Management Finance - Activity-Based Costing - Case Study Example

Management finance Contents 3 Part A 3 Part B 4 Advantages 4 Disadvantages 6 Part C 6 References 9 Bess Ltd is a furniture producerand seller with workshop in Lincoln. Presently the company is trying to improve its financial performances. The board members of the organization are considering and arguing among each other regarding the step that would be right to follow in order to attain the aim as discussed above. Production director is suggesting a bottom up approach for the preparation of their budget. But managing director of the company has different point of view and is considering a proper monitoring of both financial and non financial performances. He has given a suggestion for activity based costing. But this method is not known to other board members of the company. This paper will help them to understand the method clearly. Part A There are lots of key features for activity based costing. In this section of the study these features will be discussed. Activity based costing identifies different major activities that lead to overhead costs. Each and every project has some overhead costs. This accounting method of costing helps to understand different overhead costs of a project (Crosson and Needles, 2010). It is much concerned with activities that a company performs and how those activities are adding indirect costs to different products or services. The method draws a relationship between activities, costs and products. This method has key contributions in the manufacturing sectors as well. It is a key monitoring method (Hofstede, 2012). It is a very modern and well designed method which involves tracking how the resources are consumed and helps to fix cost for final output. Resources are connected to activities and activities are assigned to cost objects. Activity based costing can be treated as the replacement for absorption costing. The main feature of this method is to include indirect costs into direct costing. It has a very significant characteristic of calculating all non financial aspects related with any costs. Non financial aspects are very important for fixing a product cost. With the help of this method non financial performances are taken care of. Activity Based Costing is a technique for incurring cost for a specific given cost object. It is an administrative method. This method is made for management monitoring. It has a significant feature that it identifies all cost drivers, it also recognizes why the cost is increasing. The process is very much dynamic in nature (Chandra and Prasanna, 2011). It helps management to understand different cost drivers. It is a very widely used technique. Activity Based Costing identifies those costs that management wants to allocate. It designs cost pools for all those costs taken to offer services to other sections of the organization, instead of directly assigning a company’s services or products. It is a very detailed method which considers all the related activities of a project (Kaplan and. Anderson, 2013). All business activities are broken into different individual components. The modern method can be applied for full scope. It provides full scope of a project in part by part fashion. It is different from simple traditional costing method where costing was not done on the basis of each and every activity related with a product or services. This method collects all the data related with any activity. It monitors each and every single activity related with production. It is more of a proactive method because it tries to identify different cost drivers. Activity Based Costing considers long-term variable overhead costs related with any product. Activity Based Costing calls for a joint effort from all the sections of an organization and only finance or accounts department cannot implement it properly. It tries to recognize cause and effect relationships to assign costs objectively. The costing method often locates activities of high overhead costs. It’s one more key feature is to identify performing and non performing activities. As each and every single activity is taken care of in this method, so it is very easy to locate which activity is performing well and which activity needs to be adjusted. This method includes drivers used in different transactions. It is a very significant and important attribute. All these key features are making this method very popular among managers around the world. All these key features are very suitable for managers to deal with different management issues. Part B Here in this section of the study different advantages and disadvantages of Activity Based Costing on Bess Ltd will be discussed. This section will clarify what are the advantages the organization is going to get if they introduce this method of costing. It will talk about different disadvantages that the company may face out of this method. Advantages This method will help the organization to track costs related with different activities. It will help the company to understand whether their activities are falling in line with the industry standards. Activity Based Costing can provide much information about different areas of operations in their businesses (Cokins, 2006). The method can be used as an excellent feedback process for measuring the ongoing cost of specific product as the management of Bess Ltd. focuses on cost reduction. Cost cutting and increasing profitability is a major objective for the management of the organization (Wagener, 2013). Here Activity Based Costing will be very much advantageous for the company. It will identify different activities which are unnecessarily incurring too much cost. Management will focus towards those activities and will try to improve the situation. It provides very accurate cost for each unit. Accurate costing is very much important for managing pricing of a product, performance management, sales strategy and decision making. So, the management of the company will be in an advantageous position if they can implement ABC in their organization. It will improve their situation in terms of pricing of a product, performance management, sales strategy and decision making. It is very important for the company to analyze different reasons for overhead costs related with their activities. This method will offer significant advantages in terms depth analysis of overhead costs. Bess Ltd. will be able to identify what are the reasons that are driving different overhead costs. It is imperative for company to recognize what are the other sources of overhead costs apart from sales volume and production (Leitner, 2007). The method will offer this benefit to the management of the company. It is a great advantage of this accounting method. The company uses their own shops and its own website for selling their products. The company must know how their distribution channels are performing. Activity Based Costing will provide the organization huge advantages for measuring performances of their different distribution channels. On the basis of that they can discard any existing distribution channel and also can introduce any new distribution channel. ABC helps the organization to identify non performing products, activities and departments. It is a very significant advantage that the company can get out of this accounting approach (Rajasekaran, 2010). This can help the organization to analyze different activities for forecasting budget. Proper allocation of budget is very much important. ABC offers significant advantages to the company to allocate their budget for different activities. Modern business situation is very much uncertain in nature. Every step needs significant investments from the side of the organization. Activity Based Costing helps the company to make their investments more risk free. Activity Based Costing creates relationships between different activities and overhead costs. It will offer huge advantages for the company to fix overhead costs more accurately. Activity Based Costing also increases efficiency and productivity of the organization. With the help of this method non performing activities can be distinguished from performing activities and then the management can give focus towards non performing