Traditional Costing And Criticisms Accounting Essay
There are two traditional costing methods which are absorption and marginal costing. The main difference among these two methods is treatment of fixed costs. Absorption costing treats fixed costs as a product costs and absorbs overheads to products. The marginal costing treats fixed costs as periodical costs which means does not allocate the costs to the product. According to Geri N. & Ronen B. (2005), in real life, absorption costing is more preferable than marginal costing.
However, there are many criticisms in the traditional costing. The first one is the administrative and distribution costs in traditional costing are ignored. This is fully supported by Tardivo G. & Montezemolo G. (2009), says that traditional system is concentrating on the areas of direct and operative production, which leads to the ignoring of the cost that related to production cost as well as administrative costs. The second is traditional costing does not account in detecting the actual costs of a product since one or two cost drivers are assigned to the fixed production costs. According to Cooper & Kaplan (1992) says that this system does not measure the costs of resources properly that used to manufacture the products because of its volume-driven allocation basis. In addition, seems like Swenson D. (1995) is agreeing with Cooper and Kaplan because he mentioned that traditional costing uses arbitrary method to allocate the cost information that obtained from the particular production. This will lead negatively affect on the decision making. The third criticism is nowadays mostly companies are looking forward to manufacturing realm, which means labors are replaced by machinery in order to increase the efficiency, by adopting traditional costing that labors based is unsuitable for the company in calculating the costs. According to Roztocki N. et al (2004); traditional costing has lost the relevance in the manufacturing realm because of the heavily increased in overhead and the reduction in direct labor. If a company implemented a system that cannot provide the real cost of a product, the company might not get the profitability.
Activity Based Costing (ABC)
ABC is a new technique that invented by Kaplan and Cooper in order to overcome the criticism in the traditional costing. It can be defined as: an informative system that measuring the related costs, determines the activities performed of a production and identifies the costs that accounted to the products and service via various cost drivers which reflect the use of resources via product and services activities (Tardivo G. & Montezemolo G., 2009). ABC will allocate overhead costs into various cost pools and activity that trace the overhead costs to products (Swenson D., 1995).
The reason of why ABC is invented is because of the criticism from old traditional costing in order to become a method that more efficient. According to Geri N. & Ronen B. (2005), ABC can provide a data that more accurate than traditional costing which is more reliable for the use of decision making. Tardivo G. & Montezemolo G. (2009) seems to be agreed with Geri N. & Ronen B. and even argue that information obtained from ABC can help in reduction in cost and improvement in process. Drake A. et al (1999) seems to support this and says that majority of the companies achieved in cost reduction and process improvement. Besides, ABC differs from traditional costing through accounted for the administrative and distribution costs. This is supported by Geri N. & Ronen B. (2005) saying that ABC measures all the overhead costs such as main operating costs, marketing, general and administrative costs.
However, there are criticisms which rose by the practitioners. Practitioners say that ABC is not suitable with small manufacturing firms. According to Roztocki N. et al (2004), the reason that preventing the small manufacturing firms to implement ABC is financial resources. This is supported by Geri N. & Ronen B (2005) and says that ABC is concentrating on cost allocation which might lead to the problem of over-precision and eventually increase the maintenance costs. Therefore this will definitely stop the financial limited company in implementing the ABC. Besides, in the article of Geri N. & Ronen B. (2005) mentions that ABC cannot help the company to identify the bottleneck from resources and therefore cannot help the management to identify the best product mix. This means that ABC cannot help the organization to determine the profitability of each product. This would eventually cause the problems in terms of lost revenue, dissatisfied customers and wasted time. Furthermore, if a company is over-rely on ABC; it may cause organization to forget the importance of others non-financial performance measures such as customer service measures (Swenson D., 1995). Next, according to Oker F. and Adiguzel H. (2010), usually ABC carrying out time-consuming survey which employees have to estimate how much time they have spent on the list of activities by reporting percentages that accumulated up to 100 percent. This consumed plenty of time and estimation can be biased because employees would have reported their idle or unproductive time as productive time in the survey. This will lead to the problem of inaccurate cost driver rate are calculated which based on the resource capacity that fully used.
