An Introduction to the method of cost accounting

Published: Last Edited:

This essay has been submitted by a student. This is not an example of the work written by our professional essay writers.

Since the 19th century, cost accounting has been seen as a vital part of an organization particularly in manufacturing industry. In the manufacturing industry, almost any organization is capable of out producing and out selling any of its competitors and gaining high revenue and high profitability. However, organizations found out that the most efficient manufacturing method is being able to increase productivity while reducing costs. Therefore, costing system that provides an accurate cost calculation plays a very important role in this industry until these days. a comparative analysis of ABC and traditional costing.pdf

In recent years, cost accounting is seen not just as a cost calculation method used by organizations for measuring its profitability and performance, it is also essential information that is needed by decision makers. These days, with consumers demanding for better products, organizations seeking the latest technology in production, and demand for control in organizations, improvement in costing systems has been developed. The development of a costing system a historical perspective

Traditional costing system

Prior to 1980s, traditional costing was the costing system used by most organizations. Although traditional costing is cheaper and easy to be implemented compared to the costing system that were developed during 1990s Cost system choice and incentives traditional vs ABC, it is not a suitable method to be implemented by organizations in the modern economy nowadays. TQM and ABC

Manufacturing industry in the current economy strive on manufacturing products while reducing production time. As such, organizations in manufacturing industry has adopted manufacturing concepts such as just-in-time(JIT) and introduced robotics into production to speed up production time and reduce the need for labour involvement in production. As argued by A. Gunasekaran, manufacturing industry nowadays are more of capital intensive rather than the traditional labour intensive manufacturing style. Application of ABC: some cases experience Hence traditional costing system which calculates costs by allocating costs through direct labour hour basis will provide inaccurate costing information therefore this system is considered unsuitable in manufacturing industry nowadays.

As time passes, organizations in the 1980s began to search for new costing systems that is suitable for the changing economy as they realized traditional costing system is outdated and does not accurately explain the changes and consumption of costs. The development of a costing system a historical perspective

Activity based costing

New cost accounting system was introduced to suit the cost calculation method needed in the developments in manufacturing industry. Application of ABC: some cases experience As B. Mishra and I. Vaysman stated, "Activity Based Costing has become the accepted remedy for significant limitations of traditional cost accounting system", Activity Based Costing system (ABC) was developed to provide solution to the distortions caused by traditional costing system to the newly developed manufacturing concepts. Traditional vs ABC

One advantage that ABC has is it could provide a clear picture of how the business of the organization is being managed. It has the flexibility of reporting the type of information that is needed by management for decision making. Also, ABC apportions cost according to its appropriate cost drivers which would provide management with detailed accurate cost calculations to detect the cost of all activities. Traditional vs ABC The cost information provided by the system allows organizations to efficiently decide on product pricing and product designing which if not properly valuated might lead the organization into severe long run losses. ABCS: adv & disadv

In light of the increase in global competition, ABC is seen as a costing system which will provide organization with the most efficient cost information in the future and large organizations are recognizing its advantages. ABC: a concept whose time has come Therefore the implementation of ABC in an organization that is not performing well due to the changes in the current economy can provide extra capacity to the underperforming organization.

Many organizations have chosen to implement ABC system as its cost accounting system because of its significant role in the valuation and decision making processes of these organizations. Traditional vs ABC ABC too has its drawbacks. Even though it is a useful system, companies are required to pay high set-up cost compared to the using of traditional costing system. It is also time consuming and requires constant updates due to the frequent change in the market. ABC at Diebold

There are organizations which implemented ABC system but are not reaping the benefits which the system provides. One most common reason for ABC system to not work in an organization is poor implementation process. Cost system choice and incentives traditional vs ABC Organizations might have rushed into implementing the ABC system or using it to replace other costing method such as traditional costing system without proper planning such as confirming the participation of every staff in the organization during the implementation process and also taking all possible consequences into consideration.

