Advanced Management Accounting and Activity Based Costing - Case Study Example

Advanced Management Accounting Table of Contents 2 Introduction 3 4 a) 4 b) 4 2. 7 Conclusion 10 References 12 Introduction Activity Based Costing (ABC) system of accounting was first introduced in the year 1980 by Robert Kaplan & William Burns. The ABC method of accounting is a procedure based on which the manufacturing industries diminish the ratio of direct labour and material costs where technological developments has reached at its apex keeping the indirect & overhead costs at an increased position. ABC especially focuses on how information can be made more perfect or genuine related to costs of various products and services. An organization implements the ABC method of accounting system can attain or develop a vast understanding on the business techniques and organizational goals for smooth running business and cost related behaviours for ABC analysis (CIMA, 2006). Hence, ABC is determined as an unique method or technique for allocation of overhead, services and products among others. Costing is a major consideration for an organization to ascertain costs of products and/or services. ABC system of accounting firstly acquires the overheads costs for the organizational exertion thereafter undertaking the costs of overall activities with products and/or services. The ABC method of accounting holds the versatility to produce specialized products, so that a genuine as well as verified decision can be made and presented by the management relating to the price of selling and delivering any products or services (CIMA, 2006). The objective of ABC analysis indulges the process of determining or achieving the felicitous or adequate outcome with activities and resources including effects over the pricing of a particular product or service (Maiyaki, 2011; CIMA, 2006). In this regard, the objective of this paper is to focus on ABC method of analysis applied by James Hospital. So, the aim of ABC method is to assist James Hospital to determine cost of various products and utilize the method for better management decisions. 1. a) The James hospital has planned to ABC system with the aim of obtaining appropriate information in terms of pricing. It is a private organisation and with the increasing implementation of medical technology, the organisation in 2012/13 has initiated plans to adopt ABC system. The management has considered two types of operating system one is ENT and the other is cataract basis. Calculation of different prices related to overhead as well as direct cost has been done on the basis of existing method and ABC method for providing a better pricing index for the hospital. b) Estimation made with the use of the ABC system ensures more accuracy in terms of pricing of services and products for determining an enhanced path to consider overhead rates. The ABC defines every cost related products clearly, so that the management or an organization can visualize the results or outcomes of a particular product and can execute the same in the process. Both the operations that include ENT and Cataract operations will hold a lower selling price when calculated under ABC method instead of the existing method. The ABC method helps in charging price of a defined product. It also helps to find and eradicate unwanted costs and gives opportunity to an organization. The ABC method of costing is more competitive as well as profitable compared to the existing method, as it undertakes each and every cost related to operations to form a better management with flawless budgeting and performance. Moreover, the operations are forecasted that will not harm the profit margin, as the changing costs will remain the way they have been allocated. The process of allocation of resources is carried by the ABC process in such a manner that is cost efficient as well as profitable for various departments of services related to various activities (Maiyaki, 2011). The ABC method of costing looks over every activity of cost related products and services for providing a definite result about how to allocate the costing activities. The process for determining cost of internal management can be estimated in an appropriately with the use of the ABC method. This method creates a distinction of how products can be classified according to cost and priority. The advantage of using ABC method is that it reduces or eliminates the misrepresentation within various products.ABC involves the process of ascertaining costing activity that can add value to a particular product or service more efficiently with available resources. The management of James Hospital is required to produce appropriate pricing strategy with appropriate amounts or costs due to the decrease in the stay of patients in the hospital (Rasiah, 2011). ABC method also ensures that the new prices are undertaken and are sufficient for covering the facilities offered in terms of costs in the long run. Cost efficient products with their respective resources can be very well justified as well as analysed through this costing process. This ABC method helps the management of an organization in synchronizing the products with their actual cost, so that consumers’ demand can be met. It balances the total output of resources with the actual cost in relation to the resources, which are consumable or consumed (Manalo, 2004). ABC method of costing is to be applied in the hospital to allocate cost to different products as well as tasks or activities based on the availability of resources. This method is different from the traditional method of costing that is applied in private sectors such as James Hospital. The traditional costing method focuses towards