Activity Based Management (ABM)
Information that provided by ABC that being used for management is called ABM. This effort would guide the organization to achieve the competitive advantage as well as business strategies (Tardivo G. & Montezemolo G., 2009). Besides, ABC is a subset of ABM because ABC supplies the information and ABM uses the information for various analyses to generate the improvement of a business (Tardivo G. & Montezemolo G., 2009). The purpose of ABM is to handle the relationship between product performance and production process and also to achieve the demands of customers by creating value (Bengu H., 2010). There is another way of saying ABM which provided by Tardivo G. & Montezemolo G. (2009), strategic variables can be controlled by the company who adopted the ABM and those variables are related to the evaluation of medium and long term proficiency of the combination of products.
Since ABM uses the information provided by the ABC, this shows that ABM solves the deficiencies from the traditional costing. For example, traditional costing does not show the real costs of a production (Tardivo G. & Montezemolo G., 2009). According to Kennedy T. & Affleck-Graves J. (2001), ABC can play crucial role in performing the important information for the management to make decisions.
Activity Based Budgeting (ABB)
ABB is a development from the activity based concepts into a budgeting phase. According to Hansen S.C. (2011), the developments of ABC and ABM have enhanced the intention into developing of budgeting. This is supported by Bengu H. (2010), saying that ABB is a part of activity based costing as well as management and also ensures to provide the analysis of costs and profitability in a more accurate and easier way. Hansen S.C. (2011) is agreeing with Bengu H. by saying ABB is computerized based and re-running a particular model when there is a change in environment in more simpler way compared to traditional budgeting. According to Grahame S. (2007), he criticized that conventional budgeting (traditional budgeting) under the volume based costs can provide an accurate budget but when this approach is unlikely to provide an accurate budget when there is uncertainty in business environment. Hansen S.C. seems like agreeing with Grahame S. that uncertainty in recent rapid changing environment will make traditional budgeting become unreliable. This problem can be solved by using ABB because it’s implemented with various operational planning systems (Hansen S.C., 2011).
Time Driven Activity Based Costing (TDABC)
According to Ayvaz E. & Pehlivanli D. (2011), TDABC is defined as an improved version of ABC which helps the company in estimating the demand of source of each process, product and customer with the help of required time in order to complete the cost of capacity unit time. In other words, it is a simplify approach of ABC. It is because TDABC requires only two estimations which are capacity cost of a department and capacity usage of each transaction that happened in that department (Oker F. and Adiguzel H., 2010). Ayvaz E. & Pehlivanli D. (2011) seems to be supporting Oker F. and Adiguzel H. by arguing that the main thing of TDABC is diversified calculation of capacity and distinguishing the inactive capacity cost. The purpose of TDABC is aimed to solve the criticisms which found in the ABC method.
The first criticism that TDABC can solve is the maintenance costs of ABC. According to Oker F. and Adiguzel H. (2010), TDABC ensure fast and inexpensive model maintenance and also can be used in any industry or company with various complexities such as in products, customers as well as processes. This is supported by Gervais M. et al (2010) by saying TDABC is aimed to respond to the criticism of ABC regarding on the complexity of implementation and costs. The second criticism that TDABC solved is the time consuming problem. Regular surveys that committed to the biased results no longer conduct in TDABC which simplify the time consuming of this method because of the use of time standards (Gervais M. et al, 2010). From another source of explaining how TDABC save the time is TDABC simplifies the first allocation process. TDABC does not allocate overhead costs to hundreds of activities which happened in ABC and eventually saved the time and effort when carrying out the TDABC (Oker F. and Adiguzel H., 2010). Seem like Stout D.E. and Propri J.M. (2011) are agreeing with above two authors by mentioning that TDABC removes the need for time-consuming, interview and survey process that define pools. The next criticism that TDABC hat overcomes from ABC is calculating the idle capacity that can never be found in the ABC method (Gervais M. et al, 2010). With TDABC, organization can compare the value of used capacity to the value of available capacity; this can let the manager determine the cost of under-activity. With another support from Ayvaz E. & Pehlivanli D. (2011), they mentioned that with this advantage, appropriate decision on source planning can be made by the manager from evaluating the inactive capacity of quantity.
