Research-Based Articles on Activity Based Accounting
Activity-based costing technique developed in the 20th century. Before ABC costing, the tradition costing technique was used for the allocation and management of the cost of products and services. ABC has been found to be successful for many types of firm and providing firms with efficient management of resources and cost management. This report seeks to discuss the activity-based costing as management accounting topic. The report will take two research-based articles on activity-based costing and will discuss the purpose, similarities, differences, and lessons learned from two studies for Companies in Australia.
Activity-based costing is completely different from the traditional costing approach. Traditional costing method was leading to miscalculations and was giving more importance to the pricing and volume of product than to the activities. In order to fill the gaps and preventing of wrong costing and pricing the new model of costing introduced as an activity-based costing. ABC is the process of management accounting which distributes the cost to goods based on their activities. Activity-based costing measures the cost of not only the products but also of the activities involved in the production of products (Schulze, et. al., 2012). It measures the cost drivers and works on one idea which is the creation of cost due to activities. This model also works on the idea that product use activities in order to gain value added. The first step of ABC costing is to recognize the activities which are leading to overhead cost, and then find the group activities which involve the same cost drivers and finally assign the total cost overhead cost to each product and service by computing the cost of the pool at absorption rate. ABC basically uses cost driver in allotment of cost under which cost driver is same as traditional costing.
It is significant to organize a firm on the basis of activities, not on the functions or products. ABC is the group of actions which add value to product and service and generate cost and consumption of resources. It can also be said as a costing system where the focus is made on the activities individually as the objects of cost (Cannavacciuolo, et. al., 2015). The activities include designing of products, setting machines, distribution of products and operating machines. There has been an increase in the adoption and implementation of ABC.
In the US, UK, and France there is an increase in the extent of implementation of the ABC system. In the US the adoption rate is increased from 11 in the year 1993 to 52% in the year 2003. In the UK, the rate of adoption increased from 6% in the year 1991 to 23% in the year 2001. In France, the adoption rate increased from 15.9% in the year 2002 to 33.3% in the year 2008. ABC method is also implemented in many developing countries. Further, the rate of adoption is higher in Asia than in Africa (Charaf and Bescos, 2013). In the year 2007, the rate was 36% in Malaysia and 35% in Thailand. The rate is only 24% in Tunisia. The use of ABC costing has been found to be effective in profitability competitiveness and value of shareholder as per the manufacturers of US.
The process of Activity Based Costing
The process of activity-based costing involves three phases. The first phase involves the determination of activities which is performing by classification of goods and services. The second phase involves the determination of cost drivers which develop metrics utilize for the allocation of cost to the goods and services provided. The third phase is allocating of cost based on the rate of the product, services to consumer activities. Resources level is determined by the cost drivers. Batch costing also failed in the allocation of overhead cost as batch produces volume based production and where unit size and volume are significant. The process of ABC involves the unit going via more activities and more overhead costs. This results in avoidance of miscalculation which is there in traditional costing (Askarany, et. al., 2010). Activity drivers provide the most feasible allotment of the product and service because drivers are dissimilar to the characteristics of production.
Advantages and disadvantages of Activity-based costing
Apart from any other costing method, activity-based costing method is considered as excellent for many business needs. The method is more convenient for many industries and also accepted at a great level. The method has been found to be more useful for the entrepreneurs in services industries (Drury, 2013). The traditional method of cost has been given up due to the non-generation of non-financial information, production of inaccurate cost information, lacking in better distribution of overhead cost and was acting as a barrier to the improvement in the operations of the business.
In overall activity-based costing are providing the following major advantages which are here discussed below:-
- Enhancement in the cost of the product, helping in making the better decision which is also improving performance measurement.
- More reliable and accurate information is available for the cost.
- There is an enhancement in the reduction of cost.
- The process of activity-based costing gives realistic view by detecting and elimination of waste.
- The model is also helpful in recognition of non-value adding activities.
- ABC is also assisting in making effective targets for reducing cost.
- A detailed framework is available for analysis of cost variances.
- The method is applicable to the cost objects other than the products.
- It is also used for the improvement of accounting measured.
- The method is also helpful in capture cost horizontally and in relation to the process of business (Heath, et. al., 2012).
- Better awareness is created for an accountant to service work and also for better visibility in case of cost arrival.
- “What if” is also facilitated to business with the use of this method.
Apart from the advantages researchers also revealed some disadvantaged activity-based costing as every costing method may have benefits and disadvantaged naturally. Some of the Shortcoming in the utilization of method is here presented below:-
- The implementation of activity-based costing is complex.
