Nowadays, global competition is driving the business towards restoration in order to strengthen their position in the global economy. The attention focuses on product quality, processes for the production, and improving workforce. However, many companies are still using the same traditional costing systems, Cooper and Kaplan (1991).The absorption costing paved way due to the lack of visibility for indirect costs so the ABC has been adopted by many organizations rapidly.
According to Krajnc et al. (2011), the main difference of ABC to absorption costing lies on how they treat indirect production costs (overheads) and sales. The fundamental goal of ABC is to identify as much as possible direct relationships between products and resources consumed through activities conducted from production to disposal.
The ABC system is based on the assumption that the support activities such as activities and sales, the cost of which traditional systems characterized as overheads, offer opportunities for the implementation of activities, and thus are not just for sharing costs. In an absorption costing when the volume of overheads is larger, the likelihood of distortions in reported costs is also greater. In general, overheads that exceed 15 percent of the total cost can cause inaccuracies, Turney (1996). Many companies had major problems by these inaccuracies and so they started using ABC.
Get your grade
or your money back
using our Essay Writing Service!
The traditional approach to cost allocation consists of three steps:
Concentration of costs in the productive and non - productive parts.
Allocation of the cost of non-productive segments in section production.
Distribution of the resulting costs of production in the department products, services and customers.
The costs resulting from the traditional approach suffers from imperfections and this may lead to erroneous costs and taking non rational decisions. For example, traditional costing method allocates the cost of inactivity products. That is, these products are charged for resources not consumed. Unlike traditional costing, ABC system accumulates on top overheads for each organisational activity and then assigns the costs of activities to products, services and customers.
In traditional systems, the cost depends largely on the volume of production and is distributed according to a single criterion, Ballard and Yong-Woo (2002). Using a unique method to measure the volume of production as total cost driver, infrequently meets the criterion of cause and effect sought in distribution costs. But this provides relatively inexpensive and suitable means of financial reporting.
In contrast, the systems of ABC have the innate flexibility to provide specific reports to facilitate management decisions on the costs of activities made in order to design, to produce, to sell and deliver the product or services of the entity. The essence of this flexibility is the fact that these systems focus on the concentration of expenditure through various core activities, while traditional approach to cost allocation focuses on merger costs through organizational activities.
It is clear that the information available from the absorption systems, it is not sufficient for companies that want to adopt continuous improvement programs to beat the competitive and rapidly changing environments which operate in. The traditional costing system does not provide accurate information on the consumption of various resources and activities of the organisation. On the contrary, ABC is rich in the area of information system, which could be said to be necessary for a successful business.
As illustrated above, there are significant differences that derive from the way each method interprets the origins of cost. Therefore ABC systems differ from absorption systems in two main ways:
The tanks of costs are defined by their activities, and not as functional cost centers.
The drivers of costs used to share expenses activities for products, are structurally different from those of traditional systems.
According to Ronen and Geri (2005), manager's at all organisational levels understand the data generated by ABC as more accurate and reliable than those data produced by traditional costing. Consequently, ABC derived a lot of supporters speedily. A business according to Lindquist et al. (1997), applies ABC costing having two main objectives. To be able to understand in depth the specific cost structure of the side processes and be able to assess the true value of its products.
5.2 The impact of ABC costing system
ABC was the most famous innovation in costing the last thirty years. It was designed during the 1980's in the U.S. Some surveys concluded that a number of companies which had started to implement ABC, decided to terminate it after a short period. Though, in recent years, executives realised the benefits of ABC and became widely accepted. According to Helberg et al. (1994), many companies adopted it because ABC:
Always on Time
Marked to Standard
Provides accurate information regarding the lines to cost a product.
The products are designed to increase the value of the customer and allow an efficient cooperation between the departments of the company.
Continuous improvement of operational activities.
A study by Ittner, Lanen and Larcker (2002), which examined the relationship between ABC and production efficiency, proved that extensive use of ABC is associated with higher levels of quality and greater improvements both in terms of time as well as in quality. Furthermore, Stratton et al. (2009) made a research in 348 firms and indicated that the use of ABC provided significant value to businesses. They concluded that ABC provides to organizational units high value in strategic and operational level. Another study by Swenson (1995) measured the satisfaction of executives on the implementation of ABC and how important is the information given by ABC in strategic decisions. He found out that companies which used this system showed significant improvements in cost reduction because of the information provided by ABC. Further, Capusneanu and Cokins (2011) indicated that ABC helps managers to properly manage the indirect costs and understand the profitability of products. Also, many firms using ABC showed significant administrative benefits.
On the other hand, many researchers revealed the negative impact of ABC by observing various firms. There was no perceptible difference between the responses of companies that have implemented ABC costing and those who had not applied regarding the level of satisfaction.
Cobb et al, (1992) found that the disadvantages for using ABC for a year, included difficulties in collecting accurate data. In addition, many firms illustrated that managing costs was difficult, since various activities exceeded the limits of services. The application was very time consuming, requiring not only the collection and process of data but also the interpretation of results.
