The Application Of Activity Based Costing In Modern Day Business Accounting Essay


Cooper and Kaplan introduced Activity Based Costing ( ABC ) in 1989 for supplying more pertinent product-cost information. ABC systems presume that activities cause costs and set up correlativities between activities and merchandises through allotment of costs of activities to single merchandises.

This short survey investigates the application of ABC systems in pattern, their advantages and disadvantages in comparing with traditional cost accounting methods, and the grounds for their slow use in mainstream concern.

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The research leads to the decision that ABC can be relevant for both big and little administrations in both fabrication and service industries. Its potency has been underutilised and its deployment has stagnated.

Table of Contentss










Point of view and Background of Research



Research Problem



Aims of Study



Significance of Study



Research Methodology






Data Collection



Scope and Restrictions of the Study



Administration of the Report



Literature Review



Cost Accumulation to Products



The Basics of Cost Accumulation Systems



Absorption Costing



Fringy Costing



Activity Based Costing ( ABC )



Comparison of Absorption Costing ( AC ) and Marginal Costing ( MC )



Comparison of Absorption Costing and ABC



ABC and Modern Business environment



Recent history of ABC Implementation ( Success and Failure )



Service Industry and ABC



Problems in implementing ABC






Research Methodology and Framework






Research Problem



Aims of Study



Sample of Study






Cogency of Measuring Instrument



Data Presentation and Analysis Method



Existing Cost Accounting System of JKL Plc



Constraints of Present Cost Accounting Systems at JKL Plc



Advantages of Introducing ABC Costing at JKL Plc



Disadvantages of ABC Costing for JKL Plc






Analysis of Datas



Discussion of Findingss




Index of Acronyms and Abbreviations




Activity Based Costing


Available Room Rate

Generally accepted accounting principles

By and large Accepted Accounting Principles


Fringy Costing


Gross per Available Room


Volume Based Costing


Variable Costing


1.1. Point of view and Background of Research

The ABC construct has been appreciated by faculty members and advisers since its debut in 1989. Studies nevertheless reveal that a limited figure of UK fabrication administrations have implemented, or are implementing the procedure ( Dugdale et Al, 2005 ) . Most houses, despite ABC consciousness, continue to utilize traditional bing systems like AC, VC and fringy costing.

Factors like increased competition, deregulating and turning merchandise ranges nevertheless necessitate more precise cost measuring for measuring net incomes generated from merchandises, clients and markets ( Drury & A ; Pettifer, 1993 ) .

1.2. Research Problem

JLK Plc in UK has of tardily witnessed a important bead in gross revenues because of increased competition, every bit good as by the demand of clients to acquire more value for money. JLK uses soaking up bing for intents of cost control and direction.

With ABC considered to be an advanced and effectual costing procedure, the research job concerns the virtues and demerits of JKL ‘s present costing system, vis-a-vis debut of ABC, for optimizing cost control and bettering competitory advantage

1.3. Aims of Study

This survey aims to look into the history and current position of activity based costing in the modern concern environment, particularly in the UK. The aims of the research are therefore detailed as under.

To look into the grounds and footing of cost accretion for direction planning and cost control intents

To analyze and compare the bing systems, viz. Absorption Costing, Variable Costing and Activity Based Costing being used by UK concerns, in the context of the modern concern environment every bit good as the service industry

To analyze the recent history and jobs of ABC execution ( for both successes and failures )

1.4. Significance of Study

Probe into the public-service corporation of appropriate cost accounting systems in JKL plc will assist pupils and practicians in understanding complexnesss of cost direction in specific concern contexts every bit good as the challenges involved in execution of ABC procedures.

1.5. Research Methodology

The research methodological analysis uses the instance survey method of fiscal research. Investigation into the bing systems of a specific concern house, along with survey of affair available on bing systems in the public sphere, provides significant and relevant information. The literature reappraisal inside informations the usage of traditional bing systems in the UK, every bit good as the complexnesss and public-service corporation of ABC systems.

