Methods of Cost Allocation
It has been observed that in the business environment of 21st century the industries are getting more diversified and challenging. The demand for goods and services has increased in the markets which have forced the banks to introduce new products that would be able to satisfy the requirements of the customers (Alvarez, 2013). The banks are also engaged in setting up such strategies which would help them to raise funds from the public. In order to increase their efficiency and enhance their skills, the banks have also started adopting modern technologies. In activity based costing method of cost allocation, the overhead cost is not allocated based on a pre determined rate but it is allocated on the basis of the activity consumed for the production of particular product. So, the overhead cost is allocated only to that product which demands this activity. The management comes to know about the cost details of a particular product very easily if the management is using activity based costing. This method of cost allocation is considered to be very simple because it helps us to know about the areas where the cost has been increased. There are many companies that follow traditional costing method but this method is not as simple as the activity based costing. Traditional based costing is also not very precise when compared to the ABC method. In traditional costing, the overhead cost is allocated based on the predetermined rate whereas in ABC costing it is allocated on the basis of activity and therefore, costing through ABC is considered to be more accurate (Atkinson, 2012).
There are two methods that are usually used by the organisations for the purpose of cost allocation. The first one is known as the traditional costing method and the second one is known as the Activity base costing. Activity based costing is proffered because it overcomes all the drawbacks of traditional costing system. ABC is considered to be the best cost allocation method because of its simplicity as well as preciseness. One of the major reasons of preferring this method is that management recognises the activities carried out by them and the expenditure is allocated to different product and services on the basis of actual consumption. There are different cost drivers that are assigned to the goods and services individually and hence the value can be measures accurately (Berry, 2009). The main objective for adopting this method is to know about the actual expense that has been incurred for certain goods and services. It also becomes easy to know the reason behind increase in the prices of the goods and services. So, we can say that this approach helps us to track the real consumption of the resources along with the final costing.
Benefits of Activity-Based Costing
In the ABC approach, the resources that are actually consumed are allocated properly. There are five important points that has to be kept in mind while using the activity based costing approach.. The first point is the recognition and measurement of the resources that has been consumed in a particular activity which has helped in the production of goods and services. The quantified affairs that have been performed by the employees of the company must be comprised in the cost function. The second point says that a cost pool must be introduced which will help in the allocation of different overheads to the various activities. The third point relates to the recognition of various cost drivers which is related to the products and services directly or indirectly. The cost driver recognition is considered to be very important because it has a direct impact on the expense of various goods and services. In this costing method, the overhead absorption rate is calculated for each pool separately (Boyd, 2013). However, in the last step the costs are then allocated among the various items that have been produced (Broad & Crowther, 2001).
Activity based costing is usually adopted by the manufacturing companies whereas the non manufacturing companies usually adopt the traditional costing system. In the non manufacturing organisations there are many costs that cannot be measured and recorded because of intangibility and therefore, it follows traditional costing approach. In contrast, we know that there is various numbers of activities that are carried out in the manufacturing organisations. So, the company has to maintain records of the cost incurred during the production so that the indirect expenses can be measured and allocated to various goods and services. Also when the companies do not produce large varieties of products then companies adopt traditional costing method. Direct expenses are easily measurable but it is difficult to measure indirect expenses (Datar, 2015).. If the costs that are associated with the products not recognised and measured properly then it may affect the decisions taken up by the management.
In the current scenario, we can see that the companies are engaged in the production of different types of goods and services. There are huge overhead costs or indirect costs in the production of these goods and services but these costs should not be segregated on the basis of the direct costs. It is very important to record the costs associated with the manufacturing of these goods and services because it helps in the determination of price which matter a lot in this competitive environment (Datar, 2016). In case of traditional costing, the cost that is related to volume can be recorded but the costs that are related to non volume are completely ignored. The examples of costs that are non volume are cost related to set up, handling of materials etc. These costs can be allocated by using the Activity based costing method only because it is not possible to segregate them on the basis of volume.
