CHAPTER -II
48
AN OVERVIEW -ACTIVITY BASED COSTING
This chapter deals with an overview of application of ABC system of costing.
It also covers the conceptual framework of ABC analysis, process of activity
based costing, logic and assumptions, models of ABC, traditional approaches
of costing.
2.1 Volume Based Costing
The volume based costing of products fundamentally utilize a system
whereby the total costs to produce a number of products are divided amongst
the various products. By making use of the traditional costing system, it thus
means that all the costs incurred have to be allocated to one or other product.
Volume based costing systems utilizes a single, volume-based cost driver. In
most cases this type of costing system assigns the overhead costs to products
on the basis of their relative usage of direct labour. For this reason volume
based cost systems often report inaccurate product costs. Each time a unit of
product is manufactured, it is assumed that cost is incurred. This assumption
makes sense for certain direct costs. The assumption does not work for
activities that are not performed directly on the product units. The problem
with this approach is that for most overhead activities, the proportions of the
activity actually consumed by a specific product, does not universally
correspond with a single cost driver. This holds true for most modern
companies where products are produced by a combination of manpower and
49
technology. The volume based cost accounting model employs a volumebased driver, such as direct labour hours or machine hours for the assignment
of all manufacturing overhead costs and ends up with a cost of goods sold
based on absorption costing and includes only product costs as defined in
financial accounting. Fundamentally, volume based costing systems try to
assign cost directly to products, rather than to activities first and then from the
activities to product units. The typical cost report gives information on what is
spent, but not why it is spent. When overhead costs are cut in order to reduce
total costs it is the symptoms that are treated and not the cause. In many cases
the cutting of overheads is more likely to lead to a reduction in the quality of
the products than to the long term reduction of the cost. The separation of
traceable and fixed cost is crucial when doing producted reporting of
costs. This is important, since traceable fixed costs are booked to departments
while common fixed costs are pooled in the traditional costing system
approach. The guidelines suggested for using the traditional approach is to
use a broad, general guideline in determining which costs are traceable. This
approach has obvious inherent inaccuracies. The volume based costing
systems only have one or a few indirect cost pools for each department.
Product costs are likely distorted when a firm uses a volume-based rate
if the plant has more than one activity in its operations and not all activities
consume overhead in the same proportion. The more diverse the product
mixes of the plant are in volume, sizes, manufacturing processes, or product
complexities, the greater the cost distortions are likely to be in using a volume50
based rate. Under costing a product may appear to have increased the
reported profit the product earned (assuming the firm did not lower its selling
price because of the reported lower product cost). However, the increased
profit is, at best, a twist in truth. Costs of the product not charged to the
product itself are borne by other products of the firm. Worse, under costing a
product may result in managers erroneously believing the product to be more
profitable than other products and shifting the limited resource the firm has
into manufacturing, promotion, and sales of the product when, in fact, other
products are more profitable to the firm. Severe cost distortions may lead
firms not to drop unprofitable products because the cost data show these
products are profitable.
Over costing does not increase revenues. A firm can increase the selling price
of a product, thereby increasing the total revenue from the product only if the
market allows. Increases in the selling price of a product without experiencing
noticeable decrease in the sales quantity of the product is likely an indication
that the product was not priced properly, which might be a result of under
costing of the product.
Further, over costing a product is likely accompanied by under costing
of the firm’s other products and, as a result, under pricing of one or more of
the firm’s other products. When a firm sets a high selling price that is a result
of over costing, competitors also are likely to enter the market and take away
the firm’s market share. A firm also may drop or de-emphasize an erroneously
51
over costed product when it erroneously believes the product is either
unprofitable or having a low-margin. A product-costing system that uses a
single volume-based cost driver is likely to over cost high-volume products
because high-volume products do not consume support resources in
proportion to their production volumes. As a result, a product-costing system
that uses a single volume-based cost driver often over costs high-volume
products or services and under costs low-volume products or services. The
cross-subsidizations of low-volume products by high-volume products is
likely to lead the firm not to price its products properly. This may also
decrease the profits of the firm and reduce management’s confidence in the
product cost predictions. Poor pricing can lead a firm to promote less
profitable products while not spending sufficient resources on more profitable
items.
In the recent past, there is a shift from conventional business to
business competition to drastic increase in competition in domestic and
foreign markets with responsive innovative information technology, followed
by changes in the cost of the products (combined associated cost), producers of
goods and services need to search and a better understand the concept of
accounting system with regard to fast and accurate speed in information
system. However, in the past decade manufacturers were not producing
variety of products. Labour (direct labour), is the main ingredient in the
product cost structure. But, currently due to increased customer demand for
variety of products, decreased of labour rate and wages and increasing of
52
overheads, allocation of overheads cost of the product and services is difficult
to calculate. Therefore, companies should adopt new methods for calculating
the cost and a global world view approach to such overheads system
calculation. Currently, different improved methods of allocating these
overhead are available.
2.2 Concept of Activity-based Costing
Turney (1996) defined ABC as a method of measuring the cost and
performance of activities and cost objects. It assigns cost to activities based on
their use of resources and assigns cost-to-cost objects based on their use of
activities. Based on this definition, ABC is more than product costing; it
provides a means to measure activity performance in order to determine how
well work is done in that activity. He also defined ABM as a discipline that
focuses on the management of activities as the means to continuously improve
the value received by customers and the profit earned by providing this value.
This discipline includes cost driver analysis, activity analysis and performance
analysis. Thus, the goal of ABM is to improve customer value, which
eventually improves the profit.
Customer value is the difference between what a customer receives (customer
realization) and what the customer gives in return (customer sacrifice). A
customer receives a complete range of tangible and intangible benefits from a
purchased product. These benefits include product features, quality, service,
reputation and brand name. Customer sacrifice includes the cost of purchasing
53
the product, the time and effort spent acquiring and learning to use the
product and the costs of using, maintaining and disposing of the product
(Hansen , Mowen & Shank 2006).
Swenson (1995) defined ABC as an information system that assists with
decision making—essentially a decision-support system. While he defined
ABC broadly to include ABM, he claimed that some researchers prefer to use
the term ABM when ABC information is used to support operating decisions.