1.5.1. Sample

The sample, or instance chosen for the survey, is JKL plc, a medium scope cordial reception house in the UK. The house ain and operates seven hotel belongingss.

The house uses soaking up bing for its traditional cost control and direction maps. Contribution/margin constructs of fringy costing are used jointly with monthly and one-year budgets and turn overing prognosiss for internal coverage intents. These systems have been traditionally followed. Reducing tenancy degrees, every bit good as decrease in ARRs and RevPARs, caused to a big extent by the on-going economic convulsion has necessitated efforts to look into the function of cost accounting and direction systems in incorporating beads in borders.

1.5.2. Datas Collection

Information beginnings are categorised into primary and secondary beginnings ( Newman, 2005 ) . Secondary beginnings are the bedrock of qualitative research and are mostly sourced through library research. Such information beginnings are accessible in the public sphere and are gettable from organizational web sites, or from the survey of pertinent publications like books, magazines, diaries and media ( including newspaper ) studies.

It is felt that focussed and careful library research, along with instance information from the administration under survey, will be equal for accessing disposed and pertinent information for the survey. The research method adopted is qualitative in nature and focused on intensive library hunt and instance analysis of the existent costing system of JKL plc.

1.6. Scope and Restrictions of the Study

The survey is limited by the informations accessed from the public sphere on the topic under survey. Whilst information obtained from JKL plc provides relevant information, the survey of more administrations would hold helped in proof of findings.

1.7. Administration of the Report

This research is consecutive organised, the introductory subdivision is succeeded by a reappraisal of bing literature, followed by the research inquiries, a description of the selected research methodological analysis and model, the informations presentation and analyses and eventually the treatment of findings.

Literature Review

2.1. Cost Accumulation to Products

Cost accretion is an of import aspect of managerial accounting for fabrication procedures. The information accretion inherent in the procedure helps directors in countries of control, planning and determination devising ( Rushinek, 1993 ) .

Assorted operating expense costs are allocated to merchandises, taking to progressive accretion of costs. The procedure enables administrations to ( a ) to quantify full costs of merchandises ( B ) encourage efficient merchandise direction by directors, and ( degree Celsius ) measure different options for direction control, planning and determination devising ( Putra, 2008 ) .

2.2. The Basics of Cost Accumulation Systems

Cost accretion systems place non merely the objects of costs but besides the method of apportioning costs to production. There are two of import cost accretion systems, viz. occupation order and procedure bing systems. Job order bing systems are utilised by administrations that produce relatively little measures of different merchandises or services to the specifications of clients ( Kinney & A ; Raiborn, 2009 ) . Jobs, depending on the context of concern verticals, can associate to undertakings, contracts, battles or clients ( Kinney & A ; Raiborn, 2009 ) .

Procedure bing systems on the other manus are used by administrations that industry big volumes of homogenous goods, such as detergents, bricks or gasolene ( Kinney & A ; Raiborn, 2009 ) . Overheads, unlike direct stuff and labor, ( which are easy traceable to specific merchandises or services ) , need to be accumulated over clip and so allocated to the merchandises produced or the services provided during such periods. Cost allotment, represents the allocated charge of an indirect disbursal to one or more merchandises through the deployment of a sensible method ( Putra, 2008 ) .

2.2.1. Absorption Costing

Absorption bing systems distribute a portion of all incurred outgos to each and every merchandise or service offering of concerns. The usage of such systems can assist in the ascertainment of the long term coevals of net incomes of each merchandise or service.

Absorption bing systems conventionally categorise costs by map. Gross saless sums less production costs quantify fabricating or gross net incomes. Operating or net net incomes are determined by accounting for costs of other concern maps from gross net incomes ( Coulthurst, 2000 ) .