- The method requires a change on the part of employee and management. There is resistance in adopting the method.
- Detailed technical skills and installation of equipment are also one of the needs of this approach.
- Activities sometimes become difficult to be identified.
- The system is also found to be more feasible for high overhead Companies.
- A high investment is required for this system.
- There is difficulty in collection of data.
Working of ABC
The first step of ABC is acknowledged and identifies resources which are used in activities such as labour cost, material, and equipment. If the activity is to measure the meter then it requires the labour (includes salary and fringe benefits) for the reading meter. The equipment will include depreciation, lease, and any reading devices. Materials will include expendable items and cost of vehicle fuel (Nassar, et. al., 2013). After the true cost of goods and services identification, the ascertainment of consumption is made which are collectively used for generation of products. In other words, it is tracing or assignment of cost and based on the deriving of activities such as customer request, work order and purchase order and complaints. Once the cost of production is determined the management to enhance the process and attain the effective performance. It also improves quality and reduces cost. As better, faster and cheaper the output of the firm there is high efficiency and effectiveness in operations.
Hence, the management accounting leads the firm not to place focus on the type of cost and classic financial accounting instead of focusing on actual activities including expansion of dollar. Management is able to clearly track the dollars going in the supply chain and making the process of supply more efficient.
Purpose of two studies
The purpose of one study is to create a relationship of activity-based costing with the strategy of business and performance in Moroccan enterprises. The purpose of another study is to provide importance of activity based accounting and costing for giving a true measure of services and goods and assist in supporting target business and requirement of improvement. The two studies have provided the advantages of using the activity-based costing (Elhamma and Zhang, 2013). Both the studies have initiated the journal with defining of activity-based costing and how it has taken a new shape in business.
The first study has set out with following research questions:-
The study aims to analyse the results of research done on the enterprises of Morocco. The following questions are presented below:-
- What is the adoption rate of activity-based costing in Morocco?
- How is the strategy of the business impacted by the use of the ABC method?
- What is the effect of the ABC method on the global performance in accordance with the strategy of business?
The paper is segregated into three sections including the definition of ABC, adoption rate of ion number of countries and the conclusion on basis of the study.
The second study has the following research question which is here presented below:-
- To look out the ways of implementation of ABC in a different industry.
- To analyse the capability of industry in the adoption of Activity-based costing.
- To apply Activity-based costing in a different industry.
- To evaluate the working of ABC.
- To evaluate how performance and output are measured with the application of activity-based costing and recommendation of business model approach.
Similarities and differences in the findings of two studies
The article by Eggers and Bangert (1998) have emphasized today’s environment of business. As per the article, there has been immense pressure on the business to breed to survive in the competitive environment. Business has to provide the products and services at a lowest possible price and thus the ABC approach has been effective in managing the cost. The study of Elhamma has revealed the strength of activity based on accounting on the weakness of the traditional costing system. Further study of Eggers and Bangert and Elhamma expressed the ABC costing method as a management accounting system which is used for assessment of cost, the performance of activities as well as cost in relation to other objects. Both studies also provided the definition of ABC costing as the assignment of cost on the basis of resources and allocate the cost objects.
Elhamma and Zhang, (2013) also stated that ABC costing is also helpful in avoiding the shortcomings with respect to conventional cost system with the aim of dealing with overhead cost. Eggers and Bangert supported Elhamma by providing importance of ABC costing by stating the model to be a contemporary management tool which is integrating measurement of cost, performance and process activities.
The article by Eggers and Bangert, (1998), has started with some different opinion such as searching for efficiency which is required for the water supply industry. Water supply industry is required to respond to the current business environment and for that, the study has used activity-based costing to measure the gain from implementing of the model. Eggers and Bangert convinced by stating the importance of free market and better achievement for water industry with the use of management accounting techniques. It also took the example of sitcom start trumpeting Company for finding a solution in selling long distance services of the telephone. The water industry is required to have more drivers for enhancing cost-effectiveness and many utilities in order to facilitate in-house reduction of cost and outsourcing of public and private sector. The municipal government and private sectors are feeling extreme pressure due to budget and rates are continuously rising for regulatory compliance, repairing of infrastructure and
The article on Elhamma and Zhang, (2013), has focused on manufacturing firms and emphasis on the importance of having more accurate costing information. Manufacturing firms are required to take an effective decision as per the manufacturing environment. ABC is an economic model and methodological which assess the cost and performance of activities, assign of resources and developing of the casual relationship of cost drivers of activities. The article surveyed implementation of ABC in many developed countries and as per the survey; the US companies are becoming more popular in using the ABC model. This includes the US Fortune 1000 companies. In the UK the first implementation was made by the Innes and Mitchell. In Ireland ABC model is used to 27%.
