Activity Based Costing. Discuss the chief issues faced by directors in emerging economic systems who want to implement ABC.
This essay purposes to discourse the undermentioned subject: Activity Based Costing is an illustration of a successful direction accounting technique that has been widely adopted in different sectors in the UK. Primarily, the significance of Activity Based Costing ( ABC ) will be explained. Second, is demonstrated how the execution of ABC accounting technique in assorted sectors such as fabrication, fiscal services and banking, retail, wellness and authorities, influenced negatively or positively some companies. Last, is presented whether or non the Activity Based Costing method is an appropriate accounting technique that should be implemented in organisations or should be rejected.
As fabrication environment turns to be computer-integrated field and, at the same clip the manufactured merchandises diversify, traditional cost methods can critically distinguish merchandise costs. The thought of activity-based costing ( ABC ) was foremost designed and introduced by Robin Cooper and Robert S. Kaplan. ABC could happen solution for the deformed jobs that occur. A definition of ABC is “ the aggregation of fiscal and operation public presentation following the important activities of the firm-to-product cost ” . This accounting technique is divided in five phases: a ) sum actions into activities, B ) study the cost of activities, degree Celsius ) identify activity Centres, vitamin D ) select first-stage cost drivers and vitamin E ) select second-stage cost drivers. In order to be decently implemented, this method has to be organised in seven parts: an ABC seminar, a design seminar, design and information assemblage, progress meetings, an executive seminar, consequence meetings, and reading meetings ( No and Kleiner, 1997 ) .
2. What is Activity-based bing
The activity based bing method was ab initio presented by Cooper ( 1988 ) and Cooper and Kaplan ( 1988 ) ( Baird, 2007 ) . ABC is an appropriate method of measuring the product/service costs more accurately when diversified. The traditional cost accounting methods aim to pull off the units of a specific merchandise which means that the rating of the costs depends on the units allocated in a merchandise, for case, figure of direct labor hours, machine hours or stuff costs consumed in doing the merchandise. On the other manus, ABC method marks to the activities utilized for the fabrication of the merchandises at the concluding phase of the production procedure ( Cooper, 1990a ; cited in No and Kleiner, 1997 ) .
The chief difference between ABC method and the traditional cost accounting methods is that the former emphasizes in happening the costs in activity degree, that is in unit-level, batch-level ( i.e. figure of set-ups ) and product-level features ( i.e. figure of parts, figure of times ordered ) and non in the unit-level features as the latter ( Raffish, 1991 ; cited in No and Kleiner, 1997 ) .
3. Execution of ABC method
An illustration of ABC execution in the fabrication sector is the instance of a big Chinese fabrication company, Xu Ji Electric Co. Ltd. The most important indexs of a successful application are the top direction support and the important presence of devoted professionals. Particularly the underdeveloped states, such as China, attempt to heighten fabrication engineering and Information Systems ( IS ) due to the aid of foreign investing capital and engineering transportations. The uninterrupted hunt for improved accounting methods, though, can non assure that will give solutions to the emerging economic systems ( Liu & A ; Pan, 2007 ) .
The success of ABC is wholly connected to the right design of the method, which means that apprehensible and realizable aims have to be introduced, objectives that express wholly the schemes of the house. Top precedence is the devotedness and support of top direction, the proviso of equal resources in a timely mode, the engagement of employees and the aggregation of information ( Liu & A ; Pan, 2007 ) . After a long-run period of research upon ABC in GM, Anderson ( 1995 ) refers six execution phases based on Kwon and Zmud ‘s theoretical account: induction, acceptance, version, credence, routinisation and extract ( Anderson, 1995 ; Liu & A ; Pan, 2007 ) .
In other words, the success of ABC can be summarised in four important factors:
Technical factors: The cognition of the application of such system. This consists of the acknowledgment of cost drivers and activities, activity choice for each merchandise, connexion among organizational strategic ends and ABC and the consciousness of the ability of bing computing machine systems to back up ABC method ( compatibility issues ) .