Roberts and Silvester (1996) point out that ABC and ABM are sometimes used
interchangeably by researchers. They referred to ABC as the actual technique
for determining the costs of activities and the outputs that those activities
produce. They referred to ABM as the fundamental management philosophy
that focuses on the planning, execution and measurement of activities as the
key to competitive advantage. In turn, Hicks (1999) described ABC as a
powerful management concept that can be adopted and used by any
organization to gain a competitive advantage through greater understanding
of product or service costs, process costs and the organization’s overall cost
behavior. These definitions commonly describe ABC/ABM as a method that
can be used to gain competitive advantage. Competitive advantage is creating
better customer value for the same or lower cost than the best offer of the
competitors or creating equivalent value for lower cost than that offered by
competitors (Hansen, Mowen & Shank 2006). Plowman (2001) described ABC as
a means of establishing product costs more accurately. He described ABM as a
means of enhancing profitability by focusing on a process view of the business
54
and a deeper understanding of product, channel and customer profitability.
Generally speaking, ABC systems refer to the method used to determine the
cost of activity and cost objects. In contrast, ABM systems refer to the use of
ABC information in making strategic and operational decisions. Hence, the
researcher intends to use the terms ABC and ABM interchangeably to describe
a management information system that can be used by managers to support
strategic and operational decisions.
Activity-based Costing system basically differs from other costing system in
the way it gives stress on indirect resources demanded by the product. It
emphasizes the need to obtain a better understanding of cost behavior and
thus ascertain what causes the overhead costs. After the collection of accurate
data on direct material, direct labour and direct expanses under the system the
next step is to examine the demands made by particular products on the
indirect resources on the basis of the following three rules (Cooper and
Kaplan, 1998).
1. Focus on expensive resources.
2. Emphasis on resources whose consumption varies significantly by
product or product type; look for diversity.
3. Focus on resources whose demand patterns are uncorrelated with
traditional allocation measures like direct materials, direct labour and
processing time etc.
The logic behind these three rules of ABC is that it is the activity which causes
costs, not the products and it is the product which consumes activities in turn.
55
Hence, while computing the cost of a product due consideration is given to
those factors that drive cost. In fact, analysis of resources consumption by the
products with the help of cost driver is the essence of activity based costing.
2.3 Process of Activity-based Costing
Based on the above logic of understanding the cost of activities and their
relationship to the products the activity based costing traces costs to the
products. Cooper (1989) describes the whole process by incorporating the
following process.
1. Aggregating actions into activities
2. Reporting the cost of activities
3. Selecting the first stage allocation bases
4. Identifying the activity centers
5. Selecting second stage cost drivers
It is beneficial, because the information that is available about the
consumption of the resources by the centre is often different from that
available by product. For instance, set up personnel might record their spent
in each centre but not on each product. Using ‘set up hours in first stage
56
permits the system, to capture some of the differences in resource
consumption, by the centers even though the information is not available at
the product level.
2.5 Activity-based Costing: The Logic and Assumptions
There are a set of logics that guide the mechanism of Activity-based Costing.
These logics are highlighted as below:
1. Resources consumption: activities directly consume resources. This
logic is quite different from that of conventional costing where costs are
traced to the products under the notion that product consumes
resources. Conventional allocation bases thus measure only attributes
of the individual product item. The number of direct labour or machine
hours or material in rupees consumed. Under ABC, the logic in contrast
is that resources are consumed to perform some activities and hence
these activities are the focus of costing process. Resources are therefore,
traced to activities. Products consume the activities in turn. Hence, the
activities are traced to the products on the basis may be volume related
or transaction related. Thus, the costing element is no longer the
product but those elements the transaction affects. Under ABC system,
the unit cost of a product is determined by dividing the cost of an
activity by the number of units in the activity.
2. Management focus: managers do not manage costs; they manage the
activities that cause costs. This logic has a lot of managerial
considerations. Managers basically decide and control the activities
57
demanded by the products and hence accounting information need to
be provided to them in order to facilitate the activity management. As
pointed out earlier, activities demand resources consumption that is
simply measured through costs. When the focus is on costs as it is in a
typical budgetary control system under conventional management
accounting, the managers are handicapped to understand the cause and
effect relationship between the costs and resources. Under the ABC
costing system, the focus of the management is taken care of by
providing information regarding the cost of resources supplied and the
cost of resources used. ABC system brings activity measures as a bridge
in between the
product
cost
and resources.
A
micro
level
understanding of the intermediary transformations has a lot of strategic
managerial significance (Johnson and Kaplan, 1987) particularly in
efficient and effective resource utilization through creative value
adding process. Moreover, this logic causes a shift in managerial
attention from “spending the resources” to “efficient consumption of
resources”. This assumption is well supported by the experiences
drawn from Weyerhaeuser’s’ charge-back system where managers
could control the use of resources that caused corporate overhead costs
and be held responsible for that. The importance of such an assumption
can be felt in the light of most perplexing insidious tendency for
corporate overhead cost to rise steadily even though it is considered a
fixed cost.
58
Assumptions of Activity-based Costing
Although Activity-based Cost systems often provide better product cost data
than conventional VBC system, they are based on a number of assumptions
that should be evaluated before ABC costs are considered superior. According
to Roth and Borthick, 1991) two assumptions underlying ABC are:
1. The costs in each cost pool are driven by homogeneous activities.
2. The costs in each cost pool are strictly proportional to the activity.
The first assumption, homogeneity, means that the cost in each cost pool is
driven by a single activity or by highly correlated activities. The second
assumption, proportionality states that all costs in the cost pool vary
proportionally with the changes in activity level. Costs which are subject to a
non-linier function violate this proportionality assumption. But, in practice
little violation is accepted because of cost effectiveness of the system.
2.6 Activity-Based Cost Model
Determining the best product mix of a company correctly is an important
requirement to increase the profitability of a company. To make the right
decisions, management needs more accurate information about the optimal
product mix and the restrictive bottlenecks of a company. ABC, together with
the theory of constraints (TOC) philosophy and mathematical programming,
can provide management with more accurate information about the optimal
product mix of a company and can help to identify the bottlenecks that should
be focused on to improve the system.
59
Based on the above logics and assumptions activity based total cost of
production is computed as the sum of the cost of all activities performed.
These cost vary with activities performed at different levels of production
organization. The cost behaviour under ABC procedures a more complex cost
function in a factory as compared to that under conventional product costing.
The cost function is assumed is stated a follows:
C= vU + bB + pP + S
Where,
C = Total cost
v = per unit variable cost
U = Number of units produced
b = per batch variable cost
B = Number of batches produced
p = per product line variable cost
P = Number of product lines
S = All other costs that do not vary with some activity measures (Fixed).
