How to Implement a Simple ABC System in QuickBooks - dummies

How to Implement a Simple ABC System in QuickBooks

By Stephen L. Nelson

All you do to implement a simple activity-based costing (ABC) system in QuickBooks is what you’re doing right now. In other words, just keep on tracking your operating expenses by using a good, decent chart of accounts. That’s 90 percent of the battle.

You also need to take care of just one or two minor, additional items. First, you turn on the QuickBooks Class Tracking feature. Class Tracking lets you categorize income and expense transactions as falling not just into income and expense accounts, but also into particular classes.

Second, when you record an expense, you also identify the class into which the expense falls. Using classes that correspond to your activities — well, you can see that’s all it takes, right?

You can make ABC very complicated. Furthermore, if you go out and hire an outside consultant — somebody who wants to charge you thousands or even tens of thousands of dollars to set up one of these systems — you may end up with something that is very, very powerful and very, very complicated.

That being said, however, ABC systems don’t have to be that complicated, particularly if you just want better allocation of your overhead costs rather than a system to look at the cost drivers or the activities that comprise your overhead costs. ABC can be pretty straightforward. This is especially true in a small or medium-size firm. In fact, you can probably implement a good, first-rate ABC system by taking the following four steps:

  1. Look at your overhead costs.

    Verify that you have enough overhead to be worrying about. If you’re in a business with big fat margins and very low overhead, ABC may not make any sense for you. The incremental value that you achieve by allocating overhead more precisely may be simply a manifestation of an obsessive-compulsive personality disorder rather than good accounting.

  2. Identify the big overhead cost.

    You must do this if you decide that you want to allocate some or a bunch of your overhead via an ABC approach. Don’t spend time trying to accurately allocate some penny-ante amounts (unless they’re simple-to-allocate ones that can be done at the same time as the bigger project).

    Go for the biggest bang you can get for your buck. Create an ABC system that allocates, with a minimal amount of effort, a large chunk of your overhead. Don’t get too pedantic.

  3. Identify the principal activities that use up the overhead costs.

    In the simple example of the imaginary hot dog stand business, you have only a single activity: serving a customer. You’re certainly going to have more activities than that. However, you don’t need to create a list of 80 activities.

    Identify the big activities that enable you to allocate your overhead. The fewer the activities you can use to do this, the easier your accounting will be. Find a handful of activities that let you fairly and accurately allocate overhead to product lines. That’s the big picture.

  4. Trace the activities to products by using the appropriate measures.

    After you’ve identified the handful of activities that let you connect overhead expenses to products, be sure to use the appropriate measure — also known as a cost driver — to tie the overhead expenses to the product lines or service lines.

    In the example of the hot dog stand business, one overhead cost — rent — didn’t even need a cost driver. The supplies expense also didn’t need a cost driver because you were able to allocate that cost through simple observation.

    The wages expense required a more sophisticated textbook approach to allocation. To allocate the wages expense, you created an activity called serving the customer and then allocated that activity’s cost based on the number of steps that each product line required.

An ABC system is a tool that you can use to manage your overhead costs and the profitability of the products or services that you sell. Practically, you want to focus on the big overhead costs, and in the end, all you really want is an ABC system that produces useful numbers — numbers that help you think about your business more clearly and creatively.