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In recent years, many companies have significantly changed their management accounting systems and emphasised the importance of performance measurements in assisting strategic and production decision-makings, in order to meet the current business environment which is characterised by escalating competition, changing competitive strategy and shorter product life cycles. As a major component of performance measurements, traditional management accounting practices and techniques, especially the field of costing system, has been the subject of a great deal of criticism and innovation since the mid-1980s as it focuses primarily on the internal environment and tends to ignore the competitive external environment. Even though a great deal of empirical research has claimed that traditional costing systems are irrelevant with current business environment as they failed to fulfil contemporary company information requirement, especially for the aspects of the organizations' competitiveness and long-term performance (Kaplan, 1984; Johnson and Kaplan, 1987; Hiromoto, 1988; Bromwich and Bhimani, 1989; Carnes and Hedin, 2005; Drury, 2008), there are still a large number of companies retaining the traditional costing systems as their major cost-management tools (Dent, 1996; Mishra and Vaysman, 2001). Since there is far from being a consensus over the utility of traditional costing system, this essay aims to discuss the relevance between the traditional costing system and current business environment, by analyzing two representative traditional costing techniques which are traditional absorption costing and traditional standard costing and introducing other advanced contemporary cost-management techniques such as activity-based costing and just-in-time as well as total quality management.
II. The relevance of Traditional Absorption Costing Systems:
Traditional costing systems emerged in the early 1900s. With high setup times and long production runs, traditional costing systems also involved high proportion of direct costs such as labour cost. As a consequent of the stable environment in those years, the traditional costing systems have been considered as the preferred costing system. However, due to the increasing competitive pressure in current business environment, the traditional costing system, especially its two representative costing techniques, have been the subject of a great deal of criticism and innovation in recent years.
As one of the traditional costing systems, traditional absorption costing system measures direct costs at the unit of production and allocates indirect costs on volume-based production. Traditional absorption costing system used to be the preferred cost-management tool in the 20th century. However, due to the current competitive business environment, there is far from being a consensus over the utility of it (Baxter, 2005). First of all, the traditional absorption costing system use an arbitrary method with the utility of volume-based overhead absorption bases such as labour hours or machine hours, which does not indicate the true cause of overheads and may result in producing misleading cost estimates. Moreover, the inaccurate measurement of product costs can not only lead to the difficulties in making cost savings in overheads but also result in poor pricing and sales mix decision-making, by creating managers' incentives to overproduce. (Ratnatunga and Sharma, 1997; Drury, 2008)
Due to the significant limitations of traditional absorption costing system, more and more companies are in favour of employing other contemporary cost-management tools such as activity-based costing (ABC), which can provide more relevant and accurate cost information by emphasising the utility of activity cost centre and allocating the overhead costs based on true cost drivers rather than direct labour or machine hour involved in the traditional way. According to the application of cause-and-effect drivers, ABC approach can not only improve pricing and sales mix decision-makings but also enhance the accuracy of profitability analysis. Nevertheless, there are still a great many accounting authoritative bodies have adopted absorption costing. With an absorption costing system, fixed overheads can be deferred and included in the closing inventory valuation, and should be noted down as an expense only when the goods are sold. As a result, absorption costing can offer a more reasonable picture of profit calculation as losses cannot be directly reported in the periods when stocks are being rose (Drury, 2008). Moreover, due to the fact that contemporary management cost-accounting techniques such as ABC involves complicated production process and costly employee training, retaining the traditional absorption costing system is much more suitable for those companies which have simple production line and fewer cost drivers, as it is less expensive to implement than the ABC technique. In addition, when managers' private information is characterized by low uncertainty, employing the traditional costing system can provide higher expected profit for firms' owners than the ABC approach. Mishra and Vaysman (2001) present a further explanation for this view point. They indicate that firms with low uncertainty about managers' private information will prefer to retain the traditional method because the additional informational rents paid to managers under contemporary management accounting techniques such as ABC method will exceed the gross benefits from better production decisions. If managers' private information are characterized by high uncertainty, those companies will adopt activity-based costing rather than retaining the traditional system, due to the gain from better information outweighs the additional informational rents paid to managers. Thus, some companies rationally adopt the new costing system while others retain the traditional system, due to their different purposes and different circumstances. In other words, the traditional absorption costing system and the activity-based costing system can coexist in current business environment with particular situations.
