Activity Based Costing ( ABC ) is an accounting method that assigns costs to activities harmonizing to their usage of resources, instead than merchandises or services. This enables resources and other related costs to be more accurately attributed to the merchandises and the services which they use. It does non alter or extinguish any costs, in the other manner ; it provides elaborate information on how costs are consumed. The chief benefits of Activity Based Costing are supplying understanding into the fastest growth and least seeable component of cost-overhead. We can besides better profitableness by supervising entire life-cycle cost and public presentation so that we can better the effectivity of budgeting by placing the cost of different service degrees. In add-on, ABC costing does promote uninterrupted betterment and entire quality control because control and planning are directed at the procedure degree and it links the corporate scheme to operational determination devising. By utilizing ABC costing, we can besides extinguish waste by supplying visibleness of non-value added activities. Besides that, ABC bing aid to better brand or purchase, gauging, and pricing determinations which based on merchandise cost that reflects the fabrication procedure. Although there are many benefits of ABC costing, there are besides a few restrictions. ( J. Antos )
Restrictions of Activity – based Costing
There are a few restriction of utilizing ABC costing. First, we may devouring more clip to roll up informations for illustration informations refering legion activity, roll uping informations, look intoing informations, and come ining them into the system. Besides that, one time implemented, the activity-based coting is dearly-won to keep for illustration the cost of purchasing, implementing, and keeping activity-based system. This system may do waste seeable which some executives and directors do non desire their foreman to see because it may be hard to put up and set up, peculiarly if that organisation is utilizing more traditional accounting method. Furthermore, it can be clip devouring if all activities are to be costed and besides it may supply excessively much inside informations which befoging the bigger image. Activity-based bing informations can easy be misunderstood so it must be used carefully particularly when it is used for determination devising. Before doing any important determinations utilizing activity-based costing informations, directors must acknowledge the costs which are truly relevant for the determination at manus. ( Ray H. Garrison, 2008 )
Value-Added versus Non-value-Added Activities
Every organisation requires information to apportion resources, monitor the actions taken, set precedence and do determinations. Activity-base bing provides the accurate cost information by apportioning overhead costs. However, activity-based direction is concentrating on enhance the usage of ABC from merchandise bing to a comprehensive direction tool that concentrate on diminishing the costs and at the same time bettering procedures and determination devising. After that, a polish of ABC used in activity based direction is the categorization of activities to value-added and non-value-added. A non-value-added activity can de defined as the production or service related activities that can be eliminated with no impairment of merchandise properties ( Miller, 1992 ) . Non-value-added activities are activities that merely add cost to or increase the clip spent on a merchandise without increasing the market value of the merchandises. Activities such as the storage of stock list, edifice care ; review and stock list control are illustrations of non-value-added activities in fabrication companies. Examples of non-value-added activities in service industry consist of clerking, charge, going, advertisement, cleansing, taking assignment, response and etcetera. Harmonizing to David and Robert ( 1995 ) , doing non-value-added activities seeable is one of the advantage of activity based direction but it is the most hard to accomplish.
Value-added activities are activities that increase the worth or market value of a merchandise or service to clients. For case, activities like technology design, machining, packaging, executing surgery, supplying legal research for legal services and etcetera are categorized as value-added activities. When people understand and accept the grounds why an activity is classified as non-value added or value added so the lucidity and understanding between value-added and non-value-added activities are achieved ( Miller,1996 ) .
Cost Hierarchy In Activity-Based Costing
A cost hierarchy classifies costs into different cost pools on the footing of different type of cost driver or cost allotment bases or different grades of trouble in placing cause-and-effect or benefits-received relationships ( Horngren et Al. P 142, 1999 ) . There are four degrees to place cost allotment bases or cost drivers, the categorization is shown as follow:
Unit-level activities: these activities can be defined as resources sacrificed on activities performed on each single unit of a merchandise or service ( Horngren et al, 1999 ) . For case, fabricating runing costs such as energy and fix which have relationship with the activity of running a machine are unit-level activities.
Batch-level activities: Activities performed for a group of merchandise units or services instead than to each single unit of merchandise or service ( Horngren et al, 1999 ) . Examples of batch-level cost in fabricating are setup cost and procurance costs. Then, the figure of apparatuss or apparatus clip is illustrations of cost drivers in batch-level activities.
Product-sustaining activities: These activities are defined as resources sacrificed on activities that performed in support of an full merchandise line, but non performed every clip when a new batch or unit of merchandises is produced ( Horngren et al.,1999 ) . Design costs and technology costs are illustrations of product-sustaining activities in fabrication industry.
Facility-level activities: Activities required to back up or prolong the organisation as a whole and can non be traced to single merchandise ( Horngren et al, 1999 ) . The illustration of this activity includes place office general disposal costs.
In fact, the successful categorization of these activities provide directors a structured manner of believing about the relationships between activities and the resources they consume.
Activity Based Costing for Service Industries and Small Business
It is widely known that activity based costing has been used by most of the big corporation such as makers. In fact, activity based costing has been widely implemented by little concern and service industries such as Bankss, air hoses, hotels, infirmaries, insurance companies, fiscal services houses, accounting house, railwaies and etcetera. However, activity based costing has seemed to be more successful when implemented in big corporation instead than utilizing in little concern. Harmonizing to Henrick noted, he mentioned that companies with non so much merchandises and markets are non seemed to acquire every bit much advantages from establishing costs on activities as companies runing with diverse merchandises, service lines, channels and clients.
