Activity-based costing is besides known as ABC costing is a bing theoretical account that organizes activities in an organisation and allocates the cost of the each activity resources to all the merchandises and services harmonizing to the existent proposition by each. In others word, it is an accounting method that allocates concern to roll up information about their operating costs. Activity-Based Costing ( ABC ) has been supported and approved as a footing for doing strategic determinations and for up net income public presentation ( Kaplan and Norton 1992 ; Turney 1992 ; Cooper and Kaplan 1991b ) . Under Activity-based costing ( ABC ) , company will cipher the cost of the resources used in each of these activities. Activity-based costing ( ABC ) largely allocates indirect cost, fabricating operating expense and direct cost to the merchandise and services. Those costs will so apportion to peculiar activities such as be aftering technology, or fabrication, after that, the cost is linked to different merchandise and services. In this manner the organisation can easy gauge the cost of the merchandises and services for the thought of placing and extinguishing those which are unbeneficial and take downing the monetary values of those which are overpriced. In such act, organisation may besides increase their net income by cognizing the cost of the merchandise or services with the usage of Activity-based costing ( ABC ) . It helps to command the costs at an single degree and on a departmental degree in an organisation. Supervisors are able to make a information to bring forth a better budget and raise a greater overall considerate of the disbursals that required maintaining the company running expeditiously. In add-on, activity-based costing is able to assist the organisation or company to happen out costs which are unneeded for the merchandise and services, some costs might non be necessary costs for the merchandise, and so under ABC costing, it will be given to assist the organisation to extinguish the unneeded cost. As a consequence, company or organisation may gain a net income. In add-on, as Kaplan ( 1990 ) predicted, ABC information is now besides by and large used to measure uninterrupted sweetening and to oversee procedure public presentation. It helps to repair the monetary value of the merchandises and services every bit good, by allocate and gauge the cost of the merchandises and services, Activity-based costing ( ABC ) can repair the monetary value of the merchandises and services.
In recent decennaries, Activity-based costing ( ABC ) has been turning of import to the cost allotment. This is because this costing is the most effectual when organisation has used over a long term period instead than short term period. Besides that, fabricating operating expense costs have increased radically in these old ages. The fabrication operating expense costs can no longer associate with the productive direct labor hours and machine hours. For illustration, one merchandise might take more clip in one expensive machine than another merchandise, but since the sum of direct labour and stuffs might be the same, the extra cost for the usage of the machine would non be recognised when the same wide ‘on-cost ‘ per centum is added to all merchandises. In add-on, ABC bing become importance is because the mixture of the merchandises and the mixture in clients ‘ demand have grown and some merchandises are produced in big groups, while others are produced in little groups. There is no deny that activity-based costing ( ABC ) is utile to the organisation to put monetary value and apportion cost such direct cost, fabricating operating expense and direct labor cost, but there is some restrictions by utilizing this method every bit good. Activity-based costing is an accounting method that allocates the cost of each activity resources to the merchandises and services, nevertheless, some of the operating expense costs are hard to apportion to the merchandises and clients such as the executive ‘s salary. The executive ‘s wage is an operating expense cost which is hard to apportion cost to the merchandises and services, these sort of costs are known as ‘business prolonging ‘ which are non allocate to the merchandises and clients, because it is nonmeaningful. As a consequence, ABC costing has its utility every bit good as restriction.
The balance of the paper is organized as follows. The following subdivision relates background sing Activity-based costing ( ABC ) and some theory in relation to ABC costing and traditional costing. The subsequent subdivision is some illustration of some company that applies ABC costing. Last will be our decision for this paper, sum-up of the paper.
Background
Activity-based costing was introduced because traditional costing had indiscriminately added disbursals in indirect labor cost. Automation has dramatically shifted the balance ; reduces the demand for labour and increased the capital investing degrees. ( Gerhard P. , 1999 ) Hence, traditional costing had become wrong or have mistake for the merchandises and services. This is because the indirect labor cost is non caused by all merchandises. Therefore, Activity-based costing had been introduced to get the better of the job.
