ABC and ABM : Together or separate - Case Study Example

? ABC and ABM – Together or separate? Contents Contents 2 Introduction 3 Activity Based Costing 4 Activity Based Management 6 ABC and ABM – Together or separate? 8 Conclusion 10 References 11 Introduction Globalisation has brought along radical changes in the ways in which businesses are carries out. The technological improvement in the different countries has made the world a bigger platform for competition. These changes can be noticed in the world of information in the financial as well as the non financial fields. Most of the organisations in the present day rely on the data and subsequently the information about the various performance metrics of the different functions, employees as well as the demands of the markets and the end users. Most of the organisations at the present day depend on the costs systems in various areas of their businesses like the designing of the product offerings which would meet the needs of both the customers and the enterprises. The businesses would be able to reap their desirable amount of profits and the expectations of the customers would be fulfilled. The cost systems would also act as a signalling parameter that would indicate any kind of discrepancy in the production quality as well as efficiency in the production processes. The employees would also be assisted in their day to day activities which would help in their process of learning. This method would also help the suppliers and the distributors on the negotiation of the prices and the quality as well as to reach to the target customer segments. Therefore the management of the cost systems through the implementation of the new technology has become an essential part of a business to survive the competition in the world platform. Thus the three main functions that these cost systems help the managers with are the valuation of the cost of the goods sold and inventory, which is mainly needed in case of financial reporting, the evaluation of the various costs that the company may incur in the future endeavours and how to reduce them, as well as to make available the right information at the right time to the managers in order to help them in the decision making process. ABC and ABM are the two major managerial systems that help the managers in their decision making process. The various aspects of these two methods have been analysed in this report and the convergence has been assessed from the various aspects of a business, especially the accounting procedure. Activity Based Costing Activity Based Costing (ABC) is a method in which a thorough analysis is done on the production process in a company in order to understand the costs that emerge, the services that the customers are offered with and the optimal usage of the resources. In most cases it is seen that the indirect costs are accounted in the inappropriate way which result in the wrong pricing of the products1. The ABC technique makes takes the cost effective path which remove the chances of improper allocation of the indirect cost in the process of production. The direct cost and the indirect cost are separated in the various actions that take place in a firm. The method mainly considers that the costs are variable for each of the activities and the component of fixed cost can be accounted for only for a very short span of time. The concept of activity is extremely in case of this costing technique and it considers the various functional department and their uses of the resources. This method also entails the different techniques of calculation of the costs involved with the production, distribution as well as on the customers. Any enterprise that applies this method on the decision making process of their managers would witness the increase in their level of profitability from the initial stages of implementation of the processes. The distinctive features like the reduction in the cost and the profit loss reduction make the technique acceptable to most of the managers of businesses. The information relating to each step of the production process contribute to the detection of the subsidised effects that happen due to the surge in the volume of production, diminution of the sub activity as well as the decrease in the selling prices of the end products. These issues that comprised of the traditional methods of costing have been completely removed from the ABC technique and make a correct assessment of the costs of the resources which would include the cost of the raw materials, equipments along with the remuneration of the employees. The figure below depicts the ABC technique in a schematic manner. Figure 1: Activity Based Costing2 Thus ABC addresses the various issues that used to crop up in the traditional methods of costing. The reasons for the success of this technique over the traditional techniques in the context of accounting have been listed as follows. First of all the method provides an analytical treatment of the allocation of the overhead cost along with the cost drivers that are considered to be arbitrary. Secondly, the analysis is done in a coherent manner which separately provides the information for the administrative divisions of the business as well as the strategic business units. Thirdly, the benefits of the customers are also considered in this case. The selling price of the final products are also analysed in the most transparent method. The transfer pricing method in case of ABC method across the internal business divisions is also done in a fair technique. Activity Based Management The Activity Based Management is a management of the business activities which would be instrumental in the improvement of the value attained by the customer as well as the profit of the company earned on delivering the value to the end user. The ABM methods therefore entails the activity analysis, analysis of the drivers of the cost and the assessment of the performance which is mainly done by the acquiring the information from the ABC technique. ABM in a way enhances the excellence of a particular business in a way of providing information which in turn would help in the strategic decision making process for the long term. This would include the decisions of the