Advantages Of Activity Based Costing Accounting Essay

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Activity-based costing or what we normally said as ABC is a method to calculate the costs of products and services of a company. ABC is calculated by capturing the activities involved in the production of products and services. ABC is considered as a better and more effective method than traditional cost accounting method in managing processes and arranging resources of a company. This is because of traditional cost accounting system is allocating the cost based on only one of the measurements while calculating the cost such as direct labour hour or machine hour.[1] (Chung, H.M. and Khan, M.B.)

Advantages of Activity-Based Costing

Activity-based costing or ABC is complicated and pricey to carry yet there are still many companies choosing to use ABC method because of its benefits or advantages. Nowadays, direct labour is replaced by the technologies or machine, therefore the classification and accuracy of margin become harder to achieve. As the result, indirect cost is becoming the majority part of the total cost.

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Secondly, the cost of products is able to be accurately calculated by using ABC method, companies can put a suitable price for their product and will not face problems such as losing a bid due to the price of product highly set or facing a lost due to setting a low price which cannot cover the cost of manufacturing the products.

Thirdly, by using ABC method, manufacturers will know which product is giving them the highest profit and therefore they will know which product that they should focus in order to get the highest profit for their companies. . Manufacturers will also know which product is giving them the lowest profit or even a loss so that they can take the correct strategies to overcome the problem such as spending lesser time and capital in such products. Apart from that, manufacturers can set a more suitable price and order size for their products. [2] (Horngren, C.T., Gary, L. and Stratton, W.O.)

Disadvantages of Activity-Based Costing

Although ABC method is a better way to calculate the cost than traditional method, however there are still some limitations. One of the limitations is allocation. The finding of ABC method can be impractical as not all costs have their suitable cost drivers. Some of the costs should be allocated to other departments instead of manufacturing department such as factory’s insurance and property taxes.

Secondly, there are some costs which are not included in the finding of ABC method such as marketing cost, research and development cost as well as advertising cost. Next limitation is about the cost to implement ABC method. It is costly to implement a new ABC system for those companies which are using traditional costing method. Last but not least is about time used to develop ABC system. In order to develop a new ABC system, it can be time consuming as normally the time taken for development and implementation is one year or even longer. [3] (Source: Activity-Based Costing and Management)

Difference between Activity-Based Costing and Traditional Costing System

The first difference between ABC method and traditional cost accounting is knowledge in allocating the activity and cost driver is required in ABC method but detailed knowledge in allocation is not required as only total overhead cost and a very simple allocation rule is required in traditional cost accounting. Another difference is a single overhead will be distributed differently among few products as each product uses different rate of overhead in ABC method but the overhead in traditional cost accounting is divided equally among the few products. The result of ABC method is more accurate compared to traditional cost accounting as it is close to the true cost of production. In term of cost of implementing, traditional cost accounting is cheaper compared to ABC method. [4] (Schmidt, M. 2012)

Is it still that despite the disadvantages and advantages?

ABC is a good tool in measuring the cost of a product but it still has its disadvantages. First of all, the cost allocation of ABC method is imperfect as not all the costs have their cost drivers as not all cost should be included in manufacturing. I think that this problem can be solved by only taking out the cost that shouldn’t be in manufacturing department and reallocated the cost to the correct department instead of manufacturing department. There is also some costs is not included when calculating the cost of products. Companies can choose to add in the cost and divided among the products so that they can get a more accurate cost. Even though the implementation of ABC costing is time consuming and costly but many companies willing to implement it as they think that it is worth to implement it. This is because ABC method can give out a cost that is more accurate. By having an accurate cost, then only management can set a price that is competitive enough to compete with other competitors and yet still can have profit. Besides that, they can also enable management level to know which product generate most profit and vice versa so that they can produce more products that gain most profit for company and do some advertisement for product that is having low sales amount.

How Implementation of Activity-Based Costing of Case Studies:

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A case study of a Thai telecommunication company had been carried out and according to this research, there are some factors that led to the success of the implementation of ABC method in this company. First of all, top management is in a very important position toward this success. Top management is having the authority or power to motivate his employees to take part in the implementation of ABC method. When the employees are taking part in the implementation, they will know more about ABC method and this will reduce their fear and finally will lead to the success. After employees decided to take part in the implementation of ABC method, enough practice and training should be given to the employees. Training shouldn’t carry out by external consultants, the training can also be carried out by top management whom have this kind of knowledge. Internal resource such as IT department is important to the implementation of ABC method as well. In order to get an accurate result, calculation is very important. Therefore, IT department is required to set up software for the employee to process the data for cost calculation. [5]

Second case is a case that taking place in one Catalan Town Hall of Spain which is the only town hall that had been successfully introduced ABC method. A survey had been carried out to find out what are the reasons of slow development of ABC method. Through this survey, factors that affect the development are being known. The first factor is employee is scared of changed to ABC method. They are worried about that ABC method is being used as a monitoring tool that a cost calculation system. This happens especially among the senior employee. Therefore, to overcome this problem, higher management level need to stress that ABC is a tool that use to improve the management and it is not only for monitoring employee. Besides, politician seems to be not interested in Catalan Town Hall which will lead to lack of resources that put in for development of ABC method or other cost accounting system. Following by lack of resources, there will be lack of experts in ABC method and finally ABC method is failed to implement. [6] (Bagur, L., Boned, J.L. and Tayles, M. 2006)

Another case study is taking place in Jordan. Most of the Jordanian companies are using ABC method instead of traditional costing method as information generated by traditional costing method is not enough to support the industry of Jordan. Besides the reason of accuracy, increase of types of cost and products are reasons that contribute to companies in Jordan are moving toward ABC method instead of traditional method. Employers and employees in Jordan are willing to change and sufficient training is provided to employees, therefore resistance from employees which usually happen in other countries do not exist here. According to the research done, ABC method is being proved that it is successfully implementing in Jordan. ABC method is now a part of daily processes for most of the companies in Jordan as they are happy with the calculation and result of ABC method which is more accurate by using its method of calculation. [7] (Sartorius, K., Eitzen, C. and Kamala, P. 2011)

The last case study is carried out in Bahrain. Although it is only a small quantity but there are still companies start to use ABC method. There are 2 factors that affect the companies in Bahrain start to use ABC method. The first reason is the managers or accountants are foreigners that come from developed countries and the second reason will be employees that studied in developed countries contribute the idea right after they joined the companies. The primary reason for implementing ABC method is about the cost. Companies will like to control and set up a suitable price for their products and stay competitive. According to the research, the reason why most of Bahrain companies still using traditional costing method is they are happy with the traditional costing method. Another reason is traditional costing method is their primary costing system used in the companies. [8] (Nassar, M., Morris, D., Thomas, A. and Sangster, A. 2009)

Conclusion

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In conclusion, companies nowadays are moving from traditional costing system to ABC methods slowly, some apply both traditional and ABC method It is because every manufacturer is competing with each other to get a higher market share for their products. Even though the implementation of ABC is costly and time consuming but some companies that willing to pay is still will implement ABC method as this is a tool that can help companies to achieve their companies’ target, that is getting the highest market share. Companies nowadays are reducing workers and replacing by machinery therefore indirect cost becomes the majority of total cost. Apart from that, ABC method enables companies to know the real cost of products thus they can fully utilize this information. For example, when there is bidding, companies can put at a lower price as tender price which they can afford so that the percentage of getting the bid is higher.