Why the Activity Based Costing Is Fashionable Yet - Essay Example

MANAGEMENT ACCOUNTING; RESULTS INTERPRETATION By Comments Obtained from the Results The results stated between the ABC and the traditional absorption costing shows that the ABC method is better than the other since it entails relatively higher profits which is the key thing in accounting results. However there is a difference between the costs incurred in both methods .The ABC cost per unit incurred in producing the products was a bit high unlike that of traditional method, the total cost was 204.8583 and that of traditional was 204.100. This is a slight difference as compared to the profit obtained. On the other hand the traditional absorption cost has a less profit of 250, compared to the cost per unit the profit is less and hence it is a total loss to the company. The profit should be higher than the cost of production. Reasons why the Activity Based Costing is Fashionable Yet Does not Provide Information There is increased desire by companies to know the behaviour of factors that drive to different cost .In increasingly competitive business environment organizations seeking to maintain or improve their competitiveness need cost information that is relevant and accurate. This system is based on cost modelling that traces an organization expenses both direct and indirect (Thukaram, 2007, p. 171). The activity based costing is fashionable because it has the advantage of advanced technology to the management of an organization. Hence; organizations are automating what previously had been manual jobs. The primary reason for the shift is also due to the different channels of distributing the variety of products and services, in addition the organization has been servicing different types of customers (Nolan, 2004, p. 17).Hence sufficient information can be obtained to make decisions about the profitability of different product lines. It also helps the organizations provide value added services or “top-ups” to existing products on actual cost incurred basis thus creating efficiency. The introduction of this greater variation and diversity creates complexity and increasing complexity results in greater overhead expenses. The fact that this expense overhead in recurring the labour expense does not mean that the organization is becoming inefficient, is means that the company is offering variety to different customers (Humphrey, 2007, p. 100).It traces indirect cost also called overhead to products, customers and services by identifying resource and their cost, the consumption of this resources by activities and performance of activities to produce output. Thus eliminating unprofitable items from the product line, thereby increasing profitability without increasing prices, a valuable option in recessionary times .Examples of resource expense are salaries, operating supplies, equipment depreciation and electrical power. Resources cost are traced using resource drivers and activity cost are traced using activity drive. The ABC gives visibility to work activities and their .Activities are a group of tasks in the same function that are governed by the same driver and same intensity of resource consumption. It determines the number of activities done in the organization, how many people perform the activity, how much time is spend on performing the activity ,what resources are required to perform the activity, what operational data best reflects the performance of the activity and the value of the activity to the organization (Nair, 2006, p. 39). ABC presumes that products are or services consume activities, and activities consume resources. Hence it helps in Identifying and eliminating non-value adding activities, or activities that do not contribute to the final value of the product or process. Examples of non-value adding activities include needless inspections and duplicate processes. The activity based costing calculates historical cost to provide insights, understanding and focus. It is basically full absorption costing but without violating rules of causality as it is typically done with the traditional cost allocation of indirect expense (Cokins, 2003, p. 25). This aids in determination of the prices on different products and services. The limitations of using the ABC are that it involves life cycle costing. The descriptive view of ABC typically covers a time period of such as a month, quarter or year. Products and customers pass through a life cycle. ABC may measure unusually high product cost during a products early stage, when it requires attention to stabilize production .The product might appear unprofitable today but in the future as those cost subside. This shows it does not calculate the multi-period costs across a life cycle, but it costs snapshots during each period can be used as inputs for life cycle costing (Swenson, 2005, p. 168). Organizations that follow activity based costing are forced to maintain two cost systems and accounting books that is one for internal use and the other for external reports ,filings and statutory compliance (Yin, 2005, p. 56).  The activity based costing faces serious challenges in practical application, for appropriating some of the fixed overheads such as the chief executive’s salary on a per-product usage basis, is next to impossible. Moreover the process of data collection ,data entry and data analysis required to divide the fixed overhead costs among units based on usage ,requires substantial resources and remains costly to maintain. Although activity based costing is a scientific approach, the method of implementation is complex, time consuming, and costly.  Similarly, employees rarely devote 100% of their working hours to productive activities, and not all productive activities add value to the product or process of the firm. For instance, the ABC method fails to account for the time employee takes part in a first aid awareness campaign, leading to substantial ‘cost leaks.’ There is no meaningful way to assign such business sustaining costs to products on a proportionate basis, and products and services share such costs equally (Argyris, 2007, p. 101). There is too much attention needed to detail and control. This might obscure the bigger picture or make the firm lose sight of strategic objectives in a quest for small savings, making the firm “penny wise and pound foolish” (Bhimani & Bromwich, 2009, p. 39). For instance, ABC might identify one distribution channel as non-remunerative, or an inspection as non-value adding. Such channelling or processes might be non-profitable, but placed in the first place to achieve some other strategic objectives (Gupta, 2008, p. 32).The above statements have stated that the activity based costing is fashionable and yet they don’t provide extra information to the organization. References Argyris, C. a. (2006, September). Implementing New Knowledge. Accounting Horizons, 8(3), 83-105. Bhimani, A., & Bromwich, M. (2009). Management Accounting: Retrospect and prospect. London: Elsevier. Cokins, G. (2003, September/October). Measuring Profits and Costs Across The Supply Chain For Collaboration. Journal of Cost Management, 3(40), 22-29. Gupta, A. (2008). Financial Accounting for Management. New Delhi: Pearson Education India. Humphrey, C. a. (2007, August ). Theories and case studies of organizational accounting. Auditing and Accountability Journal, 9(4), 86-106. Nair, M. (2006, March/April). The Keys To Implementing activity based management. Journal Of Corporate Accounting and Finance, 15(3), 37-42. Paul M. Nolan. (2004). Critical Success Factors for Enterprise ABC Solution. Journal Of Performance Mnagement, 17(3), 15-22. Swenson, D. (2005, September). The benefits of activity-based cost managment to the manufacturing Indurstry. Journal Of Mnagement Accounting Research, 14(7), 167-180. Thukaram, R. M. (2007). Management Accounting. New Jersey: New Age International. Yin, R. K. (2005, february). Case Study Research. Accounting Organizations and Society, 15(7), 55-70. Read More