Advantages and Disadvantages of Activity Based Costing
The report highlights the growth of activity based costing over the years. Analysis of 2 different research projects is done in the project based on similarities, differences and research methodology of both the projects. There is high cost reduction pressure over the companies due to the existing of perfectly competitive market and competitive pricing which can be resolved through activity based costing. The advantages and disadvantages of activity based costing are discussed thoroughly in this project along with solutions for the removal of the later. Activity based costing is the process of allocation of indirect costs to different processes. The costs are directly allocated to the processes in the ratio of sales of the company making the technique relatively easy. This allocation is done based on a suitable cost driver. As per activity based costing method, the total cost is allocated to different activities which are further assigned to different cost centers based on nature of cost and finally distributed on cost driver’s basis which helps in dividing the costs and calculate per unit cost of any activity (Awasthi, Omrani, & Gerber, 2018). A relationship between activity and cost is always established under activity based costing such as electricity can be distributed based on machine hours and rent based on space occupied. It helps in allocating costs effectively and efficiently for optimum utilization of scarce resources available. The costs are generally divided under 3 different categories- the fixed costs, variable costs and semi variable costs.
There are many advantages of activity based costing which can be listed in the following manner:
1. This technique helps in detecting the nonproductive and inefficient repetitive activities which the company can remove by properly evaluating the same. This in turn will enable the company to perform its operations more efficiently and reduce the total costs involved in such operations (Boghossian, 2017). If the company finds outsourcing of these activities cheap, it can be an alternative option for achievement of the specified goals.
2. In case of manufacturing and service industry this technique helps in accurate pricing of the products by allocating the costs to the activities to which it belongs thus preventing allocation of lower costs to some products and higher costs for other products. This makes product wise profitability analysis of the company difficult for the management.
3. The company can estimate the manufacturing overheads that the company can reduce to increase the profitability by calculating the correct profit margins through activity based costing.
4. For different products of the company this method provides the standard key for correct costing along with time driven costing. Both these methods were formulated to provide correct and accurate cost allocation and the logic for each allocation.
Activity based costing techniques has many demerits involved in it which are very harmful for the organization. These demerits are as follows:
1. Under activity based costing the performance of the managers cannot be linked to its results because it may result in something which is drastically different from that which can be determined under traditional based costing. This difference or irregularity may lead to conflict between both the parties (Dan, 1995).
Discussion on the selected journals
2. This type of costing will lead to additional investment of funds and requires extra time since it is not a standardized process and not in line with the Generally Accepted Accounting Principles (GAAP). So there arises a need to prepare a separate cost report by the company which are prepared as per the guidelines of the Generally Accepted Accounting Principles (GAAP).
3. Due to the involvement of huge costs and expert knowledge required for the process of activity based costing this method is not very popular among the small companies as implementation of this process is very difficult for them. In these small companies the number of products is much less. So, the cost heads and cost base is also very low. Due to this the difference between the results as per traditional costing and ABC costing is not very high. So, implementation of ABC costing will not make any impact on the profitability of the company (Eddy, Filip,R, & Warlop, 2004).
4. If the data entered ABC costing is incorrect or inaccurate and proper time is not allotted for this method, ABC costing will remain useless for the company. Therefore, execution of this method involves correct data base, proper results and a lot of time.
5. A person must have in-depth knowledge of the nature of the company along with its methods of operations. He should be expert in costing terms such as the cost pools, cost drivers, allocation logic etc. for the execution of activity based costing in the organization. So, we can say that it is one of the most necessary conditions for implementation of the same.
In this assignment two journals have been selected that highlights the different aspects that are related to ABC costing. In this assignment few similarities and dissimilarities between the two journals and their specific outcomes has been discussed. The two journals that have been selected are The Measurement and Management of Unused Capacity in a Time Driven Activity Based Costing System” by Veii’s Naci Tanis and Hasan Özyapici (Naci & Hasan, 2012) and “The Value of Activity-Based Costing in Competitive Pricing Decisions” by Eddy Cardinals; Filip Roodhooft, and Warlop Luk. All the analysis conclusion and recommendations are based on the given journals for the company (Eddy, Filip,R, & Warlop, 2004).
The first journals highlight the importance of activity based costing for allocation of the cost especially in manufacturing industries and that is driven by various factors. But when activity based costing cannot be applied or it fails than the companies opt for more advanced technique of costing that is known as the Time driven activity based costing which is said to be the best ways for the allocation of the given cost for the companies. This has been discussed in the second journal article that has been selected.