The cost function recognizes that varying costs are due to more than just
changes in quantity of outputs (U). Costs also vary with the number of batches
and the number of product lines. The above cost equation as compared to
traditionally followed under marginal costing (Total cost = variable cost per
unit x quantity produced + fixed costs) has more explanatory variable under
60
the assumption that additional variable correctly capture how cost vary in a
particular factory under study (Zimmerman, 1995). The notable difference in
this cost model is that the so called fixed cost under marginal costing is broken
into three parts; part that varies with batch level activities and part that does
not vary with any activity (fixed). Empirically it has been found that the third
part as stated above constitutes a very small percentage of the total cost
(Cooper and Kaplan, 1998). Thus, the cost model under ABC is more
explanatory in nature as compared to the conventional cost function under
marginal costing.
2.7 Cost Drivers: Key to Activity-Based Costing
Cost drivers are technically defined as those activities or transactions that are
significant determinants of costs. ABC relates the overhead costs to the forces
behind them (activities or transactions) because the tracing of overhead costs
to the products requires the cost behavior to be well understood and for the
purpose, the appropriate cost drivers, better to say the dictators of cost
behviour must be identified. Kaplan and Cooper, 1987) claim that traditional
distinction between fixed cost variable and variable costs does not enough
information to design a cost system. They advocate that variable cost should
be analyzed between short term and long term costs. Short term variable costs
are labeled as variable costs under conventional cost systems vary with
measures of activity but not instantaneously. On the basis on this analysis they
classify the cost drivers into the following two categories (Cooper and Kaplan,
1988).
61
1. Volume based costs drivers
2. Transaction based cost drivers.
The above mentioned costs drivers are not independent but they are
determine by the number of cost drivers. Accordingly of a single cost driver
depends on the factors include:
(i) Product activity
(ii) Relative cost of the activities
(iii)
Volume diversity, etc.
The goal of ABC is to improve the accuracy of product costs and provide a
means for the improved management of process and support activities. It is
part of a process of continuous improvement aimed at improving the value
received by the customer and enhancing profitability by providing this value.
It is worth noting that manufacturing a product or serving a customer is
constrained by the desirable level of profits. A firm would discontinue
manufacturing unprofitable products or serving unprofitable customers. In
this regard, management should focus on the manufacturing costs in making
their product decisions. Customer service costs can burden product costs,
causing the product to be unprofitable. ABC systems separate product-driven
costs from customer-driven costs. Product-driven costs are the costs required
to manufacture a product. These costs include design, procurement, quality
control and engineering; in contrast, customer-driven costs are the costs of
delivering, serving and supporting customers and markets. These costs
include distribution, research and development (R&D) and customer orders.
62
Thus, ABC helps managers to determine the loading between product-driven
and customer-driven costs. This analysis will allow management to
discontinue supporting unprofitable products, customers or markets.
In a rigorous business environment, manufacturing and supply services have
become very hard to maintain satisfactory returns or profits. Therefore, the
role of cost estimation for products and services has become more critical.
Before the modern business management times, accounting was being just
used to record the cost of products and/or services. However, the important
role of cost estimation and cost information appeared after the advent of
modern business management techniques. This is especially because the
traditional cost systems are known to distort the cost information by using
traditional overhead allocation methods. However, decision makers, assuming
information is relevant, prefer more accurate product cost information to less.
The best method so far is ABC system which is related to manufacturing
overhead cost. The customer driven environment of today’s manufacturing
systems and the competitive pressure of the global economy force
manufacturing services and organizations to become more ^exible, integrated
and highly automated in order to increase their productivity at reduced costs.
But it is impossible to sustain competitiveness without an accurate cost
calculation mechanism. The rapid advancement of enormously expanding
information technologies and vigorous global competition have caused the
irrelevance of conventional management accounting systems (MAS) in
63
providing useful information to assist management’s decision making,
planning and control in both service and manufacturing organizations.
2.8 Relevance of ABC System
The Activity-Based Costing system as one of the best costing systems was
introduced by two researchers of the Harvard University named Robert S.
Kaplan and Robin Cooper for the first time. The above system makes the
strategic decision like costing the products and determining the optimized
component possible by the correct measurement of the cost of costing objects.
Further, it provides appropriate management by representing the useful nonfinancial information associated to organization’s process and gives numerous
guidelines in order to improving the performance of organization activities
(Osmani and Yousefian, 2000).
In manufacturing companies, marketing, selling, distribution,
service research and development and general administration functions have
become more significant expense categories than in the past. Conventional
cost accounting systems, which emphasize inventory valuation, have
neglected the huge investments and expenses in an organization’s service
functions. Again, conventional cost system cannot accurately assign the costs
of non-volume-related overhead activities. Assigning overhead costs by using
only volume as a basis can supply management with an incorrect picture of
how costs are established. Similarly, products cost can be distributed if the
non-volume related overhead costs are significant proportion of total
overhead costs. The solution to this problem in service firms, as well as in
64
manufacturing is to implement activity based cost management (Hussain &
Gunasekaran, 2001).
Research works that have been carried out on the activity-based costing
(ABC) system in respect of service firms so far are scanty to some extent. The
main focus has been on manufacturing firms, even though the use of ABC in
manufacturing firms is not common, most of the firms in this sector stick unto
traditional cost accounting system (Kock 1995; & Hussain and Gunasekaran,
2001). ABC can be defined as a method of costing activities that are necessary
for the production of products or services (i.e. activities being undertaken)
(Dandago, 2003). According to Turney, ABC is a method of measuring the cost
and performance of activities and cost objects. Hence, the system assigns cost
to activities based on their use of resources, and assigns cost to objects based
on their use of activities.Furthermore; ABC was described as a full absorption
costing method that gain more and more ground than conventional methods,
due to more correct cost assessments and superb tracing of the costs
(Emblemgrag, 2001). ABC was also defined (Drive, 2001) as a system that
allows organizations to track the cost associated with activities performed to
produced products or to deliver services.ABC can be a powerful tool for
industrial decision makers (Lere, 2000). Global competition and rapid
advancement of information and communication technology have made the
irrelevance of conventional management accounting system in providing
useful information for managerial decision making, in both service and
manufacturing
organizations
(Hussain
65
&
Gunasekaran,
2001).
The
shortcomings of traditional costing system, in terms of validity, accuracy,
consistency and relevance, increased the need for modern management
accounting system, hence, ABC can be used as a tool for planning, control and
decision making in service management.
2.9 ABC and Cost Allocation
The assignment of costs to products, customers, or other cost objects has
always been a thorny issue. For external reporting, production costs must be
assigned to products for both income and asset reporting purposes. For
operational cost control, strategic decision making, and performance
measurement purposes, however, many organizations also capture and assign
costs from the other functions in the internal value chain. What methods are
used to measure costs and profits across the value chain, and does their usage
vary by function? We identified the most frequently used types of methods as:
•
Actual costing,
•
Normal costing,
•
Standard costing, and
•
Activity-based costing.