The thoughts of Activity-based costing were recognised in the fabrication sector of the United States during the 1970s and 1980s. It is based on George Staubus ‘ activity Costing and Input-Output Accounting. Throughout the old ages, the Consortium for Advance management- International, besides known as CAM-I offered a formative function for analyzing and formalising the doctrine that have become more officially known as Activity-based Costing. CAM-I had explained Activity-based costing ( ABC ) as “ aˆ¦.the aggregation of fiscal and operation public presentation information following the important activities of the house to the merchandise costsaˆ¦ ” the chief point is that the traced to the cost and it is non frailty versa. ( Joon J and Brian H. K. , 1997 )
Activity-based costing ( ABC ) was foremost introduced in 1987 by Robert Kaplan and Robin Cooper as a chapter in their book Accounting and Management: A Field Study Perspective. Robert Kaplan and Robin Cooper was first focal point on the fabrication industry where when there is an increasing in engineering and productiveness betterments, it has reduced the comparative proportion of the direct costs of labor and stuffs, but it increased the comparative proportion of indirect costs. For illustration, when there is an addition in engineering, such as machines will cut down the labor which is direct labor, it has increased depreciation of the machines which is an indirect stuff. Besides that, Robert Kaplan and Robin Cooper had explained Activity-based costing as a method to work out the traditional costing direction.
The really first extension of Activity-based costing into fiscal establishments such as banking establishment was appeared in an article in Journal of Bank Cost and Management Accounting ( Volume3, Number 2 ) by Richard Sapp, David Crawford and Steven Rebishcke in 1990. They stated that fiscal establishments besides have varied merchandises sets which had created chances for cross subsides. In add-on, in 1991 in the same Journal ( Volume 4, Number 1 ) , writers had concluded that Activity-based costing ( ABC ) can be more accurate in apportioning the cost in this environment.
Manufacturing industries and fiscal establishments have varied merchandises and clients which can do cross-product and cross client subsidies, such as banking industry has undergone alterations in staffing degree and productiveness degree. Therefore, as forces disbursals represent the largest individual constituent of non-interest disbursals in fiscal establishments, these costs should besides be qualified more accurately to the merchandises and client. Therefore, Activity-based costing may even be a more utile tool for making so.
Activity-based costing was further explained in 1999 by Peter F. Drucker in the book of Management Challenges of twenty-first Century. Peter F. Drucker had stated that Traditional costing is method to apportion cost to make something, for illustration to cut a prison guard yarn, whereas for activity-based costing records the cost of non making, such as the cost of waiting for the needful portion. Activity-based costing ( ABC ) reports the costs that traditional costing does non make.
Traditional Costing Systems versus Activity-Based Costing ( ABC )
3.1 Traditional Costing Systems
The traditional cost accounting methods were designed around 1870 – 1920 and in those yearss industry was labour intensive, there was no mechanization, the merchandise assortment was little and the operating expense costs in companies were by and large really low compared to today. However, from the 1960s – peculiarly 1980s – this changed quickly. For these grounds, and more, traditional cost accounting has been called everything from ‘number 1 enemy of production ‘ and inquiries whether it is ‘an plus or a liability ‘ have been raised.
Traditional bing systems apply indirect costs to merchandises based on a predetermined operating expense rate. Unlike ABC, traditional bing systems treat overhead costs as a individual pool of indirect costs. Traditional costing is optimum when indirect costs are low compared to direct costs. Traditional bing systems are simpler and easier to implement than ABC systems. However, traditional costing systems are non every bit accurate as ABC systems. Traditional bing systems can besides ensue in important under-costing and over-costing.
3.2 Activity-Based Costing ( ABC )
Activity-Based Costing ( ABC ) arose in the 1980s from the increasing deficiency of relevancy of traditional cost accounting methods. Research workers have acknowledged the jobs in traditional costing systems. Drucker ( 1963 ) is among the earliest 1s to indicate out that indirect costs are caused by minutess but non by end product volume. Miller and Vollmann ( 1985 ) agree with Drucker ‘s position and reverberation that the primary drivers for ingestion of operating expense are minutess:
aˆ¦ in the “ concealed mill, ” where the majority of fabricating overhead costs accumulates, the existent drive forces come from minutess, non physical merchandises. These minutess involve exchanges of the stuffs and/or information necessary to travel production along but do non straight ensue in physical merchandises ( Miller and Vollmann, 1985, p.144 ) .