The first case study aims to determine the importance of ABC Costing techniques in manufacturing industries. It states how ABC Costing can be used to determine the prices when there is no proper information available to the companies. There is a lot of competition in the market also it can be seen that the pricing of the products become difficult because no proper information is available in the market (mejia, Tosi, & Hinkin, 2017). In cases where traditional method of costing is used the prices that are calculated based on that are almost wrong and not accurate and hence companies need such techniques which can overcomes these challenges. The pricing methods and the base data when coupled with the market feedback gave the correct information only when there was no direct competition between the two. During this period the ABC costing was analyzed and it was found there were two assumptions that were considered which included that the ABC Costing gave more accurate results when the information from the market was more informative and less uninformative and the second assumption was that the outcomes from ABC costing was more better than traditional costing methods when the data was more informative (Werner, 2017).
Analysis and Explanation of the Journal articles
To test this a test was conducted where 131 management graduates and costing students where asked to allocate cost based on the techniques of ABC Costing and traditional costing. From the results that were accumulated it was found that there was minimum relationship between the market conditions and the pricing decisions and it was found that in competitive market conditions the companies have limited information about their competitors and hence it was not a driving force that entities need to recon with and thus the second assumption was not correct.
The following research questions can be stated?
- How is ABC Costing method better than the traditional system of costing and what are the areas in which they need to improve based on that?
- How are the market information plays an important role in pricing decisions of company and if they hold significance in the advanced form of costing?
The second journal article states how companies can overcome the limitations that are there in case of activity based costing and where they can make effective use of their unutilized capacities so that there is better efficiency and effectiveness in operations. The answer to such kind of scenario is time driven activity based costing (Sithole, Chandler, Abeysekera, & Paas, 2017). Most of the companies are working 24hrs in day and thus it gets very difficult to judge the unused capacities for the companies so to solve this problem there are two types of capacities that are known as compulsory and real unused capacities. In this paper the author aims to show how the inefficiency in ABC costing can be reduced if it is adopted based on the time driven capacity technique. In this case the employees are allocated to the productive areas based on shift rather than on unused capacities. Also, there are other drawbacks in case of ABC costing like the selection of the cost drivers for every department and that was very difficult as not all companies were having same drivers and this process was different for different companies and so we see that there was no level of uniformity that should have been there (Meroño-Cerdán, Lopez-Nicolas, & Molina-Castillo, 2017).
Time driven activity based costing can be descried as a better version of the ABC Costing where the management need to aware of the total resources they might need to complete a given activity for the company. There are two parameters in this type of costing which are the cost per unit of the resources and the number of resources that might be required by each activity. It helps in giving better results that are based more on logic and are somewhat accurate (Covaleski, Evans, Luft, & Shields, 2003). The companies can conduct surveys within the organizations to understand what are the specific requirements of the units are for each activity and this can be done by asking the employees who work on such activity.
The research questions that can be proposed from this kind of study are-
- How is time driven activity based costing better than the activity based costing and what are the parameters based on which the companies should judge the effectiveness of the both?
- How can companies adopt time driven activity based costing in their operations and what are the factors that they need to keep in mind?
Thus, we see that both the articles are based on the different aspects of activity based costing and speaks about ways companies can improve the drawbacks from the traditional costing and get the most accurate results when it comes to cost allocation and pricing decisions. A few similarities and dissimilarities between the two articles have been stated below for analysis (Grundy, Held, & Bero, 2017).
Purpose of the Selected Journals and the Proposed research questions
There were many similarities between the two case studies out of which some are stated below:
- Both the articles highlight the need for better costing techniques so that companies can make better allocation of the cost and the overall pricing decision of the company is also accurate. They tend to sort the various problems that companies might have with respect to allocation of cost and how they can find the correct cost drivers and that can help them in better allocation of the bases. Both the theories helped in making the overall pricing more accurate and reduced the stress over the competitive market in general.
- Both the articles are highlighting the needs for better time management and cost management for the companies. In case of traditional system of costing there were lot of issues present in the ways the management used to allocate the cost and thus better techniques like ABC was developed and now it can be seen that ABC is having its share of disadvantages and to overcome that the TDABC was developed by the company so we see that change and updating is happening every now and then and companies need to be sure on how they are allocating and adapting it (Jefferson, 2017).
Major dissimilarities between the two articles –
- The first article talks about the importance and the parameters that can be associated with activity based costing and the drawbacks of the traditional system of costing is highlighted. It reflects lights on the important parameters that important for better allocation of cost as per the ABC Costing method. The second article highlights the drawback of the ABC costing and state ways on how companies can improve their position and adopt better costing techniques like the Tome Driven Activity based costing that has all the important elements that ABC lacks and that which can help in better allocation of cost in all ways (Kusolpalalert, 2018).
- The first article is based on the concept of selection of appropriate measures that can help in better cost allocation, it aims to highlights the issues that are associated with selection of a proper cost driver. On the other hand, in case of the second article it highlights the need of better time management rather than better resource allocation so that the unutilized capacities cannot be left vacant and are used and thus help in improving the overall efficiency of the process.
