Exploring the evolution of cost accounting and managerial control practices


This assignment talks about the with relevance to the changing nature of industrial competition. The management accounting system has been evolving since the beginning of the last century, adapting to the needs of the changing business environment. A review of the cost accounting developments used in the manufacturing industries was not suitable to the present day business needs. (Kaplan, 1984).

1.1 Traditional System

The Relevance Lost "The Rise and Fall of the Management Accounting" by Johnson and Kaplan (J&K), referred to the challenges faced by today's organizations due to the rapidly changing technological environment which they have to compete, global trading and changes in the exchange rate fluctuations and raw material prices. Management Accounting System (MAS) as a vital element in achieving corporate success in a competitive environment. The arguments set out by J&K was that the technology was there, however what is lacking is the knowledge from experience and commuting them. J& F illustrated the historical developments emphasizing on the cost accounting practices of the textile mills and railroads to the industrial enterprises and up to the scientific approaches. (Johnson & Kaplan, 1987; cited by Mahmoud et al., 1990).

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Cost accounting developments and managerial control techniques was highlighted, elaborating the challenges which the business were unable to cope with the traditionally developed practices. The shifting from cost management to cost accounting where J&K argues that all management accounting practices used today has been developed. Improvements to the system of process control and product costing was discussed with ways to improve them in the future. (Mahmoud et al., 1990).

The remedies proposed includes management accounting system should achieve adequate time frames for the undertaken activities. The future performance as proposed by J&K should move away from short term profits emphasis and towards long term measure of performance and non performance indicators. (Mahmoud et al., 1990).

1.2 Activity Based Costing.

The rapid advancement of the information technology and the global competition has caused the irrelevance of MAS, in providing information for managerial decisions. The short coming of this resulted in a need for better MAS modified to suit the dynamic business environment. ABC can be used as a tool for planning, control and decision making purposes. ABC traces costs to activities rather than products and uses a large number of cost drivers instead of one to two volume based drivers in a traditional system. (Gunasekaran & Hussain, 2001).

Cooper (1990) stated that ABC systems presents a hierarchy of four mutually categories of activities. "The unit -level activities performed at each time a unit is produced; Batch level activities, where a batch of goods is produced; product level activities - needed as to support production of types of products and facility - level activities to sustain a facility's general manufacturing process".

Also, Cooper (1990) mentioned that the Full ABC system consist three different types of bases. They are unit level, batch level and product level. Attempts to match level of a base used to assign costs to produce the activity level, avoiding distortions. Thus provide improved insights into fixed costs management and easier access to relevant costs. The benefits of ABC should outweigh the additional costs caused by their increased in complexity.

ABC is not a replacement of the traditional accounting system, but only an enhancement where it continues to use traditional accounting system. However, it's more useful for gathering and utilizing information for internal reports in helping performance. (Forsythe et al., 1999).

2. ABC system and its developments

The first development of ABC was by Cooper & Kaplan to overcome the problem of costs' allocations and misinformation on where to invest. (Gering, 1999). During the 1990's ABC has gained a profound impact on the growing industries. A primary reason was due to the fact that its ability to provide accurate cost information for the current global market. (Needy et al., 2003).

Many small companies are not familiar with ABC (Needy, 2003); however, Gunasekaran et al., (1999) placed relevance on the importance of ABC's in small & medium firms. They emphasized that the technological tools such as spread sheets tools enables ABC to capture the benefits without having to undergo huge costs in complex software developments. (Hicks, 1999; cited by Gunasekaran et al., 1999).

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Recent studies into the development of ABC using statistical analysis package was validated, which concludes that ABC methods are more accurate than the traditional volume based allocation techniques. (Needy et al., 2000).

Also, Geri & Norman (2005) further criticized ABC as follows: Is based on subjective arbitrary cost allocations- use of a more complicated costing system, but not necessarily an accurate or useful one; ignores constraints and does not differentiate a bottleneck from excess capacity - if an excess capacity constraint exists then the optimal product mix should be determined according to the product's contribution per unit of the limited resource. The costs of the various products are not relevant for the product mix decision. ABC regards the relation between activities and resource consumption as linear, absolute and certain - i.e. additional activities result in additional costs, and reduced activity level imply cost reduction.