The net incomes reported with the usage of soaking up bing system for fabrication houses for peculiar periods are dependent on both production and gross revenues degrees as fixed fabrication operating expenses are absorbed both in work-in-progress and in finished goods stocks. Closing stocks at the terminal of accounting periods render fixed fabrication operating expense costs that are absorbed into stock ratings to be shifted to subsequent periods ( Coulthurst, 2000 ) . Absorption bing systems require premises about allotment of many costs and are therefore prone to greater grades of subjectiveness.

2.2.2. Fringy Costing

Fringy bing systems highlight behavioral as opposed to functional properties of costs. Such systems segregate costs into variable and fixed elements. Variable cost elements are those where costs per unit stay unchanged and entire costs change in line with activity degrees. Fixed elements are those for which entire cost corsets unchanged for specific periods and are independent of activity degrees ( Coulthurst, 2000 ) .

Fringy bing systems, whilst non implemented easy, can assist in planning, control and decision-making, peculiarly for multi-product concerns ( Coulthurst, 2000 ) .

Contribution of distinct products/services towards the full fixed outgo of concerns, in fringy costing systems, is determined by cut downing variable costs from gross revenues. The fixed costs are considered to be period costs and are offset from parts to find the net net incomes for specific periods ( Coulthurst, 2000 ) .

2.2.3. Activity Based Costing ( ABC )

Activity based costing is a modern twenty-four hours bing system, wherein costs are allocated on the footing of the cause-effect correlativity of costs with the activities that drive costs. Conventional bing systems tend to apportion indirect costs on slightly easy identifiable standard like direct labor hours ( Bradford, 2008 ) .

ABC can be utilised by most industries because of its adaptability for constitution of costs at different degrees ( Bradford, 2008 ) . ABC is nevertheless best utilized in complex administrations that are non wholly service-based. Administrations with complex constructions can happen ABC systems utile, because of its value in state of affairss where bing information is hard to measure or measure. ABC can besides go inaccurate in state of affairss with low correlativity between the costs being allocated and activities. Such fortunes can render rating of costs complicated and inaccurate ( Bradford, 2008 ) .

2.3. Comparison of Absorption Costing ( AC ) and Marginal Costing ( MC )

An of import difference between soaking up and fringy bing systems relates to the postponement of fixed fabrication costs. Increase in stock list, under AC, leads to the postponement of a portion of current fixed fabrication operating expenses to subsequent periods through stock list histories ( Nurre, 2010 ) . Subsequent sale of such stock list units sold leads to postpone costs go throughing into income statements as elements of the cost of goods sold ( Nurre, 2010 ) .

Estimates of values of shutting stock lists differ between AC and MC systems.A Merely variable fabrication costs are included in stock list in VC, whereas all fabrication costs, whether variable or fixed, are included in stock list in AC ( Nurre, 2010 ) .

2.4. Comparison of Absorption Costing and ABC

Use of AC frequently leads to misstatement of merchandise costs because of its simplistic cost assignment procedure, which is based on apparent steps like direct stuff, labour monetary values or units, or machine hours. ABC nevertheless attempts to closely look into cost behavior in order to enable the development of precise merchandise costs ( Agui, 2009 ) .

ABC systems emphasise on the costs of complex production activities, compared to conventional AC systems. Its usage enables costs of complexness to be separated out with merchandise line costs being mapped straight to merchandises. This leaves lesser operating expenses to be assigned utilizing labour hours ( Agui, 2009 ) . ABC helps in better apprehension of hard currency flows, with more costs being straight traced to merchandises. Its usage facilitates production of precise product-line or merchandise costs, thereby correlating costs to existent production. ABC besides aids certain concerns to better grok their activity flows ( Agui, 2009 ) . ABC nevertheless requires finding of relevant cost drivers, which can be manipulated every bit much as conventional overhead allotment systems by smart directors ( Agui, 2009 ) .

2.5. ABC and Modern Business environment

Management Accountants, until the early 1990s, depended on established cost accounting methods to present information on merchandise and service costs. Traditional cost accounting systems were nevertheless felt to be unequal for the turning complexness of modern twenty-four hours concerns, because of their instead arithmetical simpleness, and apt to supply misdirecting information ( Zeisel, 1997 ) .

