Crocargo Logistics, Time-Driven Activity Based Costing - Essay Example

?Executive Summary: Crocargo Logistics is a logistic services firm. Amongst its services are import, export, transit and discrepancies of parcels andpacket from an air carrier to Auto shop or vice versa. The company although is getting enough contract to remain in the market, is still running operations a loss. The business has been unable to generate enough capital to increase the ultimate profitability of the firm. The fundamental problem highlighted in this case is that of an inadequate costing system and an internal environment characterized by friction. The company is operating in a very hostile and competitive marketplace. The costing system that is needed to support the operations of the company is totally inadequate to keep the company operational for a very long time. The current costing system has been developed by the company’s operations manager who is more than satisfied with her costing system. She is not willing to take anyone’s opinion regarding the problems inherent in her system, as a result of which the company is not accounting for the costs it is actually incurring. The general manger of the company has finally realized this problem and has called for an external help who would suggest a more competitive costing method. Introduction An activity-based costing technique is one of those techniques which enable a company to identify its costs objects more accurately. This aspect of this technique has profound implications on a business, for instance it allows a company to identify unnecessary costs, price its products or services more efficiently and last but not the least it allows a company to be more competitive in its industry. This technique enables a firm to reduce and control its operating costs while producing quality products for its marketplace. A cost accounting manager can utilize this technique to indentify the amount of resources a cost objects is consuming. This will allow him to implement different kind of strategies to curtail costs (Armstrong, 2002). Since the focus of this report is the service organization, therefore it is important to known that since the level of competition and regulation in the service industry has increased drastically; therefore it is important that a dynamic costing system is working in the company that would enable it to remain competitive. So it goes like more the environment is competitive, more the costing system needs to be sophisticated. The costing system should effectively match costs with different cost objects. All these objects are integral to the ABC costing system (Brimson, 1991). Since the level of competition is high in the service competition, therefore a service firm needs to accurately estimate its costs. This new change in the industry has made costing a strategic issue; it has become so important that it effects long-term strategic decisions as well as day-to-day operating decisions. Costing has become so important because it helps a firm in: product or service organization, staffing and resource allocation. Accurate costing allows a company to plan resource consumption, price services properly and implement different strategies. But it is very difficult to initiate an Activity Based costing in a service firm, because in a service firm an employee is engaged in multiple activities involving different time-period. This makes it difficult to trace the resources consumed by a cost object (Cagwin and Bouwman, 2002). Even though the service industry is interested in implementing an activity based costing system, but since these models are made using the activity based costing models of a manufacturing firm as frame of reference, therefore the industry is facing multiple problems with regards to this technique’s implementation. The fundamental problem for this service industry is the absence of inventory, which receives an utmost importance while undergoing a valuation process. Other important cost variables are direct material and labor which are also absent in a service industry. This leads to a problem of estimating standard costs (Startton, Desroches, Lawson, and Hatch, 2009). Since standard estimating cost is difficult to find because there is no direct material cost, no direct labor cost and etch, so in order to find accurate cost to estimate the right price for the service a service firm needs to focus on the following points (Fei and Isa, 2010): Which services are profitable Which services should be emphasized Emerging trends to be seen in order to move towards profitability Finding hidden costs to come up with accurate prices From these points it is clear that costing in a service firm is more complicated than a manufacturing firm. Therefore, the costing method used in a service firm needs to be forward looking and adaptable. And in this regard there is no other costing technique like Activity-Based costing which is so dynamic that it can be adjusted in a service firm. An activity based costing system is important for a service organization because the idea on which this system rests generate information which helps a service firm to take long-term, strategic business management and operational management decision. This technique breaks an entire business into a number of small visible