Activity Founded Costing (ABC) can be an accounting method that assigns costs to activities according with their use of resources, alternatively than products. This enables resources and other related costs to become more accurately attributed to the merchandise and the assistance which they use. It generally does not change or eliminate any costs, in the other way; it provides detailed information about how costs are used. The main great things about Activity Structured Costing are providing understanding into the speediest growing and least noticeable aspect of cost-overhead. We can also improve profitability by monitoring total life-cycle cost and performance so that we can increase the effectiveness of budgeting by figuring out the cost of different service levels. In addition, ABC costing does encourage continuous improvement and total quality control because control and planning are directed at the process level and it links the corporate technique to functional decision making. By using ABC costing, we can also eliminate waste material by providing visibility of non-value added activities. Besides that, ABC costing assist in improving make or buy, estimating, and costs decisions which based on product cost that shows the processing process. Although there are many benefits associated with ABC costing, there's also a few constraints. (J. Antos)
Limitations of Activity - centered Costing
There are a few restriction of using ABC costing. First, we might consuming more time to gather data for example data pertaining to numerous activity, collecting data, checking data, and coming into them into the system. Besides that, once implemented, the activity-based coting is costly to keep up for example the price of buying, putting into action, and retaining activity-based system. This system may make waste material visible which some executives and managers do not need their boss to see because it could be difficult to create and establish, particularly if that organization is using more traditional accounting method. Furthermore, it can be time consuming if all activities should be costed and also it may provide too much details which obscuring the bigger picture. Activity-based costing data can certainly 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, professionals must recognize the costs which are actually relevant for the decision at hand. (Ray H. Garrison, 2008)
Every organization requires information to allocate resources, keep an eye on the actions considered, set concern and make decisions. Activity-base costing provides the accurate cost information by allocating overhead costs. However, activity-based management is focusing on improve the use of ABC from product charging to a comprehensive management tool that focus on decreasing the expenses and concurrently increasing techniques and decision making. After that, a refinement of ABC used in activity structured management is the classification of activities to value-added and non-value-added. A non-value-added activity can de thought as the creation or service related activities that can be eliminated with no deterioration of product traits ( Miller, 1992). Non-value-added activities are activities that simply add cost to or raise the time spent on something without increasing the marketplace value of the products. Activities like the storage space of inventory, building maintenance; inspection and inventory control are types of non-value-added activities in processing companies. Types of non-value-added activities in service industry consist of bookkeeping, billing, vacationing, advertising, cleaning, taking appointment, reception and etcetera. Relating to David and Robert (1995), making non-value-added activities obvious is one of the benefit of activity established management but it is the most difficult to accomplish.
Value-added activities are activities that boost the worthy of or market value of a product or service to customers. For instance, activities like engineering design, machining, packaging, undertaking surgery, providing legal research for legal services and etcetera are categorized as value-added activities. When people understand and admit why a task is classified as non-value added or value added then your clarity and understanding between value-added and non-value-added activities are achieved (Miller, 1996).
A cost hierarchy classifies costs into different cost pools based on different type of cost drivers or cost allocation bases or different degrees of difficulty in discovering cause-and-effect or benefits-received relationships(Horngren et al. p 142, 1999). A couple of four levels to recognize cost allocation bases or cost individuals, the classification is shown as follow:
Unit-level activities: these activities can be defined as resources sacrificed on activities performed on every 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 experience of running a machine are unit-level activities.
Batch-level activities: Activities performed for a group of product systems or services somewhat than to each individual unit of product or service (Horngren et al, 1999). Types of batch-level cost in processing are installation cost and procurement costs. Then, the number of setups or set up time is examples of cost drivers in batch-level activities.
Product-sustaining activities: These activities are thought as resources sacrificed on activities that performed to get an entire product line, however, not performed each time whenever a new batch or unit of products is produced (Horngren et al. , 1999). Design costs and executive costs are examples of product-sustaining activities in manufacturing industry.
Facility-level activities: Activities necessary to support or preserve the organization as a whole and cannot be traced to specific product (Horngren et al, 1999). The exemplory case of this activity includes home office general administration costs.
In simple fact, the successful classification of the activities provide managers a structured thought process about the connections between activities and the resources they take in.
It is well known that activity centered costing has been utilized by most of the top organization such as manufacturers. Actually, activity structured costing has been extensively implemented by small business and service sectors such as finance institutions, airlines, hotels, private hospitals, insurance firms, financial services businesses, accounting firm, railroads and etcetera. However, activity founded costing has appeared to be more lucrative when applied in large firm somewhat than using in small company. Relating to Henrick known, he described that companies with not so much products and market segments are not seemed to get as much advantages from basing costs on activities as companies working with diverse products, service lines, channels and customers.
