Overview of ABC Costing Model
Disucss about the benefits of Activity-based costing method to maximize the operational efficiency of a company.
The present report is undertaken to gain an examination and evaluation of the costing method of activity-based analysis (ABC) that is used largely by business corporations at present to attain competitive advantage. This has been carried out by aligning the ABC costing model as per the corporate strategies of a selected ASX listed entity. This is followed by providing recommendations to the company for the implementation of ABC model and also suggestions about other management accounting tool suitable to be applied within the company. The business entity selected in this context is NEXTDC Limited, a technology company of Australia involved in providing data services to its business client.
Definition and its importance
Activity based costing is the popular costing model or method which is used by business entities for the identification costs incurred in various production activities and align them to the product cost. Activity based costing allocate the cost to each product line on the basis of actual resources used in each activity. Activity based costing model supersede the traditional costing model as its uses various cost driver to allocate the overhead cost as compare to traditional costing model which uses only machine or labour hour rate to allocate all the overhead cost. The allocation of overhead cost has been performed through identifying the number of activities involved in the production process of product and then allocating the total activity cost to the products through using the cost driver applied to each activity. In this all overhead cost are allocated to the products in more meaningful way so that it is possible to track the actual overhead cost applied to the final product produced by the business organization which is not possible in the case of traditional costing method. As activity based costing uses meaningful data to allocate the overhead cost and also provide information related to the pricing of the product that helps the costing manager to take decisions that is profitable for the business. Under traditional costing method the cost allocation leads to wrong information related to product costing as cost allocation is done using single base even the particular activity used for the particular product or not (Bhimani, 2007).
The importance and characteristics of activity based costing has made it popular among the cost managers as it helps in taking the important decisions and also maximizing the operational efficiency of the company. The main purpose of using the activity based costing method is allocate the indirect costs in most logical manner that is not possible to apply in traditional costing method. It means traditional costing uses arbitrage method cost allocation which does provide results as per the resource utilization by each product. Activity based costing method make use of cost pool to divide all the indirect costs in each activity and through use of cost driver, per unit activity cost has been found and after that it is allocated to each product line as per the consumption of units of each activity. Overall it can be said that activity based costing method is best costing model till as it make use logical method to allot the overhead costs which no other costing method uses.
Characteristics and Benefits of ABC Costing Model
In past few decades, great importance has been received in context to the activity based costing model as manufacturing overhead cost has been increased a lot and there has been no relation of overhead costs with the machine hours and direct labour hours. It has been seen that some products are manufactured in large quantity while some are manufactured in small quantity that leads to wrong allocation of overhead cost when using the traditional costing. This issue has been resolved in activity based costing as overhead costs are not based on the labour hour rate or machine hour rate (Horngren, 2005).
Features of the Activity based costing model
- Activity based costing helps in providing the detailed view of all the indirect cost incurred in manufacturing of the product which is not possible in case of traditional costing
- ABC costing is best model to monitor the total life cycle cost of product and also provide detail information about the performance of the product. It helps in increasing the profitability of the company.
- ABC helps in monitoring the budget effectiveness and also promotes continuous improvement in the quality of products and services by identification of the non-value adding activities (Kuchta and Troska, 2007).
Identification of Company’s Mission & Objectives
NEXTDC Limited is recognized to be a technology company listed on ASX 200 that is involved in transformation of businesses by providing innovative data services. It has become an independent data centre operator involved in providing enterprise-class services at both domestic and international level. The strategic mission of the company is to deliver its customers the best-in-class engineering solutions recognized within an industry and also placing continuous focus on sustainability and energy efficiency. The company aims to realize its strategic mission by developing the largest country’s independent network of carriers that enables the customers to source and connect with the cloud platforms. The long-term objective of the company is to provide innovative data services to businesses through their outsourcing solutions, connectivity and infrastructure management software services (About NEXTDC, 2018).
Identification of Company’s Corporate Strategies
NEXTDC is emphasizing on the use of data centre strategy for empowering its business. It is adopting the use of IT infrastructure services for attaining a competitive advantage in the technology market as businesses requires the use of a right IT strategy for gaining success in the present competitive business world. The company by creative innovative IT infrastructure and services is facilitating the IT leading companies to achieve excellence in delivering their products and services to the customers. The company together with its partners aims to create an ecosystem that provides largest independent network of carriers to their customers and scaling their IT services. The designing of each data centre takes into account the optimal physical, technical and operational environment as per the needs of IT infrastructure of the client (A data centre strategy to empower business, 2018).
Explanation of ABC Model in assisting to Achieve Company’s Strategies
The effective cost management of business operations is becoming essential for the growth and development of IT companies. The globalization of business world is causing the integration of IT related systems and devices for improving their competitive position. As such, adequate management of costs is an essential requirement for strategic planning of the IT environment to improve their profitability position. As such, NEXTDC is involved in developing of IT related infrastructure and services and therefore need to implement an efficient system of cost management for maximizing its operational efficiency and driving its sustained growth and profitability.