activities; this allows a company to more accurately attaches a cost to each activity. Not only does it enable a firm to place accurate costs but also it helps a firm to compare actual and standard cost for an activity. This allows a company to effectively manage its resources and bring effectiveness in it processes. The effectiveness of activity based costing can be enhanced by using it along with advance management tools like the Balanced Scorecard (Gosselin, 1997). The fundamental reason for a service firm to adopt activity based cost is that almost all of its operating expenses are fixed once resources are committed to undertake that activity. This fact creates the utility for an activity based costing system in a service firm. By using this technique a service firm gets information like cost of processes, profitability of services, customers and markets. As the scale of operations increases for an organization this costing technique starts to get more complex. The operations and updating of these costing systems become very time consuming and tedious for its managers. And ultimately this leads to dissatisfaction amongst the employees. Due to the dissatisfaction with this system many companies have given up its use. Time-Driven Activity Based Costing: This version of activity based costing came as a result of the criticism of the original activity-based costing. This new version reduces the complexity of activity costing system. This new system eliminates the implementation and operational problems which were encountered in the traditional ABC-costing system (Hicks, 1992). The basic framework for Activity based costing is that it groups indirect costs by processes and the activities entailing the business entity. This cost is later allocated to specific cost objects e.g. finished products, service and etch. Than a particular cost driver is assigned to each business activity. By doing this a service firm can now assign activity cost to a specific cost object. In this way an activity based costing accurately allocates indirect cost to services (products) and customers. This helps a firm to come up with a more accurate unit cost of a service or product, which in turn helps the firm to make better operational and strategic decisions. The main aspect of Activity-based costing is that it amalgamates value analysis, process analysis, quality management and specific costs into on single tool for analysis. Activity based costing gives way to Activity based budgeting, it does this by identifying different activities, calculating individual costs, selecting a cost drivers and its measurement for different activities provide information which enables company managers to efficiently manage these costs and undergo more effective budgeting of enterprise costs, this process is known as Activity based budgeting (Khozein, Dankoob, and Barani, 2011). These two tools, by providing accurate data on costs of service or product, allow the firm to undertake a firm wide performance and profitability analysis. Both these techniques when implemented by the firm, gives rise to activity based management in an organization. The difference between traditional costing systems, previously used in service industry and activity based costing system it that this system uses the right set of assumptions. It ensures that all pertinent information about costs are gathered and utilized to accurately allocate a cost to an activity. This in turn allows better decision-making and cost control, which was not possible in previous costing systems. As mentioned above, the utility for activity based costing has arisen because of the extreme competition that has engulfed the service industry. This new environment makes it imperative upon a firm to acquire accurate information about a service, activities involved in the service and last but not the least customers. This was traditionally not the mode of operating in a service industry because there was not that much competition in the service industry. Mangers of a services company was least concerned about the cost of a particular service, how the processes will be carried out and last but the least they were totally callous about customers. This technique of costing allowed managers of a particular department to budget their departments’ expenses more accurately, they could use this information to contrast actual verses the budgeted cost and find out discrepancies for latter resolving. Activity based costing as mentioned above encompasses customers perspective also because it allows a company to identify its most valuable customers or group of customers. An efficient activity based costing system will allow a service company to extract information that will enable it to manage its customers intelligently; it does this by identifying the cost associated with each individual customer group (Szychta, 2010). The new version of Activity-based costing that is Time-based Activity based costing, takes an aggregate view of the resource consumed in offering a service e.g. materials, labor, outside services. This version technique uses time as the primary cost driver. The dimension of time is used to allocate cost of a resource directly to the cost object e.g. transaction, orders, finished products, services and customer. The difference