Activity-Based-Costing in Practice and Factors Affecting Its Successful Implementation - Essay Example

Finance and Accounting Activity-based-costing (ABC) in practice - the factors affecting the successful implementation of an ABC system Contents Contents 2 There are five different stages to establish the activity based costing and these are as follows- 3 Literature Review 4 Factors affecting the successful implementation of ABC system 7 Main difficulties encountered during ABC implementation- 8 Research Methodology 10 Quantitative Research Method 10 Qualitative Research Method 11 Conclusion, Limitations of Previous Research Studies and Identification of Research Gaps 11 References 13 Introduction Activity based costing is a new concept which is used to allocate the overhead costs to the related products. ABC is considered as an alternative to the traditional method of overhead costing. It focuses on the activities which drive the costs. It identifies that overhead costs can vary in a particular proportion with the changes in activities. Unlike the traditional method, ABC does not measure the utilization of production volume as the basis of absorption during calculation of overhead costs. It traces the overhead costs of the products by focusing on the specific activities which causes costs to arise. ABC also provides useful information about the cost of the product which is helpful in decision making (Weetman, 2012, pp. 85-88). According to Drury, ABC method can be used for various cost management applications like customer profitability analysis, business process management and value chain analysis. According to some other management accounting literature ABC can be divided in four genres like contingency research, basic research, critical research and consulting. It can be seen that type of the contingency research is one of the most important development on the topic of ABC. However, some countries have given more attention to the contingency based research. There are five different stages to establish the activity based costing and these are as follows- Identifying the main activities that happen in a company. Identifying the factors that mostly manipulate the cost of an activity. These factors are known as cost drivers and they directly indicate the process in which an activity attracts the cost. Cost pool for each activity should be created to trace the costs. Calculation of cost driver rate by dividing the total cost in the cost pool by the number of times the activity happens. Allocation of each cost to each product by analyzing the demand for every activity (Weetman, 2012, pp. 85-88). Literature Review Johnson (1990) has described that ABC, ROI and Variance Analysis are the most important concept of management accounting in 20th century. According to Mitchell (1994), ABC system got high profile popularity by the work of Kaplan and Cooper. Bhimani and Piggott (1992) have stated that Activity Based Costing has many important benefits over other costing systems like it increases the cost accuracy of product and provides more comprehensive information about cost incurred to ensure better performance. It also provides more accurate data which helps the managers to take better decisions and increase efficiency for sensitivity analysis. It is also considered as a valuable model which adds value to the organizational activities and transactions. According to some research studies, respondents told that they are satisfied and they think that ABC provides more accurate costing result than the traditional method of costing. These studies have also stated other benefits like accurate profitability analysis for customers, positive behavioral effect on employees, accurate insight into cost behavior and causation and better measurement of performances. According to Mitchell and Innes (1991) have stated that Activity Based Costing gives more relevant costs of product which is useful to reflect the total overhead cost of the product. They have also indicated that ABC provides better pricing and product strategies through the existence of realistic information about the product profitability. Cohen et al., (2005) have conducted a questionnaire survey in 2003in some 177 leading companies. According to the study, there are various implementation benefits of ABC and the findings can be divided into six different categories like Cost Management, Cost Accounting, Decision Making, Performance Management, Relationship Management and General Management. These benefits along with their parameters can be seen in the following diagram- (Cohen et al., 2005:12) Factors affecting the successful implementation of ABC system According to Sartorius et al. (2007), there are some factors that create problems in implementing the ABC and the study states that these factors are problems in identification of activities, lack of identifying the proper cost drivers, less support of the top management, wrong selection of software and personal resistance from using ABC. These are the main factors affecting the successful implementation of ABC. Cobb et al. (1992) has found that major problems that were faced by some USA companies during the implementation of ABC were that lots of work was involved in the system but there were lack of necessary accounting staff, lack of computer resources, problems in selecting the cost drivers. He has also identified some issues due to which successful implementation of ABC could not be done and these are as follows- problem in collecting the quantitative data regarding the cost drivers, higher priorities like survival of a company during the phase of recession, problem in linking the cost drivers directly to the product lines. Apart from these, the companies which adopted the ABC process had faced some difficulties in the initial stage like selection of cost drivers, linking cost drivers, uncertainty in using ABC in case of stock valuation and choices of activities. According to a study conducted by Anderson (1995) on General Motors has found that there are some technological factors that affect the success of ABC. The study has developed an outline to evaluate the hypothesis and implementation of ABC about the factors which affect the implementation of the ABC system. These factors include wrong selection of cost drivers, lack of