Most administrations paradoxically continue to utilize unequal bing systems, because of their demand for bing information and their limited pick of available systems ( Geri & A ; Ronen, 2005 ) . They need bing systems for decentralization and control of decision-making, fiscal coverage, monetary value justification, and public presentation measuring. Most houses cleaving to their established systems because of the complexness of ABC systems and the greater attempt required for presenting improved results, ( Geri & A ; Ronen, 2005 ) . ABC nevertheless recognises that the bulk of fabrication costs in modern concerns are established by a figure of activities and that effectual cost control depends upon optimizing the effectivity of these activities ( Moral-Basco, 2010 ) .A

2.6. Recent History of ABC Implementation

Many big houses confronting stiff planetary competition have acknowledged the insufficiency of traditional volume-based bing systems in trappings of dependable cost information and are now implementing ABC to develop their costing cognition. Whilst ABC is now being implemented in many big administrations, there are few studies of smaller houses following its use ( Narcyz, 2003 ) .

The bulk of surveies that have tackled the effectivity of ABC have focussed on designation of factors that influence effectivity of ABC systems. One such survey found ABC relevant for finding of competitory schemes, public presentation rating and compensation, and non-accounting ownership ( Malmi, 1997 ) . It has been suggested that cardinal jobs associated with ABC execution relate to famine of sufficient internal resources, particularly computing machine resources and forces clip ( Malmi, 1997 ) .

2.7. Service Industry and ABC

Service administrations are different from fabrication concerns because of their greater engagement of labor in their operations. Most labour costs can be straight traced to organizational service end products. The balance costs are typically charged to distinct overhead cost pools, which are so assigned to peculiar battles, by and large on the footing of a per centum of direct labor cost ( Pirrong, 1993 ) .

Such charging of overheads misrepresent overall battle costs, if dissimilar types of occupations lead to incurring of costs that are disproportional to direct labor costs incurred, or to measure of hours worked. Administrations will mensurate public presentation falsely if accounting systems indiscriminately assign costs to occupations, alternatively of delegating costs that reveal true inputs ( Pirrong, 1993 ) .

Service administrations by and large do non use cost driver techniques for cost measuring and assignment. They can nevertheless roll up costs of assorted maps and delegate them on the footing of activities, or cost drivers, which cause costs to change ( Pirrong, 1993 ) . Such steps can take to better appraisal of costs of diverse classs of provided services, better the rating of past public presentation and do cost anticipations for possible battles more meaningful ( Pirrong, 1993 ) .

2.8. Problems in implementing ABC

Administrations implementing ABC spend significant money, clip and attempt in roll uping and analyzing informations. Too much of item can thwart directors engaged in ABC execution. Lack of item can conversely ensue in unequal informations. ABC initiatives besides fail because of the deficiency of organizational application on working on results provided by generated informations. This mostly occurs in administrations that were in the first topographic point averse to debut of ABC ( Cokins, 2000 ) .

Cokins ( 2000 ) states that the use of mean cost rates, the use of overly elaborate information, and the failure to correlate information to public presentation can besides blockade ABC undertakings. ABC execution is limited by high package costs. Time can be another confining factor for administrations seeking speedy solutions. It is observed that whilst some administrations get consequences from ABC fleetly, others typically take around one one-fourth to see its paybacks. This clip frame could nevertheless, depending on the merchandise or concern rhythm, be much longer ( Proctor, 2009 ) .

2.9. Drumhead

The foregoing literature reappraisal suggests that ABC systems have many advantages over traditional systems. However, some jobs, chiefly of complexness and of economic sciences of execution, have limited its usage by administrations.

Research Methodology and Framework

3.1. Conceptualization

Research methodological analysiss for surveies in finance research demand to be formulated after contemplation on the character of research, as besides on the wherewithal and substructure available with research workers ( Laurel & A ; Lunenfeld, 2003 ) .

