Using ABC For Small Service Sector Business Not For Profit Accounting Essay

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Definition of ABC

Using ABC for small service-sector business, not for profit. How small service business sector might use ABC to produce product cost for service

To evaluate internal efficiency, quality and profitability per product or service line

Discussion on benefits and drawbacks

Since the change of business environment and activities, this has resulted in the tools and techniques used for developing management accounting. Although the old technique of management accounting has some limitations attached to them for example, the use of absorption costing method is said to be in appropriate in the modern world. It is also noted that the old ways of measuring management accounting performance can also produce an inaccurate result. As a result of this, ABC has gained a unique reputation.

Definition of ABC

ABC was first introduced by Cooper and Kaplan (Cooper and Kaplan, 1988) who conceptualized the ideas underpinning these systems and coined the term ABC. Academics and practitioners have produced much wide ranging literature concerning this new innovation since its emergence.

Kaplan, R. S. & Cooper, R. (1998). Cost and Effect. Boston, MA: Harvard Business School Press.

Extensive academic debate focused on the usefulness of ABC techniques and the contribution that these techniques could make to the performance of the organization (Ittner, et al., 2002; Baird et al., 2007). Generally, Activity Based Costing by C. Drury, (2008) can be defined as "an accounting technique that allows an organisation to determine the actual cost associated with each product and service produced by the organisation without regard to the organisational structure".

Ittner, C. D., Lanen, W. N., & Larcker, D. F. (2002) 'The association between activity-based

costing and manufacturing performance', Journal of Accounting Research, 40(3), pp.


Baird, K., Harrison, G., & Reeve, R. (2007) 'Success of activity management practices: the

influence of organizational and cultural factors', Accounting and Finance, 47, pp. 47-67.

G, Cokins (1999) pointed out that "ABC was developed as a practical solution for problems associated with traditional cost management. And that ABC is not a replacement for traditional general ledger accounting. Rather, it translates general ledger data into costing information". Since, it emerged as a logical alternative to traditional cost management systems that tended to produce insufficient results when it came to allocating costs.

Cokins, Gary. "Learning to Love ABC." Journal of Accountancy. August 1999.

Using ABC for small service-sector business, not for profit

D,Hicks (1999) Indicates that "ABC does not require a massive effort to implement and that it is effective for any size business". He argued that managers of large companies who toiled unsuccessfully to implement the program failed to fully understand ABC in reality. In spite of the bad press, smaller organizations are beginning to see that ABC can work as effectively for them as it does for large companies. He also stated that an organization has to perform certain activities to provide the products and services it sells, and those activities cost money. The cost of each of those activities is measured and assigned only to those products and services requiring the activity, using appropriate assignment bases (called drivers). By doing this it is possible to get an accurate picture of the real cost of producing each product or providing each service. In fact, the data can be designed to provide the cost of serving each customer, too. Non activity costs such as direct materials or direct outside services do not need to be included since they already are attributable to specific products or services. Which he noted that the concept of ABC is actually simple by implement this method.

Hicks, Douglas T. "Yes, ABC Is for Small Business, Too." Journal of Accountancy. August 1999.

How small sercive business sector might use ABC to produce product cost for service

According to G, Cokins (1999) ABC is designed to provide useful financial insights into a company's operations; it's a process that should be well within accountants' sphere of expertise.

Cokins, Gary. "Learning to Love ABC." Journal of Accountancy. August 1999.

In order to implement ABC it will involve proper planning and commitment from the higher management. Probably, it is best to do a test study or experiment on a department whose profit-making performance is not living up to expectations. These types of circumstances have a greater chance of ensuing and showing those in charge that ABC is a feasible way for the company to save money. If this test did not give any cost-saving measures then, it could either be the activity-based costing system has been improperly applied, or it may not be right for the company.

Robert S, (2003) pointed out that "the old ABC model has been complex for many businesses to execute because of the high costs expended to interview and study people for the preliminary ABC model, the use of biased time allocations, and the complexity of maintaining the model as (i) resource spending changes, (ii) fresh activities are added, and (iii) enhancement arises in the range and density of individual orders, channel and customers".

However, the following are the steps a company is required to take in order to use ABC to produce product costs for services:

Firstly, there is a need to set up a team in charge of deciding the activities necessary for the product cost or service. The team must cover departmental areas such as human resources, finance and an external consultant if possible.

Secondly, after assembling the team, data on materials and utilities is needed in order to ascertain which of the activities really cost money to the business with a high level of attention to details and concentration is requires as some of the costs may not be obvious. As soon as all the costs are noted, the result must be entered into ABC software which will help the business to analyse and get facts on what is needed to boost their profit margin and make the activity more resourceful.

Thirdly, after analysing the data collected via ABC and cost effective activities has been determined, the next step is to choose the methods that can be taken to boost profit. Any activities that are deemed to be too expensive can then be outsourced in an attempt to enable them more cost-effective.

Cokins, Gary (1999) illustrate the potential of ABC, by considering the following two financial reports of a department's expenses. One is taken from a general ledger and the other from an ABC analysis:

Chart of Accounts View

Salaries $621,400

Equipment 161,200

Travel expenses 58,000

Supplies 43,900

Use and occupancy 30,000

Total $914,500

Activity-Based Costing View

Key/scan claims $ 32,000

Analyze claims 121,000

Suspend claims 32,500

Receive provider inquiries 101,500

Resolve member problems 83,400

Process batches 45,000

Determine eligibility 119,000

Make copies 145,000

Write correspondence 77,100

Attend training 158,000

Total $914,500

Although the above report both provides the same total as the ABC report, the ABC report provides information that can be applied to cost management. Although the ledger information is accurate, but it fails to report the business process costs that run cross-functionally that is, across an organizations departmental boundaries. It also fails to show the true total cost of fulfilling a customer order that passes through many hands.