Stratton (2009) cited in his research that Kaplan & Anderson in their article states that many companies gave up ABC due to the complex nature of the operations, time and cost been expensive to handle. Despite this negative impact on ABC's criticism, surveys such as Brag Survey used to study the ABC was one of the type of methods frequently used amongst industries. (Stratton et al., 2009)

Criticisms by Geri & Norman (2005) follows, nevertheless they have quoted as saying even most firms did abandon ABC, it seems favorable amongst many other firms judging by the studies (Brag Survey). However, Tinkler (2002) emphasized that one of the failings of ABC has been the restrictive use in costing and the practitioners failed to develop its use as an active management tool.

2.1 Time Driven ABC system

Many firms abandon ABC due to the fact that it was unable to capture the complexity of the nature of the operations, took too long to implement and is too costly. As a result new approaches estimate the resource demand by each product or transaction and assign the resource cost to this activity. The cost per unit of supplying resource capacity and the unit times of consumption of resource capacity by product. Capacity is measured in terms of time availability, but it uses resources whose capacity is in other units. (Kaplan & Anderson, 2004).

In a time driven ABC respond to Sharratt (2005), criticizes that this technique has its place in certain departments such as IT departments and certain activities. It does not engage in repetitive activities where it needs to be clocked reliably, and using time driven methods creates confusions and unreliability. However, Kaplan & Anderson disagreed with his characterization of its limited applicability. (Time driven ABC Respond, Harvard Business Review, pp 144).

Even though theory suggests that cost data are error free and the conditions under which they operate are cost stringent (Noreen, 1991; Datar & Gupta, 1994), a study by Cardinaels & Labro reveals that (Cardinaels & Labro, 2008),

2.2 Activity Based Budgeting

Benefits obtained from ABC, the activity model provides a dynamic new approach to planning & budgeting. Tinkler (2002) stated that organisation reversed the flow to estimate their budget requirements by simply taking the unit costs as calculated by the ABC application and adjusting the driver qualities to reflect the forecast business volume. This approach was referred to as the back calculation method, which assumes that the current business processes were efficient and cost effective, and that the resource capacity were fully used without under or over use.

ABB is a powerful tool for budgeting, because of the number of "what if" scenarios run to evaluate the impact that different levels of the demand will have on the materials, salary costs and overheads. (Tinker, 2002).

An integrated ABB overcomes the problems such as allocation of budget are recognized as been on competitive basis because of limited resources, the competitive bidding process is seen as best imperfect, since the company expects a certain performance level to attain and that certain costs levels vary with changes in volume activities. Connolly & Ashworth (1984).

Shane (2005) further elaborates that by developing a activity based budget, managers will be able to exercise their control in proportionate to their needs changes, uncovering hidden costs and viewing which activities are most and least expensive. Also, it can access the full efficiency by identifying where cost is reduced.

2.3 Activity Based Management (ABM)

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It's a management approach where companies use ABC information to make the decisions regarding the value of activities, products and customers. (Damito, 2000).

Where ABC attempts only to measure product's true costs, ABM uses cost information to evaluate an entire operation. It distinguishes between the value added costs and non value added costs to minimize the non value added costs. (Bellington, 2000).

In order to assists managerial decisions making ABC is extended to an Activity Based Management System (ABM), to facilitate managers in their decision making processes (Cooper & Kaplan, 1991).

Competition in the global world has recognized Volume Based Costing (VBC) inability as a tool to improve costing knowledge (Johnson & Kaplan, 1987; Turney, 1989).