between this new version and the old version is that it the previous version used to assign resource cost to an activity before allocating it to the cost object. Experts believe that using time as the primary cost driver finds its utility because most resources like personnel and equipment can be measured by keeping track of the time these resources are available to get the work done. This leads the managers to find out the amount of time required to perform each activity. This will further be used to calculate the activity’s cost driver rate. This rate will enable the manager to calculate the costs of activities performed for a product or service. These calculated figures are sent to the management so that they could come up with an operational strategy that will help the company to reduce these costs and utilize capacity more efficiently (Piper and Walley, 1991). Problems in Implementing an Activity-Based Costing System: The fundamental reason behind the failure of implementing an Activity-based costing system is that organizational personnel implementing this technique, lacks the knowledge required in implementing each aspect of the technique. This lacking leads to ineffective launching and implementation of ABC costing, budgeting and management systems, that further leads to the wastage of financial resources and human resources in an organization. To cope with this failure the organization needs to further direct capital resource to the implantation processes, because the previous capital that had been invested was far too much to let go. This have given rise to the concept of sunk cost. Not only is inexperience important but also this task requires an organization to use both its financial and nonfinancial resources this leads to the problems like lack of proper training, inflexibility of implementation team, organizational resistance, cumbersome reengineer of existing costing technique and etch. Thus implementation of an Activity based costing creates problems on an organizational, managerial, environmental, individual, and technical factors. Another important problem in the implementation of this system is that an accountant who basically is the person who will implement this system, but since an accountant seriously lack sufficient interpersonal skills, which are vital for the successful implementation of this kind of system therefore an environment of friction gets in to the organization. These problems are common to all kinds of organizations who are or want to implement an activity based costing system (Roztocki, Valenzuela, Porter, Monk, and Needy, 1999). Crocargo Logistics: The logistics company is currently engulfed with multiple operational problems. Since the company is undergoing an exponential growth period, its current procedures and systems are not well designed to cope with this kind of growth. Its current costing method is utterly simple to identify all the pertinent costs of the service, as a result of which the company is unable to price its services accurately. It is winning contracts in the industry more than its competitors but still the company not able to reach its break-even and is not generating enough cash to sustain its operations. The reason behind this issue is that the company is not adding all the costs it would incur in order to get the project done. As a result of which it is engaging in contracts which would be unprofitable for it. Since all costs are not accounted for therefore the bi price is kept low. After doing the activities in the contract the company finds out that it is not taking enough capital home. Another important issue with the company is that of an increase in interpersonal friction between the departmental heads. Each department is considering itself to be doing an excellent job given their limited resources. Other than that the entire organization is unaware of its supporting and core business activities. The company is performing more activities than required to perform a task. As a result of which it is squandering its limited resources. Most importantly the current costing procedure is totally not compatible with the number of activities the firm is undergoing and also the firm is operating in a highly competitive market. The company has totally undifferentiated products and this fact alone makes it imperative for the company to price its services competitively. Acting as a low cost service provider would not be good for the company as it will not be able to sustain its operations for a long period of time. The company’s processes needs to be tailored for four services of the company which are: Import, export, discrepancies and transit. All these services have multiple overlapping activities, which are not accounted for in the costing system. The General Manager Robert Zurunkel, is a very wise man. He is quick to realize the problem the company is currently facing, after discussing the problem with his managers (the meeting ended in a deadlock) therefore he is quick to react by hiring Ms. Sarah Bellum, who is a dynamic professional. After conducting a series of interviews with the departmental managers, she is of the opinion that the company needs a more complex and rigorous costing system that could trace cost back to its activities which are creating those costs. Her apparent