Another possibility which causes organizations to fail in implementing ABC system is managers in those organizations misuse the information provided by the costing system for the purpose of self interest. Cost system choice and incentives traditional vs ABC ABC system is implemented in organizations because it generates accurate and well quality information for managers with the purpose of managing the processes of the organization. However, due to the high quality and usefulness of the information generated by the system, managers uses all the information together with their expertise to make decision which serves them best without the knowledge of the owners of the organizations. Thus this has caused the organization to suffer low profitability while the manager benefits from a system implemented through the finance provided by the organization for the welfare of the organization.

Also, the reason for the profitability of some organizations had worsen since the implementation of ABC system was due to no segregation of duties among the managers involved in the set up of the ABC system. Cost system choice and incentives traditional vs ABC Even in the smallest of organization, it should always allocate a manager particularly only for designing the system, another whom is only involved in overseeing the implementation stage of the system while one manager who only perform the duties of maintaining the system. This segregation of duties would minimise the chances of managers involved in management of the system while also the implementation of the system thus reducing the risk of managers misusing the ABC system for personal benefits.

Activity Based Management

Activity Based Costing system is most commonly used in manufacturing industry to generate accurate and significant cost information for the purpose of decision making. Nowadays, organizations introduced Activity Based Management (ABM) as a new system which benefits from the information provided by ABC. The purpose of ABM is to use the information generated by ABC to improve the performance of an organization which significantly increases the profitability of the organization. Application of ABC: some cases experience

ABM was developed based on ABC and it can now be used not only in manufacturing industry but also in others such as the service and the process industries. ABM an overview ABM benefits organizations by providing guidance on planning, managing and controlling of its activities to achieve the highest quality in terms of manufacturing a product, providing a service, and also satisfying customers. ABM uses the information generated by ABC which accurately measures the allocation of costs on cost objects and activities. Hence, because ABC provides only information while ABM helps management in making decision, organizations perform better through the application of both the systems. Application of ABC: some cases experience

ABM assist in decision making processes by indentifying the value-added and non value-added activities. It is essential to identify and discontinue any non value added activities which is wasting the resources of the organization because it does not provide any benefits to the profitability of the organization. Traditional vs ABC

Even though ABM is considered better than the traditional costing system, it has its flaws that are mostly similar to ABC. One problem that caused ABM to fail in deliver the desired result in helping the organization is the complexity of implementing the system. Top management whom failed to spend time in getting to know the complex system often chose to reject the implementation of ABM. Top management rejects the system because they do not see the benefits that exceeded costs of implementing the system due to the complication of the system. Arthur Andersen lessons from ABM battlefield. Hence without the involvement of top management, the system failed to provide efficient information that the organization requires.

Activity Based Budgeting

Budgeting is an important management tool used by organizations to plan, control and coordinate activities and also as a performance measurement. The traditional budgeting system of conventional budgeting system prepares budget by adjusting future budget based on the financial performance of the current year. Similar to the traditional costing system, conventional budgeting is an outdated system in the contemporary economy as it would not improve the budgetary process of an organization because as Samuel Idowu, senior lecturer in North East Surrey College of Technology argues that it only amends the previous years' budget instead of re-evaluating the costs incurred by the organizationin preparing for future budget. Budgeting a management tool

Other than ABB, Zero Based Budgeting system (ZBB) was also developed to overcome some of the weaknesses of conventional budgeting. ZBB prepares budget by critically reviewing the costs and activities that the organization is involved in while performing budgetary procedures. ZBB would take into account all the costs and benefits of funding the activities that the organization is involved for consideration before deciding whether to budget more funds for the particular activities or to discontinue it. zero based budgeting This system overcomes the flaw of conventional budgeting which organizations might budget more funds for an activity without proper consideration on the significance of how it might benefit the organization. Budgeting a management tool ZBB is more than just a budgeting process, it is also a systematic management process. Management in organizations that implemented ZBB performs planning, budgeting and operation decision making in order to generate information for decision making purposes. zero based budgeting It is an advantage that the system is better than conventional budgeting because conventional budgeting only provides budgeting information for budgeting purposes while ABB