Activity-based Costing: Advantages and Disadvantages

Activity-based costing is an information system, that assigning resource of cost to products or services based on the activity consume. The Economist, June 29th 2009, Activity-Based costing Thus, ABC can help the manager to obtain more accurate and up-to-date costing information to evaluate the cost budgeting to maximize profit. (Metin Reyhanoglu, Activity-Based Costing System: Advantage and Disadvantage, Ankara University, Turkey, Pp.2) In additional, ABC can provide a company with precise cost information to improve company performance. In order to allow identify the products and prevent inefficient or unnecessary activities for cost reduction and enter in the wrong marketplace. (Turney 1991, Pp.50) The ABC is become most popular since1980’s from the rising lack of relevance of traditional cost accounting of assigning costs and to enhance its usefulness to decision making define by English man’s Robin Cooper and American’s Robert Kaplan.

ABC system follows two stages to identify the cost. Firstly, is accumulates manufacturing overhead costs for each activity consume; Secondly, identifying the resources and activities consume and then assigning the costs to the products, services and customers. ABC is an alternative to Traditional Cost Accounting in which a company’s overheads are assigned in proportion to an activity’s direct cost. This is dissatisfied whereas two systems which are absorbed the same costs but can use very different amount of overhead. Hence, for a company using TCA system that make and more and more variety products would lead to large losses. For the today’s manufacturing, ABC systems is most appropriate to adopted for companies to customise products, this is because it can assigning indirect costs more accurately. While ABC look complex whereas TCA is simple, because ABC required a lot of specializes knowledge to be able implemented correctly and provides positive results.

It is a well know that the Traditional cost accounting (TCA) is a systems usually assigns costs based on single volume to measures such as labour hour, machine hour and etc. It is arbitrarily assigning manufacturing costs overhead to units produced (only to product). It is an allocate manufacturing costs directly to products or services such as direct labour hours, direct labour costs or machine hours. But TCA is fails in assigning non-manufacturing costs such as administrative expenses because it is not absorbed in to products or services. This is a reason why the TCA system often report inaccurate in product cost compare to ABC system.

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But in the situation, the company where there is a large diversify of products or high level of automation, thus, the overheads’ misrepresentation will be significant in TCA system. Therefore, ABC system is more appropriate to adopt it can help the manager to analysis more accurate cost management than TCA system. ABC can provide reliable information in calculation product costs and is best practice for products and service profitability analysis. Therefore, today’s manufacturing most of the management recommendation using ABC to determine costs. When overhead is high, diversify products, therefore cost of determine cost of mistake high and competitive is stiff thus ABC is able to calculate the precise cost of product compare with TCA. ABC system is help to evaluate performance and set budget which can assist the manager to use this information to control and comparison purpose. To prevent over budget situation and overcome unpredictable occur. ABC can help the management to set clear picture of the objective to guide the company toward given target. For the TCA system is determining the cost of production after the produces. Therefore, TCA system is almost obsolete whereas ABC system is become famous. ABC can provide more precise information in determine cost of product and control the quality of the products to prevent sacrificing by competitor.

Advantages & Disadvantages

In the advance manufacturing, many companies adopt ABC system because its can provide more advantageous offer so that can reduce misrepresentation in product costs. ABC can provide more logical, relevance and accurate information to assist company calculation more precise cost of product and evaluation the performance, leading to increase profitability measurement.

For the accurate measurement of ABC that can help managers more effective at decision making. Therefore, a better decision can improve the management strategic and tactical planning effectively, detect changes in unpredictable and allows managers to detect mistake become crucial.

To be profitability, a company must calculate its product costs in order to make its pricing decision. Therefore, ABC system is an effective product costing system more appropriate to adopt. It can provide management with the vital information, timeliness and accurate information to designed standard costs to compare the variance between actual costs. Management can analysis the mistake and take corrective action of variances. It can minimize the risk of error estimate product cost.

To remain ahead of competition, the company must be offer goods and products of the good quality and right price for retain customers. Thus, the company is in interest the prices competitors set of their products. This is an important factor for the company to determined cost of product and making decision whether is a right time to enter a new market. If the selling price set too high lead to loss lots of loyal the customers and damages the company image. Therefore, the company must prepare contingency plan for changing needs of the market.