About NEXTDC Limited
Activity-based cost analysis method seems to be suitable to be used by the company for achieving operational effectiveness. This is because ABC method of cost analysis enables the company to add value to its overall operational process by elimination of non-value adding business processes and systems. The company needs to accurately identify the resources consumed by its different activities involved in its operational processes such as CPU’s, data storage, communications and power consumption. Therefore, it is rather difficult for the company to allocate the overhead costs on an individual product basis for collection of realistic accounting data about its operational cost (Wegman and Stephen, 2009).
The ABC costing method helps in assigning the cost of resources to a group of activities and then assigning it to particular cost objects. ABC model adopts the multiple cost drivers and also helps in identifying the unique cost drivers for each value-added activity. It helps in identification of the cost drivers as per the individual activity level and gaining an insight into the resources consumed at each activity level involved in development of products and services of the company. ABC model helps in accurate identification of the costs for different type of internal services provided by the company. This helps in conversion of indirect costs involved in creation of its various data centre services and converting them to direct costs. This helps the management accountants to gain an estimate of the actual cost consumed in creation of its services (Kaplan and Anderson, 2007).
The management accountants can also effectively differentiate between the value-added and non-value added operational process steps of the company and therefore elimination of the operational steps that are resulting in wastage of resources. This helps in reduction the cost involved in creation of data centre services of the company and helps it to attain large profitability promoting its sustainable growth and development. The increased knowledge about the cost drivers will help the management accountant of the company to identify the activities that consumes larger resources and developing consecutive strategies for reducing the consumption and eventually the operational cost (Neuman, 2004).
The management accountant of the company can adopt the use of following methods for implementing ABC costing method into its operational process:
- Designing a Seminar for the management tem: This method involves designing a seminar to provide in-depth information regarding the benefits of implementation of ABC costing system for the company. The seminar can focus upon providing knowledge to the management personnel’s of the company at all levels regarding the identification of the activity centers and method for assigning costs on an individual product basis and collection of accounting cost data relation to the overhead resources consumed in production a required level of services for the clients. This all involves the identification of the major operational activities, determination of the costs of the activities and the factors that drives the activities. This is followed by determination of the quantity of each cost driver on an individual product basis and at last computing the activity-based costs on the basis of the products or services (Kaplan and Anderson, 2007).
- Breaking of Overhead Costs into Major Components: This is necessary to identify the resources consumed by each activity level within the company. This is essential to be identified by the management accountant before the implementation of ABC system for ensuring its successful adoption. The overhead costs can be segregated into the following major components in the company that are wages of the technicians, maintenance and repair of the IT systems, deprecation and taxes and other resources. This will help the accountants to gain an estimate of the amount of overhead costs resources consumed in creation of specific volume of services that need to be reduced with the use of ABC costing method for driving its operational efficiency (Jones and Dugdale, 2002).
The company is also recommended to adopt the use of absorption costing method in which product costs involves both the fixed and variable costs. It absorbs the overall cost involved in creation of a product or services that includes both the fixed and variable costs. The costing method is also recommended by the Generally Accepted Accounting Principles to be implemented for full absorption of the overall costs incurred into product costs. The method will prove to be effective in gaining an estimate of the overall fixed and variable costs that is involved in the operational process of the company (Epstein and Lee, 2015).
Conclusion
The report has provided an in-depth knowledge of the usefulness of ABC costing method for assigning the direct costs to a particular product that is sometimes difficult to be identified by the management accountants. The use of ABC costing method will prove to be highly beneficial for NEXTDC Limited to identify the overhead resources consumed by the complex operational processes of the company. This will assist the company to take strategic decisions for driving the profitability of the company by elimination of non-value added services creation.
References
About NEXTDC. 2018. [Online]. Available at: https://www.nextdc.com/our-company [Accessed on: 29 May 2018].
A data centre strategy to empower business. 2018. [Online]. Available at: https://www.nextdc.com/news/data-centre-strategy-empower-business [Accessed on: 29 May 2018].
Neuman, B. 2004. Cost Management Using ABC for IT Activities and Services. Management Accounting Quarterly Fall 6(1), pp. 29-40.
Kaplan, R. S. and Anderson, S.R. 2007. The innovation of time-driven activity-based costing. Cost Management, pp. 5-15.
Jones, T. C. and Dugdale, D. 2002. The ABC bandwagon and the juggernaut of modernity. Accounting, Organizations and Society 27(1-2), pp. 121-163.
Wegman, G. and Stephen, N. 2009. The activity-based costing method developments: state-of-the art and case study. Journal of Accounting Research and Audit Practices 8 (1), pp.7-22.
Horngren, C.T. 2005. Cost Accounting – A Managerial Emphasis. Pearson Education.
Bhimani, A. 2007. Activity-based Costing: How far have we come internationally. Cost Management 21 (3), pp. 12-17.
Kuchta, D. and Troska, M. 2007. Activity-based Costing and Customer Profitability. Cost Management 21 (3), pp.18-25.
Epstein and Lee. 2015. Advances in Management Accounting. Emerald Group Publishing.
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