3. Impact of the developments of ABC's on companies

In determining the process of different service costs in a bank, Hussain & Knox (1994) demonstrated that the estimation of the product unit time is complex calculation involving work measurement process. That is work carried out is measured for every activity such as a deposit or a payment. The time spent is kept track of the various activities measuring the output produced during the specific time interval, unit time is calculated. Using this unit time the cost of producing a specific product type can be calculated by estimating the percentage of time spent on each activity. (Gunasekaran & Hussain)

Transnet Freight Rail successfully developed a network ABC from scratch using standard principles of ABC and has been applying them specifically to costing in a network. Networked Industries are particularly difficult to cost and produce profitability and efficiency report because of the shared nature of their operations. Another difficulty is that it's hard to recreate historical network transactions. The system uses the recreated activity data for as a basis to allocate the costs. These determined rates are then used for costing services together with the pre-determined rate for rate determination. (Gillman, 2008).

Dow chemical company involved in a highly competitive market serves customers with better products at low costs. ABC is the foundation of a decision -support system allowing its global business to report contribution margins by customer, product and geography. In the past Dow has done much work to shift its strategy. It includes ending the diversification strategy adopted in the earlier days, refocusing on its core business - chemicals & plastics. Also, expand globally by increasing reliance on logistic management. Since its integration of ABC to ABM in the early 1990's the company is seen making progress than before. Dow's implementation of ABC costing in value based management has provided management a better understanding of the company's costs. (Damito, 2000).

In Danish school sector ABB is used where the basic unit, pupil enrollment, is easy to define. Here activities are measured as the number of pupils. (Serritzlew, 2006).

UMPH a nonprofit religious organisation, completely self funding, used a variable costing approach in producing financial reporting, however this approach has eroded. ABC provides UMPH with vital insight into the reasons for costs in our operating structure and the relationship of those costs to products and markets. By implementing ABC approach, UMPH attributes costs to the process that generated the expenses. The company now has a true representation of true costs associated with the production of products and services. (Forsythe et al., 1999).

4. Conclusions

The MAS implemented in the earlier centuries were furnishing with relevant, accurate and timely information; however it was unable to cope with the changing technological environment where the required information needs to be curtailed to the current business needs. New management techniques which focus on the efficiency of the firm in utilizing its resources need to be introduced. (Gunasekaran & Hussain, 2001).

ABC used a tool for planning, control & decision making in service management traces costs to activities rather than products providing a more reliable and correct picture. ABC also uses large number of cost drivers instead of one or two volume based drivers. The short coming of traditional MAS, in terms of validity, accuracy, completeness, consistency, understanding and relevance increases the requirement for modern MAS such as TDABC, ABB & ABM in their decision makings purposes. (Gunasekaran & Hussain, 2001)

As such, due to significant large scale operations, rising costs and employee irritations found ABC inadequate for implementations. The data estimates and storage expansion elevated the ABC to progress further into Time Driven ABC (TDABC) system. In this approach, managers directly estimate the resource demand imposed by each transaction, product or customer. (Kaplan & Anderson, 2004).

ABB is designed to improve the link between activity and budget. The ABB is likely to fail unless activity can be defined and measured with reasonable accuracy. (Serritzlew, 2006). Budget strategies and their attendant analysis are important, but justification remains the primary ingredients to the success of the budget. (Shane, 2005) ABB -creating a nexus between workload and costs.

Companies operating under the principles of value based management uses "managing for value" that guides decisions for all levels of management. ABM uses a value creation principles and detailed business analysis to develop and optimize strategy and uses fact based approach to understanding and exploiting drivers of value creation. (Damito, 2000).

Well managed service firms in the different business sectors with a good understanding of their markets, customers and information technologies can become more profitable in a more deregulated, more competitive environment. In manufacturing companies, functions such as marketing, selling, distribution, service, research and development, and general expenses have become more significant than in the past. (Gunasekaran & Hussain, 2001)

Despite the need for MA in the increasingly important service sector, review literature shows that the research in services is much lower than manufacturing, although there are studies such as Morissete (1998), concern both manufacturing and services. (Gunasekaran & Hussain, 2001)

In general ABC's development in all business entities was not fully successful as (Forsythe et al, 1999). Implementing ABC & Balance Scorecard has shown that implementation of ABC in UMPH was unsuccessful, and a more integrated format to support the new operating structure was implemented such as Balance Score Card.