Activity-based costing is a system that attempts to accurately follow indirect costs to merchandises by apportioning indirect costs to activities and so to merchandises based on their use of the activities. ABC is optimum when truth is really of import and when indirect costs comprise a big proportion of entire costs compared to direct costs. ABC is normally used in the fabrication sector because ABC systems are more accurate than traditional bing systems because they provide a more precise dislocation of indirect costs. However, ABC systems are more complex and more dearly-won to implement. The spring from traditional bing to activity based costing is hard.
Comparison between ABC bing and Traditional costing
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Beginnings: Zhaoxun C. , and Liya. W. , ( 2007 ) , “ A generic activity-dictionary-based method for produt costing in mass customization ” , Journal of Manufacturing Technology Management, Vol 18, Issues 6, pp.682
Example of Traditional Costing versus ABC
In this subdivision, allow us demo some illustration that compares traditional costing and activity-based costing.
Assume that FireOut Inc manufactures steel cylinders and noses for two theoretical accounts of fire asphyxiators.
Cylinders
Nozzles
Fabrication Costss
Traditional Costing
ABC
Traditional Costing
Direct Materials
RM 40
40
30
Direct Labor
12
12
12
Operating expense
30
17
30
Entire cost per unit
82
69
72
Overstated RM 13 Understated RM 65
4. Activity-Based Costing ( ABC )
4.1 Activity Cost Pool
An activity cost pool is the overhead cost attributed to a distinguishable type of activity ( e.g. , telling stuffs or puting up machines ) . The activity cost pool is the entire cost associated with an activity. Each type of primary cost driver that is traced to an activity cost pool. This can be done by placing all the costs of an activity in footings of costs can be straight charged to each cost pool. If some resources are shared by several activities, so some step of allotment will be necessary. The footing of allotment should reflect every bit closely as possible the extent to which each activity consumes the shared resource. The best appraisal of apportionment rate does non impact the truth ( Keegan and Eiler, 1994 ) .
ABC allocates overhead in a two-stage procedure. The first phase allocates overhead costs to activity cost pool. Example of overhead cost pools are telling stuffs, puting up machines, piecing merchandises, inspecting merchandises. The 2nd phase assigns the operating expense allocated to the activity cost pools to merchandises, utilizing cost drivers. The cost drivers measure the figure of single activity undertaken or performed to bring forth merchandises or supply services. Examples are figure of purchase orders, figure of apparatuss, labour hours, or figure of reviews. ( Jerry J. W. , Paul D.K. , Donald E. K. 2008 )
The four stairss involves in ABC costing
abccosting.jpg
Beginnings: Jerry J. W. , Paul D.K. , Donald E. K. ( 2008 ) , “ Managerial Accounting: Tools for Business Decision Making ” , 4th edition. pp. 147-175
ABC involves the following four stairss:
Activity Cost Pools
Estimated Operating expense
Puting up machines
Machining
Inspecting
RM 300,000
500,000
100,000
Entire
RM 900,000
Measure 1: Identify and sort the major activities involved in the industry of specific merchandises, and apportion fabrication operating expense costs to the appropriate cost pools.
Beginnings: Jerry J. W. , Paul D.K. , Donald E. K. ( 2008 ) , “ Managerial Accounting: Tools for Business Decision Making ” , 4th edition. pp. 147-175
Measure 2: Identify the cost driver that has a strong correlativity to the costs accumulated in the cost pool.
Activity Cost Pools
Cost Drivers
Expected Use of Cost Drivers per Activity
Puting up machines
Machining
Inspecting
Number of apparatuss
Machine hours
Number of reviews
1,500 apparatuss
50,000 machine hours
2,000 reviews
Beginnings: Jerry J. W. , Paul D.K. , Donald E. K. ( 2008 ) , “ Managerial Accounting: Tools for Business Decision Making ” , 4th edition. pp. 147-175
Measure 3: Calculate the overhead rate for each cost driver.
Activity Cost Pools
Estimated Operating expense
( RM )
Expected Use of Cost Drivers per Activity
Activity-Based Overhead Ratess
Puting up machines
300,000
1,500 apparatuss
RM 200 per apparatus
Machining
500,000
50,000 machine hours
RM 10 per machine hr
Inspecting
100,000
2,000 reviews
RM 50 per review
Entire
900,000
Beginnings: Jerry J. W. , Paul D.K. , Donald E. K. ( 2008 ) , “ Managerial Accounting: Tools for Business Decision Making ” , 4th edition. pp. 147-175
Measure 4: Assign fabricating overhead costs for each cost pool to merchandises, utilizing the overhead rates ( cost per driver ) .
