Activity Based Costing Benefits Accounting Essay

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In recent years the economic downturn has created a globalization shudder. The world was hit by information technology and open economies. This has lead to competition in ever sector being increasable high however the construction industry is increasingly competitive. Cost accounting has been widely discussed in reason years, to try and minimize cost and to improve competitive advantage. Traditional costing is seen as the way track and minimizes cost of development.

"Cost management is the process of planning and controlling the budget of a business. Cost management is a form of management accounting that allows a business to predict impending expenditures to help reduce the chance of going over budget"

Improvements to cost management have taken place since the early sixties there are many different theories. (Skoyles 1965) discussed a radical change in traditional cost estimating methods that had been proposed in the UK. His theory was not successful due to the time consuming and also due to lack of knowledge of production methods by Quantity Surveyors at the early stage of the process. (Barnes 1977) proposed a less radical approach to operational cost estimating for construction projects, suggesting the use of different cost drivers for estimating the cost of resources, which were classified into fixed, quantity based, time-based, and price based.

(Glad and Becker 1996) states effective cost management should incorporate the following

Span a multi-dimensional of costs, labor and plant.

Focus less on track and reporting and more on cost planning and control.

Support every key business decision, including sourcing, pricing, investment, efficiency and productivity measures, product elimination and new product introduction. Therefore, the proposed solution was aimed at eliminating the root problems and thereby al the unfavorable phenomena that stemmed from them can be resolve.

Studies have only reported on the disadvantages of Traditional Cost Management. The majority of studies were taken on the manufacturing industry where cost of material, labor and marketing are the key components. The construction Industry however has many components were it is difficult to calculate cost e.g. time delays.

New methods of Cost Management have been introduced however the construction industry is slow to implementing these new methods. These methods require strategic set of management accounting skills.


City Corp is the refurbishment and update of a 1980's office building located in Perth CBD Western Australia. To meet the client's needs as the new tenant. The building is ten stories high and comprises 20000 m2 of usable floor space. The basic utilities infrastructure and main plant is provided centrally, no work is required within this scope of work to the main mechanical and electrical plant. The scope of work requires the demolition and removal of the existing fittings, finishes and internal partitions, along with amendments and renewals to the mechanical and electrical installations to accommodate the new layout. The works include the construction of interior partitions, new ceilings and wall and floor finishes, along with associated MEP works, IT installations and new furniture.

Managing costs is high on the agenda for City Corp. There are a number of measures that can be implemented to insure cost is reduced. It is the process of estimating, budgeting and controlling cost so the project can be cost effective.

Estimate Costs: Is a approximation of the resources required to complete the development.

Control Costs: Monitoring sub-contractor, and managing changes to the project.

Determine Budget: Is the practice of aggregating the estimated costs of a particular activity.

Cost management is the process by which construction companies control and plan the costs of the project. Cost Management is not a well defined term it combines both cost accounting and management accounting. When properly implemented cost management will translate into reduced costs, increased value and over all profitable organization. There is no legal obligation for a company to complete a cost management plan however it has proven success. Furthermore there is no standard form for completing a construction management plan a company can choose to do as much or as little as required.

Activity Based Cost Management

Activity Based Costing is the breaking up of the project into manageable work packs where cost and budgeting can be manageable on a small basic. This system is a break off of Traditional Cost Management

Activity Based Cost Management does not solely deal with money, its aim is to approach the performance of the organization to provide a more effective way of viewing its efficiency. Activity Based Cost Management is follows the following principles:

Figure 2: Activity based cost management

Activity Based Costing Benefits

Activity based cost management has numerous benefits. As a project progresses throughout the project life cycle its priorities most critical changes.

Identifying cost activity centers, helps go supports managers to work out how to maximize shareholder value and improve performance. Activity based cost management also helps in identifying the most and least profitable sectors e.g. inefficient sub-contractors. Activity based cost management helps developments with cost intelligence to reduce cost.