Many detractors of ABC said that the method usually had problems in changing of attitudes rather than technical. Some executives indicated that they should be prepared for any reactions by employees of the company until they understand that the information drawn will have consequences in the work within and outside the enterprise.
Tornberg and Sievanen (2002) emphasized that small firms presented significant drawbacks in the first years of implementation of ABC. The major drawbacks are the high cost of operations and the difficulty to measure the volume of activities. For this reason, small enterprises are unable to make the adoption of this system. Furthermore, such systems require significant maintenance costs and continuously updates.
Kaplan and Anderson (2004) also argued that although ABC seemed a very attractive method of managing limited resources of an enterprise, in practice its completion was very difficult. Many executives were forced to leave the program due to the difficulties arising in determining the degree of analysis in which the company was ready to proceed. In addition, Collins and Munter (2001) argued that companies which offer services required precise knowledge of their products. But this is not always easy to achieve because of the variety of services.
5.3 ABC System and Sainsbury's
ABC can help Sainsbury's to manage activities effectively within the parent and subsidiaries companies. Through this system Sainsbury's eliminates unprofitable items, thus, increasing the rate of profitability without actually increasing the prices. Also, ABC manages overheads of Sainsbury's in order to keep prices at a minimum level for their customers even if there is an imminent increase in the value of the overhead costs. In addition, ABC helps the company to understand which items are credited for most of the profits and analyses which suppliers are worth dealing.
Further, Sainsbury's uses ABC to understand practices between stores. Through the system firms can understand optimal layout, cost structure as well as the consumer habits by geographical area. Hence, ABC assists Sainsbury's to determine the operating standards and identify good practises from one store and apply it to all other stores.
6.0 Conclusion/ Recommendations
According to Searcy and Roberts (2007), the need for a company to apply ABC system depends on several factors. Although it provides a number of important advantages over the traditional costing, the effective application of the system is not so simple. Nowadays, many companies aim not to replace traditional costing but supplement it using ABC. Before taking any action, every business should consider the position and experiences in order to decide whether the adoption of such a system needs to be considered.
This Essay is
a Student's Work
This essay has been submitted by a student. This is not an example of the work written by our professional essay writers.Examples of our work
Regarding the application of ABC to Sainsbury's, it can be noted that ABC is one of the best tools for the management of the firm to manage the relationship between stores and producers. So Sainsbury's ABC system has to be aligned to the present market in order to enable competitive pricing and also retain the customer satisfaction.
10.0 References ABC System
Ballard, G. and Yong-Woo, K. (2002)Â Case study-overhead costs analysis. [report] Brazil: Proceedings IGLC-10, p.1-13.
Bell, J., & Ansari, S. L. (2000).Â The kaleidoscopic nature of costs. [U.S.A.], McGraw-Hill.
Capusneanu , S. and Cokins, G. (2011) Sustaining an Effective ABC-ABM System.Â Theoretical and Applied EconomicsÂ , 18 (2), p.47-58.
Cobb, I. et al. (1992)Â Activity-based Costing: problems in practice. London: CIMA.
Cooper, R. and Kaplan , R. (1991)Â The Design of Cost Management Systems: Text, Cases and Readings. NJ: Prentice-Hall, p.370-380.
Helberg, C. et al. (1994) Simulating Activity-based Costing.Â Industrial. Management & Data Systems,, 94 (9), p.3-10.
Ittner, C. et al. (2002) The Association Between Activityâ€Based Costing and Manufacturing Performance.Â Journal of Accounting Research, 40 (3), p.711-726.
Kaplan, R. and Anderson , S. (2004) Time-Driven Activity Based Costing.Â Harvard Business Review,, 82 (11), p.131-138.
Krajnc, L. et al. (2011) ACTIVITY-BASED MANAGEMENT OF LOGISTIC COSTS IN A MANUFACTURING COMPANY.Â Traffic Management, 24 (1), p.15-24.
Lindquist, T. et al. (1997) Can ABC bring mixed results?.Â Management Accounting, 78 (9), p.28-33.
Ronen, B. and Geri, N. (2005) Relevance lost: the rise and fall of activity-based costing.Â Human Systems Management, 24 (2), p.133-144.
Searcy, D. and Roberts, D. (2007) Will Your ABC System Have What It Takes?.Â Management Accounting Quarterly, 8 (3), p.23-28.
Stratton, W. et al. (2009) Activity-Based Costing: Is It Still Relevant?.Â Management Accounting Quarterly, 10 (3), p.31-41.
Swenson, D. (1995) The benefits of activity-based cost management to the manufacturing industry.Â Journal of Management Accounting Research, (7), p.167-180.
Tornberg, K. and Sievanen, M. (2002) Process-based costing: The best of activity-based costing.AACE International Transactions;, p.151-156.
Turney, B.B.P (1996), Activity Based Costing, the Performance Breakthrough, London: Kogan Page