III. The relevance of Traditional Standard Costing System:
As to another conventional costing system, standard costing system involves recording production operations at standard or predetermined costs and analyzing the variances between the actual costs and the standard costs. In consistent with a series of repetitive operations, standard costing system is regarded as an appropriate tool for planning budgets, managing and controlling costs, cost management performance evaluation over a period of time (Drury, 2008). However, numerous dissenters argue that traditional standard costing and variance analysis may not appropriate for the current competitive business environment. First of all, due to its internal-oriented cost control, traditional standard costing and variance analysis can produce misleading and misdirecting management since it neglects the external market-oriented factors such as quality, lead time, flexibility and innovation. Secondly, different from the just-in-time (JIT) and total quality management (TQM) which intends to provide just-in-time delivery of quality materials and achieve the minimisation of inventories, this costing system does not highlight the importance of quality and delivery as it focuses primarily on bulk purchasing and substituting suppliers to obtain costs reduction. Besides, by comparing to the TQM technique which is seeking opportunities for continuous improvement with the aim of zero waste and 100% quality, the predetermined standards and the tolerance of the inefficient activities of this traditional method will increase managers' incentives on maintaining cost rather than pursuing a continual cost improvement in today's competitive economic environment. Moreover, by stressing on labour and machine efficiency variances measurement, over-production will be encouraged and thereby results in excessive inventories. This contradicts the philosophy of JIT which aims to attain the minimisation of waste and zero inventory. In addition, with the utility of volume-based overhead allocation rates, management may be misdirected to control the allocation rates instead of the total product costs, which ultimately induces inaccurate establishment of overhead levels and high cost operation are overlooked. The measure is similar to that of the traditional absorption costing, where the true cost drivers are also not identified. Thus, by employing the activity-based management (ABM), this defect can be eliminated since the cause-and-effect drivers will be used to identify the appropriate relationship between business activities and production costs. Furthermore, due to the blindly emphasis on the improvement of department efficiencies, this traditional costing system neglects the overall efficiency of the value chain, which serves to hinder non-value added and cost inefficient business activities and thereby loses the chances to reduce costs. This conflicts with the concepts of JIT and TQM which emphasise to employ redesigns of business processes to attain performance improvement. Additionally, financial variance reports on a period-to-period basis cannot provide enough meaningful and timely information to facilitate proper control activity to adapt to contemporary fiercely competitive business environment, since real-time information are in great need by the current empowered multi-skilled employees. The periodic financial variance reports also hinder the successful implementation of JIT and TQM which facilitates proper control action and always seeks opportunities for continuous improvement in a dynamic business environment. (Drury, 2008; Noordin etc., 2009)
Even though there are significant limitations of traditional standard costing system, it still plays a crucial role in current management accounting with proper improvement. Primarily, with the utility of demanding instead of attainable performance standards, managers can be motivated to strive for continuous improvement. Secondly, standard costing and variance analysis can not only be employed in controlling cost and evaluating performance but also in estimating tracking costs of inventory and maintaining decision-makings' database, with the aim of improving cost efficiency as well as retaining the flexibility and sensitivity to the unstable market and customer preferences. Besides, this traditional approach can also be employed to keep empowered work teams in the contemporary JIT or TQM environment well informed of the financial influences of their activities. Moreover, cost gap can be determined, reduced and eliminated by incorporating the standard costing system with the target costing technique. (Johnson and Kaplan, 1987; Bhimani, 2006; Drury, 2008)
From the theory-based perspective, due to the escalating competition, changing competitive strategy and shorter product life cycles, companies should adopt the contemporary advanced management cost-accounting techniques instead of traditional costing systems in the current business environment. However, a great many firms still prefer to retain the traditional costing systems in spite of their significant limitations. Numerous empirical research assert that traditional costing systems still have some advantages compared with contemporary advanced techniques. Firstly, the utility of traditional costing systems can avoid fictitious losses being reported and provide higher expected profit in financial report for firms' owners than other contemporary common cost-management tools such as activity-based costing. Moreover, retaining the traditional costing systems is especially suitable for those companies whose private information of managers is characterized by low uncertainty. Besides, the application of a contemporary management cost-accounting technique can be much more expensive than employing a traditional costing system, due to the fact that contemporary techniques involve complicated and costly production process and employee training. In other words, although there are many benefits of adopting new advanced techniques, traditional costing systems still play a crucial role in the current business environment. Therefore, it is quite hard to reach the conclusion that traditional costing systems are irrelevant to the current complicated business environment because it can still coexist with other contemporary management cost-accounting techniques in particular situations (Mishra and Vaysman, 2001; Atkinson and Kaplan, 2007; Drury, 2008).