Organizational factors: Top direction support, preparation investing, adequateness of resource and construction of administration and civilization.
Behavioral factors: Engagement of staff members when ABC is applied and apprehension of single users ‘ behavior.
Other associated factors: Competition, committedness, quality and relevancy of cost information to managerial determinations, size of administration, compensation and wages, general demand for alteration and civilization ( Liu & A ; Pan, 2007 ) .
Financial services and banking sector
ABC can be besides applied on service sector. Service companies consider the labor cost for employees as the most critical cost whereas in service corporations dominate professional labor costs. Overhead costs are portion of a house every bit good. When taking topographic point a service, occur overhead costs in every house and they can be easy categorised as service operating expenses in order to be compared with mill operating expenses in a fabrication company ( Hussain & A ; Gunasekaran, 2001 ) .
In a fiscal establishment the services that provided to the clients are recognised as indirect costs. Due to mechanization, indirect costs replaced with direct costs which confuse the cost of resources consumed or utilised and the existent client services rendered. ABC method differentiates from the traditional cost methods because it can supply accurate cost informations about merchandises and client profitableness ( Sapp et al. , 2005 ) .
The construction of ABC attack in fiscal establishments consists of two-stage theoretical account. First, creates the relation between resources and activities and so the cost per unit of activity is implemented to the ingestion of activities such as clients and merchandises for the rating of the aforesaid classs. Costss like rewards, depreciation, ownership and information processing are located to activity costs pools based on a computation of each activity ‘s require for the specific resource. The first phase is finished, when the tracing of overhead resources to activity cost pools is achieved. The 2nd phase purposes to measure the activity unit cost relied on cost drivers. In other words, costs drivers measure the cost units of activities to each product/customer relied on the sum of the activity that product/customer demanded. For illustration, an appropriate cost driver associated with the activity cost pool, such as a new auto loan, is the figure of new auto loans ( Sapp et al. , 2005 ) .
So, the designation of a cost driver for every cost pool is critical to calculate the activity unit cost. Once this procedure is completed, activity costs can be allocated to products/customers relied on the sum of that driver is consumed. Summarizing the costs of all activities that comprise a product/customer, a concluding merchandise cost can be defined. As it seems, ABC is a dominant tool for fiscal establishments and Bankss because the cost informations that provides can take directors non merely to profitable determinations but besides to progress the competitory place of the house. Finally, through this system, organizational and customer/product profitableness can be easy recognised ( Sapp et al. , 2005 ) .
ABC system has high installing and care cost particularly when the traced activities might be fossilised, chiefly where this is written into package. It is besides known that ABC depends on the look that “ activities consume resources ” which is inextricably connected to the managerial determinations, determinations that can change, be delicate, or heighten the aforesaid look. An accountant, who implements this bing method, might confront a figure of jobs such as non-traceable costs and more exactly the corporate advertisement. Such a job could take to the failure of ABC execution. A solution to excel the job is to group all non-traceable costs into one cost pool and reassign them across merchandises. However, this scenario could do failings in activity-based costing system ( Tollington & A ; Wachter, 2001 ) .
By and large, it is deserving stating that retail sector has short client rhythm and might be influenced less by fluctuations in resource ingestion and disbursement than other economical sectors. What is more, the per centum borders in this sector of economic system have the inclination to be narrow, something that requires attending to the merchandises ‘ and services ‘ costs offered to clients. ABC system is utile in footings of explicating the usage of overhead resources, chiefly in separating among added value and non-added value activities. This bing method may be one of the most improved overhead soaking up methods, though the hunt of a precise product/service cost might be undefinable ( Tollington & A ; Wachter, 2001 ) .