The Case survey methodological analysis is a valuable model for research and is suited for survey of application of fiscal issues to houses. It helps in obtaining holistic perceptual experiences of complex issues and facilitates combination of secondary survey with primary research ( Tellis, 1997 ) .

3.2. Research Problem

The literature reappraisal, read in concurrence with the purposes and aims of this study, leads to framing of the undermentioned research inquiries.

What are the advantages and disadvantages of ABC as compared to the other managerial/cost accounting techniques?

Are the modern-day cost accounting techniques more utile than the traditional techniques

3.3. Aims of Study

The major aims of this research are twofold, foremost to measure the advantages and disadvantages of ABC when compared with other cost accounting/management techniques and secondly to find whether modern-day cost accounting techniques being used by JKL Plc would be more utile than the conventional techniques.

3.4. Sample of Study

JKL Plc, the sample administration chosen for survey is utilising soaking up bing for its cost direction maps. It is utilizing variable/marginal costing for internal coverage along with annual/monthly budgets. JKL plc updates its monthly and one-year turn overing prognosiss to supervise and command costs and grosss and modify schemes for operations at each accounting location.

3.5. Methodology

Case study research helps in obtaining a holistic comprehension of the cultural systems of action. Whilst instance survey research is non considered to be trying research, it enables the obtaining of multiple positions of the topic under survey and is therefore really suited for subjective and interpretive research issues ( Tellis, 1997 ) .

A specific probe into the cost accounting systems of JKL Plc can therefore be really relevant for the accomplishment of the purposes and aims of this survey.

3.6. Cogency of Measuring Instrument

The unit of analysis is critical to the instance survey methodological analysis. Case surveies are inclined to be selective, foregrounding one or two issues which are indispensable in understanding the strategy being examined ( Tellis, 1997 ) .

Validity, in the instant instance, as JKL plc is representative of the cordial reception industry, which in bend is established and good known in UK. The industry is moreover evolving and contextual to the modern concern environment.

3.7. Data Presentation and Analysis Method

Data has been obtained through interviews and audiences with the staff of JKL plc. Information obtained has been cross verified through look intoing from different beginnings and analysed carefully in order to get at the undermentioned findings.

3.7.1. Existing Cost Accounting System of JKL Plc

JKL plc uses traditional cost accounting systems. The system of costing is basically based upon rules of soaking up costing, even as some usage is made of variable and fringy costing in internal studies. Budgetary control is done through preparation of budgets on the footing of historical figures, and supervising through half annual ratings.

Direct and overhead costs are segregated at the degree of engagement of costs. Indirect costs are absorbed into the cost of services. Allocation of indirect costs is made on the footing of direct labor costs.

Costing systems are based on rules of departmental accounting and reflect the fact that costs related to suites, nutrients and drinks, and other services are generated by sections. Approximately 75 % of the costs of the hotel are fixed. Whilst suites have fixed costs of 15 to 20 % compared to gross revenues, nutrients and drinks have both high fixed and variable costs. The house ‘s bing systems do non give much significance to rating of stocks. Cost planning and control is focused on cost Centres, as merchandises do non organize peculiar points of analysis.

3.7.2. Constraints of Present Cost Accounting Systems at JKL Plc

The present cost accounting system at the house has been go oning for many old ages and directors are familiar with its assorted dimensions. Whilst the system has sufficed in the past, directors now find the allotment of overhead costs on the footing of labor costs to be instead arbitrary. Sing the fact that operating expense costs are really significant, and in many instances more than direct costs, the present systems are ensuing in skewed and unrealistic cost presentations.

The current costing system is non foregrounding uneconomical outgo and processes that do non add value. It is besides hard for the hotel to present costing of supply ironss, procedures and value watercourses with the bing costing system.

The undermentioned indexs signal demand for fresh inputs in the costing system.