Differences between ABC and Traditional Costing Methods
Activity based costing is used in order to determine the various components of the total cost of a product. This helps the management to recognise the avoidable costs and take steps to reduce them which will further lead to reduction of prices of the products. The features of this costing method are discussed below:
- The total costs are divided into two parts in this costing approach. These two of them are known as direct costs and indirect costs. The allocation process helps the management to differentiate between the direct and indirect costs which help the management to get a clear picture of the true cost (Easton, 2010).
- The allocation of cost under this allocation method is very logical and so the information provided by this accounting method has proved to be reliable and correct.
- All the cost that are related to the product in any manner is identified irrespective of whether it is related to the product or the time period. So, this provides management a chance to trace out the incremental costs that has been incurred.
- The cost drivers are considered to be one of the most important components of the costing method. These cost drivers are also known as activity drivers. These cost drivers helps to allocate the cost in a particular time period. Few examples of the activity drivers are machine setups, production orders and power consumed.
As we know, in the current scenario the competition among the corporate are immense as well as diversified. Therefore, it is important for all the companies to enhance all the products produced by them in order to maintain its position in the market (Horngren, 2012). It has become the necessity of every company operating in the market to adopt ABC method in order to compete well with the competitors. The organisation must make comparisons of various value added method at different levels with the cost that are related to the product as it would help the management to take correct decisions. This would help the management to stop the activities which are not very important and add those activities which would increase the efficiency of production. The ABC approach focuses on the activities mainly and not on departments which helps the management to assess the decision making process. There might be certain activities that does not add any value such activities should be avoided. It is important for the management to trace out such activities and eradicate or minimize them because it will have an impact on the effectiveness.
This report clearly stated the significance of the activity-based costing method in taking several decisions in relation to the competitive environment of the market. Also, a basic discussion about the article and the effectiveness of the same in relation to the price setting of the products being sold in the competitive environment have been made. the new and modern techniques used by the activity based costing method outplayed the ineffective and old traditional costing systems because of which it has become one of the major competitors for the process of decision making as a whole (Kim, 2008). Hence, it can be concluded that the application of activity-based costing in the managerial framework of an organization will help to enhance the performance of the company because of the innovative and fresh ideas adopted by it.
It can be clearly analyzed by the report that the main reason behind the adoption of activity-based costing method in such a competitive environment is the innovation action. This can also be understood as the adoption of a new method to get a different viewpoint and help the companies to conduct business with new and fresh techniques. A clear analysis of the activity-based costing system has also helped us to understand the relevance of action research in the organizational frameworks which was further helpful to establish new and fresh Management Accounting theories in the system (Menifield, 2014). Also, by analyzing such articles, it can be clearly stated that that action research can be very helpful to find a new and fresh solution for the researcher which can help him to transform the current system by making several changes in the possibilities and properties of the current environment. It has been also observed that the innovative action research will help to eradicate any kind of restrictions that have been present because of the traditional accounting system by the application of new concept like the activity-based costing which will be much more efficient and effective in this competitive environment. Therefore, it is very important for an organization to implement and modify search new theories of accounting while analyzing the financial data of the organization.
Adoption of New Methods for Decision Making
This report is mostly concentrated on the matters that are associated with the price setting and cost system that is used by an organization in order to fulfil the process of costing by the application of activity-based costing method in the managerial framework of the company. Also, significant discussions have been highlighted which states the benefits of using an alternative costing approach for cost determination in the competitive market which will be very profitable for the organization (Noreen, 2015). It has also been commented about the activity-based costing system that it will help the organization to achieve the goals by using the enhanced costing systems that will help to make particular pricing decisions and profit performance of the organization at the whole. The researches that have been undertaken throughout the article have clearly stated the importance of the cost refinement system in an organization for the purpose of cause determination and setting prices which will further help to gain an informative response from the market. Also, an assessment has been made to analyze whether the activity-based costing can help to modify the prices in relation to the competitor’s plans which is not providing much information. A huge backlash has been observed because of the high dependence on an uninformative response from the markets by the user. The application of activity-based costing played a major role to support the market by giving efficient information over the biased and unconventional information provided by the traditional costing methods. The basic reason behind this can be the application of activity-based costing in the organization filtered out any kind of relevant information present in the documents.