Although ABC can help manager manage overhead and understand profitability of products and customers as well, despite managers should be aware several limitations.

For getting accurate information is not easily, sometimes the company need spent lot of times to collect data and investigate, that all is not free thus caused consume a lot of human resources and valuable time. It is a well know that the ABC system is not cost free. Lot of the company considers an ABC is likely to be very expensive to implementing. Due to ABC was not updating because designs difficult and time consuming to develop. But found out that ABC can only be implemented in certain companies from certain industries because not all the companies suitable advanced system like ABC. For small businesses for choosing not implement of the system. Despite, some large businesses have discarded because of high maintenance and complex to implement.

However, despite the claimed limitation of ABC, but still have company prefer to implementation of ABC system. Because its can provide most reliability and effective information. Eventhough ABC has consumed most of time and cost to gather information but it can result to get first-hand information for better strategic planning. The accurate information can assist in minimizing the waste, saving time, and easily to identify the cost of product simultaneous cost save. ABC system can help to reduce resources consumption and boost profits.

Around the world, different companies have adopted ABC in order to minimize the costs and increase the profit. In this paper would be discuss the adoption of ABC system in four (4) countries with different culture and industries to identified the factor that critical to implementation.

Case study one: Restaurant Industry in Tunisian

According to Amel B. Hadj Salem-Mhamdia and Bahia Bejar Ghadhab’s “Value management and activity based costing model in Tunisian restaurant” article was reported that the tourism industry play an important roles for Tunisian’s source of income and restaurant industry is highly competitive and is central to the success of the tourism industry.

Costing method play an important role to further develop the restaurant industry in Tunisian due to costing method might direct and/or indirect lead the business to maximize the profit and minimize the cost.

In this first case study, ABC system was successfully implemented the “a la carte” style restaurant in Tunisia (only a single restaurant in Tunisia). Thus, ABC system fully recommended adopting due to able to determine accurate cost of product in term of cost incurred of different activities involved in all menu items. This is because every different activity it can mainly directly affect the cost in the menu. Thus, ABC system can provide reliable and accurate information to calculate costs of the menu item and profitability measurement. In order to forecast the ingredients order, adjustment of recipe grade, etc. Operation Department (Chef, Services staff) is important for a restaurant, ABC system able to analysis the adjustment of operation salary, operation hours, staff arrangement.

ABC system is a significant benefit for restaurant industry; it can provide reliable information useful for market research and culture analysis in service industry especially can improve of planning and cost control analysis. Simultaneous can directly perceived the restaurant’s activities via customer satisfaction survey analysis. In order to help managers make a good decision drive for restaurant’s profitability and competitiveness. In the conclusion, ABC system has been suggested as an appropriate method for guiding and leading the process of making decision. ABC is a viable method to estimate product costing in restaurant and also conduct a price sensitivity analysis in order to learn about the price elasticity patterns of the menu. The ABC system can be identifying the basics of service direction and service experience in a specific culture environment.

Case study Two: Telecommunication Industry in Portuguese

According to the Maria Joao Martins Ferreira Major’s “Management accounting change in Portuguese telecommunication Industry” article was reported the telecommunication company in the Portugal changed the management accounting system in order to evaluate more accurate product cost and provide efficient information to enhance the decision making.

In this subsequent case study, conduct in Portuguese telecommunications company call Marconi, the main activity of the company is providing long distance telecommunication service. The Marconi’s telecommunication business was operating in a monopoly organization in Portugal, hence was not facing any competition pressure issue. For today’s industry, the telecommunication market in Portuguese become more and more competition attack the market. Therefore, the Marconi required the manager with significant market power should follow cost direction in order to justify the cost. So the Marconi decided to implemented ABC system in order to stay competitive and deliver more applicable and precise data which can be used by the management.

In this research, the Marconi changed its TCA systems and replaced it with ABC system due to the company did not have a proper cost systems to control costs. ABC system, it can provide reliable information can be used to calculation the cost model which to satisfy the Portuguese telecommunication. The result of ABC system is highly recommendation to adopt in the telecommunication company in Portugal, because it can provide significant information to provide precise cost calculation of telecommunications’ interconnections. Thus, the European commission clearly designated that the ABC system is more appropriate used to allocate the common costs to the cost of product.

