Activity-based costing

Activity-based costing method is of high utility for organizations as it helps in segregating costs as direct and indirect costs and apportioning them to their actual source. It helps in tracing unnecessary costs and taking necessary measures to reduce or eliminate them. Read case studies to understand how ABC method helps in decision making.

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MANAGERIAL ACCOUNTING

Activity-based costing
Executive Summary
Activity-based costing method is undoubtedly the best costing method in the present times. It
is of high utility for the organizations as it helps the analysts to segregate costs as direct and
indirect costs and after the identification of indirect costs the same are apportioned and
allocated to their actual source based on the funds consumed by such sources in order to
produce a particular product or services. It helps the management of the organization in
tracing the unnecessary costs and taking the necessary measures in order to reduce or
eliminate the same. The management of the company can take necessary and valuable
decisions based on the results derived from the ABC method
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Activity-based costing
Contents
Introduction...........................................................................................................................................4
Motives for ABC costing........................................................................................................................5
Case studies...........................................................................................................................................7
 Case study 1...................................................................................................................................7
 Case study 2...................................................................................................................................8
Similarities and difference in above two case study............................................................................10
 Similarities...................................................................................................................................10
 Differences in case study.............................................................................................................11
Outcomes............................................................................................................................................12
Conclusion...........................................................................................................................................14
References...........................................................................................................................................15
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Activity-based costing
Introduction
ABC method is a simple method that derives precise results that can be used by the
management for apportioning the overheads to their respective activities and also in decision
making. ABC method provides better utility as compared with the traditional costing method.
It overcomes the shortcomings of the traditional costing method. Activity based costing
method allows the organizations in decision making. It allows the company to survive and
combat intense competition prevailing in its industry. The shortcomings of the traditional
costing method can be resolved by incorporating ABC method. In conventional costing
method the overheads are apportioned to all the activities while in the case of ABC methods,
the overheads are allocated to their actual source. Activity based costing method may affect
the performance of the company but it also allows the analysts to identify the reasons and
areas owing to such performance that needs to be taken care of by means of taking required
valuable decisions.
The five steps that can be used to calculate costs by Activity-based costing method are
discussed below-
First step- the analyst should trace all such activities that consumed resources so as to
develop a particular product or service. By doing this the analyst will be able to calculate the
costs that were generated by activities in the production of goods or service.
The second step- In the second step, it is required for the analyst to apportion the indirect
costs and assign them to its respective activities. Creating cost pools for each and every cost
item shall help in the allocation of overheads to their respective activities.
The third step- In the next step the analysts are required to identify all the cost drivers and the
reasons behind the incurring of costs as well. This is because that the cost drivers help in the
tracing of unnecessary costs and identification of improper pricing of goods or services
(Vaitilingam, 2010).
Fourth stage- Next, the analysts are required to procure and evaluate the overhead absorption
rate for every single cost pool.
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Activity-based costing
Fifth stage- The analysts are required to assign all the indirect costs to their respective
sources depending on the resources consumed by such activities in the production of goods or
services.
Motives for ABC costing
 Expenditure control
All the processes and the procedures followed with respect to cost are categorized under this
method. This method provides an overview of the whole system which helps the company
management to take serious steps about the expenditure control and this is the reason that this
system of control costs more than the old conventional one which was commonly used. This
system helps to categorize different costs in order to understand them with ease (Robinson &
last, 2009). The main focus of the system is to display all the cost categories which will help
to cut off extra or bogus expenses from the company field which will yield more positive
result from the company’s part (Drury, 2013). Activity-based costing system can be attained
by a company if this method is sincerely followed and obeyed with.
• Section wise analysis
The section wise analysis is done which relates the expenses actively or passively put up with
the company’s processes. It is to be noted that when the activities or tasks in the company are
dealt with and funds are allocated to them, it seem s that all the tasks belong to the same
nature and so the cost wise categorization becomes somewhat difficult (Horngren, 2011).
