Problems In Traditional Costing System Accounting Essay
Traditional bing systems had been used for decennaries by organisations in doing of import determinations and there is non much alteration in the direction accounting techniques since the 1920 ‘ . From the book published by Johnson and Kaplan in 1987, they stated that from 1920 to the mid 1980 ‘s, there were no new invention in direction accounting techniques and concluded that the traditional costing were less equal in describing the proper cost allotment. Due to many unfavorable judgments towards traditional costing system, the development of Activity Based Costing has been brought up.
This study analyses the development of the techniques of Activity Based Costing, Budgeting and Management from the early 1990 ‘s to the present twenty-four hours.
Development of Activity Based Costing and its Development
2.1 Problems in Traditional Costing System
Absorption costing or the full cost method which is categorized under traditional bing systems is the most normally used cost allotment method, past and soon, in the United States. The ground it is called the full cost method is because soaking up bing assigns all fabricating cost to the cost of the merchandise ( Garrison, 2006 ) .
The chief usage of soaking up bing method is to describe fiscal information to the stockholders and other external stakeholders. It has proved to be an of import tool for directors to do determinations. However, in the late 1970 ‘s, the cost construction within organisations began to alter drastically due to rapid addition in overhead and indirect fabrication cost because of the addition in cost of capital and technological factors within the fabrication environment ( Cokins, 2002 ) . During that clip, directors believed that a direct correlativity exists between direct labor hours and fabricating operating expenses but the job arises when the nature of costs were altering and fabricating operating expenses costs and direct labor costs were going more and more adversely correlated over clip ( Garrison, 2006 ) .
In 1987, Kaplan and Johnson wrote a book about the jobs in the direction accounting pattern during that clip. In that book, they argued that the out-of-date direction accounting systems was still someway the same since 1920. They argued that the information systems were geared towards fiscal coverage, as was the determination devising procedure which causes a general impetus from cost direction to be accounting. They besides argued that bing direction accounting system could non accommodate to a freshly competitory environments, new manner of direction and production techniques in the modern organisational construction ( Kaplan & A ; Johnson, 1987 ) . This book represents the beginnings of Activity Based Costing methodological analysis.
Execution of Activity Based Costing
Activity Based Costing was introduced as the reply for an improved full-cost product-cost computation as the theoretical account grew into a more fully fledged costing system for hierarchies of activities and cost objects. Activity Based Costing is a two-stage process where cost of resources in the first phase are allocated to activities to build Activity Cost Pools, which in 2nd phase are allocated to be objects based on these objects ‘ usage of the different activities. It is besides a tool for cost and public presentation measuring towards activities, resources and cost objects ( for illustration merchandises and services ) . Activity Based Costing is knows as a “ horizontal ” or cross-functional cost position and it can supply fact-based penetration into the disbursement and profitableness of merchandises, services and clients ( Narong, 2009 ) .
There are three guidelines to back up cost allotment in Activity Based Costing. The first would be ‘Direct-cost following to merchandise ‘ . Trace the cost of flexible resources towards single merchandises that are entirely related. These are cost of direct stuff and direct labor. There are besides some capacity-related costs that will necessitate to be included in the entirely used for one merchandise. The 2nd guideline is the ‘Indirect-cost allocating to merchandise ‘ . There are three indirect costs that need to be allocated. The first would be the ‘Multipurpose resource costs ‘ . It occurs when resources are consumed by multiple merchandises. These are the operating expenses that need to be allocated into the merchandises. Second is the ‘Cost Centers ‘ where merely the three-step allotment procedure uses the cost centres to apportion costs of a group of consumables or indirect resources necessary to run cost centres and it besides includes major production machines and human resources. The 3rd indirect cost is the ‘Activity Costs ( cost pools ) . The principal of allotment of this indirect cost is to divide activity cost if the cost or productiveness of resources is different and if the form of demand is different across resources. Every one of the activity cost has a cause and consequence relationship with the cost driver. Last the 3rd guideline is the ‘Activity cost drivers ‘ . Cost drivers should associate to manner in which activity costs are consumed. For illustration, apparatus cost is assigned to a merchandise devouring a setup activity-based on apparatus clip if setup clip drives the costs ( Park and Simpson, 2008 ) . In a simpler term, Activity Based Costing is a bing system that improves and helps the organisation to place activities and apportion the cost to each several activity.
In the article written by Geri N and Ronen B ( 2005 ) , they stated that Activity Based Costing can supply more accurate and dependable cost informations to the directors and determination shapers so that they can make up one’s mind which 1 is suited for their determinations. There is another article by Tardivo G and Montezemolo G ( 2009 ) , which they besides have the same position with what Geri N and Ronen B stated in their several article, where they both agreed that Activity Based Costing can supply more accurate informations for determination devising and besides it may cut down costs and betterment in production procedures ( Tardivo G & A ; Montezemolo G, 2009 ) . Most companies that use Activity Based Costing have seen betterment in their public presentation with the decrease in costs and betterments in doing the right determinations. This statement is backed by Cooper R where he stated that the merchandise cost should be allocated equally and it is indispensable in finding the public presentation of the company in the current competitory environment.
Activity Based Management
Activity Based Management is derived from Activity Based Costing itself with extra constituent to depict any application of Activity Based Costing informations to direction determinations. Activity Based Management focal points on pull offing activities or concern procedures in order to accomplish organisational aims. Activity Based Management besides reduces cost drivers and transportations resources to economic value to make activities or concern procedures which clients ‘ wants and willing to pass money for it. It besides measures public presentation for cost, clip, quality and results so that the users of the information would understand how their activities would lend to the mission and scheme of the company. Activity Based Management supports Balanced Scorecard in making public presentation measurings. One of the fringe benefits of Activity Based Management is it improves company ‘s hard currency flow, and increases the quality of the information produced and besides decrease in rhythm clip. It can besides be used as a foundation for a Business Process Redesign and supports gain sharing amongst the person involved.
