ABC and Traditional Costing System
In today’s business world, Cost Accounting plays an integral part for the business organizations in controlling various costs of the businesses. Cost accounting refers to the process of recording, classifying, analyzing, summarizing, allocating and evaluating different alternative courses of action so that the costs of the companies can be controlled (Drury 2013). In the cost accounting process of the business organizations, the use of two major techniques can be seen; they are Activity Based Costing (ABC) and Traditional Costing System. The popularity of these two costing techniques can be seen all over the world as the companies become majorly beneficial from the use of these costing approaches. However, in the recent years, it can be seen that the business organizations have a fondness towards the implementation of ABC in their business operations due to the superiority of ABC over traditional costing approach in many areas (Vanderbeck 2012). The main aim of this report is to conduct an analysis and evaluation of the various techniques of ABC in the business organizations.
ABC is considered as the latest development in the system of cost accounting. Under the process of ABC, the cost accountants absorb the overheads on a more realistic manner than the equitable basis. In today’s business world, due to the technological advancements, the manufacturing firms are forced to use advanced technology in the manufacturing process. In this kind of situation, increase in overhead can be seen along with the decrease in direct costs; more importantly, decrease in direct labor cost can be seen. Now-a-days, it can be seen that single companies are manufacturing large number of products. The automatic system in production increases the amount of overheads (Emblemsvåg and Bras 2012). Thus, under this highly competition market, it is required for the companies to implement correct costing of products so that misleading decision-making process can be avoided. Some expenses like cost of material handling and machine set up are only incurred at the time of the production process (Hilton and Platt 2013). The adding of these costs is done with volume rated costs like purchase expenses and manufacturing expenses. This is not the correct method for of cost accounting. Under the techniques of ABC, the calculation of these expenses is done separately and they are appointed in the end products in order to get the correct product cost. For this reason, ABC has the potential to provide more useful information to the cost accountants for various costing porpoises. Thus, ABC put more focus on a cost activity rather than on the departments, sections or divisions. Various value adding activities or non-value adding activities can be seen in the departments, sections and divisions (Frazier 2014). With the help of ABC, the cost accountants become able to eliminate non-value added activities for the proper allocation of product costs.
ABC Implementation Process
The features of ABC and Traditional Costing System are discussed below:
- Under the process of ABC, the total costs are divided into two types; they are Fixed Costs and Variable Costs. This segregation of costs is needed for providing quality information for the designing of suitable cost system in the manufacturing companies (Schulze, Seuring and Ewering 2012).
- With the help of ABC, cost accountants become able to make proper distinction among various patterns of cost patterns.
- Under the process of ABC, the cost behavior patterns have relation with cost volume, diversity of costs, various cost events and cost times.
- In the techniques of ABC, the cost accountants are required to identify the appropriate cost driver so that the overheads of the products can be traced (Tsai et al.2014).
- Under the process of ABC, the cost drivers provide the dictation of various cost behavior patterns.
- It is easy for the manufacturing organizations to apply the techniques of traditional costing system. In addition, cost accountants do not face any difficulties in tracing all associate direct costs with the products that includes labor and direct cost of materials (Cooper 2017).
- For the manufacturing organizations having large number of a few products, traditional costing system provides the cost accountants with good idea about the costs of the manufacturing products.
- In the process of traditional costing system, the cost accountants assign the manufacturing overheads based on the volume of the cost drivers; like total amount of direct labor required for the production of an item.
- In most of the business organizations, traditional costing system is used for the production of profits. The use of cause-and-effect technique can be seen in this (Rumble 2012).
The increase in popularity for ABC in the manufacturing organizations can be seen as it provides great assistance to the managers in the decision-making process. It is essential for the business organizations to follow certain steps in order to implement ABC. The process involved in the implementation of ABC is discussed below:
Identification of Activities: In the first step, it is required for the firms to identify the cost activities and they are required to be grouped together in the activity pools. These activity pools may include fractionally assigned costs for the supporting activities to the individual products (Akhavan, Ward and Bozic 2016).
Analysis of Activities: After the first step, it is required to analyze various cost activities for the clear identification of processes that support the manufacturing of products so that the systematic inaccuracies in the traditional costing system can be avoided. It implies that the implementation of ABC requires the analysis of cost activities so that the mapping of those cost activities can be done. This analysis of activities helps in the identification of indirect cost relationships.
Costs Assignment: Based on the findings of above discussed step 1 and step 2, the assignment of costs is done to the activity pools. For example, the assignment of human resource costs is done to indirect administrative or indirect costs of management. These cost pools have major contribution to the object cost of production (Öker and Ad?güzel 2016).
Calculation of Activity Rates: In this step, the initial analysis of the activity rates is done by including direct labor hours or indirect support labor. The assignment of these activities must be done to the value of real currency. This step requires the adding of all weightings. For example, production labor hours needs to be in terms of weighted labor rate that includes the benefits costs.
Assignment of Cost-to-Cost Objects: After the identification and definition of activity costs, pools and rates, they are assigned to the cost objects in the next step. Objects refer to the results offered to the customers. In the manufacturing and non-manufacturing environments, these products are required to have some saleable value for the comparison of assigned costs.