Impact of the New Ideas on Both Companies and Consultant
Case 1 (TDABC on Service Industry)
This case study from academic journal that provided by Hajiha Z. and Alishah S.S. (2011) is about the examination of implementing the TDABC in hospitality industry. Profitability on various customer groups will be analyzed with this system. The results of this systems were compared to a local hotel which applying the ABC system.
Based on the results, TDABC lets managers to decide an optimal strategy that use to enhance the productivity and processes as the results of the ABC system show that the ABC is not suitable in analyze the customer profitability as it ignores the cost of idle resources. The next impact is time equation of TDABC provides a better situation for manager to update the formula without carrying out time-consuming surveys. As one of the finding says that staff of the hospitality industry affect the profitability directly, therefore, this has given the person who in managerial position a task that he or she must find a suitable strategy to maximize the productivity with the idle capacity that has been discovered. Furthermore, with TDABC, as managers can differentiate profitable and non-profitable customers which eventually give a better idea to let managers to maximize the profit of the company (Hajiha Z. and Alishah S.S., 2011).
Based on above impacts, TDABC has provided a proper data on profitability and cost of a customer and also detecting out the non-added value and shows the real capacity of each single section of the hotel. These are very helpful in service industry as managers can make better decision making with that information.
Case 2 (TDABC in Manufacturing industry)
From the case study provided by Stout D.E. and Propri J.M. (2011), a company which operating as a domestic consumer-electronics manufacturer has replaced ABC system with TDABC dues to the recent popularity of TDABC.
The first impact is more accurate costing information is provided compare to ABC. It brings a better alignment product and customer costs with resource consumption to the organization because through the model, organization can fit into the estimation that they made easily from the management. The next impact is on the perspective of maintaining the system. TSABC is easier to maintain as compares to ABC. This can be proved by the use of time equations. Since company XYZ is a simple business model, this has allowed company XYZ to have “virtually maintenance free” in TDABC system.
The above impacts are related in providing a better information to make decision and also the saving the maintenance costs on system implementing which would help organization to development better in future.
The most basis accounting system is the traditional costing which comprises of absorption and marginal costing. Many companies have beneficial from adopting these systems. However, when time passes, many practitioners points out the weaknesses of traditional costing. From here, ABC method has invented and adopted by most of the companies as it overcomes the criticism of the traditional costing. For example, ABC will produce more reliable information for manager to make decision because ABC takes all the costs and allocated them into various cost drivers since traditional costing only allocated the costs into machine and labor hours. In order to make ABC becomes a more efficient system; ABM and ABB have invented to help the ABC. ABM uses the information that provided by ABC to do strategic management planning while ABB uses information provided by the ABC to do budgeting. The existence of ABB and ABM makes the company that adopted the ABC making good profitability and cost management. Everything seems well but there are weaknesses raised from the ABC technique. One of the weaknesses is ABC carried out time-consuming survey which eventually never produces out an idle capacity. Therefore, TDABC has been invented by Kaplan and Anderson. TDABC is a more simplify and easy to carry out for the organization that adopted it. TDABC born to be solved the shortcomings of ABC which are long time of collecting data, high maintenance costs and various types of activities that deal with the costs of production. TDABC has brought many benefits because of its simplify way to implement and information that reliable to make decision and increase efficient of organization. From the case study, organizations that serve in service industry do obtained the costs and profitability of customers which help the organization to increase the profit. Besides that, managers can obtain the idle resources which cannot be found in ABC method. While in manufacturing in case study 2, the organization also experienced a reduction in maintenance costs after adopting the TDABC. Everything seems to be great but the efficiency on each organization is all depends on how well the organization carries out the system and as well as the structure of organization that implement it.
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