ABC Model and Its Features
Discuss About The Macmillan International Higher Education.
The present report is developed for the purpose of providing relevant information about the use of ABC model in improving the management accounting information provided to the top management team. The report aims to disclose the significant knowledge about the use of ABC model and its significant advantages to the Board of Directors of an ASX listed company. The company selected in this context is Wesfarmers Pty Ltd, a leading retiling company of Australia traded on the stock exchange. The report incorporates the detailed information regarding the ABC model and its features and how it can be aligned with the selected company current goals and strategies. Also, it has provided necessary recommendations to the selected company regarding the implementation of ABC cost accounting model. The report also provides suggestion about the adoption of other management accounting tool besides ABC that is suitable to be applied by the company.
Activity based costing model refers to powerful management tool used by the companies to produce accurate and cost effective cost structure for their product pricing. It helps in cost distortion and leads to sustainable development of the organization that is very important in the competitive era of globalization and highly competitive business environment. The role of cost and management accounting is very important for both manufacturing as well as for service industries. The cost and management accounting helps in allocating the costs occurred in cost of goods sold to internal and external cost structure. It provides better reporting structure and provides relevant information to help the managers in making the useful decisions. It can be said that through use of activity based costing model management can produce relevant information that is required for the planning, control and performance measurement purpose. The basic cost management accounting principle is that all the cost occurred for the production purpose has been absorbed in the cost object. The costs that are easily traceable in the products are referred to as direct cost and costs that are not easily traceable are referred as indirect cost. In traditional costing system direct and indirect costs are allocated using the single recovery rate while in activity based costing model both costs are allocated using the multiple recovery rates depending upon the activity the cost has been occurred (Lucey and Lucey, 2003).
Activity based costing models is the most used costing approach that precisely allocate the overhead costs to those products that actually uses it. The main purpose of applying the activity based costing model is targeted reduction in overhead costs. Activity based costing is based on the two stage procedure to allocate the overhead costs. In first stage all the important activities are identified related to the production and the total production costs are aligned to activity on the basis of resources used by each activity. For this purpose activity cost pool statement has been prepared in stage one and in second stage all the cost drivers appropriate to each cost pool are identified for calculating cost rate per unit of cost driver. Through using the cost rate per cost driver all the overhead cost are allocated to each product line (Anderson and Young, 2012).
Features of Activity Based Costing Model
There are numerous advantages of the activity based costing as it helps to reduce the production costs through providing the purposeful information and other opportunities available to reduce the production cost. Management can make changes to the activities that consume more cost as it was allocated to it. It was not possible in case of traditional costing approach. Through use of activity based costing one can identified the value added activities and non value added activities, so that decisions can be made regarding the termination of an activity on the basis of some meaningful reason. The main disadvantages of the activity based costing system is that it is not suitable for small entities as it requires huge level of investment before making it fully workable (Collis, 2015).
- Activity based costing lays emphasis on different costs and for different purposes and it identifies only those costs that are relevant for the decisions needed to identified the overall costs of a product. It means it allocates only those costs to the products that are relevant or applied while manufacturing of the particular product. In this way, all those costs that lead to undue increase of product cost are ignored and also decision regarding the make or buy of products can be taken on reasonable basis.
- Activity based costing model provides important decisions regarding the distinction between the cost behavior patterns. The main distinction between the cost behavior patterns are related to volume, time and events (Anderson and Young, 2012).
- Activity based costing model uses activities identified during the production of products to allocate the overhead costs to each product line. Cost driver of each activity helps to calculate the cost rate of each activity so that it can be allocated to the products reasonably.
- Activity based costing model proves to be most effective model to reduce the cost and to align the cost control procedure for each activity
- It helps in rectifying the inaccurate cost information that is generated through use traditional costing method (Collis, 2015).
Wesfarmers Ltd, a supermarket giant in Australia, is involved since its establishment is involved in retailing operations. The diverse business operations of the company include supermarkets, liquor, hotels, convenience stores, home improvement, office supplies, department stores and industrial divisions. The major objective of the company is to provide high returns to shareholders and also aims to achieve it by adequately satisfying the customer expectations. Also, it aims to enhance the employee commitment to work by providing safe and healthy workplace environment that motivates them to perform better and achieve organizational goals and objectives. The strategic mission of the company is to promote the long-term growth of the shareholders by development of strong core values and value-creating strategies (Wesfarmers Pty Ltd, 2016).
Wesfarmers daily business operations are guided by the following strategies:
- Promoting the strengthening of its present business by achieving operational excellence and adequately meeting the needs of the customers
- Promoting the growth opportunities through seeking entrepreneurial initiative
- Regular renewal of its portfolio by the use of value-adding transactions
- Carrying out its operations by the use of long-term management for promoting sustainable growth of the business operations (The Wesfarmers Way, 2018).