description of the costs technique suggests that she is interested in installing an activity based costing system in the firm. For this activity based costing system the following design can be used: Activity Based Costing System for a service oriented organizations: ( Szychta, 2010) The above figure defines an ABC system; this is a two-stage system that assigns cost to each business activity. This design considers an activity as a cost object, which is creating the cost for the organization. This system first assigns cost to the activities and from activities it will assign cost to objects like services: importing, exporting and transit. After finding out the cost the manager will give weights to the new cost objects or activities. Over here the company will use time as the cost driver and equate it with the underlying cost of each activity. This will give the final cost for the activity that will allow the firm to identify value added activities, determine trade strategies and eliminate activities which squander resources. Previous Costing Issues: As mentioned above the company undergoes bidding program to win service contracts. But since the company has running its operations with generating enough capital to sustain its operation, therefore it is plausible that it is underestimating its costs. The current situation illustrates the problem that the company is not able to come up with the true cost of its services as a result of which the company is not in a good position to negotiate the prices of its services. As a result of this, most of the time the company is undertaking its contracts at a lost price. Other than this one major issue of untraceable costs, the company’s departments are performing multiple activities. These overlapping activities are having a cost associated with them. These costs are totally not present in the final cost of the service to which an industry mark-up percentage is applied. Since the underlying cost to which the mark-up is applied is low therefore the final price of the service also turns out to be low. Looking at these problems it is clear that the company is running unprofitable operations, which ultimately will reduce its chances to survive in the market place. (Roztocki, Valenzuela, Porter, Monk, and Needy, 1999) This model for Activity based costing for a manufacturing firm, in its first stage assigns a cost to a cost pool lying within an activity center, based on a cost driver. In the second stage costs are transferred from the cost pools to a product based on the amount of each activity consumed by the product to come to its final form. In a manufacturing firm, once the main activities are identified appropriate cost drivers are identified for each expense category. While in the second stage activities are traced to products using the cost drivers selected for each activity in the previous stage. However data in this stage will not be available that easily. Gathering appropriate information is essential in order find the true value of the final costs. An important aspect of the needed information is the proportion needed in each stage of an activity based costing. Every activity consumes a portion of an expense category; similarly each product consumes a portion of an activity. Zurunkel Doubts Concerning the Current Costing System: Yes, Mr. Zurunkel’s concerns about the current costing system are correct. His feeling regarding its over simplicity is absolutely correct. This costing method is unable to account for all the costs that the company is incurring to offer its services. If the GM gives the order of replacing the current costing system, than Ms. Heidi Clare’s department that handles the incoming parcels without destination information or torn up parcel containers would benefit the most. Since this department has to undergo multitasking therefore it is important that all the activities that this department performs on a parcel are accounted for. Costing Based System on Activities: Since, the entire case is concerned about the ignorance of cost by the company’s current accounting system; therefore, the proposed accounting method by Ms. Sara Bellum is being considered to identify activities on which organization is incurring cost, but is not accounting these costs in its service prices. This accounting method is appropriate because it accounts for all the costs the organization is incurring. This will enable the organization to come up with competitive prices, which would enable it to maintain sustainable operations. Analysis of the Sarah Bellum’s Proposal: The obvious strength of this method is that it will enable the company to identify activities on which it is unnecessarily squandering its limited resources. This method will also tell the company about hidden cost objects as a result of which the company will enter bids which are profitable for it. However, the most apparent problem with this costing method is with its applicability in a service organization. Other than this problem, the new costing method will bring to surfacing the existing organizational friction. The organizational friction that is currently engulfing the company is very apparent from the discussion of the company’s top managers. And since the implementation of this costing method requires the support and willingness