Objectives of research
Discuss about the Small-Medium Enterprises’ Responsibilities and Activity Based Costing (ABC) or Traditional Cost Accounting (TCA).
To analyze the effectiveness of using Traditional Cost Accounting (TCA) in Small Medium Enterprises (SMEs)
SMEs are operating under immense pressure to remain relevant in the current competitive world. The efficiency of TCA in SMEs has been diminishing over the years, and slowly ABC taking over (Öker & Ad?güzel, 2016). In TCA, the product costs are assigned by the unit-level drivers only. The TCA is not usually an effective approach since it does not allocate precise overhead costs to the cost objects. It regularly basis its cost allocation on the machine or labor hours and, therefore, it becomes difficult to determine the actual cause as well as the relationship between individual products and indirect costs. It looks at what was spent and performs estimation regarding cost allocation (Öker, & Ad?güzel, 2016). Therefore, the causes of variances are not known since where the cost occurred is not determined. However, despite its disadvantages, it looks at; indirect cost identification and estimation, choosing the cost drivers and its value estimation, and computation and application of overhead rate.
To investigate the effectiveness of using accounting based on activity (ABC) within SMEs
ABC has been identified as an effective approach over the TCA. It splits/ separates overhead into activity cost drivers, thereby creating a more stable and productive assignment of costs. Therefore, this makes ABC a method of choice over the TCA in SMEs operations (Vanshal et al., 2013). A more useful budget planning is achieved as well as efficient service/product pricing. It also helps the managers in making proper decisions regarding competitive strategies and the product mix. The effectiveness of ABC is shown in the fact that it is a process-oriented technique, it uses drivers at several component levels, and it’s founded on the fact that the cost objects consume activities as opposed to the consumption of resources. ABC implementation and usage in SMEs encourages innovation and efficiency in operations through better planning and improved pricing (Foroughi et al., 2017). For instance, it offers more significant support for operational, strategic, and financial decisions and also the manager’s concerns regarding the cost allocation accuracy are alleviated.
To assess benefits of using accounting based on activity (ABC) within SMEs
ABC method has numerous benefits in enhancing the success of the SMEs. As such, it has been adopted by several small- and medium-sized organizations globally (Hall & McPeak, 2011). One of the outstanding advantages is the benefit it confers in the decision-making process in the product mix as well as in overhead management. Its usability has been proven appropriate and beneficial to all operational aspects of every company. ABC also is extra-precise cost-estimation technique as compared to the TCA (Qian & Ben-Arieh, 2008). Managers are in a better position to identify parameters that have no value addition to the activities of the business and hence remove them. The accuracy of ABC in cost estimation has also been validated by Singer & Donoso (2008). It is more evident especially in organizations that are facing higher product diversity. Therefore, ABC is beneficial in cost reduction, performance measurement tool, decision-making particularly on product mix, pricing, and accuracy in data costing.
To investigate the effectiveness of using accounting based on activity (ABC) within SMEs
To assess the limitation of using activity-based accounting (ABC) in SMEs
Although ABC has numerous benefits in the development and success of SMEs, still some disadvantages can be noticed. For instance, despite the fact that straight allocation of overhead costs to products is possible, there remain some overhead costs that require being dispensed using arbitrary volume-based cost driver tools like labor and machine hours (Vanshal et al., 2013). Additionally, cost bases and cost pools increase accelerates the occurrence of errors especially in the determination of product cost. The implementation of ABC as well only works under specific conditions to offer beneficial results. Also, its performance impact still raises concerns since many adopters of the ABC system, abandon some critical implementation aspects. ABC method also is more sophisticated as compared to the TCA systems. As such, its implementation and usage are expensive and not many SMEs can afford and thereby limiting their competitiveness with others (Oseifuah, 2018).
ABC System in Small and Medium Enterprises (SMEs)
The role of SMEs in the development of the national economy has been of great importance. They have a great contribution to the manufacturing organizations output as well as the employment opportunities. To improve their overall performance and competitiveness, SMEs are adopting approaches that give then a good turnover of their resources. As such, ABC is taking over the TCA as it improves the productivity and quality of the company significantly (Rasiah, 2011).
As compared to the TCA, ABC system provides better and accurate information regarding the cost patterns as well as the relationship that exists between the overhead costs and their drivers. The basic concept of ABC system in product costing lies in the fact that there is equality between the product cost and cost incurred in obtaining the raw materials and also the total cost of all the operations involved in the production process. The system makes it clear that although some overhead resources increase as the volume of the products manufactured increase, other overhead resources do not (Rasiah, 2011). Due to the various benefits, it has received much acceptance in several SMEs ranging from the governmental, private, non-profit, profit-oriented, manufacturing and retailing companies. Its adoption is due to advantages that it confers in decision-making such as; improved product mix, product engineering investment, and product pricing.
There are several steps involved in the implementation of ABC system. The approach assigns indirect costs to the products and services of the organization and, thereby it finds the value of every activity taking place in the production process as it assigns a cost to every product by its consumption.
To assess benefits of using accounting based on activity (ABC) within SMEs
Step 1: Activity identification
The initial step involves identification of activities that occur in the organization. After that, they are grouped or assembled in what is generally known as the activity pools. Activity pools also known as activity buckets are the organization’s supportive undertakings that tie with a specific product line. They usually involve the fractional costs of the supporting activities that are assigned to individual products. In this step, also, the organization is inspected to determine the number of operations and resources available (Rasiah, 2011). For instance, machines available, equipment’s, labor, vehicle depreciation, and supporting function machines.