Actually the primary aim of activity established costing in small industry is not a different with making company. The target is to figure out the main element activities that generate costs and record how many of those activities are performed for each and every service provided. Then, professionals have the ability to create data to provide better budget and concurrently the expenses of a company are known better. The prevalent method of identify activities, activity cost private pools, and cost motorists is the same for manufacturing company and service companies. Furthermore, the classifying of activities as value-added and non-value added, and the effort to decrease or eliminate non-value added activities are being used in service sectors too. Since service sectors and company companies are using the same goal of activity centered costing, then why it is sometimes difficult in implementing activity-based costing operating industries? The issue of putting into action activity-based costing in service companies is that a larger 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 checking account and home loan. However, many expenditures for service functions are induced by demands by specific customers alternatively than service requirements. Thus, customer action which is the feature distinguishing these systems from activity based costing as used in manufacturing companies has to be taken into account when employing ABC system in services industries( Cooper and Kaplan, p. 467, 1991). Service companies offer differentiate services in order to meet customer needs. Each service, using its characteristics, makes different needs on the organization's resources. Thus, service companies have to boost their service quality and the variety in service line. Concurrently, service companies have to focus on customer economics a lot more than processing companies. The expense of marketing, advertising, delivery and serving of the merchandise might be customer specific in processing companies. In contrast, for service companies, even the essential operating costs of standard service are determined by customer patterns (Cooper and Kaplan, pp234-235, 1998). Therefore, an excellent ABC system for Service Company will provide the information for the measurement of costs and success at the customer section level and market level.
Since small business and large companies are using the same purpose of activity centered costing, then why does small company get less reap the benefits of using activity based mostly costing equate to large corporation? In fact, insufficient knowledge and complex people in implementing the activity founded costing system in small company may lead to unsuccessful of using this technique in small company. Moreover, activity based mostly costing software is expensive. Most ABC experts discover that special-purpose ABC software must make the duty manageable. At $6, 000 and up for one package sold by ABC Systems, software can add significantly to outlays because of this kind of accounting technique ( Make Henricks, 1999). So, small company considers using ABC is squandering of money credited to not a great deal gains and products differentiation because of their products. Thus, they omit using ABC.
Activity-based Costing system used in large corporation and service business for the current grouping of costs and evaluation of success of product (service) have a tendency to be sophisticated, costly and hard to change to quickly changing business environment. For example, ABC system found in in the past in large financial service organization required seven-hundred employees at more than one hundred facilities to submit monthly survey of their own time. Thus the company employed 14 regular people merely to acquire and process the info and concurrently prepare management records which got more than four weeks to get ready (Kaplan & Anderson, p 3, 2007). Some employees questioned the accuracy of product and activity cost calculations due to long time to prepare accounts and complexity of ABC system. Because of this, operation, marketing and sales managers spent the perfect time to argue the correctness and reliability of calculations rather than making decisions bettering effectiveness of techniques, success of products and customers and capacity utilization. Therefore, Kaplan and Anderson developed new formulae of activity-based costing namely Time-Driven Activity Centered Costing (TDABC). It was designed to eliminate the problems in ABC system execution and procedure in large entities. Thus, Kaplan and Anderson who was simply the author of the new formulae identified the following problems with normal ABC model: ( Kaplan & Anderson, p 7, 2007)
It was costly and long time needed 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 article the info.
A lot of the ABC model were local and didn't provide an involved view of company-wide included success opportunity.
The ABC model cannot be easily uploaded in order to support the quickly change of business environment.
The model was inappropriate when it overlooked prospect of unused capacity.
A Traditional Costing System is an accounting system that assigns overhead to products based on predetermined plant wide volume of device based result 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 several way to identify activity cost pool by allocating overhead, after that, the expenses are designated to products using related cost individuals that gauge the activity used. ABC system bring a few benefits for managers in a corporation which provide more exact product costs, better cost control and better data for decision making. (Ray H. Garrison. , Eric W. Noreen. , 1997) However, this technique also offers several limitation which is the difficulty involved in gathering data associated with cost drivers and activities centers. Although there are a few restrictions, ABC system is a good accounting system under certain conditions and it is the right costing system to work with. The redesign and establishing a fresh costing system is an essential decision to a corporation because these require substantial cost and much more effort to achieve. Therefore, professionals should be careful when employing new changes in priced at system. (Jerry J. Weygandt. , Donald E. Kieso. , Paul D. Kimmel. , 2002)