Furthermore, ABC establishes an efficient managerial tool to support manager in decision within the new business environment. In addition, ABC system can provide accurate and up-to date information to support calculate product costing more precise through the allocation basis and assists managers better understanding of the drivers on costs. Finally, the telecommunication company choosing ABC as the “right” costing system sacrificing TCA in order to assist manager evaluate interconnection prices strategic more adequate was an important issue.

Case study Three: Hot Spring Country Inn in Taiwan

According to Wen-Hsien Tsai and Jui-Ling Hsu’s “activity-based costing: a case study in Taiwanese hot spring Inn’s cost calculation” article was reported the Hot Spring Country Inn is run a nontraditional style business in Yang-Ming-Shan area of Taiwan. The company is provides nontraditional lodging, hot spring and meal serving services.

In this third case study, the Country Inn was forgone TCA and adopt ABC as their costing management because ABC system is more practice and appropriate for the company and can provide more accurate information for evaluate cost management and pricing set-up.

The ABC system is more applicable to use because the company has various products such as lodging, hot spring and meal serving. Therefore, ABC system can provide more relevant and accurate information to calculate the cost. For the diversify products thus the overhead which indirectly traceable to the product, therefore proportion the overhead of the total cost is very significant. The ABC system more concern on the precise cost assigning and overhead allocation. For instant, the Country Inn fully agree the implemented ABC system is really more benefit and useful costing management. And ABC system can provide more accurate information for pricing decision and make a better decision.

Meanwhile, the Country Inn faces on seasonal customer fluctuation unstable, while in winter the hot spring use can hit to the maximum whereas in summer season would drop minimum. Thus, using ABC system can overcome this seasonal issue. The manager can implements ABC system to allocate resources costs based on activity consume and assign the overhead costs to product based on direct labour hour to overcome limitation of TCA system in order to calculate more accurate cost of product and prevent losses. After the Country Inn adopts ABC system, the unit costs of each product in the market segment obviously clear and can provide useful information to assist managers on decision making and cost-volume-profit analysis. Therefore, the Country Inn fully agrees choose the “right” costing system and define activities well.

Case study Four: Automotive manufacturing in American

According to Paul Jurek, Bert Bras, Tina Guldberg, Ji, D’Arcy, Seong-Chan Oh and Stephan Biller’s “Activity-Based Costing applied to automotive manufacturing” article was reported the GM adopt activity-based costing to evaluate demand and response offer from local utility company in an American automotive manufacturing industry. General Motors Company known as GM is produces cars & trucks and sells & services these vehicles is an American multinational automobile, and among the largest auto-producer in the world.

In this case study, automotive industrial is a complex, consume large amounts resources and high competitive. Due to the way to increase competitive advantages is implement ABC system to analysis the production and operating cost in order to minimize the expenses due to ABC able to identify the cost in detailing for each production stage and/or material cost. It can assist the operator for selection of material and/or production method, i.e. hours of labour, amount of space, length of melding, efficiency of machinery.

Also, ABC able to advise the demand and response for the product and this may help manufacturer to determine the cost allocation for resource, material, marketing plan, etc. In conclusion, ABC system is suitable for huge production industrial even the implement cost is high, because the return in direct and indirect benefit or profit due to of able to identify the cost in detailing and helps to allocate more resources on profitability products.

Conclusion

As the research from different industries in above, ABC has demonstrated leading to produce more reliable, precise in costing management and cost-volume-profit analysis. Thus, those industries fully agree the ABC system is a more appropriate costing system to implement for the nowadays. Despite, the ABC system cost expensive and consumed most of time, but those companies still willing to adopt ABC sacrificing TCA in order to overcome limitation of TCA. ABC systems identify easily to determine the cost of product, minimize the waste and simultaneous save cost. Therefore, ABC system more appropriate adopt for the company. To conclude, ABC system can provide accurate information for resulting in better decision, strategy planning and forecasting for future development.