Both the studies have their share of advantages and disadvantages and it depends on the management of the company on how they utilize the same for their benefit.
Specific Outcomes from the research articles.
- The first research article highlights the importance of activity based costing and the importance of proper resource allocation and cost base without which there might be chances that the results of pricing decisions are not accurate. It also highlights how activity based costing can be better than traditional system of costing and it also encourages managers to follow such type of costing technique which is far more efficient.
- The second outcomes from the first article can be stated as that it establishes the fact that market information is very limited and thus in perfectly competitive scenarios it won’t be possible for the companies to get correct information about their competitors, hence in that case we see that cost allocation based on cost drivers is a better way. It can also be seen that when traditional system of pricing is used it is often possible that the prices are not correct or optimal and hence the need arises that optimal pricing techniques should be used so that the revenue is not hampered and that is possible only in the case of ABC method (Egelund-Mu¨ller, Elsman, Henglein, & Ross, 2017).
The analysis of the second research paper lead to the following outcomes and learnings
1. The shifting of manpower to different productive areas and effective utilisation of minimum resources was the main focus of this second research paper. It focuses on the need of effective utilisation of capacity by better allocation of resources by making the employees work on shift basis.The defects of the traditional based costing and the volume based cost allocation methods is removed through the concept of activity based costing which helps the companies to identify the possible output by determining the practical and effective capacity of the machines.
3. The inefficient processes and activities of the company is also highlighted through this research paper along with the methods by use of which the company will be able to remove them resulting in the increase in overall efficiency of the operations of the company.With respect to the allocation keys, activity based costing leads to a standardisation of the companies by the refinement of the traditional costing system. Through this the comparability of data increases. Thus through this technique estimation and forecast of the future becomes very easy for the company.
Conclusion
Based on the overall analysis it can be said that both the articles have highlighted the need for good costing technique very properly, along with major focus on areas like better resource allocation, cost budgeting, allocation based on other factors like the capacity available, the market information that is available. In all cases the primary aim of the management is to make sure that their pricing policy is correct in par with the market trends and their overall profit is not affected because of that. So we see that there are many costing techniques and methods and it entirely depends on the companies which method they want to apply but proper analysis should be done and based on the overall requirement of the company, the process should be selected and proper disclosure also should be given.
References
Awasthi, A., Omrani, H., & Gerber, P. (2018). Investigating ideal-solution based multicriteria decision making techniques for sustainability evaluation of urban mobility projects. Transportation Research Part A: Policy and Practice, 116(2), 247-259.
Boghossian, P. (2017). The Socratic method, defeasibility, and doxastic responsibility. Educational Philosophy and Theory, 50(3), 244-253.
Covaleski, M., Evans, J., Luft, J., & Shields, M. (2003). Budegting Research Three Theoretical Prespectives and Criteria for selective Integration. Journal of Management Accounting Research, 15(3), 3-49.
Dan, S. (1995). The benefits of activity-based cost management to the manufacturing industry. Journal of Management Accounting Research, 7, 167.
Eddy, C., Filip,R, & Warlop, L. (2004). The Value of Activity-Based Costing in Competitive Pricing Decisions. Journal of Management Accounting Research, 16, 133-148.
Egelund-Mu¨ller, B., Elsman, M., Henglein, F., & Ross, O. (2017). Automated Execution of Financial Contracts on Blockchains. Bus Inf Syst Eng, 59(6), 457-467.
Grundy, Q., Held, F., & Bero, L. (2017). A Social Network Analysis of the Financial Links Backing Health and Fitness Apps. American Journal of Public Health.
Jefferson, M. (2017). Energy, Complexity and Wealth Maximization, R. Ayres. Springer, Switzerland . Technological Forecasting and Social Change, 353-354.
Kusolpalalert, A. (2018). The relationships of financial assets in financial markets during recovery period and financial crisis. AU Journal of Management, 11(1).
mejia, L., Tosi, H., & Hinkin, T. (2017). Managerial Control, Performance, and Executive Compensation. Academy of Management Journa, 30(1).
Meroño-Cerdán, A., Lopez-Nicolas, C., & Molina-Castillo, F. (2017). Risk aversion, innovation and performance in family firms. Economics of Innovation and new technology, 1-15.
Naci, T., & Hasan, O. (2012). The Measurement and Management of Unused Capacity in a Time Driven Activity Based Costing System. Journal of Applied Management Accounting Research, 10(2), 43-55.
Sithole, S., Chandler, P., Abeysekera, I., & Paas, F. (2017). Benefits of guided self-management of attention on learning accounting. Journal of Educational Psychology, 109(2), 220. Retrieved from https://psycnet.apa.org/buy/2016-21263-001
Werner, M. (2017). Financial process mining – Accounting data structure dependent control flow inference. International Journal of Accounting Information Systems, 25(1), 57-80.
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