2.10 Activity Based Costing as a Catalyst
Performance management has become the key driver for profitable growth of
organizations. Corporate Performance Management (CPM) comprises all
processes, methodologies, metrics and systems needed to measure and
manage the performance of an organization. It works best in a performance
driven culture and needs to adapt to the specifics of the organization. An
66
efficient CPM empowers executives with necessary information for
appropriate decision making. It creates focus on the business, processes,
performances, profits and customers. It is a management process which
effectively links strategy, measurement and operational processes to the end of
creating shareholder value. An effective CPM entails developing a framework
where corporate performance management is built on a process framework
and facilitates true cost and profitability insights. To succeed in an
increasingly
measurement
competitive
system,
it
global
should
market,
also
besides
have
having
continuous
an
efficient
profitability
improvement plan. To achieve this, a company has to know the cost of its
entire economic chain and has to work with others in the chain to manage cost
and maximize profitability.
67
Chart 2.1
Source: CAM-I
Activity Based Costing is a method of determining cost for an activity thereby
enabling process costing. It assigns cost to activities based on the use of their
resources and assigns cost to cost objects (product/customer/channels) based
on their use of activities. Activity Based costing methodology helps to analyze
not only the product profitability but also customer and channel profitability.
These are not possible in traditional costing. Activity Based Costing enables to
find true cost. Activity Based Costing increases the accuracy of cost
information by linking overhead and other indirect costs to products or
customer products more precisely. Moreover, Activity Based Costing analysis
will provide process cost measures that, along with quality and cycle time
measurement will enable an organization to become truly a Total Quality
68
Management company. Activity Based Costing is a catalyst for an effective
CPM.
2.11 Time Driven Activity Based Costing
Time Driven ABC simplifies Activity Based Costing by removing the need for
time consuming interviews and employee surveys that are prone to error and
expensive to maintain. Time Driven Activity Based Costing needs only two
parameters;
1.
The cost of supplying resources to activities and
2.
The time it takes to carry out activities.
In order to do this Time Driven ABC uses estimates or calculations of how
much time it takes to carry out an activity.
Cost and time equations: For many Manufacturing Companies 'average' and
'approximate' times are adequate for their product costing calculations, but
for companies with a high investment in plant and equipment, accurate times
are needed as activity, process and manufacturing costs represent a high
percentage of the cost of their products. Cost and time equations are
therefore a key feature of Time Driven ABC as they enable companies to
quickly and accurately calculate the time needed to complete an activity.
They also mean that fewer people are needed to set up and maintain the
company's cost models, so less time is spent generating data and more time is
spent using it.
Available Capacity: Time Driven ABC has a concept of 'available capacity’.
Because this takes idle and un-used activity time into account, it takes a
69
realistic approach to costing that enables you to model the complexity of real
operations and accurately assign costs to products in a way that is in line
with the way in which the activities are consumed. As a consequence, a key
differentiator between conventional Activity Based Costing and Time Driven
ABC is that excess capacity costs are not automatically assigned to products.
Product costs are therefore not distorted by automatically burdening them
with the cost of unused capacity. Time Driven ABC has many advantages
over conventional Activity Based Costing and Cost Accounting methods and
it delivers many benefits, especially when it is combined with the type of
cost-pull consumption methods used by SBM’s Activity Based Process
Model. Like Time Driven ABC, SBM's Activity Based Process Model needs
only 2 parameters, the cost or price of supplying a resource and the time or
quantity in which the resource is consumed.
2.12 Activity Based Costing in Various Sectors
(i) ABC in Electricity Industry
In a deregulated context, the competition between electricity or gas suppliers
is savage. Indeed, with raw materials where nothing, or almost nothing, is
applied in term of transformation, suppliers have for main levers of
diversification their price structure which is basically based on a
mathematical modeling approach. To make their customers’ portfolios grow,
those suppliers can basically use market characteristics commonly shared by
all of them. That’s why, after a few years of market opening, the suppliers
70
have to find other levers to provide competitive prices: the costs used to
make the pricing can be optimized for many suppliers by following an
analytic approach based on the analytical accounting. The main objective that
a supplier should stand is to optimize the costs of the activities used to
provide customers with products and services. In this context and since IT is
now closely linked to the business activities, it becomes possible to propose
the suppliers an approach using the analytical accounting figures to calculate
faithfully the costs of their products and services. Several methodological
approaches (e.g. Balanced Scorecard, Activity Based Costing / Activity Based
Management, UVA) can be applied to reach such objectives of costs
optimization without deterioration of the quality and the performance of the
processes. Energy suppliers therefore could take advantage from an Activity
Based Costing (ABC) and Activity Based Management (ABM) methodology
by following a rigorous analytical approach that could be designed.
(ii) ABC in Banking Sector
The Activity-based costing (ABC) is a completely new corporate cost control
theory and approach that started extensively in the western countries in the
end of 1980’s and was first applied by the advanced manufacturers. It
establishes
the
basis
for
business
process
reengineering
through
distinguishing value-added activities and non-value-added activities. Based
on the cost driver of every activity, ABC can overcome many defects in the
conventional cost accounting, provide plenty of relevant and accurate cost
information to help managers implement the strategic management and seek
71
for sustainable development opportunity.ABC has been adopted by more
and more international commercial bank such as CITI Bank, etc. In the
commercial bank, it is not such a success to apply the ABC as the cost
management. The reason lies in the fact that most of businesses are not
modernized and there is still a lack of some coordination in the management
work, so they are not completely qualified for the application of ABC. Based
on the study of application of ABC in Bank of China, the article analyses the
differences between the conventional cost approach and ABC on cost analysis
and management, inquire into how to raise the core competitiveness of
domestic commercial bank.
(iii) ABC in Telecom Sector
Activity Based Costing (ABC) has been discussed widely in industry in the
past five years as an alternative to or improvement of previous costing
practices. In most full (or absorption) costing systems, overhead has been
allocated by adding pre-calculated percentage charges to the direct costs. To
applying for ABC, telecommunication networks have to be standardized,
flexible, and value -added chain. Also cost is measurable and homogeneous in
each process step. The activity in telecommunication network can be process
steps and switching is a typical process. For example, a long distance call
passes by several switching processes. In this case, we can calculate cost per
switching following to call time and distance used by subscriber. In the central
process steps in telecommunication network, cost varies according to traffic. In
the access process, access is getting shorter by multiplexing and switching
72
decentralization and expense becomes to decrease, while it will be happened
the additional cost with the demand of the increase of access capacity. Call
consists of switching, connection before call, and call connection. In this
operating level, cost driver is the number of switching (or CPU process time)
in switching process and the time to call in channel and transmission process
respectively. Applying procedure of ABC in Telecommunication Network is
as following. First step, organizing systems to measure labour hour, varied
statistical data, and production cost occurred in the process. Second step is
recognizing cost driver in each process. Third step, aims at separating the nontraffic sensitive cost (NTS) with the traffic sensitive cost (TS) in each process of
production activity. Fourth step, coding in product unit and beginning to
measure and record statistical data to separate direct cost based on activities.
