Activity Based Costing

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Activity-based costing is a practice focused on the ‘budgeting and analysis process that evaluates overhead and operating expenses by linking costs to customers, services, products and orders. ‘(Chutchian-Ferranti. J et al (1999)). It was from the mid 1980’s that this practice really started to develop due to flaws which were being identified in the traditional costing system. Tom Kennedy et al (2000) argues, ‘that the current practice of ABC is now at its peak with 20 percent of companies worldwide using or either considering the practice of ABC. ‘

‘Much has been written about the demise of the traditional accounting systems and the revolutionary attributes of activity based costing (ABC). Given the significant professional services that have developed on the back of it, it is interesting that the system is not as popular in practice as its supporters would suggest. ABC has been hailed as the answer to our prayers, but things are never that simple. ‘ (Kennedy T and Bull R (2000) ‘The Great Debate’) In the above paragraph Tom Kennedy et al (2000) says ABC is ‘not as popular in practice as its supporters would suggest.

‘ This maybe the view of Tom Kennedy but past surveys carried out argue that ABC has been adopted successfully and will carry on being. According to Kip R Krumwiede (1998), ‘over 1/2 of responding companies which took part in the survey have tried ABC, 54% are using it for decision making. (fig 2) Of those companies, 89% say that it was worth the implementation costs. ‘ Below are two pie charts which back up that statement of Kip R Krumwiede, they show how ABC has been adopted in different industries in the early years of its existence.

(Management Accounting, 1998, Vol. 79, Iss. 10) From the organisations which took part in the survey the diagram above gives an idea of how many have accepted ABC and who have not. As shown, 49% have decided to commit to ABC while another 25% are considering committing to ABC. Only 5% of companies have strongly objected to ABC which is nearly one in ten companies. From these figures it shows that over 3/4 of the organisations surveyed have at least considered implementing ABC. Management Accounting, 1998, Vol. 79, Iss. 10)

Figure 2 shows that the companies which have successfully adopted ABC, 54% are using ABC for at least somewhat decision making within the company. But at the other end of the scale it shows that a minor percentage (2%) have implemented ABC then abandoned it. Regarding the statement made by Tom Kennedy we have to try and understand on what scale ABC would be seen as a popular practice. From the results of the survey which was carried out it maybe, be concluded that the adoption rate percentage was of a high nature and that the practice of ABC does have many supporters in industry.

Since the demise of traditional costing and the arrival of ABC there are many supporters of the method but there are also people within the industry which strongly appose the acceptance of ABC as a method used for financial measures. Previously in this report we have looked at the adoption rates of ABC over the past years, now it could be advantageous to study the reasons why or why not ABC has been accepted. Kip R Krumwiede et al (1998) argues that, organisations ‘impede ABC adoption for at least two reasons. First, implementing ABC can take considerable time and effort. ‘ The focus of the organisation has to be on the implementation of ABC.

If the focus isn’t present then there will not be the sufficient resources available for a successful implementation. ‘Second, ABC systems require more detailed information that traditional cost systems. ‘ Kip R Krumwiede et al (1998). With ABC needing this large amount of information to sustain implementing the practice many organisations are content with waiting for the supporting systems to be upgraded. Aamer Rafiq et al (2002) also argues, that the implementing of ABC will be a time consuming act and will need the organisations full attention. He also goes onto say that after the ABC model is up and running.

‘In the first few months it will still require manual intervention while data feeds are automated. Also, the model must run for at least six months so that it can capture the impact of seasonality. ‘ Clete O’Dell (1998) has reported ‘that the biggest barrier to implementing ABC was getting people to commit their time. ‘ This again backs up the views of Krumwiede and Rafiq in saying that organisations seem to reject ABC because of time scales needed. Looking at the other side of the argument ABC can be quite advantageous for the organisations who overcome the problem of time and resources.

‘ABC creates opportunities for cost reduction, and supports the necessary keen price negotiations. ‘ Says Etienne Van Geyt (2003). This is the case as it gives the organisation a clear view of the products cost price therefore arriving at an optimal price. ABC also tackles the problem some organisations face with cost distortion. These cost distortions can affect many areas within a business particularly customer profitability analysis. ‘Diamant Boart management were shocked when ABC analysis showed that a major customer who contributed 6%-7% of total revenue was quite unprofitable, reports Clete O’Dell (1998).

This was the case as ABC had surfaced all the special services which Diamant offered to this customer and were not charging for. Even though ABC had helped solve this case of cost distortion it is not the only way of overcoming the problem. Another method is to use a more detailed overhead allocation method which reduces the potential for cost distortions. ‘This might explain why organisations do not feel strongly compelled to adopt ABC, says Kip R Krumwiede (1998). ABC can easily be rejected in certain markets as some organisations have limited control over prices of their products.

This is simply because the operating market of these organisations is very competitive. Kirk Sherbine of Rockwood Manufacturing Company (1998) argues that ‘his company rejected ABC because the company has little control over the prices they can charge for its various door hardware. Prices are dictated by the market. ‘ He explains further, ‘ABC looked a little to complicated for our needs. ‘ In the Great Debate Kennedy also talks about the professional services which have developed on the back of ABC. Not all organisations who have tried ABC have benefited from it.

Before ABC was introduced nearly all printing firms used Budgeted Hourly rate (BHR). But since the introduction, firms have considered using ABC but the majority were quite quick to reject it. Lisa Cross (2003) says, ‘While many printing organisations believe that the information ABC yields is useful, they fear that the system is impractical because it requires an enormous amount of record keeping. ‘ The ABC method has not caught on that quickly amongst the printing firms but while most have rejected it there are a few firms which have adopted it as they see ‘ABC as a competitive weapon.

‘ Lisa Cross et al (2003). While in other industries ABC is becoming more common in the printing industry it is still not looked upon to replace the older system of BHR. This is because ‘in a BHR system, an order of a small or large size is given the same support costs. ‘ Graphic Arts Monthly (2003). For ABC to allocate these kind of costs would take an enormous amount of record keeping. Michael Lindsay, chief financial officer of Newman Print revealed that Graphic Arts Monthly (2003) ‘the costs of collecting all the information outweigh the benefit of allocating costs better.

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