Activity Cost Pools
Cost Drivers
Expected Use of Cost Drivers per Activity
Expected Use of Cost Drivers per Merchandises
The Boot
Puting up machines
Machining
Inspecting
Number of apparatuss
Machine hours
Number of reviews
1,500 apparatuss
50,000 machine hours
2,000 reviews
500
30,000
500
Beginnings: Jerry J. W. , Paul D.K. , Donald E. K. ( 2008 ) , “ Managerial Accounting: Tools for Business Decision Making ” , 4th edition. pp. 147-175
4.2 Classification of Activity Levels
It is non possible to place all the cost drivers at the same degree. In the traditional costing system cost behaviour has classified a cost as either variable or fixed. For a company ‘s fabrication costs usual usage variable cost such as direct labour. ( John C. 2000 ) But in the ABC system cost drivers are identified at the following four degrees.
Hierarchy of activities degrees
Four Degrees
Explanation
Types of Activities
Examples of Cost Drivers
Unit-Level Activities
These are related to activities that are performed such that merely one unit of a batch is affected by the activity. ( Gunasekaran, A.1999 )
Machine-related
Drilling, cutting, milling, paring, pressing
Labor-related
Assembling, picture, sanding, run uping
Machine hours
Direct labour hours or cost
Batch-Level Activities
Batch degree drivers will include the type of activities that will ease the industry of a batch of the same type of merchandise.
( Gunasekaran, A. 1999 )
Equipment apparatuss
Purchase telling
Inspection
Material handling
Number of apparatuss or apparatus clip
Number of purchase orders
Number of reviews or review clip
Number of stuff moves
Product-Level Activities
These drivers relate to the activities that need to be performed to go on a merchandise in industry. The cost of these activities must hence be divided into the entire figure of the merchandise that will be made.
( Gunasekaran, A. 1999 )
Merchandise design
Technology alterations
Number of merchandise designs
Number of alterations
Facility-Level Activities
Costss of some installation degree activities are really hard to allocate to single merchandise accurately. These will be traced to the merchandise in some mode such as the entire installation sustaining costs for a period apportioned to a merchandise with the aid of the per centum of the used driver.
( Gunasekaran, A. 1999 )
Plant direction wages
Plant depreciation
Property revenue enhancements
Utilities
Number of employees managed
Square footage
Square footage
Square footage
4.3 Decision on the execution of an ABC
Decisions refering the execution of ABC system are discussed with the aid of a conceptual theoretical account. Harmonizing to Cooper and Kaplan ( 1991 ) , before one can get down planing an ABC system, six major determinations should be made and they are:
Should the system be integrated with the bing cost system or should it be a standalone system?
Should a formal design be approved before execution?
Who should take ownership of the concluding system?
How precise should the system be?
Should the system describe historical or future costs?
Should the initial design be complex or simple?
After holding answered these of import inquiries one can get down with planing the appropriate ABC system for its demanded intents. ( Gunasekaran, A. , Marri, H.B. , and Yusuf, Y.Y. 1999 )
Beginnings: Gunasekaran, A. , Marri, H.B. , and Yusuf, Y.Y. ( 1999 ) , “ Application of activity-based costing: some instance experiences ” , Managerial Auditing Journal, 14/6, pp.286-293.
~ & gt ; Condition prefering the usage of ABC
In the last 20 old ages, there are many other fiscal and selling factors that have played an progressively of import function in warranting the execution of ABC systems ( Tsai, 1996 ) :
Measurement costs
During the last decades the debut of more advanced information engineering has become cheaper and easier to transport out the necessary computations to get at the coveted merchandise costs. Therefore, execution of ABC systems has become easier.
Increasing costs of mistake
As a consequence of the recessions which the universe encountered in the last two decennaries, it has become progressively of import to hold a profound cognition of the right production costs. This together with the falling labour base and the more expensive investing plans gives a synergistic consequence. Making incorrect determinations based on incorrect merchandise figures can take to really serious effects.
