Critically evaluate the use and purpose of activity based costing techniques

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ACTIVITY BASED COSTING 1

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There are a number of critiques directed against activity based costing techniques. An example of such kind of a critique is that it requires a large amount or pool of resources, for the management to efficiently use its concepts (Sedgley and Jackiw, 2001). This makes it difficult for small companies that have limited resources to efficiently use this concept. This is the reason some scholars argue that ABC costing techniques are just fashionable, and they do not provide extra information that can be used by the management to run a company. This paper is a discussion of the above comments, and it aims to proof the assertion that activity based costing, is not a fashionable costing method, but it is an efficient method of recording the activities and transactions of a company.

Activity based costing refers to a managerial accounting system that is responsible for the estimation of the costs of services and products by passing on the overhead costs, to the direct costs. This costing technique is able to assign the costs of each and every activity in an organization to products and services its manufacturers (Izhar and Hontoir, 2001). This is in accordance to the actual consumption that the product under consideration is able to incur. This is a departure from the previous cost accounting techniques that involved the sharing of overhead costs in an equal manner, or even allowing overheads to be part of an estimate of the overall profit or loss. An example is component product pricing (Plowman, 2001). Most management organizations have adopted the use of activity based accounting, because it has been efficient in improving their performance.

Companies normally use activity based accounting techniques for purposes of improving their costing accuracy, and not for fashion. The use of costing techniques in accounting is useful because it helps an organization to have a true value of their overhead costs and profits (Plowman, 2001). This technique helps an organization to have an accurate understanding on the costs and rates of return on an investment from its other initiatives. In these perspectives, activity based accounting techniques is able to project a true cost in these areas (Jagolinzer, 2000). The traditional costing techniques normally treat these costs as indirect costs.

Activity based costing treats these costs as direct costs. Take for example an organization that has managed to efficiently adopt and implement the provisions of activity based costing. These companies normally use the principles of ABC for purposes of supporting a decision on the pricing strategy of an organization. They may also use the principles ABC to delete or add activities or products that have a contribution on the overall financial performance of the organization.

Hoque (2005) further explains that one of the important areas where activity based costing is important and applicable is on issues regarding business process re-engineering. Under this process, it is essential to determine every basic process that each business unit undertakes or engages in. These are determined before any specific changes to the business organization are instituted. Identification and determination of these costs is important because they help an organization to have an accurate projection or view on the savings they have made, because of the changes instituted in the organization (Sharma, 2010). On most occasions, companies normally make a claim that they have made some huge savings after undertaking the process of business re-engineering.

This is without taking into consideration the various costs involved in the planning and implementation of the changes under consideration. In as much as these costs are onetime costs, there is a need of making an account of them while analyzing the performance of the business organization (Plowman, 2001). Furthermore, the identification of these costs and savings is essential because it helps in identifying the methods which an organization can use in distributing the money saved, on the exact process that passed through a change (Glykas, 2013). In its application to the process of business re-engineering, activity based costing is not fashion, but an essential tool that can be used for purposes of collecting information on the actual amount of money an organization saves.

This money can further be channelled to other areas of the organization, or used to sustain the changes under consideration. Total quality management is another important area where it is essential for an organization to use the principals of activity based costing. The major aim of total quality management is to reduce the rate of rejection of the organizations products, hence improving the efficiency and productivity of an organization (Hansen and Mowen, 2009). However, the yardstick of measuring an improvement in the productivity of an organization is by analyzing the rate of costs that an organization manages to reduce. It is only possible to measure and analyze these costs; by the use of the principles that govern activity based costing. This is used before and after the implementation of the concepts of total quality management (TQM). It is easy to apply the concepts of TQM to business organizations involved in the service industry.

This is only if the managers of the organization use the principles of activity based costing to measure and utilize the results under consideration. Another important application of the principles of activity based costing, touches on the concepts of open book management (Oliver, 2000). This is a situation whereby the management of a company are involved in the sharing of the information touching on financial position and capability of the organization. This information is shared with the employees of the organization (Hansen and Mowen, 2009). The major intention of using the principles of open book management is to make the employees of an organization to know of the financial position of the company, and their contribution to the company under consideration.

This kind of information is very important for the employees of the company, mainly because it acts as a motivational tool, where they are able to know of the effectiveness of their performance (Lucey, 2002). However, the use of open book management will achieve very little results, in making employees to be aware of their contribution to the business. This is without having knowledge on the costs the organization incurs while they are performing their tasks, and how these costs are able to impact on the production or service costs (Anderson and Young, 2001). To motivate the employees of an organization, incentives are given to them. These incentives must be measurable. It is possible to achieve this objective through the enactment of a proper principle of activity based costing techniques. Motivation of employee is important because it increases their productivity.

Employees would not be productive; hence they won’t meet the needs of the customers. Providing them with information concerning their activities within the organization is an example of a feedback process, which is an important motivational tool (Sedgley and Jackiw, 2001).

Therefore , activity based costing is not a fashionable accounting technique, but an important and essential accounting technique that can be used in improving the performance of a business organization. Those who argue that it is a fashionable accounting technique, base their arguments and assumptions on the disadvantages of activity based costing techniques. Hansen and Mowen (2003) argues that it is a complicated affair when too many activity costs and cost drivers are recognized in financial records. Based on these facts, it is always complicated to understand and maintain the ABC cost accounting system.

Agrawal and Jain (2008) therefore argues that because of the difficulty in maintaining this system, most companies or organizations are never efficient in implementing the system. On a specific note, small organizations that do not have the necessary resources or capital that can help them to efficiently implement this system. Therefore, organizations that use the ABC costing system will collect insufficient information that may not be useful to the organization. Other issues that affect the implementation of activity based costing system, touches on hiring of accounting consultants who do not have a clear understanding of the objectives of the organization (Kaplan and Anderson, 2007). This makes it difficult for the consultants to come up with a list of activities that can be used for purposes of analyzing the costs that the organization incurs.

Employees of an organization may be resistant to change, when an organization seeks to implement the provisions of activity based costing techniques. This would therefore make it difficult for the company to collect the necessary information that can make it achieve its objectives. Brigham and Houston (2004) explains that in as much as these assertions are right, but, with the right managerial practice and control, chances are high that an organization may achieve success and efficiency in their use of the cost accounting techniques.

In conclusion, the activity based costing system is used by an organization mainly for purposes of improving the product mix and pricing decisions of a company. It is not a fashionable policy, because the information obtained in it, is useful to the management. This information would provide true and accurate costs that an organization incurs. This in turn would provide a true financial report on the profitability of the organization under consideration.

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