Steps for Implementing Activity-Based Costing - Research Paper Example

Introduction Companies in their bid to increase returns must check on costs and ensure that they are well managed. If costs are better controlled, the profitability of the company will be enhanced and investors will be attracted to the company. Activity based costing has become a popular way of cost allocation and analysis and hence helps in controlling the cost. Activity based costing system recognizes that there are various activities that have to be performed by an organization to successfully accomplish their goals and objectivities (Atrill & McLaney, 2007). These activities consume company resources that need to be measured and controlled. The determination the cost amounts allocated to a particular activity will also help in the determination of the product costs hence assist in the setting of the selling prices.ABC costing system implementation requires following various steps in order to help maximize the value of the shareholders. Steps in ABC implementation The first step in the implementation of ABC costing just like other accounting system is the review of the company’s financial information. All the financial necessary can be extracted from the company’s income statement or the balance sheet. The totals of the cost of the activities can thus be identified before beginning the analysis. From the balance sheet and the income statements all the expenses that are incurred by a company can be identified (Kaplan & Anderson, 2007). The expenses can further be categorized in terms of similarities i.e. cost that are similar gathered under one heading. Secondly, the management has to identify the main activities of the business. This stage involves the determination of the major and core activities that consume the business resources and that are responsible for the large capital investment (Atrill & McLaney, 2007). These activities have to be linked to the actions that take place in the company i.e. in a manufacturing firm, the different working stations can be viewed as completely different activities undertaken to deliver the outcome to the consumers. The application of flowcharts and maps can help to fully determine all the activities performed by the company. The activity determination is time consuming and should be comprehensive. In addition, omission in identifying an activity would cause errors in the system and the exact cost will not be determined at the end of the process. The third step in the implementation of ABC costing system involves the calculation of the costs for each of the activities that were identified in the previous stage (Kaplan & Anderson, 2007). The costs should reflect the overhead resources consumed by the respective activities. In this stage, the costs would be classified as either direct or overhead costs. This will then be used in the cost allocation stage where the overhead component would be allocated based on the cost drivers. Step 4 does not exist in the traditional accounting methods. This stage involves the determination of the total cost of the activity including the capital costs that are not sometimes directly determined through ABC method. The information on capital costs can be obtained from the company’s balance sheet and the data is converted to capital charges that are then summed with the activity costs that were earlier determined (Gečevska, 2004). Capital charges include the determination of the wear and tear expenses caused when machines or other assets are used in the production process. The capital expenses could also involve the acquisition of machines exclusively used in a process or department. Where some capital costs are used in more than one department or process. The ratio of allocating the costs will have to be determined to avoid overcharging or undercharging a particular process (Gečevska, 2004). The fifth stage is that which involves the determination of the cost drivers. The cost drivers are the factors that responsible for the increment in costs and are therefore important in the cost allocation process. The cost drivers have to be expressed in quantitative terms e.g. hours, floor space, machine hours, or other units. After determining the cost drivers, it would be possible to merge the resources that are considered to have the same cost drivers before the actual allocations are made. In instances that there are no similar cost drivers, the expenses will have to be separated until the cost drivers are determined for the allocation process. The cost drivers can trace both the capital charges and the operating costs to the specific products. The next step involves determining the resources and drivers volume. This stage must be done in a manner that ensures that the costs are not overstated or understated to give inaccurate values that would impair the analysis and evaluation. The information on the actual data can be obtained from the company records by performing measurements and planned operational analysis. The total resource driver volume is also determined, as it will be used in the calculation of cost to be allocated to the process (Lucey, 2002). The final stage in the implementation of an ABC cost system is the calculation of the product costs. After the operating costs and the capital charges have been determined and summed up, the product cost shall have been determined. The establishment of activity based costing system is not sufficient. This cost allocation system needs to be accepted by the various product managers and upper management for day-to-day decision making. More still, ABC requires to be routines and considered as a normal part of the accounting system. If well embraced and integrated in the organization, activity based costing will be integrated in the primary financial system and becomes part of the company’s financial system. ABC and decision-making ABC costing will assist management in the decision making process. Since the costs are allocated to the specific activities, managers in an organization will be forced to control the total cost of the activities in a bid to be considered effective efficient in realizing the company’s objectives. The decision to undertake a particular activity by the management will depend fully on whether the activities are value additive, ABC system will therefore help in the elimination of redundant activities and thereby translate in the reduction of unnecessary costs,. ABC costing is used in determining product profitability. Since through ABC costing, the management can determine the actual costs of a product, it can use the data in making product decisions. This well help the company in position their product better and improve the customer sales. Besides, the determination of exact cost of a product will assist the managers determine the right product mix for the market. The right product mix is one that optimizes the firms returns and satisfies the customers fully. Lastly, the determination of the right price will as will enhance the power of the customer. Secondly, through ABC costing process efficiency decisions can be made. By implementing ABC costing system, the employees across the organizations gets to understand the different costs that are involved in the production. This will ensure that analysis of the cost, identification of the value added activities and implementation of the desired improvements that will help in realizing the expected benefits. The assiduous improvements of the process help achieve overall efficiency. Finally, activity based costing assist in making customer decisions with regard to the most profitable customers. Since all the costs incurred in the organizations activities are charged to a specific product or service, the cost of serving customers can be allocated to the respective customers and this will help in the determination of the most profitable customers (Activity based costing, n.d). Normally, loyal customers and high volume customers will be realized to be profitable and hence better decisions to maximize the returns of the firms. By determining total cost is incurred, managers can set prices by adding a margin on the cost to determine the selling prices. This will be dependent on the company required margin or profitability. The use of traditional accounting systems omitted some costs in the cost determination hence impaired the determination of the actual prices. Moreover, management decision will be enhanced by the fact that management can be in a position to determine with certainty which department of the organization is effective in cost minimization. This will introduce an element of competition within the different organizations departments to reduce wastages while maximizing output. The most productive department should be rewarded to ensure that they continue to maximiser their production while keeping their costs low. In summary, management accountants need to use the appropriate cost allocation method that enhances efficiency and maximizes the firm’s profitability. The use of ABC costing has played a role in organizational success irrespective of its technicalities and drawbacks. Costs are major decision determinants that have to be controlled and managed if the business is to realize its profitability. Reference Activity Based Costing - a Tool for Decision Making. (n.d.). Fibre2fashion - Premier B2B Marketplace For World Textile, Apparel & Fashion Industry, Best B2B Textile Portal, B2B Trade & Business Portal. Retrieved April 17, 2012, from http://www.fibre2fashion.com/industry-article/7/670/activity-based-costing-a-tool-for- decision-making5.asp Atrill, P., & McLaney, E. J. (2007). Management Accounting for Decision Makers (6th ed.). Harlow (England) [etc.: Prentice Hall. Gečevska, V. (2004). Implementation of Activity Based Costing (ABC) in Small and Medium Companies Using Proposed Procedure. Boston: McGraw-Hill/Irwin. Kaplan, R. S., & Anderson, S. R. (2007). Time-driven Activity-based Costing: A Simpler and More Powerful Path to Higher Profits. Boston: Harvard Business School Press. Lucey, T. (2002). Costing (6. ed.). London: Continuum International Publishing Group. Read More