Activity Based Management able to back up concerns growing by supplying information to supervise long-run strategic determinations. It allows merchandise interior decorators to hold a clearer position and understand the impact of different designs on cost and the flexibleness hence ; interior decorators may modify their designs suitably. It opens the picks to the direction by back uping quest for uninterrupted betterment by deriving new penetrations into activity public presentation by concentrating on the beginning of demand for activities and by leting direction to make inducements based on behaviour to better individual or multiple facets of the concern.
Harmonizing to Tardivo G and Montezemolo G, Activity Based Management helps organisations to be more competitory by placing cardinal facets that needs to be improved in the concern procedure. Activity Based Costing would first place all the activities that start from client order up until the cargo of merchandises to clients and after that, Activity Based Management would be used to concentrate on ways to cut down the non-value added activities, therefore these shortened down the procedure continuance ( McConville D, 1993 ) . The inquiry is are Activity Based Costing together or separate from Activity Based Management? The reply would be it is working together as Activity Based Costing would concentrate on cut downing costs while Activity Based Management would concentrate on the improving processes so that both systems would better the company ‘s public presentation and profitableness and besides betterment in qualitative and quantitative footing.
2.4 Activity Based Budgeting
Activity Based Budgeting was introduced by Brimson and Antos in 1999. Brimson argued that utilizing traditional attack for planning and budgeting, it frequently leads to devastation of value since the traditional attack on focal points on resources instead than activities. There are many factors that can be identified as the jobs with resource attack, one of the factors would be, it focuses on resources that are inputs to a procedure instead than end products or client demands. It focuses on functional sections instead than the mutualities between sections, providers and clients. Traditional budgeting tends to look more of an accounting exercising towards operational people therefore ensuing in a low committedness towards operational activates. Budgets sums based on traditional budgeting tends to tilt towards the past periods instead than calculating the future budgets. It lack towards placing the chief causes of slow public presentation by non taking earnestly wastes and inefficiencies and does non clearly show the relationship between concern scheme and employees ‘ actions.
Therefore, by implementing Activity Based Budgeting, it would put the answerability and duty of an employee to pull off their activities towards accomplishing positive public presentation marks. This theoretical account provides the penetration and the ability to understand how merchandises or services able to make demand for specific activities and by the way able to drive the demand of the resources. Management is more responsible and able to make the ability to supervise and command at a more antiphonal degree. Activity Based Budgeting can be linked to the Zero Based Budgeting attack because of its similarity. Activity Based Budgeting can be said to hold the same rule as Zero Based Budgeting but without the multiple determination bundles for each activity or plan. Harmonizing to Grasso, both ZBB and ABB portion the same focal point on the activities and the analysis required within the model for each theoretical account which does non applicable to traditional budgeting attack but it might come in ready to hand if the company has already introduced Activity Based Costing. Grasso stated that execution of Zero Based Budgeting may non be every bit expensive as many people would hold thought. As of now, many companies prefer to utilize Activity Based Budgeting because of the its popularity in direction accounting techniques. ( Grasso 1997 ) .
Time Driven Activity Based Costing
Time Driven Activity Based Costing is the most recent technique based on Activity Based Costing theoretical account designed by Kaplan and Anderson in 2004 and 2007. It is an attack where it measures the equivalent attack which composed in utilizing equivalent-time cost drivers. The chief rule of Time Driven Activity Based Costing is to interpret the cost drivers in time-equivalents ( criterions of working hours ) and it reacts to the alteration in production conditions. Kaplan and Anderson stated that Time Driven Activity Based Costing is a system that simplifies the original Activity Based Costing by cut downing the figure of activities and the analysis is made at the departmental degrees or of the procedures. They besides stated that different types of drivers are categorized in merely one equivalent-time driver. TDABC helps determination shapers to salvage more clip in doing determination if the company are spread outing its capacity or adding new activities. It besides reduces the clip needed to roll up informations based on appraisal therefore direction can concentrate on increasing profitableness instead than blowing clip to work out the correct informations.
Impact towards Companies and Advisers
Based on an article by Landry ( 1997 ) , she describes what happened to one of the Hewlett-Packard ‘s divisions in Colorado Springs when they tried to implement Activity Based Costing. The system did non work for Colorado Springs division due to the usage of many drivers and no follow through on the execution of the cost driver information therefore leads to improper disposal. The division besides puts a batch of accent on consensus instead than the benefits.
A instance survey on Thai telecommunication in 2011 was conducted to analyze the execution of Activity Based Costing in Thailand. Factors that influences the success of the execution of ABC are, it requires a competitory environment it would act upon everyone involved to be more attentive. Although the studied company did non hold a professional costing system, the execution of ABC went swimmingly. Top direction played an of import portion in the success of execution of ABC. Adequate preparation and apprehension of the ABC systems were one of factor that give success. The lone downside towards this instance survey is, it was merely one company, and therefore does non stand for the other telecom company in Thailand for the success of execution of ABC.
Time-Driven activity based costing helps Charles Schwab, a taking stock securities firm. TDABC assigns all company ‘s resources costs to be object utilizing a model that requires two sets of estimations. The company were able to place the cardinal factor that able to diminish costs and Charles uses TDABC information to lower procedure costs by several hundred million dollars yearly.