Preparation and Distribution of Management Report: After the overall analysis, the data related with costs are required to be placed in coherent and concise manner for the cost objects and processes owners. This communication of the whole analysis has importance for the justification of the whole implementation process of ABC (Draži? Lutilsky and Dragija 2012).
Evaluation of ABC
It is required to shed lights on some of the major aspects of ABC for the evaluation purpose. The main criticism related with the process of ABC is the omission of opportunity costs analysis and the reference with the past costs that are irrelevant for future decision-making process. On the other hand, the process of allocating the costs is an arbitrary process that can lead to wrong decision-making process of the companies. Apart from this, various problems can be seen in ABC in the process of dealing with different product line (Oseifuah 2013). Another main aspect required to be considered is the level of profit in the process of cost accounting. Many renowned accountants consider ABC as a method like ‘peanut butter spread’ that can lead to the distortion of costs allocation in the manufacturing organizations. However, it needs to be mentioned that the companies can become majorly beneficial from the implementation of ABC. The techniques of ABC help in tracing the costs by activity so that their reporting can be done as per the products. Apart from this, various steps involved in the process of ABC helps in correct allocation of overall cost of production among the cost drivers. Thus, it can be seen that the method of ABC helps in increasing the accuracy of the overall cost allocation process that leads to a better grip in the process of cost control (Draži? Lutilsky and Dragija 2012).
During the 1980s, many business organizations all over the world started in the adoption of ABC for their production system. The main aim of the adoption of ABC was to increase the accuracy of the production process so that the product costs can be decreased. After some time, the managements of those companies realized that ABC had many more aspects to offer to the companies apart from the calculation of cost per unit of the products or services. This was the inception of Activity Based Management (ABM) in the business organizations. Thus, ABM can be defined as the whole set of actions that can increase the efficiency of the management of the companies by using the information from ABC. The main aim of ABM is the achievement of same output level with the help of lower cost (Krajnc, Logožar and Korošec 2012).
The usefulness of ABM are discussed below:
- The focus area of ABM is the accountability of activities rather than the costs so that the performance of the system can be emphasized.
- Under ABM, the assignment of costs is done to the cost units so that that cost of organizations can be done in better manner (Jänkälä and Silvola 2012).
- The implementation of ABM helps in tracing cost to the individuals responsible for incurring them. More emphasis is put on the financial measures.
- The implementation of ABM put equal focus on the measures of both financial and non-financial performance so that functional efficiency can be brought in all functional areas of the companies (Jänkälä and Silvola 2012).
Conclusion
From the above discussion, it can be observed that the main reason for the emergence of ABC is to overcome the deficiencies of traditional costing method. The techniques of ABC segregated the whole cost in Fixed costs and Variable cost so that the even allocation of costs can be don among the cost drivers. The main feature of traditional costing system is the ease in implementation. As per the above discussion, it can be seen that cost accountants are required to follow six steps for the effective implementation of ABC in the companies. There is a relationship between ABC and ABM as the operations of ABM largely depends on the information of ABC.
References
Akhavan, S., Ward, L. and Bozic, K.J., 2016. Time-driven activity-based costing more accurately reflects costs in arthroplasty surgery. Clinical Orthopaedics and Related Research®, 474(1), pp.8-15.
Cooper, R., 2017. Target costing and value engineering. Routledge.
Draži? Lutilsky, I. and Dragija, M., 2012. Activity based costing as a means to full costing–possibilities and constraints for European universities. Management: Journal of contemporary management issues, 17(1), pp.33-57.
DRURY, C.M., 2013. Management and cost accounting. Springer.
Emblemsvåg, J. and Bras, B., 2012. Activity-based cost and environmental management: a different approach to ISO 14000 compliance. Springer Science & Business Media.
Frazier, W.E., 2014. Metal additive manufacturing: a review. Journal of Materials Engineering and Performance, 23(6), pp.1917-1928.
Hilton, R.W. and Platt, D.E., 2013. Managerial accounting: creating value in a dynamic business environment. McGraw-Hill Education.
Jänkälä, S. and Silvola, H., 2012. Lagging Effects of the Use of Activity?Based Costing on the Financial Performance of Small Firms. Journal of Small Business Management, 50(3), pp.498-523.
Krajnc, J., Logožar, K. and Korošec, B., 2012. Activity-based management of logistic costs in a manufacturing company: a case of increased visibility of logistics costs in a Slovenian paper manufacturing company. PROMET-Traffic&Transportation, 24(1), pp.15-24.
Öker, F. and Ad?güzel, H., 2016. Time?driven activity?based costing: An implementation in a manufacturing company. Journal of Corporate Accounting & Finance, 27(3), pp.39-56.
Oseifuah, E.K., 2013. Activity based costing approach to financial management in the public sector: the South Africa experience. European Scientific Journal, ESJ, 9(1).
Rumble, G., 2012. The costs and economics of open and distance learning. Routledge.
Schulze, M., Seuring, S. and Ewering, C., 2012. Applying activity-based costing in a supply chain environment. International Journal of Production Economics, 135(2), pp.716-725.
Tsai, W.H., Yang, C.H., Chang, J.C. and Lee, H.L., 2014. An Activity-Based Costing decision model for life cycle assessment in green building projects. European Journal of Operational Research, 238(2), pp.607-619.
Vanderbeck, E.J., 2012. Principles of cost accounting. Cengage Learning.
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