Step 2: Activity analysis
In this step, the main idea is the identification of indirect cost relationships, and also it assigns to the end product a certain percentage of activity directly. Some of the systemic inaccuracies are avoided in this step since the analysis of all the operations are determined. Typically, in the manufacturing process, the activities are divided into two sets. One that forms the system foundation such as resource inspection, machining, and engineering while the other deals with the output process.
Step 3: Assignment of costs
Here the costs are assigned to every activity pool and the total cost calculated. The expenses of each category are determined which relates to the main activities (Dubihlela & Rundora, 2014). For example, for a particular organization, the activity cost of various expense categories could include; the office supplies, utility, salary, and rent. For accurate tracking of all the expenses to the specific activity, the first stage cost drivers require identification for every expense category.
Step 4: Activity rates calculation
The activity rate of each activity is calculated in this step. The overall activity rate is obtained by taking the whole cost of each activity and dividing it by the activity unit expected total.
Step 5: Costs to cost objects allocation
Once identification and precise definition of the activity costs, rates, and pools have been done, then, they are assigned to the cost objects. Objects have been defined as the final results that the customer obtains. The products should possess saleable value that compares with the assigned costs.
Step 6: Preparation and distribution of management reports
Finally, the obtained cost data is arranged coherently and concisely for the sake of process owners and cost objects. The management table prepared shows every activity with its cost per unit. The analysis is critical in organizations as they can make crucial decisions (Tsai et al., 2015) concerning product lines, places to make their sales and validation of the true value of the capital equipment.
To assess the limitation of using activity-based accounting (ABC) in SMEs
TCA as compared to ABC is structural and there is always estimation of cost allocation to a certain extent. The TCA system is usually inaccurate, inflexible, and typically there is no relation between the cost applied to the product. TCA involves the determination of indirect cost, cost drivers selection, the approximation of indirect cost, valuation of cost drivers value, overhead rate computation and application. Rasiah, (2011) noted that, while the ABC looks at the activities done, the TCA looks at the resources that were spent.
The ABC systems have replaced the TCA systems due to various weaknesses they present. For instance, in numerous SMEs, they do not offer non-financial information regarding their operations. Therefore, non-financial information like throughput and defect rates in individual activity cannot be accounted for in the TCA approach (Vanshal et al., 2013). It usually provides irrelevant information on the quality and service providence to the customers. It also uses only one overhead pool where all the costs are not directed into a single product line.
Activity-based costing has received tremendous support in the recent years from several Small- and Medium-sized Enterprises. It has given these businesses an upper hand regarding competition and success as compared to those still using traditional cost accounting due to higher profits obtained. According to Mahal & Hossain, (2015), the ABC offers more precise information regarding the organizational activities leading to the production of higher lots of various sizeable products, frequent changeovers, and high broad mix.
Organizations that have implemented the ABC system run undergoing various risk despite the advantages that it confers. They include;
- Too much effort, time, and money spent during the process of gathering and processing data.
- Remarkably too many details involved.
- A level of exactness is required that is usually time-consuming as well as difficult to attain (Bazrafshan & Karamshahi, 2017).
- The software is expensive
- Insufficient data can occur if there is no detailed record.
References
Bazrafshan, S., & Karamshahi, B. (2017). Examining the disadvantages of activity-based costing (ABC) system and introducing the modern (behavior based costing) (BBC) system. International Journal of Management, Accounting, and Economics, 4(2), 163-177.
Dubihlela, J., & Rundora, R. (2014). Employee Training, Managerial Commitment and The Implementation of Activity Based Costing; Impact On Performance of SMEs. The International Business & Economics Research Journal (Online), 13(1), 27.
Foroughi, A., Kocakulah, M., Stott, A., & Manyoky, L. (2017). Activity-Based Costing: Helping Small and Medium-Sized Firms Achieve a Competitive Edge in the Global Marketplace. Research in Economics and Management, 2(5), 150.
Hall, O. P., & McPeak, C. (2011). Are SMEs ready for ABC? Journal of Accounting and Finance, 11(4), 11-22.
Mahal, I., & Hossain, A. (2015). Activity-Based Costing (ABC)–An Effective Tool for Better Management. Research Journal of Finance and Accounting, 6(4), 66-74.
Öker, F., & Ad?güzel, H. (2016). Time?driven activity?based costing: An implementation in a manufacturing company. Journal of Corporate Accounting & Finance, 27(3), 39-56.
Oseifuah, E. K. (2018). Activity-based costing (ABC) in the public sector: benefits and challenges. Management, 12, 4-2.
Qian, L., & Ben-Arieh, D. (2008). Parametric cost estimation based on activity-based costing: A case study for design and development of rotational parts. International Journal of Production Economics, 113(2), 805-818.
Rasiah, D. (2011). Why Activity Based Costing (ABC) is still lagging behind the traditional costing in Malaysia? Journal of Applied Finance and Banking, 1(1), 83.
Singer, M., & Donoso, P. (2008). Empirical validation of an activity-based optimization system. International Journal of Production Economics, 113(1), 335-345.
Tsai, W. H., Tsaur, T. S., Chou, Y. W., Liu, J. Y., Hsu, J. L., & Hsieh, C. L. (2015). Integrating the activity-based costing system and life-cycle assessment into green decision-making. International Journal of Production Research, 53(2), 451-465.
Vanshal, V., Yadav, T., & Ahirwar, Y. Y. (2013). Options for costing system for small and medium enterprises. International Journal of Innovations in Engineering and Technology.
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