overhead costs to ascertain overall cost of products or services offered to the patients. The ABC method is more preferable than the traditional method of costing, as it allows allocation of cost to different productive departments. The implementation of ABC method in the UK public sector is likely to be beneficial, as it enhances the cost management system. This system of costing generally specifies and allocates cost measures like machine hours or labour hours (Maiyaki, 2011). Unlike traditional method of costing, ABC method of costing generates each and every costing activity of an organization. The ABC method of costing is used basically in the manufacturing sectors of a company. ABC method of costing has been thoroughly put into use in other sectors for instance, banking and non-profit seeking concerns among others. Whereas, the traditional method of costing is not helpful for the financial sectors compared to the ABC method of costing. In this regard, it can be noted in simple terms that ABC method is used to calculate cost per unit of a particular product or service to recognize the direct and indirect cost to reveal appropriate results that can provide optimum fallout. ABC is likely to produce more optimum results that are effective for managing the product cost of different services. The indirect manufacturing cost can be turned into direct cost by utilizing the ABC method of costing. Similarly, different companies or organizations such as James Hospital are identified to be adopting the ABC method for ascertaining cost oriented objectives and also it can be used by the management of industrial decision makers as an important device or instrument to measure the cost of a product or service (Manalo, 2004). Moreover, in any business organization or firm basically based on long run organisational objectives must supply goods or services at a lower rate to stay a way above from their competitors and accordingly, the inflation based productive goods and services should be represented in a diminishing manner. In this context, the ABC method of costing is recognised to be an effective process, as it plays an important role in determining per unit cost and as well as overall cost of a product or services. Respectively, the ABC method assists in ascertaining the products or services to be listed in the priority section based on which James Hospital is able to retain patients (Manalo, 2004). 2. On the basis of the calculations, according to ABC and traditional method of costing, a difference in overall price can be observed from the data calculated on the existing method for eyes, nose and throat (ENT), the selling price is estimated to be 3407.50 and for cataract it has been 1201.44. Whereas, based on the ABC system, the selling price has been estimated to be lower than the existing method that is for ENT 3352.30 and for cataract 1085.26. It can be clearly identified that the estimation made on the basis of ABC system, lower selling prices are estimated as compared to the existing method. In this regard, it can be comprehended that different selling prices are charged based on the different costs. Subsequently, the price charged under the ABC system is recognised to be ideal for pricing services offered comprising record keeping and admissions, facility sustaining and care services. The ABC system of costing efficiently improves the quality as well as profitability of a particular product or service by determining the per product cost. Use of ABC is also done in the manufacturing departments of an organization providing services and private sectors like James Hospital. The ABC method is used in maximum business houses for producing cost effective products for instance, James Hospital deals with a likewise changing ambience turning up with modifications needed to stay competitive in order to have enhanced choice of services for attaining higher profit margins. The use of ABC has also cropped up largely in the service providing industries like healthcare institutions and banking sectors among others. The ABC system is not only used in the manufacturing concerns, but also plays a major role in public sectors (Maiyaki, 2011). The objective is to make available the preferable services to the consumers that are less costly. The ABC system will be preferable for James Hospital, as it grants the power to the management to accomplish the desired profitability, efficiency and performance of a definite product to make it useful for the consumers. Many service sectors like regional banking sectors and insurance companies have also effectively implemented the ABC to allocate prices of various products or services with available resources. The ABC analysis helps James Hospital in addressing the pricing issues that is strategic and internal for determining appropriate pricing strategy for the services and products offered after adopting medical technology. The ABC system provides genuine, efficient and effective charges that can be applied for retaining patients and their stay for a longer period in the hospital (Manalo, 2004). Despite of having benefits of the ABC costing method, there are few drawbacks or disadvantages in this costing process. This ABC process of costing can be lengthy as well as complex in terms of calculation, the information or data needed regarding various activities can be difficult to ascertain owing to the use of different costs. Presently, James Hospital has turned up to be more complex for adopting medical technology, which raised complexities owing to which the selling price estimated based on the existing method has become less appropriate. In this regard, the ABC method of costing is likely to be expensive to the management