The article also discussed the relationship of the strategy of business with the ABC model. The best way to organize should depend on the nature and requirement of the organization. A correct match should be there with the contingent factors and premises of the control package as per the desired outcomes. Business can maximize its performance by working on the low cost of production in industry and by creating a difference in the goods and services provided. There are many management accounting practices which are found in providing benefits in relation to the in the form of differentiation of products and low-cost strategies. The different managerial minds have set underlying differentiation for bringing low cost and influence the preferences in case of any particular practice of management.
The article of Elhamma and Zhang, (2013) argued some points of activity-based costing to be unclear and still requires an understanding of the diffusion process for innovations in contexts. Despite the popularity, the survey in the article clearly demonstrated the less impact of the ABC model on the firm. The article applied two methodological with modest sample size and perpetual approach in the collection of data. The surveyed has shown less impact of ABC mode but a high interest of the firm in using model. It has also recognized the strategies from the survey and finds the answer of a method for calculation of cost. These methods are the full cost method, partial costs, informal method, and activity-based costing. The surveyed has been performed with a perceptual approach for examining the response and contribution of activity-based costing. The author of this article also believes that the adoption of activity-based costing will lead to the replacement of direct costing and also highlighted the cautiousness in use of ABC as companies in the UK said that the method could not confirm the relationship of performance and ABC.
The article of Eggers and Bangert (1998) took the example of auto parts manufacturer named Dana Corporation which installed activity-based costing in Plymouth and believes that ABC is capable of tracking dollars in ongoing supply chain process and takes immediate action in the process more efficient. The methodology of ABC aims to create great efficiency by identification of components of activities and resources in terms of dollars. Management only requires shifting the process cantered with the implementation of activity-based costing. ABC model will also water industry to perform typical activities and ensure better in-house performance. There will be an improvement in the perception of the customer regarding the cost, quality, the process of leaner with better results and more economically.
Lessons for Australian Companies
For the restructuring process, there can be the use of activity-based costing to become more competitive and provide excellent customer service. A number of US industries have undergone a number of transformations which includes airline; gas utility industries and long distance telephone are commonly using the ABC model. Management accountant can identify the cost and numerous activities performance to make it core business process and to assist the business in using management tools such as benchmarking, total quality management, continuous process improvement and business process reengineering effectively.
Activity-based costing provides information on the previously available information. Hence this information can be very useful for the purpose of management accounting and to give a better presentation of management reports (Fei, and Isa, 2010). The process cost can be identifying very effectively and hence the management accountant will be able to develop comprehensive reports. Process owners will be responsible for process cost and also shift the focus of the organization to value productivity.
Management accountant can name the activities which are including core business processes. With the help of activity-based costing the measurement of process activities, cost and performance will become easy. The method will also measure the cost and performance related activities with applying to the services and cost objectives. Management accounting can warn the Company about the activities which require significant attention. This will be helpful in reducing cost, enhancement of quality and services performed.
In the case of the water industry, the water utility can be modelled and distribution department and activities can be distributed including labour, materials, and equipment. Department’s activities will consist of picking of material, installation of materials and travel to the job site. Manager and supervisor can organize and install materials with components of work elements which are consuming resources of departments (Eggers and Bangert, 1998). Management accountant can organize activities with the aim of finding meter setting and main extension. The end result of ABC is ending of product and combination of known for the cost. Once the activities and the costs are known then groundwork is a place for management to modify the activities into the effective process of production.
Today’s business environment requires every business to have effective management accounting techniques for a better decision. There is required to have transparency in the distribution of cost. The above study has provided with tremendous advantages of using activity-based costing and performed analysis on two articles. The one article has put light on the need of water industry which is in need of enhancing efficiency and gets counterparts within private sectors. ABC has been proven management accounting tool for better decision and offering of true measurement of goods and services. The model is also found useful in reducing in the areas which are not useful or important for business.
The second article presented the performance of ABC model in many firms and especially Moroccan enterprises. The article also made efforts in connecting the strategies of business with the activity-based costing. The article represented the importance of considering the structure of the organization, environment needs and use of non-organizational approached which includes leadership styles, the culture of leadership and legal ownership etc.