To evaluate internal efficiency, quality and profitability per product or service line

J. Cullen, (2001), cited that "costing concentrates on processes relatively than functions. He also said that managers can only administer costs by overseeing the activities that cause the costs. The principal facet is to recognise cost drivers and to apportion costs to an activity on the basis of that cost driver. An example is K. C. Supermarket' use of activity based costing for producing product cost for services and to evaluate internal efficiency, quality and profitability per service line.

The benchmark method for estimating a simple ABC model begins with identifying a compilation of resources that carry out a range of activities. For example, K. C. Supermarket customer service division that performs three activities:

Process customer complaints

Handle customer order

Perform customer credit checks

The total cost for performing these activities is £12,500 per quarter according to K. C. Supermarket report, (2010). The percentages of time exhausted by employees on these three activities are 15%, 60% and 25% respectively. The actual quantities of work for the quarter in these three activities are:

5 customer complaints

150 customer enquiry

120 customer credit checks

Allocating £12,500 supply cost to activities, by means of time percentage, and calculating activity cost driver rates as revealed below:

Activity % Cost Qty Rate

Customer complaints 15 1,875 5 £375/complaint

Customer enquiry 60 7,500 150 £50/enquiry

Customer credit Check 25 3,125 120 £26/check

The above activity cost driver rates can then be used by the project team to apportion the expenses of the set of activities performed to each customer.

If an in-house process is found not to be adding value to the business or company, organisation could possibly get rid of the process completely which as a result would decrease its overall costs. ABC also help management to try-out in recuperating the present practices of production by monitoring the adjustment in costs related to the process or even considering a wholly fresh practice. The capability to sight which changes decrease costs and increase production enables management to make more efficient an organization's production process. Efficiency is significant in staying competitive, and with ABC giving room for process excellence costs are capable to be decreased while production remains constant or even enhances.

However, there are several problems that arise when businesses try to size up the straightforward method and maintaining the model to enable it reveal the change in activities, products, processes and customers. The first problem is the process to survey and interview employees in order to get their time apportionment is expensive and time consuming. Also, due to the high cost involved in updating ABC model consistently, many of the systems are only updated infrequently which then results in outdated activity cost driver rates, and incorrect estimation of customer, process, and product costs.

Costs of helping a customer can be derived individually since ABC is now based on activities. We can ascertain profitability by subtracting product cost from the cost expended in serving each customer. This method helps to identify the profitability of individual customer and putting the products and services in proper shape respectively. The execution of ABC will also enable employees to determine the various cost involved by allowing them to examine the cost and to recognise the activities that is both valuable and not valuable. Based on this, benefit and improvement can be executed and accomplished. With ABC, small businesses are capable of improving their effectiveness and limit cost without giving up the worth for the customer.

Discussion of Benefits and Drawbacks

G, Cokins (1999) states that using ABC, data can achieve relevant cost estimates as a basis for sound management decisions which enhances strategic decision making for managers in a company. It focus on the activities that most relevant in the company. ABC also helps to active the cost efficiency in an organisation to maximise its resources and managing service in the company.

G, Cokins (1999) also narrates that "ABC corrects for the limitations of traditional costing by identifying all the work activities and their costs chat go into manufacturing a product, delivering a service or performing a process. When the individual costs are added up, a clear picture of the total cost of a process conies into view. ABC can even distinguish the cost of servicing different customers".

However, businesses that apply ABC run the possibility of wasting too much time, effort and money on collating data that is gathered. Too many details can sometimes be provoking for managers and inadequate detail can also result to unsatisfactory data. An additional cause of ABC downfall is failing to take action on the results supplied by the data. This occurs especially in businesses where ABC model is not welcomed. Cokins, (2000), cited that ABC repeatedly fails because project managers overlook the fundamental rule: It is better to be roughly accurate than to be specifically inaccurate. He also cited that the application of average cost rates and disconnecting information to action can also hamper ABC projects.

Another restraining factor is that ABC software can be too expensive. M Henricks, (1999), stated that most Activity Based Costing Practitioners find the software very efficient in managing tasks. He also said that time can be a crucial cause for businesses looking for an instant result. He said some businesses see results immediately but in reality, it may last up to three months for some companies to see the profitability of ABC and depending on the type of product phase, it could last much longer.

J. Cullen, (2001), cited that "costing concentrates on processes relatively than functions. He also said that managers can only administer costs by overseeing the activities that cause the costs. The principal facet is to recognise cost drivers and to apportion costs to an activity on the basis of that cost driver


Small manufacturing companies need reliable and accurate cost information to survive. ABC can provide accurate costing information for strategic decision making.

D,Hicks (1999) narrates Any small or midsize organization can develop an ABC system. It does not require a great commitment of time or financial resources. Nor does it require the implementation of special software integrated into the general ledger although for larger organizations that may be a benefit. It requires only that management view its operations through "the lens of ABC" and create a model that will enable it to measure costs in accordance with that view. Also according to G, Cokins, (1999) he states that when an ABC project fails, the most likely reason is that its managers designed the ABC system to be too large and require too much detail. So managers are not only looking at cost but they are also looking at the activities that are driving cost.