activities and can be able to turn around those activities as performing ones. Activity Based Costing gives more precise reflection of profit and cost. It helps the management of the organization to administer and govern all the activities and it is very much important for proper business control. Disadvantages No accounting method is free from limitations. Activity Based Costing is also having some disadvantages which have to be kept in mind by the company. ABC will have serious disadvantages if the overhead costs of Bess Ltd are mainly volume related or if it is very tiny in proportion to the total cost. It will be very difficult and almost impossible for the organization to assign every overhead costs to specific activities. It is a serious disadvantage with this method. ABC is a very costly system. It needs huge investment from the side of the company to introduce this method into their organization. ABC systems are generally very difficult to introduce. It will take lot of time and energy from the company to install it into the organization. Extra bit of budgetary allocations will be needed for installing this method. It is a very significant challenge for Bess Ltd. ABC system needs a separate data base as it cannot gather the entire information from ledger. It is an additional pressure for the company to maintain a separate data base for launching Activity Based Costing. Part C It is very important to measure the performances related with the organization and management. How Bess Ltd is performing presently is important to understand. It will help to design future course of action for the organization (Carton, 2006). It also measures how the managers of the organization are performing their duties. The organizational performances can be measured both financially and non-financially. Financial performances of the company can be measured from different accounting statements like Balance sheet and Income statement. Apart from all these accounting statements, there are other financial ratios which disclose liquidity and profitability situation of the company. Some of the non financial performances measures are customer’s perceived quality about the product, productivity and efficiency of the manufacturing process and customer’s loyalty for the product (Wentland, 2009). All these are non financial performance measures. Performance measurements are significant because it shows present performances of the organization. It also indicates in which area the company is performing very well and which areas are dragging the company’s profitability behind. According to that Bess Ltd. can adjust their performances. Managerial performances are inseparable part of organizational performances. Managers of the company decide different strategies and on the basis of those strategies the company operates. If strategies of the management are proper and successful then automatically performances of the organization will flourish (Spillane and Martin, 2005). On the other hand if managerial performances of Bess Ltd. are not up to the mark then it will be counterproductive as far as organizational performances are concerned. Profitability and customer satisfactions are the main objectives for the company. To earn profits, organizational performances and managerial performances should be measured after regular interval of time. It will be very much fruitful for the company to earn profits out their business endeavors. All the above written financial and non financial performance indicators also play very important roles to measure organizational and managerial performances. Financial indicators like current ratio tell about the liquidity condition of the company on the basis of current assets and current liabilities. Quick ratio tells about the ability of the company to payback all liabilities with the help of quick assets. Revenue is also a financial performance indicator which shows the amount of money that Bess Ltd. actually receives within a fixed time period. Net income of the organization measures the companys total profit after paying all interest and taxes. It is a very significant financial indicator for the organization on the basis of which managers of the company decide future courses of actions. All the stake holders of Bess Ltd. focus on this bottom line. Non financial indicators are no way less important performance indicators for the company. Customer loyalty shows how emotionally customers are related with different products of the organization. Loyal customers are very much important for the organization to grow heavily. Customer’s perceived values towards the product are also a very significant non financial performance indicator for the company. It shows how products of the organization are satisfying needs of customers. It is very important for the company to measure it. Productivity of employees and efficiency of manufacturing process is also very important non financial performance indicator. Efficient manufacturing process reduces lead-time for the company and increases profitability. Productivity helps the organization to reduce their overhead costs. Managers are the decision makers in the company. They decide strategic goals and performance objectives for Bess Ltd. It is their responsibility to achieve those strategic goals and performance objectives. Managerial performance measurement helps to recognize how well managers of the company are performing their duties and how professionally and intelligently they are taking the whole organization towards their expected predefined objectives. The organization generates employments for lots of people. Measurement of organizational performances is very much necessary for the future of those employees. It also helps the company to manage its inventories very well. Good organizational performance of the company motivates both management and employees of Bess Ltd. It increases the brand image of the company in the market. On the other hand poor organizational performance leads to cost cutting, downsizing the numbers of employees etc. Different strategic decisions are very much dependent on organizational performances. So, measurement of organizational performances is very much needed. Measurement of managerial performances is also very important as it shows the ability of the management to cope with the changing business scenarios. Resource allocation or allocation of budget is also a very important factor for the management of Bess Ltd. How practically the management of the company has allocated their budgets can be measured with the help of their performance measurement. Organizational performance measurement of the company reflects how the company is performing presently in comparison to its previous performances. It works as an eye opener for the management of Bess Ltd. All these performance measurements act as guiding stars for the company. Every people in the management don’t have same managerial abilities (Taticchi, 2010). But it is very important for the organization to assign right people for the right position. Managerial performance measurement can give the idea to the company about the right person. It helps the company to make any management level adjustment if needed. All the above arguments and factors are clearly telling that organizational and managerial performance measurement is very much required for consistent betterment of the company. It has huge significant impacts on company’s future. Different financial as well as non-financial indicators are very important in this aspect. Modern business world is ever-changing. Change is the only constant thing in this world. It is very important for Bess Ltd. to always remain proactive in nature. It always should measure organizational and managerial performances to remain competitive in the market. It is very important for the company to maintain sustainability. 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Business Performance Measurement and Management: New Contexts, Themes and Challenges. Milan: Springer Science & Business Media. Wagener, D. 2013. Activity-Based Costing and Its Later Development Into Activity Based Budgeting and Management. London: GRIN Verlag. Wentland, D.M. 2009. Organizational Performance in a Nutshell. New York: IAP. Read More