resources etc. Main difficulties encountered during ABC implementation- The above table shows that technical factors which affect the successful implementation of ABC are selecting cost drivers, defining the activities, allocating the resources and cost to activities are some of the common problems that were encountered during the implementation of ABC. Based on the above table we can classify the barriers and difficulties in implementing the ABC in the following three categories- The above diagram indicates the main factors or barriers in successful implementation of ABC system. It shows that there are mainly three types of problems- Technical, Behavioral and System related issues that have identified by the researchers. Among all of these, technical issues are the first step which affects the implementing process of ABC as it includes the basic problems like identifying activities, allocation of resources to the individual activity, selection of cost drivers. System related issues includes problems in collection of data and information, lack of software packages, less staff in accounting process and less time. Behavioral issues include lack of support from the top management, personal resistance in using ABC system, lack of experience and efficiency and satisfaction with the current system. Thus it can be seen that these factors should be resolved for the successful implementation of ABC. Research Methodology Research methodology is an important part of research study. Research methodology defines the process of data collection and implementation for successful research. The collection of information and data alone is not sufficient to construct a proper research methodology but it should be collected in a systematic way with a clear vision. Along with this, only assemble of data from different sources is not enough to complete the research but the data should properly concluded with interpretation of the collected information for better understanding of the readers Data collection can be done in two ways- Quantitative method and Qualitative method. Quantitative Research Method Quantitative research is a logical and data led approach and it describes the opinion of the participants form the numerical and statistical point of view. Quantitative research is done by using questionnaires and surveys that participants tick from given options. Quantitative research is mainly done by close ended questionnaires and data are collected based on the option provided by the researcher. This type of research is very flexible as it can be carried through face to face interview or by interview over telephone. Qualitative Research Method The main aim of this research method is to gain deep understanding about a specific event or organization rather than a description of a large sample population. It provides a description about the order, structure and patterns which is found among the target population. It is also known as the field research. It gathers data from the previous research studies. It does not includes manipulate variables or closes ended with fixed options. But it describes the meaning emerges from the answer of the participants. In this research project we have collected the data mainly based on the qualitative research method. Here we have not constructed any questionnaire but we have done the research based on the previous studies done by the researchers. We have gathered information from various publications and journals and books for the better understanding of the readers. Conclusion, Limitations of Previous Research Studies and Identification of Research Gaps ABC system has helped many organizations to serve the market need by providing better quality products at a competitive price. It has helped in the decision making process of the top management by assessing the customer and product profitability. With the help of ABC system, companies were able to improve the level of efficiency and were able to reduce the cost without compromising the quality of the product. It has also led the organizations to introduce models for cost reduction and thus savings were achieved. ABC system is a practical technique which can be used by companies of every size to determine their cost of production and to understand the cost drivers. With the help of this knowledge companies can create more profitable product mix and can identify the activities which are necessary for improvement. The organizations can achieve their goals with the ABC system. Limitations of previous research include lack of descriptive knowledge about the technical problems that affect the successful implementation ABC system. The researchers should do more detail research using large sample size of companies for better understanding and analyzing of the research. However to mitigate the research gaps, we can provide some possible suggestions for further research like case studies should be conducted in every companies which are using ABC method by using the following questions- How they can address the technical difficulties? How they can over the behavioral issues and system related issues. It will be helpful for further research and will be beneficial for the readers. References Weetman, P. 2012. Management Accounting Second Edition. [Pdf]. Available at: http://hmrayhan.files.wordpress.com/2012/11/management-accounting-2nd-ed-p-weetman.pdf. [Accessed on: 5/1/2014]. Bhimani, A. and Pigott, D. 1992. “Implementing ABC: A Case study of Organisational and Behavioural Consequences”. Management Accounting Research, Vol.3. Cohen, S. et al. 2005. “ABC: Adopters, Supporters, Deniers and Unawares”. Managerial Auditing Journal, Vol.20. Innes, J. and Mitchell, F. 1991. “A Survey of CIMA members”. Management Accounting (UK), Vol.69. Sartorius, k. et al.2007. “The design and implementation of Activity-Based Costing (ABC): a South African Survey”. Meditari Accountancy Research, Vol.15. Cobb, I. et al. 1992. “Activity Based Costing: problems in Practice”. The Chartered Institute of management Accountants, first Edition. Anderson, W. 1995. “A Framework for Assessing Cost Management Systems Change: The Case of Activity-Based Costing Implementation at General Motors”. Journal of Management Accounting Research, Vol.7. Drury, C. 2012. Management & Cost Accounting, 8th edition. South-Western. Read More