Fifth step, allocating indirect cost following to allocation standard based on
cost driver analysis.
(iv) ABC in Health Care Sector
Healthcare organizations use cost accounting to estimate the unit cost of
services they provide. Such information helps establish a realistic budget;
prices, identify inefficiencies and project the effect that changes in demand
would have on resource requirement. The processes involved in the
production of a labouratory test result include procurement of the sample,
logistical services, administrative procedures, performance
procedure,
professional
consultation
and
oversight,
of testing
rendering
and
administering an account and information technology and communication
73
cost. Activity Based Costing (ABC) began appearing as a costing methodology
in industries other than healthcare in the 1990’s. Since then ABC has continued
to evolve, now encompassing Time-Driven ABC and Activity-Based
Management (ABM). Many healthcare executives continue to ask how ABC
can be applied in healthcare and how it relates to existing costing methods.
Some hope it can offer a breakthrough or at least advantages over current
methods, which are perceived variously as inaccurate or too costly to build
and maintain. In Canada, spending on health care has come under increased
scrutiny. In times of fiscal restraint, there is a constant pressure to effectively
manage costs. Recent federal fiscal reforms include reductions in transfer
payments for health care, placing an increasing responsibility for these costs
under provincial jurisdiction. Direct provincial funds contributed 39.5 per
cent of total health care funding in 1980 and federal financing assumed 32.8
percent. By 1993, these figures had evolved to 46.5 % provincial and 23.5%
federal (federal contributions including transfers). Funding for health care
now amounts to over one third of provincial expenditures.
A significant
proportion of these funds is allocated to provide care in the long term care
(LTC) sector.
Recent experience gives rise to greater concern. Between 1980 and 1995,
Ontario residential and community long term care expenditures have
increased more than 400% (from $ 426 million to $ 2.14 billion).
This
experience is not limited to Ontario as other provinces are also faced with
increasing health care expenditures. Most Canadian governments are making
74
efforts to control rising costs in all sectors, including long term care. With
limits placed on government spending, responses to changing client needs will
have to be accomplished through redirection of existing resources.
Early
initiatives to control swelling budgets have focused on global cost reductions.
Internal cost control measures have also been initiated. In the health care
sector, the ability of cost accounting to act as a control mechanism depends
upon how precisely the financial data relate to the clinical work. The literature
suggests that internal cost control can come from managing cost drivers. Cost
drivers are factors which are thought to have a strong relationship with actual
costs. In health settings researchers have established associations between care
costs and broad diagnostic groupings. Diagnoses and measures of health
status have been used as cost drivers in the development case mix funding
formulas. Drivers of care costs in long term care are somewhat different from
those in an acute care setting.
For example, the presence of expensive
technologies is less common in LTC while nursing care and geriatric
pharmacy are significant cost items. Currently hospitals support a detailed
cost accounting system. Hospital cost information is available in conjunction
with diagnoses and procedure based resource intensity weights (RIWs).
Researchers and administrators have failed to develop and implement a
similar initiative for long term care. Residents of long term or continuing care
are not easily classed by a one dimensional diagnosis. Lacking the required
information for a more exact approach, funding for LTC facilities and services
in Canada is based on average per diem rates, historical global budgets, or
75
case-mix classification based on broad diagnoses and care requirements. An
assessment of costs in long term care must be linked to resident care planning,
care activities, and resource requirements. Currently, there is no ability to
assess what care related activities account for the costs. To be used to improve
the effectiveness of care, costs must be assessed through the activities where
they are incurred. We can understand care costs through Activity Based
Costing (ABC). The approach defines costs in terms of an organization’s
processes or activities.
In this way, resources are attributed to the care being provided and cost
management is aligned with outputs and outcomes rather than with
management structure. The method evolved in the manufacturing industry
and is applicable as a method of accurate case and episode costing. ABC is
useful because it models the flow of resources in the care process. Traditional
cost accounting techniques allocate costs to all units based on an average unit
cost. Although the average cost method provides acceptable product costs in
general, it often fails to provide accurate costs on individual products17. The
resulting allocation is often not reflective of the degree to which a given unit
actually uses the resources6. With average cost methods, total costs vary with
volume only. An example for long term care is seen in the per diem funding
schedule used in many provinces. The per-diem rates provide an average cost
for resident care and cannot distinguish whether any residents cost more to
care for than others. In a health care context, ABC systems focus on care
activities to measure each individual resident’s consumption of the resources.
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The ABC allocation results in costs that vary with the health status of
residents, and not only with the total volume. Summary indicators from a cost
system must address the goals of care and funding for health services. If the
care of residents is individually determined, then the costing system must be
able to allocate costs on a resident specific basis. ABC accomplishes this to the
extent that accurate information is available with respect to staff utilization.
The best measure of staff activity can be obtained through a time study
analysis.
By assessing the cost-related practice patterns, time study data
provide the best assessment of variable care costs. This data also provides key
information for determining individual case-mix index or resource intensity
weight.
Prospective payment based on case-mix is believed to provide a
reimbursement mechanism that reflects the needs of residents rather than
facility characteristics. Cost analyses in health care are typically restricted to
assessing costs, often without explicit consideration of the outcomes or
benefits.
When outcomes are examined, we are able to consider cost
minimization, cost-benefit, and cost-effectiveness analyses. Cost-minimization
analyses assume that all outcomes of treatment are of equal value. Costbenefit analyses are rare in health care as they require the difficult step of
placing a dollar value on health-related outcomes.
A review of health care cost-effectiveness literature, notes a lack of quality
research on the topic, with many studies examining costs as charges and only
rarely considering marginal costs.
In health care, marginal costs can be
expressed either in terms of severity of illness or in terms of the associated care
77
intensity required. Both require patient specific information which ABC is
able to determine. Health care providers in the United States, including those
operating under managed care and capitation arrangements are beginning to
recognize and implement this strategy. The application and research of ABC
in Canada, the U.S., and the U.K. has provided examples of its’ utility in
diverse care settings. The purpose of applying ABC is to accurately depict and
assess costs, by aligning them with care related activities. This paper presents
the development and application of an activity based costing model in
residential and community long term care settings.
