Literature Review: The Traditional Costing System
Discuss about the Application Of Traditional Cost System And The ABC.
Costing systems are informative in nature. Labour hours and number of goods manufactured are some of the values that must be initially entered in it to get outputs in the form of cost price of the product and other specific terms that are associated with the type of system used by the company because different systems evaluate the same entered data in different ways as per their nature of processing. The report explains traditional costing system and activity-based costing systems only. Undertaken costing technique must eliminate the non-worthy costs but should not be non-worthy itself. (Hopper, 2016) It should always be seen that the expenses beard to set up the costing system must be less than the profits that the company has gained because of it.
these systems have only one volume-based cost driver and so it is seen to have inaccurate pricing of the goods and any extra incentives are catered to the labour charges and so the final report produced on the goods manufacturing shows the cost to be divided among all the units and this increases the final cost price of a single product. The traditional techniques are based on the fact that production of goods will cost money. They detect the cost that is put on straight to the goods production but are not able to specify any cost that is not in direct association with the goods produced (Hopper, 2017). It can be seen that the sections requiring extra incentives are not only one but scattered all through the product manufacturing and this condition is common to most of the companies now which require both technology and manual work to make goods. The total investment required for the production of large quantities is divided among all and that becomes the cost price of the product and is seen in the financial statements. Traditional costing system divides the total expenses between numbers of production and does not summon the costs in different areas. The assessment highlights the expense but no reason is specified.
When the extra incentives related to the products has reduced the reason in which they occur are handled wisely and not the way in which they pose but it should also be kept in mind that cutting out these extras can damage the quality of the products effectively. It was seen that in the traditional costing techniques one or more extra incentives were the part of a specific product production or of the whole manufacturing factory. In this method, the extra pays were financially linked to the products and are to be kept into existence. It was seen that in the traditional costing system all the expenses are summoned up after the manufacture of the product and this was the cost price of the product.
Activity Based Costing (ABC)
The traditional costing system depended that production will require investments. Activity-based cost also bases on that but the investment is made in different areas which come together during production as to whole with simultaneous elimination of the extra ones. The basic of the activity-based costing is the detection and elimination of extra expenses but categorizing them with the reason they occur and this helps the company to relate them with customers, management, undertaken methods and not only the outputs (Robinson $ Last 2009) . The term activity-based costing can be defined as one in which different costs put up together make the picture of final cost but in an effective way because it detects the areas of investments in which the non-worthy expenses can be neglected (Parrino et. a-l, 2012). The popularity of the activity-based costing has been increased by time not only as an effective way of cost planning but as a way of cost reduction with strategic plans being made which controls the following:
- Activity-based costing
- Activity-based cost management
- Activity-based budgeting
- Activity reporting
- Performance measurement and benchmarking
- Continuous improvement
- Product/customer and sector profitability
- Business process re-engineering
It must be paid attention that different processes are to be invested in if activity-based costing is followed. The report is the analysis of the resources taken into use.
There are different areas which require expenses in product manufacturing which are not dependent on each other. During product manufacturing, the expenses are drawn from investments made in these areas and so no extra costs are incurred by the company. The use of activity-based costing separates different costs on the basis of the products with which they are associated and this helps the managers to identify them clearly and measure the number of assets they consume and in what way. The adoption of the activity-based costing is done so as to eliminate extra expenses and increase the efficiency of the company by generating new plans. The main work of activity-based costing is to identify different areas that require investment in product manufacturing and to see if they are worth the place. Implementation of cost pool in association with cost driver under activity-based costing can eliminate the extra expenses successfully.
Cost driver analysis, activity separation, calculation of performance percentage and activity-based costing should be done to maintain the efficiency of the company. Cost drivers are the one on which a process depends. It is not an output measure because it does not count the number of productions. They are creating regions which are to be invested so that the product manufacturing can be done and paying attention to these areas will be enough to see that what processes they actually handle. There are also areas which become an extra expense for the company. The use of product costing evaluates several outcome costs which will exist after the final product manufacturing and selects the beast cost-effective one.
Allocation of Cost
It is seen that the financial accounting advises keeping away the product and the periodic costs, but this should be eliminated while using activity-based costing which revolves around the fact that what are the sources of the company and the steps that would follow it. The use of activity-based costing must be such that they detect both value-added and nonvalue-added and should also be seen that the staff appointed to do so must be skilled in these areas. Nonvalue-added activity can be termed as the one whose non-existence would not alter the final structure of the product.