Other benefits of activity based costing include accurately predicting costs, profits and resource requirements associated with changes in the organization.

Activity Based Costing Disadvantages

Activity Based costing is not suitable for construction development as a clear methodology is required. The construction industry is prone to time delay and variations making it difficult to have a clear methodology.

Activity Based Costing is not suitable when using estimations. It is next to impossible to have a proper estimation of the costs for some critical activities such as R&D. When there is a discrepancy in one activity in the development it affects the whole project.

Lean Cost Management

Lean Cost Management is a process for measuring, understanding, and improving the flow and interactions of all related tasks in order to keep the cost and project as competitive as possible (J,Ross, 2011).

Lean Cost management is a process that allows the organization to track the business costs.

Provide accurate, timely, and understand information to motivate lean transformation throughout the organization, and for decision making leading to increased customer value, growth, profitability, and cash flow.

Use lean tools to eliminate waste from the accounting processes while maintaining thorough financial control.

Fully comply with GAAP, external reporting regulations, and internal reporting requirements

Support the lean culture by motivating investment in people, providing information that is relevant and actionable and that empowers continuous improvements at every level of the organization. (Maskell and kennedy 2007)


The results of practicing a lean operation sets a standard of consistent and level amounts of accuracy where it is needed to maintain a successful development.

The second advantages results from the implementation of one- piece flow through production. One-piece flow in cellular manufacturing liner removes huge quantities of WIP between process flows, equipment and machines. Most components using the techniques commonly reduce their quantities of WIP by 50-60%.

If operations are producing to demand and flow through the valve stream in a one-by one productive methodology the result in the valve stream is drastically reduced inventory stores.


The only disadvantage for Lean cost management is that it is too effective. The organization can produce better produces, however the abundance and variations of new products the consumer loses the overview. The products become old-fashioned in a short period of time. Apple is a example of this, as they produce new version of products on a regular basic.

Lean cost management does not affect the construction sector due to the consent varies of different project sites.

Traditional Cost Management

Shortcomings or drawbacks of traditional cost management

Traditional management has been criticized in reasoned years due to the inaccurate estimates. It has been shown that there was a flaw in the methodology.

The principal arguments are:

Costing systems in job order production require excessive tracing of costs to individual jobs.

Overhead apportionment rates are too broad, covering wide bands of the operating cost spectrum.

Costs that are driven by variables other than production volume are apportioned to products by volume-based rates.

The numerator of the apportionment rate is almost always direct labor hours or direct labor cost, even though direct labor is the driver of few overhead costs

Apportionment rates generally reflect the assumption that all productive resources are expected to operate at the same level of intensity (percentage of peak operating capacity)

Costs of product-related activities outside the main manufacturing or service-providing centers - mainly R&D, marketing, selling, distribution, and warranty costs - are not identified with the products they support. (Kaplan 1984)

It was established that the relationship between cost and time in the construction sector has a large influence on cost management. (Navon 1995) implied for cost management to run effectively in the construction industry it must be dynamic, proactive and able to adapt to different scenarios. Their main aim should be to back up any decision made, it helps to focus management on improvements, it is reported that the average accountant spends up to 75% of his or her time on bookkeeping activities and less than10% on analysis and process improvement.

Companies can sometimes reduce training and investment to try and reach targets, however in the long run this has an larger effect in the future.

Cost Management Process

In many construction companies cost management considerations are an after though. In other companies cost is a more important factor but this emphasis is not acted upon late until the development cycle. Projects costs of production are estimated based on drawing and accumulated from quotes and manufacturing estimates.A cost management plan is developed during the planning stage of the development. All labor and material cost incurred in the project planning phase is tracked in the CMP.

There are three cost management processes.

Estimating costs involves developing an estimating for the over all project. The main outputs of the cost estimating process are activity cost estimating, and project documents updates, a cost management plan is crated as part of integration management when creating the project management plan. It should include information related to the level of accuracy for estimate various thresholds for monitoring cost performance report formats, and other related information.

