Importance of ABC in improving organization management
Despite the facilitating and the motivating aspects in external setting, implementation of the new management accounting approaches is disappointing. Besides, accounting remains as the chief source of the management information. Nonetheless, management accounting data, driven by cycles and procedures of entity’s financial reporting, it too aggregated, too distorted and tool later to be significant for the managerial control and planning decision. This is due to the notion that the traditional costing approach focused mostly on management of costs through cost-based budgets, variances and standards, established at unit or departmental level. In this system most of volume-sensitive drivers of costs are mostly attached to overhead costs. Such tool underestimates costs of services or products of misleading measures, therefore, leading to faulty decision. Therefore, there is need to focus on activities costs and processes as the performance measure for quality results. This calls for continuous improvement in management activities through the new management accounting techniques. The report aims to examine activity-based costing and the motive behinds its implementation. To accomplish this, two studies were selected; that is, a study by Ping, Li and Yau (2003) and a study by Mojdeh, Tavakolizade and Habibi (2012) on application of ABC in manufacturing firms. The studies are aimed at assisting the researcher gain detailed understanding of ABC and its impacts on a real example. Basically, through the studies, the researcher is now able to understand what ABC is all about and its importance in improvement of organization management.
Rather than using single cost pool as well as allocation of base, ABC disaggregates the overhead input costs in a series of the cost pools and numerous allocation bases (Diavastis, Anagnostopoulou, Drogalas, & Karagiorgos 2016). This is mostly aimed at selecting the cost pool such that all overhead inputs in a cost pool are generally consumed by products utilizing that particular cost pool in same manner. Basically, the chief purpose of ABC is provision of accurate and fair cost allotment and thus product profitability assessment. It focuses on the indirect costs. In this case, it aims at defining the most accurate means for the indirect costs allotment to the cost objects (Morgan 1993). Besides, ABC is considered as the most significant innovation in the managerial accounting and cost calculation. It offers more precise and accurate viewpoint of the product cost; allocation bases utilized in the ABC system vary from those utilized in the traditional costing (Yang & Chang 2018).
How ABC works
ABC determined each and every activity linked with production of items and allocates the costs to their respective activities (Mojdeh, Tavakolizade & Habibi 2012). Cost assigned to activities is later assigned to the products which call for activity for the production as indicated in Figure 1 below.
Figure 1: steps on activity-based costing
Furthermore, ABC is the accounting approach that assigns all manufacturing expenses to the products in more logical means compared to traditional technique of just allotting costs based on machine hours (Broad & Crowther 2001). It first of all allocates some charges to their respective activities which are considered as actual cause of manufacturing overheads. Then it allots charges of the events to product which are in need of those actions (Mojdeh, Tavakolizade & Habibi 2012). It originated from the need of manufacturing or production with one of its main purpose being to produce theoretically sound costing model of an organization’s marginal economic cost function.
It most prominent character was treatment of the greater proportion of the manufacturing overhead as variable that transformed approach to cost management based on the notion that costs could be separated and aggregated again without any alteration to the entire cost information given (Broad & Crowther 2001). Therefore, ABC has been highly accepted by different firms upon assumption that it more precise identification of the costs via this system makes the firms more manageable.
According to Arora and Raju (2017), ABC is considered as a new means of thinking that offers clear and precise cause-effect relations amongst the activities, resources requirements and cost objectives, thereby assisting the firm in reducing any shortcoming of the cost attribution alteration and the accounting professional tends to mistake the product cost calculation. In another study, ABC is considered to pursue real costs (Nassar, Husam, Sangster & Mah’d 2013). Its main function is to manage the product profit margin of the individual clients and in estimating costs of same new products as the references for quoting decisions and pricing of top management.
Though ABC has been in existence since later nineteenth century, scholars have different views on the system. For instance, Yang and Chang (2018) considered that ABC could like activities of numerous segments and offer activities details in identifying entire costing information. Further, Broad and Crowther (2001) highlighted that execution of ABC has a number of benefits for organizations like performance assessment of its segments in like with cost difference, cost and resource estimation, product profitability evaluation, decision for allotment of the internal service recipient and internal recipients, as well as high-level competitive evaluation. It can more accurately and precisely compute product costs, improves effectiveness of the organization performance as well as lessen waste (Mojdeh, Tavakolizade & Habibi 2012). ABC assists entities to accomplish effective activities flow, strategic operation flow as well as cost-competitiveness.
Impacts of ABC in real-life examples
ABC has been considered as the most sophisticated and innovative management accounting tool. Given that in manufacturing sector, organizations face complex setting and more uncertainties, use of ABC is crucial since it result in cost reduction, financial benefits as well as full control of their current performance (Ping, Li & Yau 2003). ABC leads to more valuable tool in making management decision since it produces more accurate, relevant and detailed information. With adoption of ABC, organizations are able to lessen costs incurred during production without providing poor quality and making extensive utilization of the cost information for the performance valuation, management practices and pricing decisions. It could force organizations to achieve competitive advantage as well as increased efficiency in the operational and strategic decision that in turn results in improved financial performance and profitability.
