Account of Business: Adoption of Activity Based Costing System by SMEs - Assignment Example

Running Head: ACCOUNT OF BUSINESS Account of Business: Adoption of Activity Based Costing System by SMEs By ’s name University name City, State Date Account of Business: Adoption of Activity Based Costing System by SMEs Today, SMEs deal with serious challenges to be competitive in the current global market. As a result, SMEs have to build strategies that allow them to regulate their expenses. Theoretically, ABC has been successful in many research works in accounting and managerial accounting. At the same time, a number of studies propose that the ABC (Activity Based Costing) system has been a practical failure for many corporations over the past decade. The same studies even contend that organisations using ABC today present a paradox in their cost systems (Fladkjær and Jensen, 2011, p. 1). Both study results form a basis for discussing and analysing whether ABC can work for smaller businesses as they abandon the conventional costing system. The following paper discusses whether SMEs are ready to adopt the activity based costing system as an effective tool to achieve the desired level of cost savings and efficiency. First, ABC is not very popular amongst corporations today. Considering many SMEs follow the operational trends of corporations with the intention of reaching their levels of success through cost savings, the popularity of ABC amongst corporations is worth noting (Fladkjær and Jensen, 2011, p. 3). According to CIMA, ABC is a strategy for the costing and monitoring of activities that entail drawing resource usage and costing final products. Corporations assign resources to activities, and activities to cost items based on usage approximations (Chapman et al., 2011, p. 669). According to Henrik Fladkjær and Erling Jensen, SMEs seldom implement the ABC system due to two key reasons. First, ABC is very hard to apply. Second, the data basis for ABC is not accessible in the needed quality in ERP systems used by SMEs (Fladkjær and Jensen, 2011, p. 21). A highly competitive global economy contributes to SMEs’ readiness to implement ABC. A competitive economy compels SMEs to lower the price of their commodities or services by raising output, improving product or service costing, or both. Challenges related to the shift from traditional costing systems to ABC cause rates of adopting ABC to lag behind corporations (João and Machado, 2012, p. 179). Researchers Owen Hall and Charles McPeak note these challenges as the cost of applying ABC, approximating the advantages of the ABC system, and incorporating ABC into the general management outline. As a result, the Hall and McPeak recommend SMEs to consider factors that affect a business’ ability to apply new expertise. These factors are organisational willingness, fiscal effect, workflow output, and general business setting (Hall and McPeak, 2011, p. 17). Even though some SMEs may argue they are not ready to shift to ABC, they are certainly ready to abandon TDC (Traditional Costing). Since the 1970s, enterprises have used TDC since it easy and economic. The current global marketplace facilitates overhead costs’ substantial proportion in total expense. As a result, SMEs still use TDC for allocating overhead expenses, which results in errors of commodity cost (Gunasekaran, Marri, and Grieve, 1999, p. 388). With ABC, SMEs will be able to eradicate these errors as accountants consider it a modern costing method for overpowering the restrictions of TDC. Researchers Tandung Huynh, Guangming Gong, and Ngocminh Ngo say SMEs can use cost drivers to assign overhead expenses (Huynh, T., Gong, G., and Ngo, N., 2013, p. 59). Cost drivers allow SMEs to determine a more precise commodity price through ABC. At the same time, SMEs will be able to identify commodities that make profits and those that make losses. TDC does not offer the more in depth, poised information that SME managers today require for decision-making processes. SMEs are ready to discover numerous non-value-added activities. According to Huynh, Gong, and Ngo, TDC does not identify these activities (Huynh et al., 2013, p. 67). SME managers can no longer only depend on calculating the precise prices of their commodities. Instead, SMEs can use modern costing systems like ABC to recognize and verify the benefits of product and service costing in today’s global economy. For example, non-value-added activities that TDC does not detect include the frequency of replacing equipment at a plant, the many times equipment has been changed at the office or plant, the many times inspectors tested raw materials before production, and the lengthy period between unfinished products and the final stage of production (Capusneanu et al., 2011, p. 2). Organisations that currently use ABC strongly argue that using information acquired from this system in making proper decisions to enhance output procedures, raise efficiency, lower expenses, and achieve the desired level of cost savings is essential. SMEs can learn from this argument and its positive, practical findings and adopt this system of costing (Information Resources Management Association, 2013, p. 144). The basic components of the ABC system are appropriate for all types of businesses regardless of size. Although the ABC system generates a lot of detailed information, researchers caution managers to not be too overcome by this information. Managers ought to evenly focus on returns to alter activity costs as returns