Determining the budget involves allocating the overall cost estimate to individual work items to establish a baseline for measuring performance. The main outputs of the cost budgeting process are a cost performance baseline project funding requirements and project documents updates.

Controlling costs involves controlling changes to the project budget. The main outputs of the cost control process are work performance measurements, budget forecasts organizational process asset updates, change requests, project management plan updates, and project documents updates. Schewallbe, Kathy (2011). Information Technology Project Management. 6th ed. Boston: Cengage. 255-259.

Figure 1: The relationship between Cost Management Process

The project Cost Plan

Cash flow estimates can provide the information for Cost Management Plans. The final cost estimate provides a baseline for the assessment of financial performance during the project. To the extent that costs are within the detailed cost estimate, then the project is thought to be under financial control. (W.H. Lucas and T.L. Morrison 1989).

Due to the complex nature of the refurbishment a two tear cost management process is used. A cost estimate will be created during planning stage and this will then be converted to a project budget, this will be used as a guide. Delays and expenses incurred during the project are recorded and the Cost Management budget is amended. This provides a recorded to compare original and final cost. Individual tasks and sub-contractors can be managed and a unit rate can be calculated. In addition prices for material, labor and quotes can be retained to improve the cost management process.


Scope baseline: Is the product description, acceptance criteria, key deliverables, project boundaries, assumption, and constraints about the project. One of the most common constraint for many projects is limited project budget. Examples of other constraints are required deliverable dates, available skilled resources, and organizational policies.

Work Breakdown Structure: The project WBS provides the relationships among all the components of the project and he project deliverables.

WBS dictionary: The WBS dictionary and related detailed statements of work provide an identification of the deliverables and a description of the work in each WBS component required to produce each deliverables.

Additional information that may be found in the scope baseline that includes requirements with contractual and legal implications are health, safety, security, performance, environmental, insurance, intellectual property rights, licenses, and permits. All of this information should be considered when developing the cost estimates.

Project Schedule: The type and quantity of resources and the time-scale in applying them in completing the project are major factors in determining the project cost. Schedule activity resources as well as their respective durations are key inputs in this process. To estimate activity resources it is important to determine both the availability and quantities required of staff and material needed to perform schedule activities. This is just as important, and quite closely coordinated with cost estimating. Activity duration estimates will affect cost estimates on any project where the project budget includes an allowance for the cost of financing and where resources are applied per unit of time for the duration of the activity. Cost estimates with time-sensitive costs included in them, like union labor or materials with seasonal cost variations, can also be affected by activity duration Environmental factors: There are enterprise environmental factors that have to be taken into account as they influence the estimate cost process. Amongst others, they include the following:

Conditions in the market: Describe the types of products, services, and the results that are available in the market, from whom they are available and under what terms and conditions. Supply and demand conditions on both a global and regional level have a large bearing on resource costs.

Published commercial information: Commercial databases that track skills and human resources costs offer resource cost rate information, and provide standard costs for material and equipment. Other sources of information include published seller price lists.

Techniques used

Expert judgment: Labor rates, material costs, inflation, risk factors, and other variables all have a bearing on cost estimates. Expert judgment, guided by historical information, provides valuable insight about the environment and information from prior similar projects. Expert Judgments are also valuable in determining whether or not to attempt to reconcile differences that occur as a result of the different means deployed in making estimates.

Analogous estimating: Uses the values of parameters, such as scope, cost, budget and duration or measure of scale such as size, weight and complexity, from a previous, similar project as the basis for estimating the same parameter or measure for a current project. In the estimation of costs, the actual cost of previous, similar projects is used as the basis for estimating the cost of the project at hand. The approach taken is a gross valve estimating approach, which is sometimes adjusted for no differences in project complexity.

The type of cost estimation is frequently used to determine a parameter when there is a scarce amount of detailed information about the project for example, in the early phases of a project. Historical information and expert judgment are valued highly in such estimates.