~ & gt ; Factor against the execution of ABC
The determination on the execution of an ABC system should good be considered because the alteration non merely needs resources in the signifier of adult male hours and capital ( in purchasing the necessary equipment ) , but besides the engagement of employees. Besides that, the troubles of execution ABC are lost production, congestion on the mill floor and deficiency of engagement. If cost drivers are used to mensurate the public presentation of employees in developing a wages system, so the effect is that director and particularly the employees will concentrate excessively much on the cost drivers.
4.4 Advantages and restriction of ABC
~ & gt ; Benefits of ABC
The primary benefits of ABC are more accurate merchandise costing. Here ‘s why:
Performance measuring
The information provided by ABC on cost drivers and cost driver rates shows that they are potentially powerful influences on the behaviour of staff and they are used as public presentation steps ( Kingcott, 1991 ) .
Different cost object.
The ABC methodological analysis can be applied to be objects other than the merchandise. One recent development has centre on the designation of costs associated with the helping of single clients ( John and Mitchell, 1991 ) . This allows client profitableness to be analyzed and so provides direction with a market-oriented position of how net income has been earned.
Budgeting
ABC besides provides information relevant to both the scene and utilizing of overhead budgets. The handiness of cost driver volumes provides, frequently for the first clip, a step of the work of each activity ( Shank and Govindarajan, 1993 ) .
ABC leads to better direction determinations
More accurate merchandise costing should lend to puting selling monetary values that can assist accomplish coveted merchandise profitableness degrees. In add-on, more accurate cost informations could be helpful in make up one’s minding whether to do or purchase a merchandise portion or constituent, and sometimes even whether to extinguish a merchandise.
Activity-based costing does non alter the sum of operating expense costs. What it does is apportion those overhead cost in a more accurate mode. Furthermore, if the score-keeping is more realistic and more accurate, directors should be able to better understand cost behaviour and overall profitableness.
~ & gt ; Limitations of ABC
Although ABC systems frequently provide better merchandise cost informations than traditional volume-based systems, there are restrictions:
ABC can be expensive to utilize.
The increased cost of placing multiple activities and using legion cost drivers discourages many companies from utilizing ABC. Activity-based bing systems are more complex than traditional bing systems-sometimes significantly more complex.
Some arbitrary allotments continue.
Even through more overhead costs can be assigned straight to merchandises through ABC ‘s multiple activity cost pools, certain operating expense costs remain to be allocated by agencies of some arbitrary volume-based cost driver such as labour or machine hours.
4.5 Company that apply ABC
Since we had talk all the theory for ABC bing above, now allow present some practical company that implement ABC system in their company.
Milkcom is the biggest manufacturer of milk pick in Belgium. Inco group founded Milkcom in 1963. It has produces 6,700 providers and 900 workers in its production installations with an one-year turnover of $ 4 billion. The companies produces 770 million liters of milk yearly and bring forth 60 million liters of pasteurised milk, 300 ton of milk pulverization day-to-day and 1 million pieces of ice-cream. In order to stay competitory, Milkcom attempt to obtain ISO 9002 certification and develop ABC system with Vlerick school. Management able to follow their production much better after the information system had been implemented. Milkcom can manage each production line and each type of merchandise, a measure of stuff and acquire the signals if there is any alteration occurs during the production procedure. Milkcom is one of the company who success after implement ABC system. Although Milkcom had spend 3 million for development and implement ABC system, it has been worth it harmonizing to the direction. In the hypercompetitive market, it is of import to cognize the precisely of merchandise cost. This helps to continuously change the product-mix based on the public presentation of each merchandise. ( Gunasekaran, A. , Marri, H.B. , and Yusuf, Y.Y. 1999 )
Hong Kong Certified Aircraft Engineers Ltd ( HKCAE ) is a entirely fix and care work for airdrome land service equipment in Hong Kong. It founded in 1961. There are 600 employees in the company. Besides entirely on airdrome land service, HKCAE besides produces steel mills technology and other heavy industrial merchandise which are different concern features and the nature of their chief activities are dissimilar. Under the current accounting system ( traditional costing system ) , indirect costs are allocated to each undertaking at a rate of the proportionate sum of work grosss of the undertaking. By utilizing the traditional costing system, it does non supply any guidelines to difference valuable and non-valuable activities. Hence, HKCAE decide to implement ABC system. After apply ABC costing, HKCAE had centralize all the clerks into a clerical work pool to better efficiency is the organisation ‘s effort to use the reservoir of cognition by presenting the new on the job process to reinvent its concern. In add-on, it able them to difference added value and non-added value and cut down extra work. ( Chan. M.F.S. , Keung K.F. and Chung W.W.C. , 2000 )
