Benefits of Activity Based Costing, ABC

Benefits of Activity Based toll, first rudimentActivity Based apostrophizeing (ABC) is an history method that assigns embodys to activities according to their use of resources, sooner than harvests or services. This enables resources and other related costs to be more accurately attributed to the products and the services which they use. It does non modify or eliminate any costs, in the other way it provides detailed information on how costs atomic number 18 consumed. The main benefits of Activity Based cost are providing understanding into the fastest growing and least visible element of cost- smash. We can also improve profitability by monitoring total life-cycle cost and performance so that we can improve the effectiveness of budgeting by identifying the cost of different service levels. In addition, ABC costing does encourage continuous profit and total quality control because control and planning are directed at the process level and it links the corporate strategy to operational conclusion devising. By using ABC costing, we can also eliminate waste by providing visibility of non- look upon added activities. Besides that, ABC costing help to improve unclutter or buy, estimating, and pricing decisions which based on product cost that reflects the manufacturing process. Although there are many benefits of ABC costing, there are also a some limitations. (J. Antos)Limitations of Activity based beThere are a few limitation of using ABC costing. First, we may consuming more time to necessitate data for precedent data concerning numerous use, collecting data, checking data, and entering them into the clay. Besides that, once implemented, the activity-based coting is costly to maintain for example the cost of buying, implementing, and maintaining activity-based ashes. This system may coerce waste visible which some executives and managers do not want their boss to see because it may be difficult to set up and establish, particularly if tha t placement is using more traditional accounting method. Furthermore, it can be time consuming if all activities are to be costed and also it may provide withal much details which obscuring the bigger picture. Activity-based costing data can good be misunderstood so it must be used carefully particularly when it is used for decision making. Before making any significant decisions using activity-based costing data, managers must recognize the costs which are really relevant for the decision at hand. (Ray H. Garrison, 2008)Value-Added versus Non-value-Added ActivitiesEvery organization requires information to allocate resources, monitor the actions taken, set priority and make decisions. Activity-base costing provides the accurate cost information by allocating overhead costs. However, activity-based management is focusing on enhance the use of ABC from product costing to a comprehensive management tool that concentrate on change magnitude the costs and concurrently improving pro cesses and decision making. After that, a refinement of ABC used in activity based management is the classification of activities to value-added and non-value-added. A non-value-added activity can de defined as the production or service related activities that can be eliminated with no deterioration of product attributes ( Miller, 1992). Non-value-added activities are activities that scarcely add cost to or increase the time spent on a product without increasing the market value of the products. Activities much(prenominal) as the fund of inventory, building maintenance inspection and inventory control are examples of non-value-added activities in manufacturing companies. Examples of non-value-added activities in service industry consist of bookkeeping, billing, traveling, advertising, cleaning, taking appointment, reception and etcetera. According to David and Robert (1995), making non-value-added activities visible is one of the advantage of activity based management but it is t he most difficult to achieve.Value-added activities are activities that increase the worth or market value of a product or service to clients. For instance, activities like design design, machining, packaging, performing surgery, providing legal research for legal services and etcetera are categorized as value-added activities. When mountain understand and accept the reasons why an activity is classified as non-value added or value added then the clarity and understanding amid value-added and non-value-added activities are achieved (Miller,1996).Cost Hierarchy In Activity-Based CostingA cost hierarchy classifies costs into different cost shares on the basis of different type of cost driver or cost parcelling bases or different degrees of obstruction in identifying cause-and-effect or benefits-received relationships(Horngren et al. p 142, 1999). There are four levels to identify cost allocation bases or cost drivers, the classification is shown as followUnit-level activities t hese activities can be defined as resources sacrificed on activities performed on each individual unit of a product or service (Horngren et al, 1999). For instance, manufacturing operating costs such as energy and repair which have relationship with the activity of running a utensil are unit-level activities.Batch-level activities Activities performed for a group of product units or services rather than to each individual unit of product or service (Horngren et al, 1999). Examples of batch-level cost in manufacturing are setup cost and procurement costs. Then, the number of setups or setup time is examples of cost drivers in batch-level activities.Product-sustaining activities These activities are defined as resources sacrificed on activities that performed in support of an entire product line, but not performed every time when a new-fashioned batch or unit of products is produced (Horngren et al.,1999). Design costs and engineering costs are examples of product-sustaining activit ies in manufacturing industry.Facility-level activities Activities required to support or sustain the organization as a whole and cannot be traced to individual product (Horngren et al, 1999). The example of this activity includes home office general administration costs.In fact, the successful classification of these activities provide managers a structured way of thinking about the relationships between activities and the resources they consume.Activity Based Costing for receipts Industries and Small BusinessIt is widely known that activity based costing has been used by most of the titanic corporation such as shapers. In fact, activity based costing has been widely implemented by small business and service industries such as banks, airlines, hotels, hospitals, insurance companies, financial services firms, accounting firm, railroads and etcetera. However, activity based costing has seemed to be more successful when implemented in bombastic corporation