The Limitation Of Activity Based Costing Accounting Essay


This study investigated to identify whether Activity Based Costing is still relevant in all geographical locations and we have to critically discuss about the topic. There are 4 countries case study was investigated for this topic which are Belgium(Milkcom Company), Netherland(Panana), Australia(DB Schenker AB) and Sweden(SCA Packaging Obbola). ABC normally has been used for many purposes, such as product-range decisions, customer profitability analyses, cost reduction cost modeling, budgeting , inventory valuation, and performance measurement. Proponents of ABC claim that the technique helps to the efficient use of resources and consequently, to the reduction of costs. ABC also helps companies alter their product mix decisions and enables such companies to focus on profitable customers. According to the Milkcom company, the company was successful in their business because implementation of ABC. ABC helps to continuously alter the product-mix based on the performance of each products. From the Panana Company, ABC was not appropriate for the company because it is a bicycle company from saturated market which is no real price competition exists. So the companies profit and cost calculation is not based ABC performance. In addition, DB Schenker AB companies ABC performance was not appropriate because it was not updated due the complexity, time, resource commitment and the model is very efficient, but changing a complete accounting system is demanding as it affects the organization as a whole. SCA Packaging Obbola ABC performance shows that ABC was not completely implemented in the company. ABC not suitable for the company because it includes changing a whole system and ABC focuses on top level of the organization because the cost information derived from ABC is used more in management decisions. Overall, Activity based costing is still relevant in different countries and implement the companies production costs. But in some companies it is appropriate to apply in some countries it is unappropriate to apply.

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Activity Based Costing (ABC) was developed in the USA by Harvard Business School Professors Kaplan and Cooper and it is a process of individually listing and measuring the cost of each activity contributing to the production and delivery of a particular product or service. Activity based costing is a matter of assigning manufacturing overhead costs to products in a logical manner than the traditional approach of allocating costs on the basis of machine hours. Hence ABC provides a company with accurate cost information that helps the company to improve its performance by identifying the products which are being unprofitable, inappropriately priced, and segmented in the wrong markets. ABC lays in customer's demand of products generates a company's activities while a company consumes activities for the demanded products. Through using a cost system from an activity perspective a company can deliver high quality products because it looks at how successfully a product is delivered and serviced. Whether ABC still relevant in all geographical locations, which means ABC method is still apply by all countries companies for their costing purpose. These is because there might be some countries only using the activity based costing system.

Literature Review

Limitation of Activity Based Costing

Given the benefits of ABC, one would expect its adoption to be widespread, prior studies have found low adoption rates amongst companies, both in the developing and developed countries. A recent study by Innes et al. (2000), examining changes in the implementation rate of ABC over a five-year period, provided current trends in the use of ABC in the UK. They found that between 1987 and 1994, ABC adoption grew from 0 to 20 per cent, particularly among the UK's largest companies. However, many of the ABC adopters appear to be at the experimental stage, with high rates of rejection after the initial assessment. Cotton et al.'s (2003) study of 299 chartered accountants in New Zealand revealed that only 20.3 per cent have adopted ABC. In Singapore, 13 per cent of the 106 companies surveyed said they used ABC (Ghosh and Chan, 1996). A more recent study by Chan (2005) also found the ABC adoption rate of Singapore companies to be low (12 per cent). Studies in developing countries indicate the same low adoption rates as well. In Malaysia, while Abdul Rahman et al. (1998) found a mere 4 per cent of their sample using ABC, Sulaiman et al. (2002) had 28 per cent of respondents indicating that they used ABC to allocate overheads. In India, only 20 per cent of the 60 companies surveyed said they had adopted ABC (Joshi, 2001). China's percentage was even lower (Bromwich and Wang, 1991). For Chinese state-owned enterprises, the percentage was 1 per cent. Amongst foreign firms and foreign partnered joint venture firms, ABC usage was much higher at 15 per cent and 10 per cent, respectively. A more recent study by La et al. (2005) reported a 20.7 per cent adoption rate amongst Hong Kong logistics firms. There are various reasons as to why traditional management accounting practices are still widely used in developing countries. These are the lack of awareness of new techniques, the lack of expertise, perhaps more importantly and the lack of top management support.

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Milkcom is the biggest producer of milk cream in Belgium. Milkcom is a co-operative founded in 1963 by the Inco group and the federation of milk producers. It has 6,700 suppliers and 900 people work in its production facilities with an annual turnover of $4 billion. In order to remain competitive, one of Milkcom's first tasks was to try to obtain the ISO 9002 Certificate. So that ABC system was developed for Milkcom. The cost-system is fully operational and it has been implemented along with the information system developed by Marcam. With this system the

management is able to trace their production costs much better than with conventional cost systems. The computer system enabled Milkcom to have, for each production line and for each type of product, a bill of material and signals any change that occurs during the production process. Although the development and implementation of the ABC system and the information system cost $2 million in 1993 and an additional $1 million in 1994, it has been worth it

according to the management. In a growing and competitive market, it is essential to know exactly how much each product type costs. This helps to continuously alter the product-mix based on the performance of each product. This is why Milkcom has proven to be successful.