2.13 Activity Based Costing in Various Countries
(i) ABC In India
Activity-based costing (ABC) is a two-stage product costing method that first
assigns costs to activities and then allocates them to products based on the
each product’s consumption of activities. ( Dr Manoj Anand, Dr B S Sahay,
Subhashish Saha, All India Council for Technical Education (AICTE), New
Delhi (India), The cost pools in the two-stage approach now accumulate
activity-related costs. An activity is any discrete task that an organization
undertakes to make or deliver a product or service. Activity-based costing is
based on the concept that products consume activities and activities consume
resources. Activity-based costing can be used by any organization that wants
a better understanding of the costs of the goods and services it provides,
including manufacturing, service, and even nonprofit organizations. Activity78
based costing recognizes that resources are spent on activities and the cost of a
product or service is the sum of the costs of activities performed in
manufacturing the product or providing the service. An activity-based costing
system traces costs to the activity that consumes resources. Costs are
determined based on the activities performed for cost objects and their
underlying cost drivers that consume resources. Product or service costs
determined using activity-based costing reflect costs of resources consumed
for activities performed in manufacturing products or providing services. In
contrast, a volume-based costing system uses cost allocations to channel
indirect costs to products or services. As a result, the cost of a product or
service often bears little or no relationship to activities performed in the
manufacturing of the product or service. Based on the activities of most
manufacturing firms, the general levels of cost hierarchy of an activity-based
costing system are:
a)
b)
c)
d)
Unit-level cost;
Batch-level cost;
Product-level cost; and
Facility-level cost.
In an activity-based costing system, the second-stage procedure in tracing
costs to products or services is a process by which the costs of activities or
activity pools are assigned to cost objects using one or more appropriate
activity consumption cost drivers. All firms should use an ABC system when
the benefits of such a system exceed the costs of implementing it. It is
especially beneficial to firms with product diversity and/or process
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complexity. Unit-level activities are activities performed on individual units
of product or service. The frequency of a unit-level activity varies in
proportion with the units of product manufactured or service provided.
Examples of unit-level activities are using direct materials, using direct labour
hours, inserting a component, inspecting each unit, and consuming power to
run machines. Batch-level activities are activities performed for a group of
units of products or services rather than for each individual unit of product or
service. The frequency of batch-level activity is determined by both the size of
the group and the total number of units to be manufactured or provided.
Examples of batch-level activities are setting up machines, processing and
placing of purchase orders, scheduling production runs, inspecting products
by batch, and handling materials. Product-level activities are activities
undertaken to support individual products or services rather than for each
individual unit of product or service or a group of individual units of products
or services. Facility-level activities are activities performed for the entire
organization or division to meet the required operating procedure or support
the operation of the organization or division. Service organizations such as
banks, hospitals, transportation companies, law firms, and trading companies
can use activity-based costing and management in all phases of their
operations as manufacturing firms do. Many studies in India reveal that the
corporate India has more than one cost management system in use. Half of the
respondents do use absorption costing system for product costing and
financial reporting purpose. These results are consistent with the findings of
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Joshi (2001) in the Indian context. International surveys reports 50% to 70% of
the companies use 13 absorption costing for external reporting and tax
reporting purpose ( Inouse, 1988; Blayney and Yokoyama, 1991). The use of
standard costing is popular worldwide. More than 75% of the firms use it in
USA, UK, Ireland, and Sweden ( Cornick et al., 1998; Drury et al. 1993; Clarke
and Brislane, 2000; and Ask and Ax, 1997). Scarbrough et al. (1991) finds that
65% usage of standard costing in Japan. In India, slightly less than two-third of
the respondents use standard costing as a cost control technique as compared
to 68% usage found by Joshi (2001).
The activity-based costing system introduction in corporate India has
picked up momentum as 20.75% of the respondents are using it as
supplementary/ offline and 28.30% of the respondents have integrated the
activity based costing systems with ERP systems.
The survey shows an
encouraging response of the Indian corporate sector to the activity based
costing with 49% (n = 26) of the respondents adopting it. The firms are
successful in 22 capturing accurate cost and profit information from their ABC
cost systems for their value chain and supply chain analysis vis-à-vis non-ABC
user firms. The need for activity-wise cost information in budgeting, product
pricing decision and customer profitability analysis has urged the
management of the Indian firms to adopt activity-based costing systems. No
significant difference has been found in the in the motivation to adopt ABCM
across the manufacturing as well as service sector and across the stages of
activity-based cost system adoption (supplementary/offline). This implies that
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activity-based costing has equal opportunities in both the sectors and the
motivations are uniform over the stages of adoption. The major difficulties
faced by the ABCM-user respondent firms while designing activity-based cost
systems are developing activity dictionary & cost drivers and lack of review of
ABCM implementation initiative. Application of activity based costing has
resulted in changes in various management decision areas, prominent among
them, being focus on profitable customers, pricing strategies, and sourcing
decisions. However, the quantum of change observed is not found to be a
characteristic of sector (manufacturing vs. service) and level or stage of ABC
implementation. Application of ABCM has impact not only on the decisions
within the firm but also on the decisions beyond the boundaries of the firm as
evidenced by the factor analysis and linear discriminant analysis of responses
of activity-based costing user firms. The decision areas beyond the boundaries
of the firm include focus on the profitable customers, sourcing decisions,
elimination of redundant activities, distribution channel, and strategic focus.
The product mix, process simplification, and product pricing are included in
decisions within the boundaries of firm. Thus, it can be inferred that ABCM in
India is practiced in the value chain analytic framework. Due to limited scope
of the present study, a number of research issues are not attempted but are felt
in the course of study. Some of them are – one, to follow up the respondents’
claim on the impact of activity-based costing on their firm performance either
through a case study or through an event study using stock market data. Two,
is to examine the relationship between the organizational influences &
82
technological factors and the adoption of activity-based costing system by the
firm.
(ii) ABC in North America
In 1995, the Federal Accounting Standards Advisory Board (FASAB) issued a
recommended accounting standard titled "Managerial Cost Accounting
Concepts and Standards for the Federal Government". This standard was
subsequently adopted by OMB and GAO and made binding on federal
agencies effective beginning in 1998. From the first paragraph of the FASAB
standard, it is clear that this reform is seen as being of fundamental
importance to all program managers, and not just to the agency's accountants.