Wesfarmers strategic initiative is to achieve operational excellence by realizing its aims and objectives. The company can achieve this by the use of ABC costing method for improving its profitability through better capacity utilization and increased process efficiency. The operational excellence can be achieved by Wesfarmers in the retailing sector by attaining efficiency in supply chain systems with the use of ABC costing. The efficiency of the supply chain systems with the use of ABC costing can be improved significantly by the Wesfarmers and therefore attaining its strategic objective of improving the operational efficiency. The efficiency of the retail supply chain can be improved significantly by the company by gaining an appropriate understanding of the impact of retailer costs on channel. Also, it enables in developing cost models by gaining an appropriate understanding of the cost involved in various operational activities of the company. The performance of the supply chain can be significantly improved by creation of the ABC models that combine data from the manufacturing operations with the warehouse and store-level data (Kaplan and Anderson, 2007).
Explanation of the ABC Model Aligning with the Current Goals and Strategies of the Company
Wesfarmers is involved in manufacturing of different products and services and therefore it is essential for the company to identify the actual costs incurred in production of its different products and services. This is possible by the use of ABC costing model as it enables the business activities to be segregated into individual components such as suppliers, issuing purchase orders and maintaining the database. The cost identification of different components will enable the business mangers to accurately identify the cost involved in production of its various products and services. Also, it will facilitate the operational managers of the company to identify the wasteful activities that should be eliminated to reduce the cost involved in production of its various retailing products. This would significantly help the company in improving its profitability and attaining its strategic objectives of creating long-term value for the stakeholders (Ayers and Odegaard, 2007).
ABC model can prove to be largely effective for Wesfarmers to bring transparency in the value chain through identification of the improvement required. Wesfarmers can easily resolve the problem of assigning its large overhead costs being involved in carrying out different business operations on the individual basis. Thus, it can be said that the application of ABC costing model proves to be largely beneficial for Wesfarmers to assess the profitability realized for its specific product category. Also, it will help in adjusting the retail costs as per the different type of its merchandise products and services. The accurate identification of the retail costs will help in attaining cost reduction through process improvement and improving its profitability position in the long-term (Kaplan and Anderson, 2007).
Wesfarmers is recommended to adopt the use of following steps for implementation of ABC model:
- The first step involves identification of the need for cost allocation in its various operational departments. This is followed by identification of the cost driver for each of the support department cost pool on the basis of cause and effect relationships.
- This is followed by the application of a suitable method for allocation of the support department costs to the production departments. The methods that can be applied are direct method, step-down method or reciprocal method. The accurate allocation of the support costs on the basis of the operational departments will help in development of new cost pools by the operational manager of the company. This is followed by accurate allocation of costs as per the units of goods or services (Lucey and Lucey, 2003).
In addition to ABC costing model, Wesfarmers is also recommended to adopt the use of absorption costing for examining the final costs incurred in the production of the final products that incorporates both the fixed and variable costs. Thus, absorption costing method will help the company to gather the accounting data realized to the fixed expenses incurred for the production of products and services. The use of absorption cost proves to be largely effective in identifying both the direct and indirectly related costs of manufacturing. This includes costs such as direct labor, direct materials, variable manufacturing costs, variable sales cost and fixed selling costs. Thus, the use of such method of cost accounting will enable the business managers of Wesfarmers to identify both fixed and variable costs and develop consecutive strategies for minimizing its overall cost of production by elimination of non-value adding services (Warren and Reeve, 2016).
Conclusion
The report concludes that ABC model of costing is highly utilized by the business organization to achieve competitive advantage on the basis of reducing their operational costs as it contributes in elimination of non-value adding operational processes. Wesfarmers can effectively attain its corporate strategies by the use of ABC costing model as it will drive the company in achieving operational excellence.
References
Anderson, S and Young, M. 2012. Implementing Management Innovations: Lessons Learned From Activity Based Costing in the U.S. Automobile Industry. Springer Science & Business Media.
Ayers, J. and Odegaard, M. 2007. Know the ABCs of Retail Supply Chain Costs. [Online]. Available at: https://www.supplychainquarterly.com/print/scq200702book/ [Accessed on: 24 May 2018].
Collis, J. 2015. Management Accounting. Macmillan International Higher Education.
Kaplan, R. and Anderson, S. 2007. Retail Solutions: Time-Driven Activity-Based Costing. [Online]. Available at: https://www.retailitinsights.com/doc/retail-solutions-time-driven-activity-based-c-0001 [Accessed on: 24 May 2018].
Kaplan, R. and Anderson, S. 2007. Time-Driven Activity-Based Costing: A Simpler and More Powerful Path to Higher Profits. Harvard Business Press.
Lucey, T. and Lucey, T. 2003. Management Accounting. Cengage Learning EMEA.
The Wesfarmers Way. 2018. [Online]. Available at: https://www.wesfarmers.com.au/who-we-are/the-wesfarmers-way [Accessed on: 24 May 2018].
Warren, C and Reeve, J. 2016. Managerial Accounting. Cengage Learning.
Wesfarmers Pty Ltd. 2016. Annual Report. [Online]. Available at: https://www.wesfarmers.com.au/docs/default-source/reports/2016-annual-report.pdf?sfvrsn=4 [Accessed on: 24 May 2018].
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