What is Activity Based Costing?
Activity-Based Costing (ABC) is a method for developing estimation for cost in which the construction project is subdivided into discrete, quantifiable activities. The activity should be definable where productivity can be controlled in units. After the construction project is decomposed into its activities, a cost estimate is
prepared for all projects’ activities. These single cost estimates will contain all materials, labors, equipment, and subcontracting costs, including overhead, for each activity. Each complete single estimate is added to the others to obtain a total estimate. Contingency, Escalation can be calculated for each activity or after all the activities have been summed. ABC is a very powerful tool, but it isn’t appropriate for all cost estimates.
Activity-Based Costing Methodology
Construction firms have collected cost data from a multitude of different construction projects. The amount of work associated with this cost was also collected with the cost data. For example, collected data included the cost of the material, labor, equipment, and overhead to paint a room, the amount of surface area painted, and the labors required to paint the room. This best practice allowed construction professionals to obtain a cost per area and labor resources per area.
C/A = HD + M + E + S
where C/A = Estimated cost per activity
H = no. of hours of labor required to perform the activity one time
D = Wages per labor hour
M = Costs of material required to perform the activity one time
E = Costs of equipment to perform the activity one time
S = Costs of subcontracting to perform the activity one time
The activity total cost will be based on the number of times the activity is performed during a specific time frame. Cost estimators or QS engineers have collected large databases of activity-based cost information.
Use of Activity Based Costing Methodology
ABC methodology is used when a construction project can be divided into defined activities.
These activities are at the lowest function level of a construction project at which costs are monitored and performance is evaluated. Depending on the project organization, the activity may coincide with an element of the work breakdown structure or may combine one or more items of the WBS. However, a clear definition of the activities must be set so there is no overlap between them. After defining the activity, the unit of work is established. All activity costs are estimated using the unit of work.
The estimation of work units can be done by performing detailed estimates, using cost estimating relationships, obtaining outside quotes for equipment, etc. All costs including overhead, markups, profit, and should be included in the activity cost.
Identification of Activities
When you start to define a single activity, the cost estimator must balance the need for accuracy with the amount of time available to prepare the estimate. A cost estimator may be able to develop an extremely accurate cost estimate by defining smaller activities; however, the amount of time required to prepare ABC estimates for each activity may not justify the increased accuracy. The total estimated cost of the construction project may be sufficiently accurate if 10 activities are used instead of 15. On the other hand, trustworthy cost info may not be accessible if the activity categories are too general. Since the basis for the cost estimate is the activity, it is very important that the activity be selected correctly
Activity Based Costing in Construction Project Management
Construction projects involve a lot of activities. These activities consume a variety of resources (such as materials and labor). The consumption of these resources adds to the overhead costs. Activity-based costing (known as ABC) is a costing technique that determines the cost of activities without distortion.
ABC will identify these activities. The resources involved in every activity shall be identified. The cost of each resource shall be determined using the receipts of purchase. The cost per unit of material must be determined. List of activities performed to complete a job. The resource consumption of each activity must be determined.
The cost per unit of material is multiplied by the amount of each material used in the work, which results in the overall cost of the materials. The total cost of material can be obtained by adding direct labor and overhead costs to the overall cost of the material. The activity-based costing methodology is common because it recognizes the relationship between costs and activities.
This makes overhead allocations less arbitrary. One of the problems facing ABC is identifying activities that use resources. Activity-based costing software programs are available on the market (such as SAS ® Activity Based Management). They assist the users to make informed decisions.