Activity Based Costing (ABC) in Organisational Context

Management accounting may be construed to be one of the success critical aspects of business studies as the proper implementation of the same largely contributes towards the success of the organisation in the long run. The conceptualisation and implementation of various management accounting techniques involve considerations that may need to be undertaken by the management of a business organisation which are both external and internal by nature to the business.

MANAGERIAL ACCOUNTING

Executive Summary
Management accounting may be construed to be one of the success critical aspects of business
studies as the proper implementation of the same largely contributes towards the success of
the organisation in the long run. The conceptualisation and implementation of various
management accounting techniques involve considerations that may need to be undertaken by
the management of a business organisation which are both external and internal by nature to
the business. There have been a number of such management accounting technique available
for the management for the purpose of application in the real-world business problems and get
the necessary solution there from. Activity Based Costing (hereinafter may be referred to as
“ABC”) is one of such techniques which may be assumed to be a significant development in the
field of research in the management accounting studies. The ABC is a new age concept which
the managers apply in their strategic decision making process in order to achieve the long-term
corporate goals of the business is most cost effective and efficient manner. The present report
briefly discusses the concept and its application and implementation in the organisation l
context.
At the very outset of the study, the report provides an overview as to the conceptual
framework of the ABC followed by its relationship with strategic management accounting. The
subsequent part of the report focuses on the crucial analysis of ABC in terms of its benefits as
well as limitations in the organisational context. The researcher also emphasises the role of
accountants in the successful implementation of ABC as a tool of strategic management
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accounting for the managers of the business. Finally, the report provides a recommendation
before wrapping up the discussion by way of concluding note.
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Table of Contents
1.0 Introduction...............................................................................................................................5
2.0 Analysis of Activity Based Costing (ABC) in Organisational Context.........................................7
2.1 Conceptual Framework of ABC..............................................................................................7
2.2 Strategic Management Accounting (SMA) and ABC: Mutual Relationship.........................11
2.3 Benefits of ABC.....................................................................................................................13
2.4 Limitations of ABC................................................................................................................13
2.5 Role of Accountants in the Adoption and Implementation of SMA: ABC Perspective........14
2.6 Recommendations...............................................................................................................14
3.0 Conclusion................................................................................................................................16
References.....................................................................................................................................17
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1.0 Introduction
The management of a business organisation may need to undertake a number of strategic
decisions in order to operate, compete and grow in the market which the business may belong
to. Such strategic positioning may be in line with the pres-et long-term goals as set by the
owner groups or the management for the sustainability of the business in the industry as well
as in the society as a whole. In order to accomplish such corporate goals sets, the management
may often adopt strategic tools to identify the gaps in the performance, evaluate the impact
and possibility of the volatility of such gaps and corresponding results and then apply corrective
measures in order to make the business process effective and efficient. While performing such
tasks, the managers may often require critical business related data so that the decision so
undertaken may be comprehensive, informed and effective for the business. The management
accounting helps the management in this regard by providing a system management
information system (MIS) within the operational horizon of the business and thereby presenting
the refined information to the managers for the purpose of strategic decision making. In other
words, the management accounting plays a crucial role as a helping hand to the management
as far as support services for the purpose of decision making is concerned ("Strategic
management accounting: how far have we come in 25 years?", 2018).
ABC, on the other hand, is a management accounting tool (rather strategic management
accounting tool) that may be immensely helpful for the managers in order to undertake critical
strategic decision for the business in terms of pricing, process restructuring, cost-cutting and
even value creation. The subsequent parts of the paper discuss in details the concept of ABC
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along with its critical analysis and also its relationship with strategic management accounting in
an organisational context. The analysis has been perfumed by referring selected journal articles
from “Accounting, Auditing & Accountability Journal” database and other secondary data
sources and based upon the findings; the subsequent evaluation has been made in the report.
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2.0 Analysis of Activity Based Costing (ABC) in Organisational Context
2.1 Conceptual Framework of ABC
Costing has always been a challenging area of operations for the managers in terms of decision
making. An organisation incurs different t types of costs (fixed, variable, semi-variable etc.).
Some costs are directly attributable to the products which may be termed as direct costs and
variable costs. These costs are comparatively easy to identify as the same may fluctuate in line
with the scale of operations. For example, if there is no production, then direct material
consumption cost will be nil and accordingly the same will increase in the case of the
subsequent production operation. The management may face many difficulties in identifying
those costs and assigning to the products for the purpose for costing ("Strategic management
accounting: how far have we come in 25 years?", 2018).
However, these are few overheads cost which is fixed or semi-variable by nature. These costs
are, at times, comparatively difficult for the managers to identify product wise. For example,
rent of a production shop may not be easily attributable to the product unit wise and hence,
may be apportioned based on the absorption rate pre-determined by the management.
However, it has been identified that such absorption may lead to the situation of inappropriate
costing by way of over or under absorption and thereby over or under-costing of the product.
This is the situation where ABC may come into the picture as a big relief to the managers
(Hoozze & Hansen, 2014).
