Functional-based and activity-based management systems are accounting methods used to allocate the expenses of producing products, goods and services. The functional-based method is more traditional and has been in use for many years. The activity-based method is newer but gaining popularity, especially for companies that have shorter product life cycles and increased quality control requirements. Consider how each system might benefit your small business.
The main difference between activity-based and functional-based management is that the two systems allocate costs to different units. Activity-based management focuses on the processes and activities of the business, such as purchasing and receiving. Functional-based management focuses on the functions of a company and groups allocation systems by department, such as sales, administration and marketing.
Both functional- and activity-based systems attach costs to two dimensions, referred to as horizontal and vertical dimensions. The vertical dimension analyzes costs associated with customers and products, and the horizontal dimension analyzes operational efficiency and control of costs.
Cost view is the process of allocating expenses to units within your business to determine how much it costs to produce each item or unit of service. In functional-based management, the cost view involves allocating expenses first to the functional departments of the company, then to the products or services produced by each department. Product costs may include direct labor hours, direct material costs and direct machine or equipment costs. The cost view of activity-based management involves allocating cost to activities first, then to products. There are more allocations made in activity-based management because allocations also are made to activities that don’t necessarily produce a finished product, such as the cost of moving work-in-process units from one part of the building to another.
Operational efficiency is the process of evaluating the results of cost view results and applying the data to planning, budget and production goals. In functional-based management, cost control is assigned to departments, and the managers of each department are responsible for controlling the expenses of the department to meet budget and production requirements. This allows efficiency responsibilities to be tracked by one person and promotes enhanced organization and communication regarding operational efficiency issues. In activity-based management, it is much more difficult to assign operational efficiency responsibilities to one person due to the expansive cost view process.
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