• Focus on the process
The adoption of activity-based costing sees that it only focuses on all the process and the
activities going on in the company but there is no extra segregation with respect to cost but
after the disclosure of all the activities the company can itself find the weak link and thus
eliminated the extra bogus costs (Drury, 2011). The detection of any such passive or extra
costs by the management can be easily dealt with by following the back trail of the costs and
making a core plan to eliminate the same from the company’s field which will increase the
efficiency of the company as a whole
• Updated techniques
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Activity-based costing
It can be observed from the current situation that the competitiveness in the banking sector
has increased and this is why there was the need for the introduction of new costing
techniques which would give different companies an edge in the market. These new
techniques are efficient enough that they will themselves increase the positiveness of the
company which will thereby help the company to increase and raise its financial reputation
and also to provide maximum benefits and wealth to the investors and also to the third party
fund makers (Horngren & Foster, 2008). Gathering of data by this system will also help the
company to simultaneously increase the profit percentage of the company as well.
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Activity-based costing
Case studies
 Case study 1
Case Study 1 Details
Title
The impact of activity-based costing techniques on firm
performance. Journal of Management Accounting Research
Author Kennedy, T., & Affleck-Graves, J.
Year of publication 2001
Methodology Literature review
Background of study
Because of the above mentioned loopholes, it is important for
companies which want to have a strong costing pillar to adopt the
ABC method of costing in the managerial system. All the methods
and the process and the target of such procedures must be equally
noted and paid attention to by the management so that they can
follow the trail of eliminating any passive costs and to focus only
on the primary objectives and the expenses involved in the
respective fields (Kennedy & Affleck-Graves, 2001)
Findings
The structure of activity based costing can be explained in a way
that it has the power to expose and finalize all the expenses
incurred to different projects and tasks and also looks after the
labour pays and plans the way to get the maximum effort put of
everyone. All the objectives which is to be attained by the company
can be done if these techniques are followed which will also led to
ease in decision making processes (Kennedy & Affleck-Graves,
2001)
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Activity-based costing
The need of the hour with respect to the regional banks is that they are eager to find a
technique which will help them to maximize their profits and wealth and thus they will able
to serve their customers at their maximum capacity. It is also the bank's respect talk to deliver
the best and the more accurate services to their customers. Following of the above factors will
help the bank to keep up or increase their respect and will also they will be capable enough to
target and reach all their goals. All the minor, as well as the major cost of the production unit,
should be noted down so that the price set for the same can be compared to the original and
the natural cost price from the company (Kennedy & Affleck-Graves, 2001). To achieve all
the above factors there are many trails and developments going on to produce a new
technique which will be healthy and sufficient enough to cope up with all the working and the
desires of the company’s management and system.
 Case study 2
Case Study 1 Details
Title
Innovation action research: Creating new management theory
and practice. Journal of Management Accounting Research
Author Kaplan, R. S
Year of publication 1998
Methodology Literature review
Background of study
With the help of ABC method analysts are able to identify and
allocate indirect costs to their respective source depending on the
resources consumed in order to produce goods or services. ABC
method allows the management in identifying all the sources that
has utilized resources so that the same can be apportioned to its
respective source (Kaplan, 1998). With the help of ABC method,
the analysts can trace indirect costs that were unnecessary and
avoidable so as to regulate the costing of its products or services.
Activity based costing method is a very popular method around the
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Activity-based costing
globe as it is universally accepted by organizations for various
purposes owing to its multiple traits
Findings
ABC method allows the apportionment of indirect costs to their
respective activities, unlike the traditional costing method. This
forms as a basis of decision making for the management of the
company as the results derived from the method are very true and
reliable. It also allows the management of the company to segregate
costs into direct costs and indirect costs. ABC method also helps in
detecting any unwanted costs that are incurred in the development
of products or services and in order to eliminate or reduce the same,
the management can incorporate valuable decisions and various
measures (Kaplan, 1998). As the results are precise the actual
values can be easily derived. Activity-based costing method also
helps in evaluating the cost of damages that have or could have
occurred. Consumed power, production orders, etc are some
significant cost drivers in activity-based costing method.