Advantages of the ABC system are as follows:
- The pricing of the manufactured product is done in a very efficient way and saves the extra expenses of the company.
- It is seen that during the completion of product manufacturing it is seen that the total price is dominated by the extra expense every time but the ABC system eliminates that and provides the practical price.
- The ABC system understands the cost spikes and the areas where they are set to get extra without delivering anything in the product manufacturing and eliminates them as much as possible.
Exact evaluations are very important for the calculation of the product pricing before launching it in the market which can earn benefit for the company, so this step is necessary to be followed. The detection of the overheads and the extra costs which will not play any part in the success of the company are more accurately done and in this way it is much easy for the management to see and eliminate such unworthy expenses. The ABC strategy is to build that it gives every decision a run for the money and this is how the extra expenses and the overheads can be eliminated as stated in the above statement (Oker & Ad?güzel, 2016). If the plans made by the strategy are correct then the product manufactured will be of the best quality and this will attract and satisfy the customers thus increasing the profits. Balance scorecard and other features which are related to quality services are always appreciated by the ABC strategy which increases the performance of the company.
- Is all the information about the advantages, disadvantages and the effort that it takes to execute and maintain the ABC strategy?
- Are all the elements available to us to execute the plan of ABC?
- Is the evaluation be done in such a way that the expenses to execute the plan would be more than the profit and revenue generated?
- Is it easy for us to find out the functions in the plan and the expenses which are related to it?
- If the plan is executed on behalf of the company then will the shareholder be interested in the same? If the criteria are not met then what will it take to fulfill the same? (Balakrishnan et. al, 2014)
- ABC provides extra supplementary information with which “a-step-ahead” plans can be made. But will this plan be beneficial for the company?
- It is advised to use the ABC plan to the core of the business so that the management can be benefitted and helped in important decision-making situations.
- It is advised that the use of ABC must be done in order to solve evaluations related to product pricing (Chapman et. al, 2017).
- It is advised that the execution of the ABC strategy must be carried out by the accountants in the management as they are much closer and know the functioning of the company so as to make sure that the new strategy is giving benefit to the company. It should be seen that small details and every minute element are free to be neglected because they would divert the original path of the plan that is a big one related to the success of the company. The small expenses can also be neglected (Hopper et. al, 2015).
- It is not always possible for the ABC plan to deliver something beneficial and the costs incurred are not always going to turn into profits. Not all costs will disappear if a product is discontinued, an example being building occupancy costs.
The strategy of the ABC was undertaken and executed by the Chinese electrical company Xu Ji who made it count for their money as they detected the extra costs and expenses which had set in the business and were not in accordance with the traditional costs in the state-owned enterprise (SOE). The loopholes which prevailed in the business were successfully removed and a platform which high level of smooth working was provided to the company. The platform thing is not an idea in the Chinese market and in the management of the Chinese companies (Chapman et. al, 2017 ). The ABC planning has been a boon to Xu Ji in their IT department and also the accounting and ERP implementations.
Before the introduction of the ABC planning in Xu Ji, the company had been operating its functions as per the traditional business techniques which were seen to include much of the paperwork manually which was hard to aim at. The company was depending on the financial reports that were gathered from the market and this created loopholes for the expenses of the product to get miscalculated 9 Shields, 2015). Due to all this, the company was bound to make changes to the core structure as the market had turned in towards free rivalry as set up by the government.
Benefits Provided by ABC
The loses and the disadvantages the company was facing due to the path of traditional techniques was given up because it caused the company to beat a setback in terms of the pricing decisions to be made and so the ABC planning was implemented which had these top priority tasks at first:
- Trace direct labor costs directly to product and client contracts.
- Allocate manufacturing overheads on the basis of up-to-date direct labor hours to contracts.
Lessons learned
The new “Top-Down” makeover of the company in the management and the structure was well appreciated as it led way for the growth of new ideas along with training for the corporate and professionals in the company (Parrino et. 2012). The resignation from the traditional methods and the adoption of the ABC learning of the whole management with the inclusion of the latest technology in the business gave the company an upper hand in their field (Brown, 2013).