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The concept of ABS may be said to be primarily related to the accounting subject that focuses
on the cost measures of the business organisation. The tool basically identifies the cost drivers
and assign costs based on those cost drivers top the overheads for the purpose of product
costing. The costs which are not easily identifiable or traceable product unit wise, are
appropriately assigned to the product as per the cost activities and cost driver (Fei & Isa,
2010)s.
The concept of ABC is a systematic approach which may be applied by the management
through various steps. These steps are to be rigorously followed by the management in order to
get the necessary cost data, identify the required cost resources and then apply the same in the
situation in order to accurately cost the product. These steps are briefly described below.
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Figure 1: Steps in ABC
(Source: Created by author)
Step 1: Identify Resources:
The resources are basically the production expenses incurred by the business organisation for
manufacturing a product. For example, the production labour cost, indirect material cost, sales
and marketing labour cost, occupancy, utilities, set-ups, equipment and supplies etc. In this
context, it may be worth to note that none of the cost is directly traceable to the product unit
and hence apportioned to the product based on the cost drivers, discussed later on. In other
words, the concept of ABC purposefully excludes the direct costs and expenses which may be
directly chargeable to the production (Fei & Isa, 2010).
Step 2: Identify Activities
Activities represent the work performed by the business organisation for producing the
product. Such work may be performed in direct departments like sales, accounting, customer
services etc. The fundamental of the step is to identify the department where the relevant
costs are being incurred so that those costs may be accurately assigned to the relevant units of
the product or any units thereof manufactured in such departments (Fei & Isa, 2010).
Step 3: Identify Cost Objects
The ABC model is based on the profitability framework which denotes the fact that the most
costs incurred in profitable segments or departments or activities of the manufacturing process
of the business should be charged to those segments only so that the overall product costing
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becomes an efficient one. A business may be losing money by losing customers because of
ineffective after sales customer services. If the costs may be identified as per the activities, and
relevant profitability may be calculated for each cost objects, the costs so incurred in after-sale
services segment may be reduced and assigned to other areas where the comparative
profitability is higher. Such object identification may help the business to measure the
performance even the individual project, jobs or contracts wise (Fei & Isa, 2010).
Step 4: Determine Resource Drivers
The identification of resource driver is a critical part of the entire ABC model as the same
involves establishing the linkage between the costs incurred for the production and the
activities related with the production which has incurred those costs. For example, the salary of
supervisors or the customer care executives may not be directly attributable to product unit
wise. However, if the total costs in the form of salary to this human resource may be separately
identified, then the same may be apportioned as per the time spent by these human resources
on the given activity. It is needless to mention that the identification of proper resource driver
is of utmost importance for the accurate costing of the product (Fei & Isa, 2010). If the
determination of the resource driver may seem to be wrong, the entire purpose of ABC may get
vitiated.
Step 5: Determine Cost Drivers
The final stage of the ABC model is the determination of cost drivers. Such drivers trace the link
between the cost objects and activities. For example, the delivery of the product may involve
travelling expenses, depreciation of the vehicle, the salary of the drivers, fuel costs etc. It is
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quite evident that the costs will proportionally vary with the number of deliveries so made.
Therefore, these costs will be apportioned with reference to the number of deliveries so
identified. In the given case, the cost driver will be a number of deliveries itself (Fei & Isa, 2010).
2.2 Strategic Management Accounting (SMA) and ABC: Mutual Relationship
The discussion provides a broad overview of the ABC model and how it works; however, it is
also to be noted that the modus operandi of the ABC model majorly focuses on the need of the
management for getting an accurate or near accurate picture as to the cost structure of the
product from production to distribution. Since the cost identification is a complex process
because of its inherent characteristics of non-traceability at times, the management has to face
difficulty in identifying the costs accurate to the activities, objects and products or even services
(Fathi & Mousavi Dozdahiri, 2015). Strategic management accounting (hereinafter may be
referred to as SMA) may be construed to be a specific section of management accounting which
helps the management to adopt the new-age technologies and methods to identify the gaps,
issues; overcome the challenges and apply the information and insight so obtained by utilising
such tools in the practical scenario in order to undertake effective strategic decision for the
business ("Management accounting change in South Africa: case studies from retail services",
2018). Therefore, it may be said that the ABC is an integral part of SMAS in terms of its role and
functionalities in identifying and determining costs and allocating the same to the units in moist
systematic manner. The concept of SMA has been attempted to be defined by various
researchers. Some are of the opinion that the process of SMA may be segmented into six stages
which are mentioned below:
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 Stage 1: Collection of competitor information
 Stage 2: Exploitation of cost reduction opportunities
 Stage 3: Matching of accounting emphasis with a strategic position
 Stage 4 Collection of competitor information
 Stage 5: Exploitation of cost reduction opportunities
 Stage 6: Matching of accounting emphasis with a strategic position
In nutshell, it may be considered that the SMA is the comprehensive process of strategic
orientation that may contribute towards the idea generation, option evaluation, interpretation
and analysis of management accounting information for arriving a strategic positioning for the
business ("Management accounting change in South Africa: case studies from retail services",
2018). The essence behind the SMA lies in the fact that the business should always focus on
attaining the competitive advantage by re-engineering its operational process in order to create
value and thus achieve sustainability.