of the hospital to manage, imply, execute and to run a concern. Moreover, the different methods used in costing such as overhead costing can be difficult in terms of price allocation of various products. As the implementation of the ABC system is costly, small organizations or firms like James Hospital face complexities in applying this ABC system of costing. Moreover, it is time consuming and accordingly, the management will require huge time to allocate cost of products or services and place the products according to priority base. Thus, the management of the hospital is likely to face the aforementioned challenges in using this system of costing (CIMA, 2006). The ABC method provides high quality information, which results to the usage of numerous cost pools as a result makes the managerial system more costly. This system is difficult as well as highly expensive for installation and can take more than a year to get installed, which can raise the cost of a product as well as the budgetary system of the James Hospital. Information or data needed to carry on the required work by the ABC system is collected through various departments. The departments providing the required data can have other major priorities than supplying information for the ABC system, as it involves maximum numbers of departments, which can hamper other basic as well as essential works to be done by the management (Owen & Charles, 2011).The ABC method is projected on collecting quality information and pricing of goods and so, information are basically collected only once and rest of the procedure is carried on thereafter with this valuable information. With the course of time, the useful data gathered reveal its importance due to the transformation of the various operational as well as departmental structures. This process also requires funding to carry out the product costing effectively, but the management of the hospital may not be able to fund for ABC costing system, as there remains many other vital projects. Accordingly, planning is to be carried out, which is likely to be more important, as this funding system stands as a hindrance for the management to adopt ABC system in the organization. It is not always necessary that implementation of the ABC method can be a successful project until and unless it is applied undertaking every proportion. In this respect, it bears a risk owing to the fact that various departments in the organization may be devoted towards other organizational goals and correspondingly, may overlook other factors essential in ABC system. The ABC system also enlarges the total amount of errors in measuring the productivity cost by increasing cost pools with specification based on costs (Rasiah, 2011). Conclusion From the above discussion, it is quite evident from the concept that ABC method of costing is likely to be beneficial if it is applied in an appropriate manner. Considering both aspects of implementing ABC method, it can produce quality products with efficiency and profitability as well as benefits regarding this system of costing. From the above study, it can be comprehended that to achieve or evaluate efficient productive costs, this method of costing can be more profitable whether to achieve per product cost or fixing the price of a particular product for the James Hospital. The ABC system is not only beneficial for the manufacturing concern, but has also been helpful for the hospital. Overall, it can be ascertained that this system of costing can be applied in any organization, as it enables the employees as well as the managers to gather sufficient and vital information required for product costing and allocating available resources more efficient and appropriately in order to attain proper pricing strategy. The ABC method of costing is a modern, advanced and enhanced technique of costing, which may replace the existing method of costing used by the hospital for ascertaining a suitable pricing/costing system. It has been identified that the ABC system is more appropriate for the James hospital as compared to the existing methods of pricing in terms of lower selling price for the services or products offered by the organisation. On the other hand, there are certain drawbacks associated with the use of the ABC system in terms of lengthy installation and expensive procedure for ascertaining suitable pricing system. Moreover, the ABC system raises complexities for estimating appropriate prices, as the system requires various costs. However, the ABC method is determined to be appropriate for James Hospital to determine suitable prices of products or services offered for retaining the patients. References Owen, P. H. & Charles, J. M., 2011. Are SMEs Ready For ABC? Journal of Accounting and Finance, Vol. 11, No.4, pp.11-22. Rasiah, D., 2011 Why Activity Based Costing (ABC) is Still Tagging behind the Traditional Costing in Malaysia? Journal of Applied Finance & Banking, Vol.1, No.1, pp. 83-106. CIMA, 2006. Activity Based Costing. Topic Gateway Series No. 1. [Online] Available at : http://www.cimaglobal.com/Documents/ImportedDocuments/cid_tg_activity_based_costing_nov08.pdf.pdf [Accessed 07 May, 2015]. Manalo, M. V., 2004. College of Business and Economics CHED Center of Development in Business and Management Education. Activity Based Costing (ABC) Vs. Traditional Cost Accounting System Among Top 500 Corporations In The Philippines. [Online] Available at: http://www.dlsu.edu.ph/research/centers/cberd/pdf/papers/Working%20Paper%20Series%202004-11.pdf [Accessed 07 May, 2015] Maiyaki, A., 2011. The Practicability of Activity-Based Costing (ABC) In the Nigerian Retail Banks. Business Intelligence Journal, Vol. 4, No. 2, pp. 351-354. Read More