ABCs of Batch Processing

Could your cost accounting system be subsidizing your low-volume products?

August 2, 2007
from Journal of Accountancy

When it comes to adding or reducing products or services, accurate cost information is critical. Activity-based costing (ABC) provides solutions to measuring costs that traditional methods do not address. Rather than simply dividing costs among the number of widgets manufactured or services provided, ABC acknowledges that not all costs are driven by output volume. As a result, ABC identifies activities related to batches, products, customers, administration and related costs that are not driven by volume (or unit production).

As a general rule, if non-volume related activities and their related costs are not isolated, high-volume customers and high-volume products will subsidize low-volume customers and low-volume products. Minimizing this type of inaccuracy is a priority of cost measurement systems designed to support strategic decision making.

Batch activity costs are particularly susceptible to unintentional cost subsidies. This article reviews different types of batch activities, provides examples, reviews how batch activity cost is assigned under traditional costing, and how batch costs should be assigned using ABC to minimize cost distortions.

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Batch Processing in Brief

Batch processing occurs when one or more units enter a work activity, is changed by the work activity and exits the work activity. For example, a furnace may heat 50 units at a time or a process for handling paper currency may use 100-unit batches.

In many cases, batch processing promotes economy. For instance, it is more economical to transport 60 people in a bus than in 60 automobiles. In other cases, however, where there is economy in batch processing, the end-to-end process may be sub-optimized with large amounts of inventory, longer cycle times, and more rework and scrap. Just-in-time processes reduce batch sizes, in some cases to lot sizes of one, to minimize waste.

The Setup

In most cases, a batch requires a setup to prepare the material for processing. Common setup activities include data recording, quality control and material handling. These activities could be performed by a person or a machine. In most cases, data is captured, stored and analyzed, then used for process control and future problem resolution. Different factors cause setups. They include volume, time, control, product and customer requirements:

Operational volume setup takes place every time a lot passes from one work station to the next. The volume could be one or more than one. Volume-driven setups normally do not change any machine settings.

Operational time setup takes place based on a calendar event. The setup could require a quality-control batch to be processed.

Operational control setup takes place based on quality-control requirements. For example, in check processing, 300 checks are grouped into a batch with a control document containing the value of the lot. This is used for reconciliation throughout the process.

Product or conditional setup is only required to run a different product through the process, in this case, the conditions for processing change. Differences could be based on temperature, process time, energy input, chemical input or color.

Customer-based setups occur when a customer requires some degree of customization such as a private label or custom color. Another example is electronic check processing in which a bank customer sends a payroll deposit file. Setup work is required to recognize and process the file regardless of how many deposits are in the file.

The operational setups — volume, time and control — do not lead to cost measurement distortion. These types of setups exist in processes that include only one type of product. For example, production may decide that a lot size of 50 units optimizes cost, time and quality. Fifty units are released to production whether there is one product type or many product types. A 1,000-volume unit-product incurs 20 setups whether it is the only product produced in this facility or is one of many product types.

The types of setups that can lead to material cost measurement distortion include product-conditional and customer-based setups. Customer-driven setups will not cause product-cost subsidies if the setup’s cost is assigned to the customer P&L. Whether the setup’s cost is included as a service and therefore listed as a separate line in the invoice varies by customer and industry. If customer P&L reporting is not performed by the company and there are material customer-driven setup costs that are unequally distributed between products, there will be product-cost subsidies.


There is no standard. As a result, practitioners may be familiar with different variations.

Any costing approach should apply common sense. There will be environments with either low product diversity or a unique production schedule where cost measurement would not be improved by including conditional setup activity cost as a product-level activity cost.

Another strategy for minimizing cost subsidies is a round-trip assignment of conditional setups. Under such a system, both the setup to produce the low-volume product and the setup to return the equipment to its high-volume configuration are charged to the low-volume product. But in an environment where volumes frequently fluctuate and the high-volume product of today becomes the low-volume product of tomorrow, this approach becomes difficult to maintain.

From an operations perspective, the cost of conditional setups as well as all other types of setups should be measured for their use in setup-quality and cost-tradeoff decisions. This cost measurement should not interfere with providing the most relevant cost measurement for customer and product profitability.

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