of every departmental head, therefore it is quiet plausible that under the current hostile company environment this would be difficult to achieve. Cost of Services provided for by Crocargo Logistics using ABC: The revenues and costs of each of the service provided for by Crocargo Logistics have been shown in the table below: Import Export Transit Total Revenue $11,539,226 $9,987,841 $3,692,552 $25,219,620 Cost of personnel 3,075,791 5,698,837 1,614,072 $10,388,700 Cost of materials 268,426 280,097 94,427 $642,950 Cost of utilities 94,979 94,979 31,243 $221,200 Cost of external services 1,556,797 1,143,103 - $2,699,900 Rental expenses 63,577 55,029 20,344 $138,950 Depreciation 774,128 670,051 247,721 $1,691,900 Subtotal 5,833,698 7,942,096 2,007,807 $15,783,600 General and Administration Costs 3,830,765 3,315,740 1,225,845 $8,372,350 Total Cost 9,664,463 11,257,836 3,233,652 $24,155,950 Net Profit 1,874,763 (1,269,994) 458,901 $1,063,670 Conclusive Remarks: After implementing the costing method proposed by Ms. Bellum, it is quiet visible that the company is currently running its exports services at a loss. The fundamental problem as identified by this costing method is that the company is not taking into account all its export services activities due to which it is missing meaningful costs in its pricing. Another implication of this shortcoming is that the company is putting up bids which are not accounting the full cost of the tendered project; hence the company is left with no substantial capital at the end of the project. Therefore the company needs to thoroughly review its activities in this domain and account them in the final price of the service. List of References Armstrong, P 2002, ‘The Cost of Activity Based Management’, Accounting, Organizations and Society, vol. 27, pp. 99 – 120. Brimson, J 1991, Activity accounting: An activity-based costing approach, J. Wiley, New York. Cagwin, D, and Bouwman, M 2002, ‘The association between activity-based costing and improvement in financial performance’, Management Accounting Research, vol. 13, no. 1, pp. 1-39. Gosselin, M 1997, ‘The effect of strategy and organizational structure on the adoption and implementation of activity-based costing, Accounting Organizations and Society, vol. 22, no. 2, pp. 105-122. Hicks, D 1992, Activity-based Costing for Small and Mid-sized Businesses: an implementation guide, John Wiley, New York. Startton, W, Desroches, D, Lawson, R, and Hatch, T 2009, ‘Activity-Based Costing: Is It Still Relevant?’ Management accounting quarterly, vol. 10, no. 3, pp. 31 – 40. Piper, J, and Walley, P 1991, ‘ABC Relevance Not Found’, Management accounting, Vol. 69, no. 3, pp. 42 – 45. Roztocki, N, Valenzuela, J, Porter, J, Monk, R, and Needy, K 1999, ‘A procedure for smooth implementation of Activity Based Costing in small companies.’ 1999 ASEM National Conference Proceedings, Virginia Beach, October 21-23, pp. 279-288. Khozein, A, Dankoob, M, and Barani, G 2011, ‘Major factors affecting launching and implementing activity based costing system.’ International Research Journal of Finance and Economics, no. 71, pp. 112-117. Fei, Z, and Isa, C 2010, ‘Factors influencing activity based costing success: a research framework.’ International Journal of Trade, Economics, and Finance, vol. 1, no. 2, pp. 144-150. Szychta, A 2010, ‘Time driven activity based costing in service industries.’ Social Sciences, vol. 1, no. 67, pp. 49-60. Appendix Import export transit Number of parcels 3,240,000 2,804,400 1,036,800 Percentage 46% 40% 15% Total parcels 7,081,200 Total revenues $25,219,620 Revenues $11,539,226 $9,987,841 $3,692,552 Cost per day Import - days export - days transit - days Import Export Transit Cost of personnel $10,388,700 28,858 2,140 3965 1123 3,075,791 5,698,837 1,614,072 Cost of materials $642,950 1,786 2,530 2,640 890 268,426 280,097 94,427 Cost of utilities $221,200 625 152 152 50 94,979 94,979 31,243 Cost of external services $2,699,900 7,500 143 105 0 1,556,797 1,143,103 - Rental expenses $138,950 386 63,577 55,029 20,344 Depreciation $1,691,900 4,700 774,128 670,051 247,721 $15,783,600 43,843 5,833,698 7,942,096 2,007,807 General and Administration Costs $8,372,350 23,257 3,830,765 3,315,740 1,225,845 $24,155,950 67,100 9,664,463 11,257,836 3,233,652 $1,063,670 1,874,763 (1,269,994) 458,901 RESOURCE DRIVERS IMPORT Full time equivalent (days) Parcel receipt and monitoring 2,530 material Communication to AustPost 152 utilities Loading parcels into the shuttle 1,890 personnel Data entry revision 250 personnel AX3 sent to AustPost 143 ext services 4,965 28.4% EXPORT Full time equivalent (days) Activity planning 875 personnel Parcel receipt and monitoring 2,640 material Communication to AustPost 152 utilities Flight and container identification 1080 personnel Loading parcels into containers 2010 personnel Communication to Airline Companies 105 ext services 6,862 39.3% TRANSIT Full time equivalent (days) Parcel receipt and monitoring 890 material Flight and container identification 480 personnel Loading parcels into containers 643 personnel Communication to Airline Companies 50 utilities 2,063 11.8% Discripencies Full time equivalent (days) Management of AX2 discrepancies 1,430 Management of AX1 discrepancies 1,270 Parcel re-assembling 890 3,590 20.5% Total days 17,480 Read More