ABC delivers the most desired outcome in an efficient and effective manner. It provide framework for the organizations to understand causal link in between the output services and input resources and building a founding useful for linking the output with the desired results as indicated in Figure 2 below.
Figure 2: causal link in between the output services in ABC
“Application of Activity Based Costing (ABC): The case of a non-government organization” by Ping, Li and Yau (2003) is an internal management accounting journal evaluating application of the ABC in one of the non-government organization in China. With government emphasizing on the output control, and the cost-effectiveness and accountability in provision of the services, the paper purposed to analyse application of ABC in the NGOs in measuring their activities, linking their outputs with the inputs, as well as facilitating accomplishment of their objectives. In essence, the study purpose to examine how ABC could be applied in one of the NGO operating in the Hong Kong SAR while determining the service and activity costs, analysing service and activity performance as well as assessing linkages in between the outputs and inputs. To accomplish this purpose, the research question that was used to guide the study was; how can ABC be applied in an NGO within Hong Kong SAR to determine service costs and activity as well as in analysing service and activity performance?
“A Study on Application of Activity Based Costing in Khootka Food Industry” by Mojdeh, Tavakolizade and Habibi (2012) on the other hand is an international journal of the management evaluating application of the ABC in the Khootka Food Industry. The purpose of the study was to evaluate application of the ABC in the Khootka Company. With a notion that ABC assists organization have some insights on proper allocation and costing technique, the study purpose to examine experiences of the ABC users in the food as well as Beverage sector in the Komaj Saba Food Industry operating in Iran. To accomplish this, a research question for the study was; what is the comparison of effects of ABC in cost allotment and cost products?
Benefits of ABC for organizations
In a study by Ping, Li and Yau (2003) it was revealed that ABC is applicable to NGOs and helps in determining activity as well as service costs, measuring link in between outputs and inputs and analysing service and activity performance. In the study it was also established that ABC provides not just better or accurate cost control but also increasingly offers result control for different organization and in particular to NGOs. It was also found out that with implementation of ABC, NGOs management are able to identify bottleneck events and are also to further speed up cost control process. In the study, ABC was found to assist in answering some of the management accounting questions within an organization such as was resources allocation meeting organization objectives? Two, how effective was an organization in delivering output services. ABC is also found to offer clues on doing better and more with less and is found to assist organization management to control, manage and place their operations.
On the other hand, in a study by Mojdeh, Tavakolizade and Habibi (2012) it was revealed that through implementation of ABC, organizations could benefits through improved or effective production, and better input/output management. It was also found out that ABC instils some insights to the company management on its proper resource allocation and cost control. Besides, through ABC organization could accomplish effective cost control and its management could turn to be more economical which would in turn benefit the firm by providing proper products which are reasonably priced. It was also found out that ABC offers information on cost centres where product-related expenses are usually traced to. The system is found to utilize the activity-driver amount in transmitting the component’s usage on equipment costs.
Based on the analysis of the two studies findings, it is evident that the studies were similar in some ways. For instance, the two studies agree that ABC has significant benefits to organization especially that it assists them in improving their production and enable them to better manage their input/output relationship. Further, both studies established that ABC offers not just better or accurate cost control but also progressively offers result control for different organization. Third, the two studies established that implementation of ABC helps organization management in identifying the bottleneck events and to further speed up their cost control process.
Despite these similarities, there were also some differences between the studies. One, the two studies differed on the methodology used in analysing the data collected. Besides, studies used different sample size; hence, generalizing that the result was the same would be a big mistake and erroneous since different sample size yield different results.
There are a number of outcomes or lessons that can be depicted from the two studies. One of the lessons learned from a study by Mojdeh, Tavakolizade and Habibi (2012) is that ABC is one of the most significant management accounting aspect in facilitating better cost control within an organization. With better implemented ABC, organizations are able to manage most of their operations accurate. In fact, with implementation of the ABC, an organization is able to check on the causal relations and in fact determine some of the products that are unproductive. This is a better measure of enhancing operation management. In essence, ABC provide framework for the organizations to understand causal link in between the output services and input resources and building a founding useful for linking the output with the desired results. Therefore, through such system, it is easier to manage operations of an organization more accurately and precisely. Such outcome is effective in the day to day operations of the companies and would therefore be influential to management accountants working in Australian firms. This is based on the fact that the lesson learned in the study would enable management accountants to implement ABC in their operations which in turn would enable them better manage the company in terms of costs and resource allocation during production.
The second outcome or lesson that can be depicted from this study is the fact that ABC helps in reducing the costs of the on compassing high expenses. In this sense, ABC enhances complete control over costs which is a crucial for any firm. Besides, under the ABC system, most of the volume-sensitive driver attached to the overhead charges as cost-effective modes of enhancing better match in between the revenues and costs. Besides, the ABC identifies the most relevant activities within the company and assigns different cost objects to relevant activities. By enhancing complete control over an organization costs as well as allocating cost to every respective activities, cost is reduced. Besides, ABC produces more accurate, relevant and detailed information. Hence, by adopting this system, organizations could be able to lessen costs incurred during production without providing poor quality and making extensive utilization of the cost information for the performance valuation, management practices and pricing decisions. This lesson is applicable to management accountants in Australia as they would try to use the concept gained under this study and try to put it into practices. In essence, through the above lesson, management accountant could be able to utilize the ABC system in their organization to reduce unnecessary costs being incurred in their operations as well as pointing out some of the most unprofitable products in their operations. This could in turn helps these professional to improve on their organization profitability and performance.
