The case study is performed on AVL Textile Company to find out the difference in product costs resulted from the company’s traditional cost management system and newly implemented ABC (Activity Based Costing) system. AVL Textile Company is Pakistan company that produces wool and polyester products. AVL Textile used Absorption Costing as the traditional cost management method. To analyze the difference between results generated from Absorption Costing and ABC system, calculation for five products was done using the two methods and results were compared. The authors thoroughly evaluated both systems. They found Absorption Costing is not a sufficient tool for the company’s situation, while ABC system can be successfully implemented for cost analysis. The cost of product calculated from traditional method is much lower than the one from ABC method.
The Benefits of ABC
ABC helps manager to gather correct information from each cost driver and produce results with high accuracy. The magnitude of ABC is to calculate based on different cost drivers of the activities demanded by each department such as production, services and sales, and generate a sum of cost of all resources. Comparing with traditional method allocating cost of service to production department, ABC method increases the accuracy of the cost analysis in a great extent. With accurate and detail data of activity usage provided by ABC system, management is able to implement effective decision on cost control. If available resource is higher than activity usage, management should cut down unused resources. On the other hand, if available supply is less than activity usage, increasing the supply must be considered.
The problems in implementation of ABC
A big problem that AVL Textile encountered during implantation of ABC is that the full-time availability of employees. As a company with 21% of hourly employees, resistance of employees from working full time hours remained a challenge during the implementation. With the right cost calculated from ABC, the sales require a cushion time period to kick off the new price and get sales on track.
What kinds of companies can benefit from ABC
ABC can be beneficial for the companies like AVL Textile that has low diversity of products and low overhead cost ratio.
What kinds of companies have little to gain from ABC
Limitation of ABC system exists in the companies with standard product lines where the main cost is the direct cost. For example, professional service companies with large labour cost and a high degree of product diversity. Due to unbalanced activity usage for products, activity usage will not be accurate and proportionate to the output volume. I
What potential pitfalls are there to avoid in implementing ABC Assumptions and limitations of ABC must be well understood. ABC is not considered the most accurate tool as it involves subjective cost allocations. Moreover, it assumes the absolute liner relationship between resources consumption and activities, while it is not possible in reality.
Godil, D. I., Shabib- ul- Hasan, S., & Abid, Y. (2013). Application of activity based costing in a textile company of pakistan-A case study. Interdisciplinary Journal of Contemporary Research in Business, 4(11), 602-625. Retrieved from http://ezproxy.lib.ucalgary.ca/login?url=http://search.proquest.com/docview/1355488461?accountid=9838