The Use of Accounting Based Costing - Essay Example

Executive summary

Accounting Based costing is intended to assign overhead costs obtained during manufacturing in a more logical way as opposed to the traditional approach that mainly involved allocation of costs considering the machine hours in organizations. ABC also is different since the costing first assign the overhead to the activities that causes it and then there is assigning to the services and goods that are actually demanding. In corporations, the accounting based costs make the recognition that the machine set ups, special engineering and those activities that are associated to causing costs are under them (Goddard & Ooi, 2008). They are the activities that cause that company to consume resources. The corporations determine costs that are incurred in each of the activities that are mentioned and then the costs are assigned those products that demand them. The paper aims at identifying the strengths and the weaknesses associated to the use of ABC approach comparing it to the traditional approach. There is also discussion of the process of ABC model implementation.

Discussion

The percentages of organizations that have implemented ABC model have varied from industry to industry. A survey conducted between the year 2010 and 2014 indicates that the highest percentage for the organizations that have implemented the approach are in the manufacturing sector where the percentage ranged between 20% and 50%. The financial service sector followed with 15%-25% (Goddard & Ooi, 2008). The public sector was third and the last sector having implemented the model being communication sector.

The ABC process flow is undertaken in eight simple steps. The first process involved in the flow is identification of the costs. The model first identifies that costs that want to be allocated. The first step is the most important processes since time is not to be wasted with giving the broad scope of the project. The second step in the allocation is loading the secondary cost pools. The process involves the creation of pools of costs that are incurred when services are provided to other parts of the corporations to support directly the services or the goods. Some of the costs that are considered include administrative salaries, computer service costs and other similar costs. The costs are then later allocated to the pools that have a direct linkage to services and products of the corporation.

The third step is loading primary cost pools. The ABC process in this process is intended to create a cost pool for the goods and the activities that are closely related to the production of goods and services (Cooper & Kaplan, 2011). In each product line, several cost pools are created since the costs are mainly incurred at the different product lines. Some of the costs that are considered in the point include procurement, advertisement, research and development and distribution costs. An organization has also the ability of creating pools for each of their distribution channel. Measuring of activity drivers is the net process in the flow. In the process, data collection systems are used to determine the activity drivers that are used in the allocation of resources in the primary and secondary cost pools (Kaplan & Atkinson, 2015). The process can be expensive but it is advisable to use the activity drivers for the information that have been collected are those which is already being collected.

The first process in the flow is the allocation of costs in primary and secondary pools. The activity drivers that have been utilized in the previous process are applied to apportion the costs in the primary and secondary cost pools. After the allocation, there is need to charge cost-to-cost objects. This is done through an activity driver to allocate contents of the primary costs to costs of objects. In the process, a separate activity driver is utilized from each of the cost pools. The costs are allocated through dividing the total cost in each of the pool by the number of activities identified in the activity driver. There is then formulation of reports where the results that are obtained from the ABC system are recorded and given for consumption by the corporation management. The last activity is acting on the information that has been collected. The process is where there us reaction of management on the ABC report. The main reaction that the management has in the report is reduction of the number of activity drivers used in the cost objects.

Strengths of ABC

Several factors have contributed to the growth of ABC in the recent decades. The increased overhead costs in the manufacturing sector have needed a process that could be used to determine it. The ABC model have also been applied in the manufacturing sector since the overhead costs are no longer correlated to the direct labor hours or to the machine hours as it has been in the traditional model. There have also been the diversity of consumer demands and the diversity of products. The other reason for the growth is that the quantities in which products in different sectors have been produced have varied (Kaplan & Atkinson, 2015). There are products processed in large bunches while there are those processes in small bunches.

The main strength of ABC is that it is from the analysis that the true costs of the individual services and products are determined. The actual costs of the products and the services can be hidden when the traditional approach is used but that are made open when the ABC approach is utilized. Corporations implement the ABC model so that they can identify the products in their operations that are not profitable or they have the aim of identifying the true costs of the services and the products so that they are able to support the pricing policies (Goddard & Ooi, 2008). The method is also used to identify those costs that are unnecessary that can be eliminated.

The management of many organizations is moved to use ABC to improve the accuracy of cots. The process makes them get closer to the true profitability and true costs of the operations that they undertake in the organizations. The costs that are determined also helps the organization to have a better understanding of the return on investment and true costs from its initiatives and other projects. In the organizations that ABC model have been successfully implemented, the approach is used to support the decisions on the items that are to be in the product portfolio, pricing of the product s and the services, and choosing between outsourcing of production or engaging in-house production.

In the ABC model, costs are allocated so that there is the achievement of the desirable motivation. The allocation done through the model is to influence the behavior of the organization and to promote managerial effort and goal congruence. Through the ABC model, there is computing of asset and income valuation. There is allocation of costs to products in the approach to measure the costs of goods that are sold (Kaplan & Atkinson, 2015). The allocations of costs also justify costs and obtain reimbursement. There are times when the prices of goods and services are directly based on costs. The prices also can make a person justify a bid that was accepted. The situation was not practical in the traditional approach.

Implementation of ABC systems improves the business processes of organizations. In its application, the ABC system allocates the costs that are not important to the business process and should be done away with. When the costs are corrected, the business process is improved. As costs of the products are determined, the clear pictures of the business is obtained and the areas where there are well performance are known and where there are poor performance, improvements are made.

Weakness of ABC

The implementation of ABC can be challenging to different organization, as the process is associated to different risks and weaknesses. The implementation of ABC is expensive. Setting up the approach can be expensive and time consuming such that small businesses are not able to engage. The process that is involved in setting it up can use up almost all the valuable resources that an organization have. The resources can be used up since for the process to be implemented, data is collected, measured, and analyzed into a new system. There are situations where the business may have the need of hiring a consultant who is specialized to help with the process. Organizations that use software also incur additional costs in acquiring and implementing it.

Misinterpretation of data is another weakness that is associated to the approach. The reports that are produced after the entire ABC process has been analyzed contain different information such as the product margins that are not similar to those that were obtained from the traditional coast model. There is also the possibility that some activity-based costs may be irrelevant when it comes to making decisions for the organization. In an example, the ABC approach does not follow the accounting standards and hence they are not suitable for eternal reporting (Kaplan & Atkinson, 2015). The figures that are obtained from the traditional method are norms and understanding ABC data together with the regular accounting information can confuse and lead to making poor decisions by the management. In situations that there is use of software, the process can be streamlined; the ABC approach maintained and then simplifies the integration with the normal cost accounting information.

Conclusion

Activity based costing is a process that have been used effectively by organizations to collect the amount of resources a service or a product consumes. The use of the approach is essential for businesses that provide customized services and products so that the true costs of the products and services are identified.