Like the other sectors, ABC system has application in wellness sector as good. In the bulk of the infirmaries, direction purposes to better the quality of patient attention, to supply up-to-date engineering ( utilizing big sums of capital ) , and to be competitory among the other administrations. This is the ground that tonss of directors choose to follow the ABC method, assisting them to hold greater focal point on the cost of activities in order to do better determinations. The trouble is to place the activities and the cost pools and to specify the drivers ( Aird, 1996 ) .
The ABC system in a wellness administration is divided in four cost activities:
Unit-Level Activities: This type of activity occurs every clip a unit of service is provided. In other words, as the figure of service units raises, the activities raise severally. For case, the review of each lab trial counts as an activity.
Batch-Level Activities: This type of activity occurs every clip a batch of service is provided. Hence, as the figure of service batches raises, the activities raise severally. For case, this type of activity measures the needed sum of set ups for a specific lab trial or the needed sum of set ups for a surgical process.
Service-Sustaining Activities: This type of activity supports the different types of services. These costs can be allocated to single services but their entire sums are unrelated regardless of the sum of batches or the sum of the produced service units.
Facility-Sustaining Activities: This type of activity supports a installation ‘s general service supplying procedure. These activities are independent to the sum of single services provided, the sum of batches run or the sum of different services. General direction, security, landscape gardening, insurance, installations care, forces and accounting can be some illustrations of this activity ( Cooper, 1990 ; cited in Capettini et al. , 1998 ) .
The utility of ABC system in the populace sector has non yet wholly explained because governmental establishments started to demo involvement a decennary after the private sector. This happened due to the being of the competition in the private administrations. An illustration of comparing between traditional costing system and the ABC system is a fire section in a metropolis and it is given to understand the different steps of costs and how this can be misdirecting for the administrations. Fire sections serve usually two maps ; to contend the fire and to carry through review services for fire-safety grounds. There are besides two types of cost in the fire section viz. overhead costs and direct labor costs ( Brown et al. , 1999 ) .
When a traditional cost accounting system is utilized, the cost of fire reviews is a amount of direct labor cost and overhead cost. This cost informations can non be accurate because the review operating expense costs include besides overhead costs that are non connected to the review process ( i.e. the care cost on equipment and fire truck ) . Furthermore, there is no cause-effect connexion among direct labor cost and overhead cost. So, what makes the tradition accounting bing method more attractive is the simpleness ( Brown et al. , 1999 ) .
On the other manus, ABC execution in the instance of the fire section three types of cost is recognised: the operating expense costs to contend fires, administrative operating expense costs and review operating expense. The consequences from this illustration have shown that the ABC system provides more accurate cost informations because the traditional cost system uses entire labour hours as an allotment base, whereas ABC uses multiple operating expense pools and allotment bases, giving a more precise designation of the costs ( Brown et al. , 1999 ) .
The cardinal factor for the appropriate pick of the bing accounting method is that all corporations should look at the positions that could give them competitory advantage and better control of their costs. ABC system may hold tonss of potencies, but on the other manus a house must be certain that such an execution truly deserving. To be more precise, a test period utilizing another accounting system such as ABC could assist the house to gain if the cost informations are traveling to be wholly different compared to the old system and if this information could assist directors to alter their determinations ( Brown et al. , 1999 ) .
To sum up, activity based bing system can be implemented in all sectors of economic system such as fabrication, fiscal services and banking, retail, wellness and authorities, every bit far as specific regulations are non ignored. For case, directors can be wholly aroused and overpass the disadvantages of ABC at the beginning or they can non be prepared to give the necessary attending. Basically, one of the most of import factors of a successful ABC execution is the top direction support and the investing in preparation.
Problems that can originate are the troubles in cost driver and information choice. Furthermore, the procedure activity informations derived from ABC might be dissimilar with the functional construction of a house. Another important observation is that there are tonss of companies that are non prepared to alter their bing accounting system into ABC likely because they are non familiar with an advanced accounting system. Finally, ABC execution is neither related to the costing or administration profile of corporations nor is relied on which method is more sophisticated, but which accounting technique demonstrates better the demands of a house.