As well as this, analogous cost estimating is generally cheaper to carry out and less time consuming when compared with other techniques. However it has also been deemed to be less precise. Such estimates can be applied to a project in its totality, or to particular segments of a project, deployed in conjunction with other methods of estimation. It is most reliable when the previous projects are similar in fact and substance, not just in appearance, and the project team members preparing the estimates have the required expertise.

Parametric Estimating: This method uses a statistical relationship between historical data and other variables like square footage in construction, to arrive at an estimate for activity parameters, such as budget, duration and cost. Higher levels of accuracy can be attained using this technique, depending upon the complexity and fundamental data built into the model. As well as this, parametric cost estimates can be applied to a total project or to segment of a project, paired with other methods of estimation.

Bottom-up Estimating: Is a means of estimating the work of a component. Extremely accurate estimates can be provided as to the cost of the individual work packages or activities. A summary of the detailed cost is given or 'rolled up' to higher levels for later reporting and tracking purposes. The cost and precision of bottom-up cost estimating characteristically influenced by the size and complexity of the individual activity or work package.

Figure 3: Illustrates the method for a successful Cost Management.

Figure 3: determine Budget: Inputs, tools & Techniques, and outputs.


Activity cost estimates: Is a quantitative assessment of the probable costs required to complete project work. Cost estimates can be presented in summary form or in detail. Costs are estimated for all resources that are applied to the activity cost estimate. this include, but is not limited to, direct labor, materials, equipment, services, facilities, information technology, and special categories such as an inflation allowance or a cost contingency reserve, Indirect costs, if they car included in the project estimate, can be included at the activity level or at higher levels.

Basis of Estimates: The amount and type of additional details supporting the cost estimate vary by application area. Regardless of the level of details, the supporting documentation should provide a clear and complete understanding of how the cost estimate was derived.

Document associated with Activity Cost estimates.

Paperwork associate with the estimate

Paperwork associate with assumptions made

Paperwork of any know constraints

Indication of the confidence level of the final estimate.

Tracking cost during the project

Tracking cost during a project is documented in every project however cost management has an extensive method. The three fundamental documents used in cost management are:

Document Expense Forms

Approve Expense Forms

Register Expense Forms

Document expense forms provide accountability for invoices, bills of lading and account statements. It is also used to track time sheets and plant records.

Approve expense forms are a method that insures the project is meeting local financial regulations. Specific codes, approval and reviews are necessary for these forms.

Register expense forms are an accounting tool that tracks all expenses verses cash flow. Two accounting methods can be introduced cash or accrual method.

Method used for refurbishment of office block.

To prevent failure in the refurbishment, a cost management process is implemented it ensures accountability and provides a tracking system to prevent over spending.

Research suggested that Lean Cost Management and Activity Based Cost Management were more suitable to manufacturing and commercial industries. Whilst activity based costing is not a perfect science it does offer a sense of financial pragmatism to the wider management process. Therefore it has been shown that Traditional Cost Management best suits this development due to the large and uncertain nature of refurbishment. Certain elements can be estimated however these change due to uncertain circumstances. It is well known that Traditional Cost Management utilize a single, volume-based cost driver, this is suitable to the development as only one point of view is being expressed.

Traditional Cost Management is improving every year. New methods are being introduced however the construction sector is slow to participate in growing process.


It is a common theory that ninety percent of construction projects are completed, late or over budget. The task of cost management is to provide a traceable record of the project and to give a depiction to the reason for the delays and the cost implemented. It is hard to interoperate project accounts until the development has been accomplished, and then it is too late to influence project management. A successful Cost Management procedure helps to reduce this risk. Cost saving is achieved successful during planning and design for the development. Changes during construction are likely to increase the project budget and delay the development Cost Management tracks these changes providing evidence if contract have been broken by any party.


Based on the findings it can be concluded that tradition cost management is best suited for the development, it was proven that traditional is best used in the construction industrial sectors.