From a study by Ping, Li and Yau (2003) two main outcomes or lessons can be depicted. One, from the study, ABC is considered as the most efficient management accounting approach in NGOs especially in determining their service costs and activities as well as in analysing their activities and their service performance and in assessing link between their outputs and inputs. Though organization staff could easily point out some of the chief reasons of the costs and the manner of providing extra and even creative information, ABC add value to this perception as it helps employees improve the outcome through enforcement of their commitment. Basically, ABC assist the firm in reducing any shortcoming of the cost attribution alteration and the accounting professional tends to mistake the product cost calculation. This in turn plays a crucial part in determining costs of respective activities.
It was also learned that ABC is not necessarily ad-hoc systems by is a management approach which offers feedback uninterruptedly. Organization’s management is required to test any recommendations, try to strengthen some of the things that seems to work and unrestraint from the one that does not work in this era of swiftly changing economic and social environment. In essence, ABC supplies critical costing and activity costing to assist organization management in giving foundation for the informed decision, promoting accountability on how to manage output and activities, enabling efficient and effective utilization of the resources as well as encouraging responsiveness. The above lessons could be very important for the management accountants operating in Australia. This is based on the fact that they would now works hard to ensure that ABC systems in introduced like in every company within Australia. This would enhance easier and better cost control by the management and in turn reducing unproductive or unprofitable operations within the organization. Basically, by understanding what ABC is all about, this would enable management accountants operating within Australia to enhance their performance far much beyond activity and costing boundaries to domain of measuring and managing strategies for delivering some values to organizations’ shareholders.
Conclusion
To conclude, the paper presented a detailed analysis of ABC as the management accounting topic selected in this case. It presented a description of ABC where ABC is said to be a provision of accurate and fair cost allotment. Further, ABC is considered as the most significant innovation in the managerial accounting and cost calculation. The system is said to offer more precise account of the product cost. The system is said to determine each and every activity linked with production of items and allocates the costs to their respective activities. Through the analysis of the two studies on ABC, it can be indicated that ABC leads to more valuable tool in making management decision since it produces more accurate, relevant and detailed information. In essence, it can be concluded that ABC enable organizations in lessening costs incurred during production without providing poor quality and making extensive utilization of the cost information for the performance valuation, management practices and pricing decisions. It can also be indicated that implementation of the ABC is usually facilitated through provision of sufficient training including increment on proportion of the overhead costs as well as increase in the number of the product variant. Through the two studies, it can be stated that ABC is the most efficient management accounting approach in determining organization’s service costs and activities as well as in analysing their activities and their service performance and in assessing link between their outputs and inputs. With such conclusions, it would be easier for management accountants with Australia to push for the new management account implementation: that is, ABC in their organization operations. Indeed, there is need to implement ABC in our organizations especially in those organizations dealing with manufacturing and production processes in order to be in a position to reduce wastage and maximize on profit making products.
List of References
Arora, AK, & Raju, M (2017), ‘The effect of firm’s size on the adoption and implementation of activity based costing,’ Splint International Journal of Professionals, 4(7), 36-40.
Broad, M & Crowther, D 2001, “Activity based costing in universities – An inappropriate technique?”, Journal of Applied Accounting Research, vol. 6, no. 2, pp. 55-89.
Diavastis, I., Anagnostopoulou, E., Drogalas, G. & Karagiorgos, T. 2016, “The interaction effect of accounting information systems user satisfaction and Activity-Based Costing use on hotel financial performance: Evidence from Greece”, Accounting and Management Information Systems, vol. 15, no. 4, pp. 757-784.
Mojdeh, K.V., Tavakolizade, R. & Habibi, A. 2012, “A Study on Application of Activity Based Costing in Khootka Food Industry”, International Journal of Management Prudence, vol. 4, no. 2, pp. 110-120.
Morgan, M.J. 1993, “Testing activity-based costing relevance: Pharmaceutical products limited – A case study”, Management Decision, vol. 31, no. 3, pp. 8.
Nassar, M., Husam, A.A., Sangster, A. & Mah’d, O. 2013, “Factors that catalyse, facilitate and motivate the decision to implement activity-based costing in Jordanian industrial companies”, Journal of Applied Accounting Research, vol. 14, no. 1, pp. 18-36.
Ping, CI, Li, PW & Yau, J 2003, “Application of Activity Based Costing (ABC): The case of a non-government organization”, International Journal of Management, vol. 20, no. 3, pp. 282-293.
Yang, K. & Chang, S. 2018, “Application of Activity-Based Costing to Green Industry for Profitability and Performance Enhancement – Recycling of Blast Furnace Slag as an Example”, Advances in Management and Applied Economics, vol. 8, no. 3, pp. 27-59.
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