Key Aspects of Activity Based Costing (ABC) - Coursework Example

ACTIVITY BASED COSTING (ABC) Table of Contents Introduction Presently, most of the corporate tries to concentrate on understanding different types of cost and the behavioural factor of cost. These factors drive the costs which influence the growth rate of the organisation. There are different types of costing methods like standard costing, activity based costing, target costing etc (Cagwin and Bouwman, 2002 p.38). It is very difficult to understand the different cost measurement methodologies. The problem arises for the managers and the employees of the organisation by mixed messages about which costs are the correct ones. So, it is essential to understand the various methodologies of costing for the purpose of blending the whole cost system and for reconciliation. Here the researcher analyses the advantages and disadvantages of activity based costing with the high level of competencies of costing. Discuss the advantages and disadvantages of ABC over standard absorption costing: The previous research report shows that standard absorption costing is the traditional form of costing which is mostly used by the manufacturing sector. On the other side the ABC costing is the modern approach of costing which is applied in all the sectors. So, it is essential to track the basic difference between these two types of costing before discussing the advantages and disadvantages of ABC costing (Gosselin, 1997 p.112). Absorption costing mainly focuses on the stock evaluation of the manufacturing company. The primary theme of this costing is to distribute the overhead cost of the organisation between different cost centres. According to this approach manufacturing cost and the direct cost also distributed in different finished products. While, the non- manufacturing cost are treated as the period cost of the company. On the other hand, activity based costing is the modern mechanism of costing mainly used in the service industry. This new approach mainly stresses on monitoring all the activities which include tracing the actual consumption of resources and comparing actual consumption of resources with the final output of the company (Dahlgren et al. 2001 p.21). So, it has been witnessed that the traditional absorption costing accumulates the cost of manufacturing as well as non manufacturing cost. The ABC based costing normally allocates different types of cost which is based on single volume measure. The main drawback of absorption cost is allocating the non production cost as a part of non production cost. On the other side, ABC costing primarily allocates the overheads and the direct cost as an overall cost driver (Estrin and Albers, 1997 p.105). Advantages of Activity Based Costing This is a simple and concise form of costing which is easily understandable to all. This approach of costing helps to highlight the scorecard and performance management. ABC is more accurate form of costing for determining the cost of products and services. This costing stresses on per unit cost rather than the total cost of production or services. Six sigma is a useful tool to check the quality of products or services. The system can integrate six sigma and other improvement programmes which is the speciality of this costing (Baker, 1998, p. 21). This is a powerful tool to manage different types of wastage of the company. The traditional absorption costing lacks the capability to highlight the benchmarking of production which can be done through the activity based costing. In the other words, it is the mirror of whole job. Disadvantages of ABC Though this system is very simple but it depends on huge amount of data but data collection is time consuming factor. The cost of implementing ABC is very high comparing to the other process of costing. So, this is very difficult to apply the system in small to medium sized organisation. Evaluate how useful ABC systems are in assisting in cost and profit management The utilisation of ABC system lies in assisting the cost as well as profit management. There are four steps to implement ABC system in cost management. Identify Different Activities There are number of processes and activities attached to produce an output. So, it is essential to follow an in-depth analysis on the operating system and some other related concerns. This analysis helps the organization to track different cost related with the each and every part of the operating system. Assign Resource Cost to activities The new system of costing involves tracing different cost as well cost objectives which helps the management of the organization to find out the cost occurrence. This system categorizes the different types of cost into three categories i.e. direct cost, indirect cost and general administration cost. Direct Cost These types of costs are directly involved with the production or services system of the organization. Example: Direct material cost, direct labour cost etc. These called prime cost of production. Indirect Cost Indirect cost cannot be allocated to an individual output. On the other word, the benefit of this type of cost can be levied on two or more outputs (Foster and Swenson, 1997 p.137). Example: Maintenance cost, indirect material, storage cost etc. General or Administration Cost These costs are not related with the production or services of the organization since these costs are unchanged at any level of output. Example: Salary of administrative employees, depreciation on fixed assets, provision for bad debts etc. Identify Outputs Identifying the outputs is a crucial task for cost management. This system can identify the output after breaking the whole task into different activities. In this step activity based costing finds out the resources consumed in each activity. Allocate the activity cost to outputs: This system is using different activity drivers to allocate the activity cost to the outputs. This allocation is mainly based on the demand and consumption of activities. This system introduced new cost management techniques which help to increase the profit as well as growth of the organization. The primary feature of this system is that it facilitates all types of organization like government agencies, manufacturing industries and service industries. The management practices are on transformation due to radical changes of cost management system. Presently, after implementing the ABC system, most of the companies are managing the organization as this system helps to determine actual cost of production or services which leads to calculate actual profit. Calculation of actual overhead cost is the most difficult area of costing. It helps to comprehensive understanding of overheads and what causes them to occur. Research the rate of adoption of ABC in the UK noted in academic publications 1990: The Activity Based Costing was introduced in 1980 for the first time as a new concept or process of costing. In this time this newly invented process was the topic of intensive discussion for the academics and research scholars. There were number of articles published on the ABC. At that time the application of the ABC model influenced the practice of the management accounting. There were 355 journals published in US and UK based on this topic. Number of surveys was organized to track the diffusion and adoption rate of ABC. The table shows that for the purpose of increasing the implementation rate. The rate of implementation increased at the slow rate but it achieved its ultimate goal. The below table shows that the most of the largest firm of UK implemented the activity based costing to identify different activities performed by the organization. (Source: Cooper and Zmud, 1990 p. 127) The empirical research on UK manufacturing industry shows that 22 % of the manufacturing companies adopted this mechanism. However, the researchers have developed different interpretative perspective of this model to minimize the factors which reduce the adoption rate. Different researches have defined ABC implementation in varied ways. Some of the researchers defined it as actual implementation of ABC while others defined it either as an actual execution or as a wish of executing it (Cagwin and Bouwman, 2002 p.32). After finding the adoption rate, it is essential to find out the degree of success of activity based costing. The above discussion highlights that success rate is mainly measured by the implementation, rating of ABC information characteristics and level of satisfaction. Most of the previous research shows that the success is measured in different stage rather than the maturity rate. The cumulative success percentage of the success is 71.4 % in UK. On the other side, the cross company analysis shows that cumulative success rate is 51.6 %. The percentage includes all the barriers and problems identified by different industries. Reference Cagwin, D., Bouwman, M. J. 2002. The Association Between Activity-Based Costing and Improvement in Financial Performance, Management Accounting Research, Vol. 13. Cooper, R. B., Zmud, R. W. 1990. Information Technology Implementation Research: A Technological diffusion Approach, Management Science, Vol. 36. Dahlgren, J., Holmström, M. and Nehler, H. 2001. Activity-Based Costing - Diffusion and Adoption, Paper Presented at the EAA-konference. Estrin T. L. D. 1997. Albers Is ABC Suitable for your Company?, Readings in Management Accounting 2. Prentice Hall. UK. Foster, G., Swenson, D. W. 1997. Measuring the Success of Activity-Based Cost Management and Its Determinants. Journal of Management Accounting Research. Gosselin, M. 1997. The Effect of Strategy and Organizational Structure on the Adoption and Implementation of Activity-Based Costing, Accounting, Organizations, and Society, Vol. 22. Baker, J. 1998. Activity-Based Costing and Activity-Based Management for Health Care. Brian Macdonald. US. Read More