Essay on Activity-based costing (ABC costing)

Activity-based costing (ABC costing) is a system which allows to assign overhead costs to products or services in an efficient manner. ABC costing provides detailed information for managerial decision-making and pricing decisions, and can outline ineffective activities in the business processes (Hansen & Mowen & Liming, 2007). This system is especially important for manufacturing organizations, where such activities as product testing, equipment testing, setting up the machines and developing new products incur significant overhead costs.

One of the industries where ABC costing is very appropriate is manufacturing of aircraft and aerospace facilities (Maher & Stickney & Weil, 2007). Study of 196 sample facilities has shows that only 5% of companies use ABC costing (Labor Aerospace Research Agenda, 2001). I have chosen the Boeing Company for applying the principles of ABC costing. The purpose of this paper is to identify a product or service at Boeing and determine cost drivers as well as application rates for these drivers basing on inputs such as Boeing annual reports and case studies of aircraft manufacturing.

The Boeing Company operates in such industries as commercial airplanes, military aircraft, network and space systems, provides services and support and develops financing solutions for Boeing commercial customers (Yenne, 2005). The company is the leading manufacturer of commercial airplanes. In this paper, the operations of the Boeing Commercial Airplane Group Wichita Division will be considered (BCAG Wichita). This division is one of the leading cost centers, and is responsible for manufacturing about 75% of Boeing commercial airplanes (Labor Aerospace Research Agenda, 2001).

The product that I have selected for analysis are commercial Boeing airplanes (717-77, MD-80, MD-90, MD-11) (Yenne, 2005). I have selected such part of the aircraft manufacturing process as fuselage manufacturing process and the stage of chemical treatment of fuselage spares in particular. It is the phase where light structures of the fuselage (larger spares and smaller spares) are transported to the pre-assembly treatment location and chemically treated. The process consists of two steps: at the first step, the parts are mounted to hoods and taken through the tank line (Yenne, 2005). At the second step, the parts are treated as process batches. These two activities form the cycle of chemical treatment of fuselage parts for commercial airplanes (Yenne, 2005). At the first stage, the production is measured in the number of hoods treated during a given period of time (daily, monthly, annually). At the second stage, output is measured in the number of details that have passed batch treatment phase.

Basing on the available data, I have chosen year 2000 as the period for analyzing chemical treatment costs at BCAG Wichita. In 1999, BCAG Wichita adopted the lean manufacturing system. As a result, treatment volumes at stage 1 increased by 24 hoods (from 30 hoods daily to 54 hoods), and 135,000 details annually were returned from outsourcers to internal treatment system (at stage 2) (Labor Aerospace Research Agenda, 2001). Treatment volumes at stage 2 have shifted from 12,000 details per month to 23,250 details per month. Other inputs used in the ABC costing procedure were (Labor Aerospace Research Agenda, 2001):
 the number of commercial airplanes produced in year 200 (489 airplanes)
 percent of commercial airplanes manufactured by BCAG Wichita (75%)
 number of hoods treated daily at BCAG Wichita in 2000 (54)
 average number of working days per month in 2000 (25)
 price of treatment at stage 2 per unit in 2000 ($3.50)
 price of treatment at stage 2 per unit in 1999 ($4.00)
 amount of funds saved due to lean manufacturing approach ($1,579,500)
Table 1 shows the activities and cost drivers of these activities.

Activity Cost driver
Processing of hoods Number of hoods
Treatment of batches Number of details

Table 1. Activities and cost drivers

Table 2 shows the calculations for determining the cost of hoods basing on the proportion between the savings on stage 1 and stage 2, and the cost of treatment of details at stage 2. Here it is supposed that the relation between the cost of processing of hoods and treatment of batches has remained the same after lean manufacturing system was introduced. Dynamics of the process is linear, so it is highly possible that this assumption is true.
number of cost drivers cost per unit total cost saved cost % of total saved cost
Activities daily monthly annual annual annual
Processing of hoods (1999) 30 750 9,000 $188.40 $1,695,640.45
Treatment of batches (1999) 480 12,000 144,000 $4.00 $576,000.00
Processing of hoods (2000) 54 1350 16,200 $177.45 $2,874,640.45 $1,179,000.00 74.64%
Treatment of batches (2000) 930 23,250 279,000 $3.50 $976,500.00 $400,500.00 25.36%
$1 579 500.00 100.00%

Table 2. Calculation of cost of activities and units
The results of table 2 (cost per unit and annual number of cost drivers) allow to calculate the application rate for each activity. Overall number of commercial airplanes for BCAG was determined as 0.75*489~367 airplanes. Table 3 shows the application rates for each cost driver per 1 commercial airline.
Activity Annual number of cost drivers Annual number of commercial airlines Application rate
Processing of hoods 16,200 367 44.14
Treatment of batches 279,000 367 760.22

Table 3. Application data
These rates allow to construct an ABC-costing table. Table 4 shows the results of activity-based calculation of the component of the price for commercial airline fuselage.
Activity Cost driver rate Number of cost drivers Activity cost
Processing of hoods $177.45 44.14 $7,832.81
Treatment of batches $3.50 760.22 $2,660.76
Total cost of chemical treatment $10,493.57

Table 4. ABC costing for chemical treatment of fuselage parts for 1 commercial airline
Thus, the cost incurred by the chemical treatment of fuselage of one commercial airline fuselage is $10,493.57, according to ABC costing technique. The implications of this analysis show that the first activity processing of hoods clearly has a potential for cost reduction, and that improving cost per unit in this category might lead to a reduction of total cost of the process.
Hansen, D.R. & Mowen, M. & Liming, G. (2007). Cost management: accounting & control. Cengage Learning.
Labor Aerospace Research Agenda (2001). Case Study: Boeing Commercial Airplane Group Wichita Division. MIT Press.
Maher, M.W. & Stickney, C.P. & Weil, R.L. (2007). Managerial Accounting: An Introduction to Concepts, Methods and Uses. Cengage Learning.

Leave a Reply