The managerial cost accounting concepts and standards contained in this
statement are aimed at providing reliable and timely information on the full
cost of federal program, their activities, and outputs. The cost information can
be used by the congress and federal executives in making decisions about
allocating federal resources, authorizing and modifying programs, and
evaluating program performance. The cost information can also be used by
program managers in making managerial decisions to improve operating
economy and efficiency. Today this managerial cost accounting standard
parallels many of the issues addressed in OMB's Program Assessment Rating
Tool (PART), including the acknowledged relationship to GPRA and the
emphasis on identifying the unit costs of activities, as shown in the following
paragraph from that standard:
83
Measuring costs is an integral part of measuring performance in terms of
efficiency and effectiveness. Efficiency is measured by relating outputs to
inputs. It is often expressed by cost per unit of output. While effectiveness in
itself is measured by the outcome or degree to which a predetermined
objective is met, it is commonly combined with cost information to show 'costeffectiveness. In order to identify the unit costs of their activities, this
accounting standard urges federal agencies to consider activity-based costing
(ABC) and activity-based cost management (ABC/M) as part of their GPRA
performance measurement.
Several costing methodologies have been successful in the private
sector and in some government entities. Four are briefly described below for
agency consideration. It should be noted that Activity-Based Costing has
gained broad acceptance by manufacturing and service industries as an
effective managerial tool. Federal entities are encouraged to study its potential
within their own operations. Implementing an ABC system requires four
major steps: (1) identify activities performed in a responsibility product to
produce outputs, (2) assign or map resources to the activities, (3) identify
outputs for which the activities are performed, and (4) assign activity costs to
the outputs. John Mercer used his experience in a sophisticated system of
governmental activity-based costing and activity-based cost management as
an important reference point in his development of GPRA. Further
information about the relationship of ABC and ABC/M to performance-based
budgeting is found elsewhere on this web site. This information includes
84
several performance budget examples that illustrate activity-based costing, a
white paper on" Performance Budgeting for Federal Agencies", and John
Mercer's congressional testimony on GPRA implementation.
(iii) ABC in China
The Chinese economy has been booming for three decades, mainly due to the
availability of abundant labour at relatively competitive prices in the
manufacturing sector. Chinese companies have been advancing their
competitiveness through rapidly developed advanced manufacturing and
information systems. By contrast, advancements in management accounting
techniques and IT-enabled business solutions have been painfully slow.
Chinese management styles rely more on managing people and relationships –
Chinese management ethos – than on technological systems and management
tools. The level of office and accounting computerization and IT-enabled
business solutions is not as advanced as those in the west. Xu Ji started from a
very
basic
level,
building
financial
accounting
systems
and
office
computerization before implementing the ABC system which captured direct
costs and variable manufacturing overheads before processing.
The main achievements of Xu Ji’s ten year ABC endeavor are that ABC
radically changed the SOE, turned PLC’s traditional costing systems and
induced standardization in their working practices and processes. ABC also
acts as a catalyst to Xu Ji’s IT developments – first accounting and office
computerization and later the ERP implementation. One distinctive feature of
Xu Ji’s ABC experience is the ‘top down’ instigation and enthusiasm of trying
85
out innovative ideas and inducing corporate-wide learning. While such a ‘topdown’ approach is not so popular in the west, it is fairly common amongst
SOEs, particularly in the northern part of China. This approach worked well
in Xu Ji, allowing them to move quickly from imitating western ideas to
developing their own – independently developed Relay’s ABC system – and
make informed decisions using sales activity analysis.
(iv) ABC in Iran
In a rigorous business environment, manufacturing and supply services have
become very hard to maintain satisfactory returns or profits. Therefore, the
role of cost estimation for products and services has become more critical.
Before the modern business management times, accounting was being just
used to record the cost of products and/or services. However, the important
role of cost estimation and cost information appeared after the advent of
modern business management techniques. This is especially because the
traditional cost systems are known to distort the cost information by using
traditional overhead allocation methods. However, decision makers, assuming
information is relevant, prefer more accurate product cost information to less.
Accounting systems of developing countries such as Iran always has some
problem; because they are follow the developed countries. In Iran there have
been severed factor influencing accounting systems.
Misunderstanding of the management accounting information for improving
organizational efficiency and this matter has devoid of the following factors:
operational turn over, accountants related to the production process, accurate
86
information about capability of product lines, identification in costs behavior,
using appropriate bases for allocating overhead costs, using budgeting
mechanism related to account contents, variances compute and proving
management reporting in appropriate periods (Etemadi & Shamszaeh, 2005).
Accounting in general and management accounting in particular is based on
lack of silks of employee and lack of interaction between experts and
academics, because academics don’t put innovation on profession and experts
neglect the academics explorations. The research has shown that variables
such as organization size, organization life cycle stage, cost structure,
competition intensity, economical crisis, importance of the cost information,
innovation, support of management levels, structure and the strategy of the
organization, internal performance measures with using and implementation
of the ABC system have had positive and significant relationship (Askarany,
Yazdifar & Askary, 2009; Kallunki & silvola, 2008; Sartorius, Eitzen & Kamala,
2007; Mealah & Nasir Ibrahim, 2007; Al-omiri & Drury, 2007; Drury & Tayles,
2005; Askarany & Smith, 2003; Golsselin, 1997; Chongrukust, 2002 and
Abernthy et al, 2001). On the other hand, the using and implementation of the
above system with variables such as the activity type, levels of the fixed costs,
production/service diversity and technology have had a negative relationship
(Askarany, Yazdifar & Askary, 2009; Al-omiri & Drury, 2007; Drury & tayles,
2005 and Alberntthy et al, 2001). Activity-Based Costing system was one of
the solutions that its right implementation and performance had many
advantage for the users. In Iran, Ahmad Rajabi in Shahid Faghihi Hospital at
87
Shiraz, Iran, applied design and application of activity based costing (ABC)
System in Cost Price of Hospital Services. Changes in the work atmosphere,
development of information technology and spreading network in recent
decades brought new revolution to the organizations in Iran. Most of the
organizations in Iran are forced to change their internal structure in order to
adapt to the new conditions which lead to introduction of modern methods of
calculation of the total cost of the services in the organizations. The activity
based costing is one of the newest methods that were applied by many
accountings writers and managements. Considering the desirable feature of
this method, the capabilities of this method has been proved in calculation of
the total cost of the services and today wide range of organizations across Iran
use this method for calculating their costs and even pricing their services.
Providing a balance between expenditures and the revenue gained in one of
the principal struggle that most of the manufacturing companies are
confronting. In the current situation finding the cost and assigning the price
of the services are based on the fix tariff, this method does not provide the
required information for decision making to managements; therefore
utilization of appropriate method of cost is necessary and important.