The new innovation theories have been presented in the article which has introduced modern accounting theory is like activity-based costing. Also, a study has been highlighted in relation to the modern accounting theories and the wider target audience who have adopted it with the help of innovation action research. Hence, it can be stated that the use of innovation action research has helped a lot to highlight the theories in relation to the activity-based costing. It can also help to terminate any kind of glucose present in the current systems that are being used in the managerial framework (Nwanji, 2016). Therefore, it can be concluded that by implementing innovation action research enhancement of theories can be made in a professional and experienced manner why the implementation of activity-based costing in the framework.
Conclusion
It has been observed that the most common problem in the regional banks is to manage the portfolios of customers and different products by adopting a cost effective measure. The banking sector always gives huge importance in allocating the costs of the various products and services. A bank will not be able to get a proper view of the profits that it has earned if it does not understand its targets. All the costs whether interest expense or the longstanding methods should be linked to the cost elements (Seal, 2012). This is done in order to add the activity cost to the operational activities that are carried out and then the results are assigned to the various products as well as customers. The banking organisations have very scarce resources and so it is very important to utilise them in the best possible manner. In order to make optimum utilisation of these resources, certain regional banks as well as financial institutions has set up various cost assignment models.
This costing approach not only helps in the identification and allocation of overhead cost but also helps in the identification of labour cost related to some particular activities which helps them to gain immense benefit. It is a major task to allocate costs to the different activities and then calculate the profits derived from the product. The results that are obtained on following this costing approach helps the organisation in taking correct decisions. there are some commercial banks in the United states that has adopted ABC costing because it has helped them to improve the process of collection of data.
The ABC approach has helped the bankers in understanding the various types of course that are required to conduct operations carried out in banks. It has also helped them to explore the various aspects of the new banking sector. We have already discussed that the organisations use this costing method for the allocation of overhead costs. So, we can conclude that it has been proved very useful for those companies that are facing huge competition. It is very difficult to generate higher revenues using scarce resources. However, this costing method has helped the banks in increasing their market share and maximise shareholders wealth.
There are many new banks that has entered in the banking sector which has increased the need of introducing relevant costing methods. This new approach has improved the efficiency of the firm and has also helped in generating higher returns which has further led to increase of shareholders interest. It has also helped to differentiate between products that considered to be attractive and those products that are considered to be unattractive by the customers.
The report has helped to highlight the significance of activity-based costing and its application in the organization to review the pricing decisions in the competitive market. It also reflects the inefficiencies that can be experienced by the organization and terms of biased costing decisions that can be provided by the activity-based costing method. Nevertheless, even after the poor performance of the activity-based costing in an organization, a proper diagnostic solution can be provided to the managers that can help them to earn a profit in the future (White, 2009).
Also in relation to this, the innovation action research can help to shed light on the fact that the use of activity-based costing method will help to introduce a new theory in the world of accounting that will help to remove any kind of drawbacks that are present in the traditional accounting methods. These researches will also allow the organization to implement new ideologies in its managerial framework. Overall, innovative action research has also helped the organization and scholars to function in an enhanced manner by supervising each and every fact with the help of activity-based costing system, thereby helping to maximize the financial performance of the organizations.
Conclusion
Activity based costing is a cost allocation method which has proved to be an effective tool in this competitive market because it has outperformed all the drawbacks of traditional costing. This method not only helps to allocate costs but has also helped to achieve their organisational goals. However, this method is usually not adopted by non manufacturing companies. Manufacturing companies that produces various varieties of products usually adopt this method and attain maximum benefits out of it. There are many arguments against ABC approach also but still it has been proved to be the most effective tool when compared to others. In the modern scenario, most companies prefer using ABC approach because it helps them to gain maximum benefits.
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