ABC COSTRING

INVENTORY
• The term inventory is define as “the systematic control and
regulation of purchase, storage and usage of materials in such a way
so as to maintain an even flow of production and at the same time
avoiding excessive investment in inventories”.
 What is ABC
COSTING
• Activity-based costing (ABC) is a costing method that assigns overhead and indirect costs to related
products and services. This accounting method of costing recognizes the relationship between costs,
overhead activities, and manufactured products, assigning indirect costs to products less arbitrarily than
traditional costing methods. However, some indirect costs, such as management and office staff salaries,
are difficult to assign to a product.
 HOW IT WORKS
• Activity-based costing (ABC) is mostly used in the manufacturing industry since it enhances
the reliability of cost data, hence producing nearly true costs and better classifying the costs
incurred by the company during its production process.
• This costing system is used in target costing, product costing, product line profitability analysis,
customer profitability analysis, and service pricing. Activity-based costing is used to get a better
grasp on costs, allowing companies to form a more appropriate pricing strategy.
• The formula for activity-based costing is the cost pool total divided by cost driver, which yields
the cost driver rate. The cost driver rate is used in activity-based costing to calculate the
amount of overhead and indirect costs related to a particular activity.
 STEPS
• Identify all the activities required to create the product.
• Divide the activities into cost pools, which includes all the individual costs related to an
activity—such as manufacturing. Calculate the total overhead of each cost pool.
• Assign each cost pool activity cost drivers, such as hours or units.
• Calculate the cost driver rate by dividing the total overhead in each cost pool by the total cost
drivers.
• Divide the total overhead of each cost pool by the total cost drivers to get the cost driver
rate.
• Multiply the cost driver rate by the number of cost drivers.
 ADVANTAGE
• Accurate Product Cost
ABC CLASSIFICATION OF
INVENTORY ITEMS
- A items: 70% of the annual
consumption of inventory is
covered by only 10% of the items in
the inventory, deserve highest
attention.
- B items: 20% of the items covering
20% of the inventory
investment(less stringent control).
- C items: rest 70% of the inventory
items(very little control)
STEPS FOR THE CLASSIFICATION OF
ITEMS:
1. Find out the unit cost and the usage of each
material over a given period.
2. Multiply the unit cost by the estimated annual
usage to obtain the net value;
3. List out all the items and arrange them in the
descending value( annual value).
4. Accumulate value and add up number of items
and calculate percentage on the total inventory
in value and in number;
5. Draw a curve of percentage items and
percentage value
6. Mark off from the curve the rational limits of
A,B and C categories.
WHEN AND WHY TO USE IT?
• The ABC Analysis can be also useful in several steps of the
Sourcing value chain .
• Demand Identification , to gather the annual spend of a site.
• Demand Aggregation , to gather the annual spend of several sites.
• Opportunity assessment, to identify leveraging opportunities.
• Different decisions may be taken from the result ABC Analysis
 ADVANTAGE
• Control
• Cost
• Improved Service
• Warehouse
• Better Forecasting
• Smart Negotiations with
suppliers
• Resource Allocation
• Inventory Optimization
• Profit
 DISADVANTAGE
DISADVANTAGE
• ABC Analysis will not be effective if the material are
not classified into the groups properly.
• It is not suitable for the organization where the costs of
materials do not very significantly.
• There is no scientific base for the classification of
material under ABC Analysis.
• The classification of the materials into different groups
may lead to extra cost. So , it will not be suitable for
small organization.
• Considers only money value of items and neglects the
importance of items for the production purpose or
assembly or functioning.
STEPS USED TO PERFORM AN ABC
ANALYSIS:
• 1st step – Identify the objective and the analysis criterion
• 2nd step –Collect data about the analyzed population
• 3rd step – Sort out the list by decreasing impact
• 4th step – Calculate the accumulated impact and the percentage
• 5th step – Identify the classes
• 6th step – Analyze the classes and take appropriate decisions
USES OF ABC ANALYSIS
• The ABC analysis is widely used in supply chain management and stock checking and
inventory system and is implemented as a cycle counting system. It is most important
for companies that seek to bring down their working capital and carrying costs.
• This done by analysing the inventory that is in excess stock and those that are
obsolete by making way for items that are readily sold. This helps avoid keeping the
working capital available for use rather than keeping it tied up in unhealthy inventory.
• When a company is better able to check its stock and maintain control over the high-
value goods it helps them to keep track of the value of the assets that are being held
at a time. It also brings order to the reordering process and ensures that those items
are in stock to meet the demands.
• The items that fall under the C category are those that slow-moving and need not be
re-ordered with the same frequency as item A or item B. When you put the goods
into these three categories, it is helpful for both the wholesalers and the distributors
to identify the items that need to be stocked and those that can be replaced.
CONCLUSION

• The ABC model works in a manner as to get prime attention to the important
items or the critical few and not have unnecessary attention be spent on the
not so important items or the trivial many. Each category has a differing
management control in place.
• This prioritization of attention and focus is vital to keep the costs in check and
under control in the supply chain system. To get the best results it is important
that items that involve a lot of costs are given the due management attention.
REFRENCES

• [Link]
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