mart which is the biggest and most successful retail chain in the world. Wal-Mart operates more than 7,870 stores in different parts of the world (Yahoo! Finance, 2009). The success of Wal-Mart is based on the low-price high volume strategy. Wal-Mart continuously focuses on changing trends in demands of products to manage its inventories. ABC is also closely linked with customer activities and provides accurate costs for various products. Selected Activity and Time Frame
The product selected for the application of ABC is Wrangler – Men’s Regular Fit Jeans which sells for $17. 00 in Wal-Mart and is one of the top selling items of the company (Walmart, 2009). There are various activities related to this product which include procurement, storage, material handling and quality control. The time period selected for the estimation of cost is 2009. Inputs Used The major difference in calculation of traditional costing and activity based costing system is the determination of overheads in these methods.
The calculation of prime cost remains same for both methods but the basic difference is in the overhead application and calculation (Hilton, 2005). The inputs used for the calculation of ABC overheads and overhead application rates include the units and cost of product, activities related to the product and the quantity of cost drivers.
Assumptions and Estimates
The selling price of the product under discussion is $17. 00. The assumed number of units purchased is 70,000 with the prime cost of the product assumed on the basis of the 2009 gross profit margin of Wal-Mart which is 23.7 percent (Wal-Mart, 2009).
The amounts and quantities of activity cost pools and cost drivers have been assumed on the basis of number of units purchased. The cost per unit according to the gross profit margin is estimated at $13 which includes both prime cost and overhead cost so it is adjusted to reflect only the prime cost of the product at $12 with the overheads at $1. The prime cost per unit is estimated at $12 per unit and the overhead per unit as calculated under Activity Based costing system is $1.53 which brings the total cost of a jeans to $13. 53. This estimate of cost is based on the various activities performed in the process of purchasing, handling and storing Wrangler – Men’s Regular Fit Jeans. These results may vary with the change in quantities of the cost drivers with respect to the units purchased. Implications Wal-Mart has achieved great success by using Activity Based Costing and has become the world’s largest retailer after beating K-Mart (Williams, 2009).
The results of the ABC costing of Wal-Mart indicate that the company can allocate resources according to overheads incurred in each activity area. The company can reduce the cost of more expensive areas and allocate more resources to the less expensive activity areas. This would not only enable the company to achieve higher profits but a true reflection of costs could be achieved.
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