Super Bakery, Inc. is a countrywide provider of mineral- , vitamin- , and protein-enriched rings and others baked goods to the institutional nutrient market, chiefly school systems. It created in 1990 by former Pittsburgh Steelers ‘ running back Franco Harris. By utilizing traditional costing system, Super Bakery had achieves their end and their gross revenues have grown at an mean one-year rate of about 20 % . Management suspected a broad fluctuation in the cost of functioning clients in different parts of the state. Yet by utilizing traditional costing methods were distributing costs over the full client base. Each client ‘s order appeared to be the same sum to finish. Therefore, Super Bakery had alterations their system to ABC system. It would more accurately delegate the costs of each order and net income border on each sale. ( Tom R.V.D. and Bruce L.D. , 1996 )
WAGDA, a company locates on Belgium, with 1,000 employees that produce extremely specialized steel merchandises used to fix constituents for fabric machines. A plan of built-in quality system was set up in the twelvemonth 1980. It can cut down the fix costs of installations that include assorted machine tools and equipments. They had implement ABC system for its budget to back up the plan. The cost system enables the applied scientists to hold detailed information about the costs of different fix services of machines in approximately 90 sections in the company. With ABC system, the section has been able to cut down 2 per centum of downtime machines. Besides, the ABC system besides enabled the section to happen the critical countries and helped them in their determinations related to the assorted investing plans such as new care engineerings and systems to better them. ( Chan. M.F.S. , Keung K.F. and Chung W.W.C. , 2000 )
On the above, there are 4 companies that had adopted ABC and success in the terminal. ABC is non 100 % suited for all the company or division. Below have an illustration of Hewlett-Packard company, which faced job when implement ABC system.
Hewlett-Packard ( HP ) is considered one of the best-managed and most advanced companies in the universe. It have the ability to accommodate to planetary competitory challenges through proficient invention and continual reappraisal of its direction and control mechanisms. Most application of activity-based costing by HP has been successful. In 1988, HP decides to implement ABC system in Colorado Springs Division, so that can supply a better merchandise costing and stock list rating. Compare with other division of HP, Colorado Spring division was a larger division that had a high mix, low volume merchandise line. Management decided to implement ABC in this division in order to acquire better cost information on which to establish merchandise pricing determinations. After implement ABC system, it help the division understand its fabrication procedures, overhead ingestion, and fabrication efficiency, but it did non assist them with their stock list rating method. Due to high heterogenous merchandise mix and high fixed cost. ( Steven P.L. , Larry M.W. and Tim M.L. , 1997 )
Decision
Traditional costing non longer provides an accurate merchandise cost because of fabrication is traveling off from mensurating labour efficiency and traveling toward more material-focused systems. ( Gerhard P.,1999 ) , Hence, traditional costing had replaced by activity-based costing.
In this paper, we had to the full discussed activity-based bing apply in fabrication. This has been help with some practical company that had implement ABC system. ABC systems trace more precisely the existent costs to the merchandises than any other volume-based cost systems. Therefore, more accurate operating expense cost allotments lead to fewer deformations ( Cooper and Kaplan, 1991 ) . However, a tradeoff should happen between the economic benefits of an ABC and the costs of implementing it. For some industries ABC systems are utile and for others non as it can be seen from instance experiences. When implementing an ABC system, a alteration in the direction construction should happen in order to ease the application of ABC. The direction should accommodate an activity-based direction system utilizing the provided information by the ABC system and accomplishing their primary mark that is doing net incomes.
Equally long as there is a strong partnership between different sections, ABC can be a great communicating tool. It can drive authorization if everyone understands their function. In order to better gross borders, you need to cognize good for cost construction of the organisation and the key of cost drivers. However, there is pro and con for activity-based costing. Sometime, it is hard to apportion some of the overhead cost to the merchandises and clients every bit good particularly in service houses. This is because a larger proportion of operating expense costs are company-wide costs that can non be straight traced to specific services provided by the company.