Considering the infirmity of present methods and the crucial need in country’s
manufacturing sector in domain of introduction and applying, calculating the
costs and the price of rendered services, preparing and codification of
scientific resources in this respect was felt. Based on the survey conducted
across the national level, there was not a proper resource.
88
Taha et.al in their research reviewed some organizational relation such
as
the
industry
type,
size,
cost
structure,
importance
of
cost
information and product and services diversity with implementation and
choice of the ABC system through the listed companies in the Tehran stock
exchange statistical sample become 301 after omitting investment companies
such as Holding and Leasing and as sample volume determined 170 in regard
Morgan table. Research data accumulated by the questionnaire which sent the
companies addresses acquired from their web sites. The results of research by
logistic regression model with the 33.5% response indicate positive
relationship in the cost structure, importance of cost information and
product/services diversity (NP/SL), and negative relationship in the industry
type, size and product/services diversity (volume and support) with
implementation and choice of the ABC system. Also cannot reach the results
indicating significant relationship between above organizational factors and
using the ABC system. Besides attempting to improve the methods of
measurement the variable, future research should consider incorporating
other important variables that have been omitted from this study but which
are likely to influence cost system design. The most notable omitted
independent variables are organizational such as top management support,
resistance to change by providers and users of accounting information, lack of
relevant employees’ skills, competition, organizational life cycle stage,
89
economical crisis, and quality of information technology and level of the fixed
costs.
2.16 Implementation of ABC
According to Compton, there are six steps in implementation of ABC.
1.
Forming the team
A multidisciplinary team must be assembled to design the ABC system to
reflect correctly the workings of the company. This team should be selected
and assigned to the project full time. It should be composed of three to five
people, and should include representatives from manufacturing, marketing,
management information systems (MIS) and accounting. All team members
must be open-minded, knowledgeable about the company’s operations, and
well respected. The benefits of the team approach include smoother
implementation and greater design effectiveness. Members from across the
organization also ensure a broader acceptance due to better communication,
transfer of knowledge, and awareness of the benefits.
2. Deciding on Design Choices
At least six major decisions should be made before an ABC system can be
implemented. These are as follows (Compton, 1996):
a. Should the system be integrated with the existing system or
should it be a standalone system?
b. Should a formal design be approved before implementation?
c. Who should take the “ownership” of the final system?
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d. How precise should the system be?
e. Should the system report historical or future costs?
f. Should the initial design be complex or simple?
3. Training
Training is essential for effective implementation, execution, use, and
acceptance of an ABC system. Training is an ongoing process throughout the
life of the project. Three groups should be addressed in designing a training
program Management: Management must have enough knowledge about
ABC and its potential benefits. Implementers: The implementation team must
have enough knowledge about technical design needs, software modeling
capabilities, and project organization. Users: Users should understand the
benefits of the ABC information system and how this information can be used
in decision-making (Compton, 1996).
4. Gathering Information
A vital component of the ABC implementation is identifying the information
requirements of its users. Each phase of information gathering should include
a member of the implementation team and the user. The requirements of the
system and the information needed should be explored. Questions each user
should attempt to answer include the following: What key decisions must I
make, and how often do they arise? What other cost information would be
useful in carrying out my responsibilities? Documentation and note taking of
reviews of records, observations, interviews, questionnaires, and interfaces
91
with the existing information systems are some of the techniques that can be
used in this step (Compton, 1996).
5. Creating an ABC Systems Model
This is the most important step in the design of an ABC information system.
Each model has a set of resources, resource drivers, activity centers, activities,
cost drivers, cost elements, and cost objectives. Flowcharting is recommended
to gain a better understanding of the complexities of cost allocation. As a
starting point, the organization chart can be used in the model. The process of
converting the organization chart to an ABC flowchart by breaking down
tasks into divisions, resource centers, and activity centers is called functional
decomposition. Activity centers should be established in this step. To do this,
all activities related to accomplishing a particular attribute should be grouped.
These clusters of activities form the activity centers. Clustering activities will
reduce the level of detail substantially, but it will also decrease the amount of
effort required. A good rule of thumb is not to have more than 20-25 activity
centers for an ABC project (Compton, 1996).
6. Post-implementation Review
Like any other system initiatives, the ABC system must undergo a postimplementation period. Hidden problems must be uncovered and solved,
system components must be fine-tuned, and users must learn how to operate
the system. To assure that the desired results are achieved, members of the
ABC implementation team should be assigned as troubleshooters. They can
observe operations and assist in making any adjustments. Any necessary
92
changes should be carefully controlled. The post-implementation evaluation
enables the ABC project implementation team an opportunity to assess the
degree to which the ABC project objectives have been met, to determine the
necessary modifications, to evaluate the implementation team’s performance,
and to make recommendations about the improvements of the system in the
future (Compton, 1996). The beginning of the post plateau phase coincides
with the use of ABC as an integral component of a new generation of business
performance management solutions. These new solutions include profitability
management,
performance
measurement,
financial
management,
sustainability and human capital management. Figure1. Present the ABC
Information.
Chart-2.2
ABC Information
Source: Ahad Lotfi 7 Masoud,A.M (2012).
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2.16 CONCLUSION
ABC is an accounting method that identifies the activities that a firm performs,
and then assigns indirect costs to products. An activity based costing (ABC)
system recognizes the relationship between costs, activities and products, and
through this relationship assigns indirect costs to products less arbitrarily than
traditional methods. Some costs are difficult to assign through this method of
cost accounting. Indirect costs, such as management and office staff salaries
are sometimes difficult to assign to a particular product produced. For this
reason, this method has found its niche in the manufacturing sector. ABC is a
multi-faceted algorithm and database of financial and organizational
information. It supports performance management systems where business
users can access ABC-derived decision relevant information from their desk
top. Understanding this journey provides important lessons as organizations
continue to adopt and use ABC to create value. First is that ABC is an
integrated family of analytic costing methods. A single ABC model can
support historical cost measurement, predictive cost measurement, resource
planning, capacity planning, performance measurement and other analyses.
Second lesson is that the developments of ABC are sometimes misunderstood,
and this may lead to confusion and rejection. For example, assessing the value
of ABC in lean accounting will result in one answer if the assessment focuses
on the first generation ABC costing method. It will result in a different answer
if the focus is on ABC as a process-based resource and capacity planning tool.
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As is true with any method or technology, ABC has gained impressive
functionality over its life cycle. ABC is at the heart of integrated performance
management systems supporting measurement and analytic applications in
multiple settings. Concurrently, cumulative experience and new methods
have lowered the cost of implementing and maintaining ABC systems.
Understanding the cost-effectiveness of today’s ABC is important to assessing
its value as a strategic tool in today’s hyper competitive and volatile global
economy.
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