product mix as well as the decision of the resources that would be incorporated in the production processes3. The product designers would benefit from the technique as it would help in the devising of the processes through flexible costing techniques. It is not only a tool for accounting but also a method that helps in the improvement of the businesses continuously in the decision relating to capital investments as well as the pricing of the products. The ABM technique does not however, incorporate any cost reduction method. Alternatively it helps in the identification of the costs in a much better manner so that the managers can identify the right loopholes and the areas in which the costs can be curtailed or managed in a more efficient manner4. In order the carry out a proper ABM procedure the company has to incur sufficient amount of both material as well as human resources which would be a cost to the company. But this cost in turn would help in the reduction of the other costs that would take place throughout the production process. The outputs of an activity management process would include the cost that would be included in the business activities and processes The outlay on the non value added goings-on Performance measures that are based on the different activities The accurate cost of the products as well as the services The various drivers of these costs. The ABM model that is been frequently used in the various businesses has been shown in the figure below. The various outputs have been indicated. Figure 2: Activity Based Management5 ABC and ABM – Together or separate? Managers are able to get the true costs of the products with the help of the ABC methods. The true value of the products is derived through this comprehensive technique and it helps in the process of the accounting and financial reporting of the country at the very basic levels. The activity based management has evolved from the activity based costing. The ABC acts as the major source of information for ABM techniques for most of the organisations. The data that the managers derive out of the ABC in turn helps in getting a direction in which the value would be created and the resources would be allocated in an efficient manner which would help the stakeholders of the entire process like the employees, customers as well as the suppliers. The interrelation between ABM and ABC can be explained with the help of the chart below. Figure 3: Use of ABM6 ABC has two major applications in ABM as shown in the figure. The Operational ABM would aim at achieving efficiency in the work done, to curtail the costs as well as to utilise the assets in an optimal way. This would be done by the enhancement of the capacities of the resources for the individual business processes. Any kind of faulty activity that may exist would be eliminated by this technique. This would add to the bottom-line of the company and would help the business to reduce the unnecessary costs. Strategic ABM on the other hand would aim at identifying the different ways that would help the business to survive the competition in the industry in which it operates. The company would also be able to create a competitive advantage which would provide the business with leverage over the other firms in the business. The present day methods of effective cost management has shifted from Activity Based Costing, which aims at the analysis of the prospects of profitability of the businesses to Activity Based Management, which is more aimed towards achieving the higher goals of management through sound decision making process7. The integration of the ABC at the various functional levels to the ABM could be achieved through the complementary functioning of the two methods. The various principles of ABM like the principle of identification of the various functions, the principles of culmination performances and the principles of the non-value elimination can be done only through the proper activity based costing in each of the processes. Some of the specialists in this discipline however argue that ABM is simply a tool of the ABC method and an instrumental extension. Thus according to them the costs cannot be controlled. The activities on the other hand can be controlled which in turn would contribute to the reduction of the costs. Conclusion Thus the informed decision making of a company can take place only on the implementation of both the tools of ABC and ABM methods. These decisions are mainly concerned with the setting of the prices of the products the management of the processes as well as the enhancement of the products and the services provided by the business. The application of the methods in a parallel manner helps in the understanding of dynamics of the costs in the businesses as well as the structures in which the costing is done. On top of that the two methods help in the comprehension of the profitability from the point of view of the customers and the product, the expensed that the business processes would incur and the techniques for their improvement. ABC and ABM stand on the value continuum where the data of ABC is implemented on ABM for the designing of the products and for the signalling of the discrepancies in the efficiency, effectiveness quality and speed of the operations. Therefore these two methods converge in such a way that would help the organisation to achieve its goals and the long terms visions of sustainability. References Baker, Judith J. Activity-based Costing and Activity-based Management for Health Care. Maryland: Jones & Bartlett Learning, 1998. Brimson, James A. and John Antos. Activity-based management: for service industries, government entities, and nonprofit organization. New York: John Wiley and Sons, 1994. Cokins, Gary. Activity-Based Cost Management: An Executive's Guide. New York: John Wiley and Sons, 2002. Kaplan, Robert S. and Cooper, Robin. Cost & Effect: Using Integrated Cost Systems to Drive Profitability and Performance. Boston: Harvard Business School Press, 1998. Miller, John A. Implementing Activity-Based Management in Daily Operations. New York: John Wiley and Sons, 1996. Zander, Matthew. Supply Chain Cost Control Using Activity-Based Management. Boca Raton: Auerbach Publications, 2007. Read More