Actually the primary aim of activity based costing in little industry is no different with fabrication company. The aim is to calculate out the cardinal activities that generate costs and to enter how many of those activities are performed for each service provided. Then, directors are able to bring forth informations to supply better budget and at the same time the disbursals of a company are known better. The prevailing attack to place activities, activity cost pools, and cost drivers is the same for fabricating company and service companies. In add-on, the classifying of activities as value-added and non-value added, and the attempt to diminish or extinguish non-value added activities are used in service industries excessively. Since service industries and maker companies are utilizing the same aim of activity based costing, so why sometimes it is hard in following activity-based costing in service industries? The trouble of implementing activity-based costing in service companies is that a larger proportion of operating expense costs are company-wide costs that can non be straight traced to specific services provided by the company. ( Weygant. )
Besides that, many of the disbursals in service industries are caused by merchandise ( services ) such as nest eggs account and place mortgage. However, many disbursals for service maps are caused by demands by single clients instead than service demands. Therefore, client behaviour which is the characteristic separating these systems from activity based costing as used in fabrication companies has to be taken into history when implementing ABC system in services industries ( Cooper and Kaplan, p. 467, 1991 ) . Service companies offer differentiate services in order to fulfill client demands. Each service, with its features, makes different demands on the organisation ‘s resources. Therefore, service companies have to better their service quality and the assortment in service line. Concurrently, service companies have to concentrate on client economic sciences far more than fabrication companies. The cost of selling, selling, bringing and helping of the merchandises might be client particular in fabrication companies. In contrast, for service companies, even the basic operating costs of standard service are determined by client behaviour ( Cooper and Kaplan, pp234-235, 1998 ) . Therefore, a all right ABC system for Service Company will supply the information for the measuring of costs and profitableness at the client section degree and market degree.
Since little concern and big companies are utilizing the same aim of activity based costing, so why does little concern get less benefit from utilizing activity based bing comparison with big corporation? In fact, deficiency of cognition and proficient people in following the activity based bing system in little concern may take to unsuccessful of utilizing this system in little concern. Furthermore, activity based costing package is expensive. A Most ABC practicians find that special-purpose ABC package is required to do the undertaking manageable. At $ 6,000 and up for one bundle sold by ABC Technologies, package can add significantly to outlays for this type of accounting technique ( Mark Henricks, 1999 ) . So, little concern considers utilizing ABC is blowing of money due to non so much net incomes and merchandises distinction for their merchandises. Therefore, they omit utilizing ABC.
Developing Of New Approach to ABC
Activity-based Costing system used in big corporation and service industries for the current grouping of costs and analysis of profitableness of merchandise ( service ) tend to be complex, dearly-won and difficult to set to rapidly altering concern environment. For illustration, ABC system used in several old ages ago in big fiscal service house required seven hundred employees at more than one 100 installations to subject monthly study of their clip. Thus the company employed 14 full clip people merely to roll up and treat the informations and at the same time prepare direction studies which took more than 30 yearss to fix ( Kaplan & A ; Anderson, P 3, 2007 ) . Some employees questioned the truth of merchandise and activity cost computations due to long clip to fix studies and complexness of ABC system. As a consequence, operation, selling and gross revenues directors spent clip to reason the rightness and truth of computations alternatively of doing determinations bettering effectivity of procedures, profitableness of merchandises and clients and capacity use. Therefore, Kaplan and Anderson developed new expression of activity-based bing viz. Time-Driven Activity Based Costing ( TDABC ) . It was designed to extinguish the jobs in ABC system execution and operation in big entities. Therefore, Kaplan and Anderson who was the writer of the new expression identified the undermentioned jobs with conventional ABC theoretical account: ( Kaplan & A ; Anderson, P 7, 2007 )
aˆ? It was dearly-won and long clip had to be taken for questioning and appraising procedure.
aˆ? Data for the ABC theoretical accounts were subjective and difficult to formalize.
aˆ? It was expensive to hive away, procedure and describe the informations.
aˆ? Most of the ABC theoretical account were local and did non supply an incorporate position of company-wide integrated profitableness chance.
aˆ? The ABC theoretical account could non be easy uploaded in order to suit the rapidly alteration of concern environment.
aˆ? The theoretical account was wrong when it ignored possible for fresh capacity.
A Traditional Costing System is an accounting system that assigns overhead to merchandises on the footing of preset works broad volume of unit based end product rates such as machine hr and direct labour. ( Jerry J. Weygandt. , Donald E. Kieso. , Paul D.Kimmel. , 2002 ) In Contra, ABC system is utilizing the different manner to place activity cost pool by apportioning operating expense, after that, the costs are assigned to merchandises utilizing related cost drivers that measure the activity consumed. ABC system conveying a few benefits for directors in a company which provide more accurate merchandise costs, better cost control and better informations for determination devising. ( Ray H. Garrison. , Eric W. Noreen. , 1997 ) However, this system besides has several restriction which is the trouble involved in garnering informations associating to be drivers and activities centres. Although there are a few restrictions, ABC system is a utile accounting system under certain conditions and it is a suited costing system to utilize. The redesign and puting up a new costing system is a really of import determination to a company because these require significant cost and much more attempt to accomplish. Therefore, directors should be really careful when implementing new alterations in bing system. ( Jerry J. Weygandt. , Donald E. Kieso. , Paul D.Kimmel. , 2002 )