Panana has been a well-known producer of bicycles since the beginning of the century. After a massive reorganization when the company was taken over by Atag Holding (producer of stoves) turnover increased from $300 million to $700 million in 1993. The company's 300 employees produce annually 220,000 bicycles of 130 different types. The management has decided that it was appropriate to develop an ABC system for their company. Presently, production costs are treated as a part of an integral cost accounting system which is based on back-flush costing. Overhead costs are treated in two final cost pools which include production and sales costs. All costs are assigned in proportion to the production volume. This implies that the costs are allocated based on traditional costing methods.

But ABC system is not appropriate for Panana because it requires tremendous efforts to determine the most appropriate cost drivers. In turn this needed a significant amount of labour hours and incurs relevant costs. This investment may not be compensated for the benefits obtained by the implementation of an ABC system. Panana has a basic idea of what one bicycle costs and this does not vary for different bicycles. A bicycle with large or small tyres costs.

almost the same. Therefore, no expensive analyses are needed. A good communication channel between the management and the employees on the job is much more useful to find out the information needed for the cost calculation. Second, the market in which Panana is operating also explains why ABC is inappropriate. Panana is working in a saturated market wherein no real price competition exists, but competition is expressed in the form of offered quality goods and services. Therefore, specific cost calculations using ABC are of no significance in improving the business performance.

DB Schenker AB(Australia)

Schenker & Company was found in 1872 by Gottfried Schenker in Vienna, Australia. Around 34 145 employee in 130 different countries is working in Schenker today. The Group reported total revenues of approximately € 18, 9 billion in 2010. Schenker is a land transportation firm that offers parcel services, land transports of full and part loads, less-than-truckload freights, direct freights, cold sped and fridge freights. In Order, Schenker applied ABC as a project to analyze how much expenses went in performing certain order. First the company included one product for eight months, the company discovered that the model provided them with positive results. Therefore, they added five more products and then continued with the rest. The company observes the model to be significant in providing them with information of how resources are consumed and how much expense goes to produce an output. Despite the positive effects Schenker was experiencing from ABC, the model was not updated due the complexity, time and resource commitment. The numerical data was considered to be challenging to bring in the right way. Schenker Stockholm thinks that the model is very efficient, but changing a complete accounting system is demanding as it affects the organization as a whole.

SCA Packaging Obbola AB(Sweden)

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SCA company created by Swedish financier called Ivar Kreuger and own over 40 production units with more than 6 500 employees in Sweden. SCA produce, develop and market different varieties of products such as personal care products, packaging, publication paper and solid-wood products. In 1975 the company started to produce two main products Kraftliner and Euro power. The turnover in Obbola AB is estimated to 2 billion. Obbola AB applied ABC-project to identify how much each step in manufacturing a product cost. The purpose of applying the model was to identify the most expensive steps in order for the company to make necessary changes. But, ABC was not completely implemented in the company. Therefore, it was difficult to answer whether it did or not. Still, Obbola chose not to implement the model. Obbola thinks their experience of ABC to be limited because the usage of ABC lasted for short period of time. It still enabled the company to see how much it cost. Lastly, ABC not suitable for the company because it includes changing a whole system and ABC focuses on top level of the organization because the cost information derived from ABC is used more in management decisions. The non existence of a suitable data system to register all the information from ABC and updating it constantly limits an unappropriate usage of ABC. But Still, the model enabled the company to identify the most profitable from unprofitable customers.


From the case experiences discussed above, we can conclude that ABC systems are not really used much in some European countries which include Belgium and The Netherlands. ABC systems trace more exactly the real costs to the products than any other volume-based cost systems. Therefore, more accurate overhead cost allocations lead to fewer distortions. However, a trade-off should occur between the economic benefits of an ABC and the costs of implementing it. For some industries ABC systems are useful and for others not as it can be seen from case experiences. When implementing an ABC system, a change in the management structure should occur in order to facilitate the application of ABC. The management should adapt an activity-based management system using the provided information by the ABC system and achieving their primary target, which is making profits. Moreover, from DB Schenker AB and SCA Packaging Obbola AB case study of ABC experienced such benefits as well, but they did not continue to implement the model in their accounting system. This comes along with the limitations of ABC and other organizational factors like resistance of implementing new cost accounting system. Example of these limitations are the model being too expensive to build, requires time, resources and new way of thinking. In order for the staff to accept a new knowledge, they have to understand the result of the model and this objective seems to be hard to achieve even in the user-companies of ABC. Furthermore, the companies need support from management in such decisions because at the end the management would make the change possible by supplying staff with the knowledge and resources required to implement the model.