vary. Four steps can help with the shift from TDC to ABC, as with the case with DVD manufacturers (N.A., n.d., p. 2). Identifying activities, the first step, entails structure, burning DVDs, and drawing together cases. This step is also called an expense centre or expense pool. The second step is allocating expenses to activities, which is the monetary value of resources used up by each expense centre or expense pool. Choosing a proper cost driver is the third step that entails allocating expense to expense centres or activities with respect to a cost item (N.A., n.d., p. 2). The cost item in the DVD manufacturers’ case includes Excel and Specialty DVDs and cost drivers are the numbers of DVD lots, machine hours, and inserts. The last step is implementing the rate of cost drivers to the resources used up by every cost item. SMEs today are capable of investing financial resources and time towards implementing new technologies and the ABC system is no different. ABC calls for organisational adjustments and employee reception, investment in programs and hardware, and tools for gathering data (Gunasekaran et al., 1999, p. 391). Researchers Valentina Gecevska and Zoran Anisic contend that many corporations have used AMC successfully even though it does not assure returns within a brief period of productivity. As a result, the Gecevska and Anisic suggest a specific 8-step process for applying the ABC system for SMEs. This process substantially lowers the risks of shifting from TDC to a thorough AMC system. Gecevska and Anisic add that this process fits SMEs more than large businesses since it offers a smooth changing process (Gecevska and Anisic, 2006, p. 141). More specifically, this process does not need a high investment in stylish data gathering systems or serious organizational reform. SMEs in search of a transitional step for slowly applying a complete ABC system where the approximated data is replaced by real data can use Gecevska and Anisic’s application process (Gecevska and Anisic, 2006, p. 149). This process employs EAD and APD matrices that help in the understanding of how overhead expenses are produced. SMEs can use these matrices to identify opportunities for development. SMEs can enjoy low risks and least financial ventures when adopting modern costing systems today. Implementing TDC was originally economic for corporations and SMEs (Maygar et al., 2007, p. 348). Continuing to implement TDC will not foster the achievement of desired levels of cost savings and improved operational efficiency. As a result, an intermediate step is almost ideal for SMEs realisation of ultimate costing akin to corporate levels of costing and production efficiency (Ríos-Manríquez et al., 2014, p. 227). In conclusion, SMEs are ready to adopt the activity based costing system as an effective tool to achieve the desired level of cost savings and efficiency. Many studies have analysed ABC and TDC systems and deduced that the modern version offers management several practical solutions. These solutions are largely appropriate for SMEs because of the low risk and minimal capital. Since SMEs today deal with rising tension in an increasingly competitive global market. Among the approaches SMEs can employ to accomplish high efficiency, superlative cost savings, and market reaction is the ABC system. With examples of manufacturing SMEs and DVD manufacturers, this paper has effectively discussed reasons SMEs are ready to abandon TDC and adopt ABC. References Capusneanu, S., Topor, D., and Rof, L. M., 2011. General implementation stages of the ABC method in the Small and Medium-Sized Enterprises. MPRA: Faculty of Finance and Accounting, 15(36218), 7 pages. Chapman, C. S., Hopwood, A. G., and Shields, M. D., 2011. Handbook of Management Accounting Research. Los Angeles: Elsevier. Fladkjær, H. and Jensen, E., 2011. The ABC-paradox: Is Time Driven ABC Relevant for Small and Medium Sized Enterprises (SME)? Business and Management, No. 2, 23 pages. Gecevska, V. and Anisic, Z., 2006. Using of activity based costing (ABC) in small and medium companies. Annals of The Faculty Of Engineering Hunedoara, 4(2), p. 151-150. Gunasekaran, A., Marri, H. B., and Grieve, R.J., 1999. Justification and implementation of activity based costing in small and medium‐sized enterprises. Logistics Information Management, 12(5), p.386-394. Hall, O. and McPeak, C., 2011. Are SMEs ready for ABC? Journal of Accounting and Finance, 11(4), p. 11-21. Huynh, T., Gong, G., and Ngo, N., 2013. Apply activity-based costing to calculate product cost in small and medium enterprises. International Journal of Business and Economics Research, 2(3), p. 59-68. Information Resources Management Association., 2013. Small and Medium Enterprises: Concepts, Methodologies, Tools, and Applications. New York: Idea Group Inc (IGI). João, M. and Machado, C. V., 2012. Activity Based Costing knowledge: empirical study on small and medium size enterprises, Florianópolis, 9(18), p.167-186. Maygar, G., Knapp, G., Wojtkowski, W., and Zupancic, J., 2007. Advances in Information Systems Development: New Methods and Practice for the Networked Society, Volume 2. London: Springer Science & Business Media. N.A. (n.d.). Section 2: Activity Based Cost Technique. Chart 9: allocation of overhead cost, 6 pages. Ríos-Manríquez, M., Muñoz Colomina, C. I., Rodríguez-Vilariño Pastor, M. L., 2014. Is the activity based costing system a viable instrument for small and medium enterprises? The case of Mexico. Estudios Gerenciales 30, p.220–232. Read More