So, it has been clearly understood that traditional performance measures are not suitable for the firm as they can give wrong details to the firm because of their inconsistent and dynamic environment which may lead to bad decision making and thus making the firm suffer loss as a whole. Only focussing o the financial measures of the firm will not let the organization evaluate good reports thus making them valueless. In order for the firm to maintain a proper connection of the management and the performance strategies, the actuators must evaluate both financial and non-financial data of the firm so that the dynamicity of the firms working environment can be assessed and the decisions can be made in relation to it (Chenhall, 2007)
A balanced scorecard is a type of performance measurement system that is helpful in the ascertainment0 of the faults present in the traditional performance measurement systems. The information provided in the scorecard consists of the total information derive from the financial and the non-financial data of the firm which gives it a balanced nature for making decisions regarding the firm (Shield, 2015). BSC also analyzed the intangible assets which have become one of the major topics of completion in the market (Brown, 2013). BSC is said to have an integrated strategic management system that helps the business to formulate the strategies after proper analysis of the data prepared by the analysis of all financial and non-financial statements. The performance objectives are measured in four inter-connected perspectives which help the management to convert strategies into valued objectives that can be measured ( AbinY.
After the analysis of all the systems, it has been made clear that all the policies and the plans which have been composed using the systems should be placed in a manner where proper movement can be achieved. The board must also follow all the strategies as soon as possible because any error may be cured if they have been detected before time. Also, the board must try to have active participation in the firm’s objective and then look after the functionality of the finances and the marketing sections of the firm (Brown, 2013) The major concern of the firm is to maintain the quality of products and thus the production department must be the main focus while conduction of any analysis process. The board also seeks that the employees may have proper coordination present between them so that the firm can achieve the set targets and goals within the time limit.
Questions to Consider While Implementing ABC
Conclusion
Traditional performance measurement system is helpful in the assessment of the financial condition of the firm in accordance with the revenue earned with the help of selling however going by the benefits of ABC, the Australian business should follow the ABC model as it is more pronounced and provides advantages. These reports analyze mainly the internal accounting reports such as profitability, revenue, cash flows, investment returns, earnings per share, etc in order to prepare a systematic form of data. These topics which are analyzed are termed as lag measures because of their nature of collection from the data of previous year and thus represent historical performance. The reports and the analysis prepared by the use of such quantitative terms may help the firm to improve performance but it may also lead the firm to publish wrong decisions which can cause long-term problems within the environment.
References
Balakrishnan, R., E. Labro, and Soderstrom, S. (2014) Cost structure and sticky costs. Journal of Management Accounting Research [online]. 26 (2), p. 91–116. Available from: https://bs4e.auinstallation32.cs.au.dk/fileadmin/site_files/filer_oekonomi/subsites/DCAF/konferencer/Labro.pdf [Accessed 16 May 2018]
Brown, P. (2013). How can we do better?. Accounting Horizons. 27(4), 855–859. DOI https://doi.org/10.2308/acch-10365 Accessed 16 May 2018]
Chapman, C, Hopwood, A & Shields, M. (2007). Handbook of Management Accounting Research. Oxford, U.K.: Elsevier
Chenhall, R. (2007). Theorizing contingencies in management control systems research. In Handbook of Management Accounting Research
Hopper, T & Bui, B. (2016) Has management accounting research been critical?. Management Accounting Research. [online]. vol. 31, pp. 10-30.
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Lee, J., Park, M., Lee, H.S., Lee, K.P & Hyun, H. (2015). Application of Activity-Based costing (ABC) for Modular Building Construction Indirect Costs Calculation at the Manufacturing Stage. Korean Journal of Construction Engineering and Management, 16(4),139-145
Oker, F & Ad?güzel, H. (2016). Time?driven activity?based costing: An implementation in manufacturing company. Journal of Corporate Accounting & Finance, 27(3), 39-56.
Parrino, R, Kidwell, D. & Bates, T. (2012). Fundamentals of corporate finance. Hoboken,
Petty, J. W, Titman, S., Keown, A. J., Martin, J. D., Burrow, M. and Nguyen, H. (2012) Financial Management: Principles and Applications, 6th ed. Australia: Pearson Education Australia.
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Robinson, M & Last, D 2009, Budgetary Control Model: The Process of Translation. Accounting, Organization, and Society, NY Press
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Shim, J. K & Siegel, J G. (2009) Modern Cost Management and Analysis. Barron’s Education Series
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