Directors do non look to swear the consequences of the costing system.

Marketing forces appear to be unhappy with calculating costs.

Some services appear to be unprofitable, even though they are priced at above market monetary values.

Additions of gross revenues of some merchandises are being accompanied by worsening net incomes.

3.7.3. Advantages of Introducing ABC Costing at JKL Plc

ABC systems can assist by supplying penetrations into different facet of organizational working. Separation of costs into activity pools and designation of cost drivers for each pool will assist in more accurate definition of degrees of different costs that will take topographic point.

ABC systems will supply more accurate costing of services and merchandises. The usage of such procedures will take to better apprehension of operating expenses. ABC can farther help in guaranting that the house can monetary value its goods competitively. This will assist in bettering fight. ABC systems will besides ease benchmarking and support mark cards and public presentation direction.

3.7.4. Disadvantages of ABC Costing for JKL Plc

Execution of ABC bing will affect incurring of some disbursals by the administration and important sum of attempt on the portion of the direction accounting section. Data aggregation will be more clip consuming. The administration could confront alteration opposition, particularly from executives who may non wish concealed waste to go seeable in the new coverage systems.

3.8. Drumhead

Use of the instance survey model has helped in measuring the advantages and disadvantages of ABC execution at JKL plc in relation to bing cost accounting and direction patterns.

Analysis of Datas

Research Question 1

What are the advantages and disadvantages of ABC, as compared to other managerial/cost accounting techniques?

The advantages of ABC prevarication in its focal point on activities that are related to competitory advantage ; their usage helps in doing nucleus activities more cost efficient. It is therefore superior both to MC, where merely portion of the costs are recovered at the variable cost degree, or AC, where merely the entire cost image is available for examination. ABC systems help stockholders to maximize their wealth by helping in turn uping and bettering activities that are considered to be of import for competitory ability.

ABC systems are complex, disputing and dearly-won to implement. Some costs like managerial wage are hard to delegate to activities. Such systems are non really relevant to individual merchandise fabrication companies.

Research Question 2

Are modern-day cost accounting techniques more utile than the traditional techniques?

Both traditional and modern-day cost accounting techniques have their virtues and demerits. Both can be utile, contextually and under peculiar fiscal and economic environments. Whilst AC provides a image of entire costs and MC helps in part analysis, the usage of ABC leads to better profitableness analysis of activities.

Whilst traditional systems have been used by administrations for many old ages and do hold some utilizations, the turning complexness of modern-day concern calls for more sophisticated analysis of costs and necessitates the usage of newer systems like ABC.

Competitive concern environments need analyses of administrations, concerns, net income and cost Centres, activities and maps. The usage of traditional systems, supported by modern-day techniques can be utile for these intents.

Discussion of Findingss

The survey involved elaborate scrutiny of secondary beginnings of information and an appraisal of the bing cost accounting systems of a medium sized concatenation of hotels. The findings of the survey confirm that whilst ABC systems provide of import penetrations into organizational working, their execution is happening instead easy and continues to be restricted to larger administrations.

It is really obvious that traditional methods of costing, whilst utile in certain facets and sufficient for little individual merchandise companies, are well unequal for larger administrations with different merchandise and service lines and legion procedures. The infliction of traditional bing techniques to such procedures leads to arbitrary determinations on allotment of costs that are non representative of the true state of affairs and can take to unrealistic cost images and incorrect concern and strategic determinations.

ABC systems, whilst slightly expensive and hard to put in provide utile penetrations into organizational working and by concentrating on cardinal countries help in bettering competitory advantage.

It is therefore indispensable that addition in complexness and size of concern should be accompanied by suited accent on modernization of bing and information systems. Failure to make so can good take to decrease of apprehension of operations, cut down competitory advantage and contradict the really ground of taking on complex and growing orientated concern schemes.

It is therefore imperative for administrations to present modern twenty-four hours bing systems like activity based costing, if they are serious about growing, enlargement and betterment of profitableness.


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