In this context, it may be wise to note that the two studies as discussed herein focus on the
activity based costing as a tool to management accountants. However, the differences lies in
the approaches as adopted in both the studies. One study emphasises on the application of
management accounting in the South African’s industry based on the case studies from retail
services. On the other hand, the other study explains the evolution and development strategic
management accounting concept in last 25 years with primary focus on the development in
North American context. In nutshell, it may be construed that both the studies attempt to
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provide a critical analysis of various aspects of management accounting from the perspective of
country as well as industry in the backdrop of changing landscape of market preferences.
2.3 Benefits of ABC
The ABC model is immensely helpful for the business for the following reasons:
ABC provides an accurate product costing
ABC identifies the cost behaviours of the various cost objects and hence the
management gets insight into the cost pattern of the business.
ABC helps the management to trace the unidentifiable costs and hence it is easier for
the management to assess the gaps and take necessary corrective actions if required.
ABC helps the management to undertake informed strategic decision by provision cost
driver rates and data on transaction volumes.
The management gets to know the capacity utilisation rate of the business with
reference to the cost objects and thereby prepare the activity based budgeting for
better control and monitoring (Askarany, 2011).
2.4 Limitations of ABC
In spite of a number of advantages, the model suffers from certain inherent limitation, which is
briefly mentioned below:
 First and foremost disadvantage of the ABC model is that the model is complex to
understand. Since ABC does away with the traditional model of cost absorption system,
the newer concept and techniques may be difficult to gauge up by the management.
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 Implementation of the model may involve an investment of time, money and energy
and hence, the small business house may not afford to implement the model.
 ABC primarily focuses on the identification of cost drivers. It has been observed a
number of times that the selection of such drivers may not be possible in the real-world
scenario at times and the management may face a great amount of difficulty and
challenges in applying those to the costs objects (Askarany, 2011).
2.5 Role of Accountants in the Adoption and Implementation of SMA: ABC Perspective
Accountants may need to assume a significant amount of roles and responsibilities in
implementing the ABC model in a business context as the same involves a sizeable volume of
training, understanding and controlling (Askarany, 2011). The accountants may need to
understand the management’s vision and act in line with the same so that the application of
the model is apt for the business. Since SMA requires a learning orientation, the accountants
should play an advisory role for the business in effectively applying the monitoring the progress
of the operation as well as the model.
2.6 Recommendations
The smaller business may not be able to adopt ABC because of its complexity and
expensiveness. However, the management of smaller firms may need to get the essence of cost
objects and cost drivers so that the same may be applied in their daily routine operations even
in an unstructured manner (RUAN & ZHOU, 2017). That initiative may contribute towards the
generation of operational efficiency. For bigger firms, the adoption of ABC is surely the desired
approach. However, the application will require a considerable amount of training and cost
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involvement as well Moreover, the change may be resisted by the existing employees which
should be carefully handled by the HR department of the business so that the traditional model
of costing may be done away with the ABC in a smooth manner.
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3.0 Conclusion
Based on the discussion and analysis performed in the preceding sections of the report, it may
be identified that the ABC model is immensely effective as modern day tool for managerial
decision making. The concept of SMA has been extended from the evaluation and assessment
of accounting data to strategy formulation based on the MIS data and hence, it is the need of
the hour that the management of the businesses evaluates the ABC in their business context as
well. A careful and informed adoption and implementation of ABC and its subsequent control
and monitoring will significantly contribute towards the achievement of corporate goals and
objectives in most cost efficient and efficient manner.
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References
Askarany, D. (2011). The interaction between Target Costing and Activity-Based Costing: Is
Target Costing a True Costing Technique?. SSRN Electronic Journal. doi:
10.2139/ssrn.1888824
Fathi, Z., & Mousavi Dozdahiri, E. (2015). A survey of activity-based costing in the hotel industry.
Management Science Letters, 855-860. doi: 10.5267/j.msl.2015.6.012
Fei, Z., & Isa, C. (2010). Factors Influencing Activity-Based Costing Success: A Research
Framework. International Journal Of Trade, Economics And Finance, 1(2), 144-150. doi:
10.7763/ijtef.2010.v1.26
Hoozze, S., & Hansen, S. (2014). A Comparison of Activity-Based Costing and Time-Driven
Activity-Based Costing. SSRN Electronic Journal. doi: 10.2139/ssrn.2489118
Management accounting change in South Africa: case studies from retail services. (2018).
Retrieved from
https://search.proquest.com/business/docview/211254587/E01A8FDF220F45EDPQ/4?
accountid=30552
RUAN, Y., & ZHOU, L. (2017). The Research on Management Accounting Tools—Based on the
Comparison Between Activity-based Costing and Traditional Costing. Destech
Transactions On Engineering And Technology Research, (amsm). doi:
10.12783/dtetr/amsm2017/14848
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Strategic management accounting: how far have we come in 25 years?. (2018). Retrieved from
https://search.proquest.com/business/docview/211295731/E01A8FDF220F45EDPQ/1?
accountid=30552
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