rather than using in sma ll business. According to Henrick noted, he mentioned that companies with not so much products and markets are not seemed to get as much advantages from basing costs on activities as companies operating with diverse products, service lines, channels and customers.Actually the primary objective of activity based costing in small industry is no different with manufacturing company. The objective is to figure out the key activities that give costs and to record how many of those activities are performed for each service provided. Then, managers are able to generate data to provide better budget and concurrently the expenses of a company are known better. The prevalent approach to identify activities, activity cost pools, and cost drivers is the same for manufacturing company and service companies. In addition, the classifying of activities as value-added and non-value added, and the effort to decrease or eliminate non-value added activities are used in service industries too. Since se rvice industries and manufacturer companies are using the same objective of activity based costing, then why sometimes it is difficult in adopting activity-based costing in service industries? The difficulty of implementing activity-based costing in service companies is that a greatheartedr proportion of overhead costs are company-wide costs that cannot be directly traced to specific services provided by the company. (Weygant.)Besides that, many of the expenses in service industries are caused by product (services) such as savings account and home mortgage. However, many expenses for service functions are caused by demands by individual customers rather than service demands. Thus, customer behavior which is the feature distinguishing these systems from activity based costing as used in manufacturing companies has to be taken into account when implementing ABC system in services industries( Cooper and Kaplan, p. 467, 1991). Service companies offer differentiate services in order to satisfy customer needs. Each service, with its characteristics, makes different demands on the organizations resources. Thus, service companies have to improve their service quality and the variety in service line. Concurrently, service companies have to focus on customer economics far more than manufacturing companies. The cost of marketing, selling, delivery and serving of the products might be customer specific in manufacturing companies. In contrast, for service companies, unconstipated the basic operating costs of standard service are determined by customer behavior (Cooper and Kaplan, pp234-235, 1998). Therefore, a fine ABC system for Service Company will provide the information for the measurement of costs and profitability at the customer segment level and market level.Since small business and large companies are using the same objective of activity based costing, then why does small business get less benefit from using activity based costing compare with large corporation? In fact, lack of knowledge and technical people in adopting the activity based costing system in small business may lead to unsuccessful of using this system in small business. Moreover, activity based costing software is expensive. roughly ABC practitioners find that special-purpose ABC software is required to make the task manageable. At $6,000 and up for one package sold by ABC Technologies, software can add significantly to outlays for this type of accounting technique ( Mark Henricks, 1999). So, small business considers using ABC is wasting of money due to not so much profits and products differentiation for their products. Thus, they omit using ABC.Developing Of New Approach to ABCActivity-based Costing system used in large corporation and service industries for the current grouping of costs and analysis of profitability of product (service) tend to be complex, costly and hard to adjust to quickly changing business environment. For example, ABC system used in several years ago in large financial service firm required sevener hundred employees at more than one hundred facilities to submit monthly survey of their time. Thus the company employed 14 full time people just to collect and process the data and concurrently prepare management historys which took more than thirty days to prepare (Kaplan Anderson, p 3, 2007). Some employees questioned the accuracy of product and activity cost calculations due to long time to prepare reports and complexity of ABC system. As a result, operation, marketing and sales managers spent time to beseech the correctness and accuracy of calculations instead of making decisions improving effectiveness of processes, profitability of products and customers and capacity utilization. Therefore, Kaplan and Anderson developed new formulae of activity-based costing namely Time-Driven Activity Based Costing (TDABC). It was designed to eliminate the problems in ABC system implementation and operation in large entities. Thus, Kap lan and Anderson who was the author of the new formulae identified the following problems with conventional ABC model ( Kaplan Anderson, p 7, 2007) It was costly and long time had to be taken for interviewing and surveying process. Data for the ABC models were subjective and hard to validate. It was expensive to store, process and report the data. Most of the ABC model were local and did not provide an integrated view of company-wide integrated profitability opportunity. The ABC model could not be easily uploaded in order to accommodate the quickly change of business environment. The model was incorrect when it ignored potential for unused capacity.ConclusionA Traditional Costing System is an accounting system that assigns overhead to products on the basis of predetermined plant wide volume of unit based output rates such as machine hour and direct labor. (Jerry J. Weygandt., Donald E. Kieso., Paul D.Kimmel., 2002) In contra, ABC system is using the different way to identify activi ty cost pool by allocating overhead, after that, the costs are assigned to products using related cost drivers that measure the activity consumed. ABC system bring a few benefits for managers in a company which provide more accurate product costs, better cost control and better data for decision making .(Ray H. Garrison., Eric W. Noreen., 1997) However, this system also has several limitation which is the difficulty involved in gathering data relating to cost drivers and activities centers. Although there are a few limitations, ABC system is a useful accounting system under certain conditions and it is a suitable costing system to use. The redesign and setting up a new costing system is a very important decision to a company because these require substantial cost and much more effort to achieve. Therefore, managers should be very careful when implementing new changes in costing system. (Jerry J. Weygandt., Donald E. Kieso., Paul D.Kimmel., 2002)