Most costing and accounting methods are not designed to give information's on costs and benefits relating to quality improvement therefore other quality method is needed to provide a more complete assessment regarding performance consequences for example only few accounting and cost methods presents the opportunity cost that arises when customers are lost due to quality issues in the company.
Companies have started to apply activity based costing (ABC) to asses these hidden costs and benefits. Activity based costing concepts can assist to measure quality related costs and support quality improvement efforts. ABC came about due to competitive pressures that exposed failure in cost accounting this resulted to changes in strategy, processes and improved competitive cost position. ABC was adopted for its ability to reveal how best a firm can maximize profitability, embedded cost and assist for wise decisions making through development on new areas such as cost to serve activities, customer profitability and its use to carry out capacity planning and drive predictive modelling. In present businesses ABC has been used to measure scorecards, providing rates for customer's profitability analytics, helping devise human resources, modelling sustainability and supporting development for planning and budgeting.
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One of the factors that brought about ABC was the quest for technological innovation. As a result of competition between the Japanese and the western companies especially those in the electronics and automotive sectors. As a result of low wage labour and undervalued currencies, there were existences of de facto innovative management practices for example just in time material flow system and statistical process control. This resulted to change on western companies voicing out to unfair competition so adopted the management practices used by leading companies such as Toyota and some western companies innovated some practices which includes costing methods. There were different costing methods used by manufacturing companies and they noticed these cost accounting systems had unintentional negative strategic and operational consequences for example Tektronix allocated manufacturing overhead using direct labour and so their engineers designed products that required less labour to produce this led to increase cost of purchasing, receiving and stocking their products thereby reducing profitability. It was when the right cost of procurement was allocated using the number of products produced that the bias was corrected and encouraged engineers to use common parts wherever possible. The ABC method showed the lacking of accuracy and ability to diagnose capability after the failure of Tektronix, and the later success of Tektronix and other companies when ABC system was used brought another step to the development of ABC.
Another towards the development of the ABC method was as a result of expectation through publicity and the coming into light of first generation methods and tools. A flood of articles on ABC which was published in the Harvard Business Review journal of Cost Management, the publication stated how to implement ABC and the impacts it would have on business. This encouraged potential users and development of first generation methods brought about the development of the ABC market. There were recognitions that ABC would yield sight into profitability, due to the fact that it could eliminate the product cross subsidies inherent in cost accounting, show the sources of loss that were responsible for loss and decisions affecting profitability. This shows the ability of ABC to drive change, through improving accuracy of product cost using cost drivers and cost pool, these assist management see profitability of products, however they experienced limited diagnostic capabilities so the inclusion of activity
And a customer cost during this period facilitates increase in diagnostic power of ABC.
The ABC came into development also due to its ability to penetrate market and continue technology development, this took place in spite of the proliferation of ERP systems which were time consuming and costly and so the need to bring systems that would correct that and match with the new millennium. The ABC implementations focused on correcting the errors been experienced during the allocation of overheads to product cost in accounting system. During this development it was discovered that the ABC was also applicable to areas outside cost accounting which includes, administration, sales, marketing, supply chain and logistics. ABC also expanded into insurance, health care, banking and other industries. These industries faced challenges' during the 90s about information's on cost of services, customers and activities. The government agencies uses ABC to help ameliorate budget pressures, it also extended its use from historical costing to resources and capacity planning. The ABC model are used for budgetary cost estimation and decision making , its model revealed opportunities for cost reduction, prioritized opportunities based on time, quality and cost.
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Market penetration by the ABC varies from different countries likewise different industries, how there were evidence that its penetration rates have reached the threshold of 30 %. The Gartner Group estimated that between 20 and 50 % of global 1000 firms adopted ABC, a business survey by Business Finance in 2004 shows that 73% of firms with annual revenues in excess of $1 billion had used ABC programs. Survey in the 90s showed increasing adoption rates which was enhanced by different factors such as evidence of financial benefit, use of internet and business intelligence (BI) system to report current ABC information to managements. Another factor was the objective of many firms to get positive returns on investments, the various different systems met important goals but could not improve financial performance for example the ERP systems were able to integrate transactions but unable to guide management which products sells and which customers to serve. ABC corrected these errors and showed opportunities to improve financial performance, new systems came about towards reducing cost and effort needed to maintain ABC systems these systems includes web based survey, use of extract and load (ETL) technology to integrate ABC with data sources. The cost benefit equation of ABC enhanced functionality and reduced cost this encouraged it development.
Importance of ABC to organizations includes:
Its capability to bring about fast analytic power and faster results, it is capable to process billions of transactions in minutes, this allows for analysis of complex business model with millions of customers for example a large telecom used SAS for profitability management to create income statement for 21million customers using rates from SAS Activity Based Management, these data's yields hidden insights into various drivers of profitability through data mining and statistical analysis. The SAS profitability management from ABC produce fast result due to the fact that code rates from existing systems can be incorporated to assists an initial view of profitability, which facilitates fast result while creating a positive ROI that encourages more in depth analysis using ABM. An organization can use this to aid faster means of compelling figures and reports.
It is useful for financial planning; ABC can be used to assists the preparation of budgets and long term plans that are achieved from strategic goals and consistent with the relationship between objective and resource intensity. It has predictive capability enhancing forecasting and other analytic techniques to aid fact base scenario development for example an insurance company can use ABC to optimize process performance based on new levels of productivity, forecasting can give the volume of transactions for the process for the coming budget period. Once the forecast is complete the planner can use SAS Activity Based Management to predict the quantity the resources needed to facilitate the forecast volume of transaction.
ABC plays an essential role in human capital management (HCM) in most organization both in the government and commercial sector. These organizations work more productive using fewer people and working with SAS Human Capital Management to pull all information together and predict skills, capability and employee churn effect. ABC can be used to process cost and steps to be taken to free up cost, also it can be used to forecast the required resources needed to meet the level activities of a new transactions and lastly can assist to forecast statistically the number of people needed to achieve a targeted product, market or customers. Most companies also used it to put all employees information in a single file analysing or forecasting areas of shortage of skills and providing necessary intelligence to drive such analysis or forecast.
Most organizations have the objective to improve sustainability having in mind pressures from stakeholders, market realities and various government regulations. To do this they require measurement of the optimization of business decisions around profit and sustainability, transparency and compliance of report. ABC can help give assistance in these areas. For example SAS for Sustainability Management can use the power of SAS Activity Based Management to measure, model and report the use carbon dioxide of traditional costs and profitability. An ABM carbon model could track sources of carbon e.g. air travel to the resources that consume the carbon. The ABM would be able to track the rate of consumption of resources cost from each cost use from activities to the benefiting products, services and customers. ABM helps measures, manage and improve the use of resources in organizations.
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Lastly ABC helps measures performance of management in order to facilitate strategy execution. It is used to measure goal accomplishment, aid feedback on performance predict future outcomes and provide analysis and corrective action. However this only takes place when there are relevant and accurate performance measures are available to be incuded in the management performance analysis. In organizations ABC serves as a source of performance measures, most of these measures are usually found in the form of a scorecard where activities of cost provide the focal point for setting target and goals scoring around process performance. For example in the case of the South Dakota Department of Transportation as many as 25% of performance that were measured in SAS Strategic Performance Management are sourced from their ABC model, its derives measures found in the customer dimensions of the scorecard in which profitability relating to customers are set. Without ABC model it would be difficult to include goals, get insights of profit cliff and drive action by wider audience for managers.