Owing to the difficulty faced in the identification of indirect costs there are chances for the
analysts to consider them while evaluating the actual value of a product or services.
Taking labour expenses and machine expenses into consideration one can say that these
expenses are dependent on machine hours and power consumed (Shim & Siegel, 2009).
With the help of the ABC method, the management of the company can trace and
diminish costs that are unnecessary, therefore, helping the management of the company
in taking valuable and effective decisions (Kaplan, 1998).
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Activity-based costing
Similarities and difference in above two case study
 Similarities
Basis Descriptions
Utilization The ABC method can be seen to form an easy link between the
sources and the tasks using up the sources after keeping the
expenditure involved aside and also considering the amount and the
efficiency of the output produced by the process.
Implementation Activity based costing method is designed in a manner keeping the
present market scenario in mind. This is why it is gaining
worldwide popularity and is preferred by companies over
traditional costing method. Practicality, originality, implementation
costs, etc are few denominators that can be considered by the
companies in calculating the effectiveness of the activity based
costing. The implementation of traditional costing methods can
curve out such results that reflect huge revenues for the
organizations
Usefulness Implementing of ABC method will make the efficiency of the
banks reach a new level and at the same time the interests of the
shareholders will also be safeguarded. Implementation of ABC
method will also make it convenient for banks to meet the demands
of its customers and design plans, schemes and policies in the best
interest of its customers. Also, the banks will be able to make better
decisions based on the results ascertained from activity based
costing method.
Attention should be paid to the fact that the activity based costing technique will not only
help the bank in increasing their profit percentage and to fill their desires but will also
provide an edge over the other banks in the market. Allocation of particular expenditure
and the recognizing of the same has been useful for surviving in the competitive market.
This is particularly a way in which the accounting of the bank can reach a whole new
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Activity-based costing
level and thus this will not only increase the profit percentage of the bank but also
provide financial benefits to the investors of the same and will maintain the reputation of
the bank in the market (Lanen et. al, 2008)
 Differences in case study
Basis Descriptions
Nature of Industry
Considering the practicality of the present scenario, it can happen
that the implementation of ABC method might not be beneficial for
the companies but still, the companies are advised to opt for ABC
method owing to the preciseness of the results that are derived from
using the same. The companies should evaluate the results from
both methods and thereafter compare the results derived from them
for the purpose of making valuable decisions so as to trace any
information that can be harmful to the image of the company and
can impact its goodwill in the coming time (Larry & Christopher,
2012).
Activity-based costing method allows the companies to survive the
competition in its industries. In order to deal with the competition,
pressure and workload existing in the banking industries it is
required for them to incorporate such other strategies especially the
undertaking of appropriate costing methods. It is due to the fact that
better the market shares better will be the wealth of the
shareholders.
Focus on person and
activities
Conventional costing method is less time taking as compared to
activity-based costing method. The intuitions are believed to be the
basis of traditional costing methods which means the chances of
misallocation of indirect costs are high. This will ultimately
disallow the management of the company from taking appropriate,
valuable and required decisions. Accurate pricing strategies and
determination of actual costs are required to be known by the
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Activity-based costing
management of an organization so as to determine the price of a
product or service that can ultimately happen by implementing
ABC method
It shall be noted that it is easier to trace direct costs as compared to indirect costs. It is due to
the fact that direct costs are directly associated with product or services unlike indirect costs
as they are not directly associated with products or services. The banks also derive benefits
from taking action based costing method into use as banks get an opportunity to discover new
banking segments as well. The method also allows the bankers to come across various facts
that are related to incorporating new segments. It also helps the organizations in facing the
immense and extensive competition in its industry and outperforms its rivals. This happens
Half knowledge or misstatements about the activities of the company can also be handled by
the adoption of the activity-based costing system. Apart from the traditional conventional
method which used to directly allocate the funds to the task, this method questions the task
that what is the amount of fund that should be allocated and why which eases the company’s
ethics of work and detection (Needles &Powers, 2013). Also, the resources used up by the
company tasks can be easily found out by following the back trail of all the activities if they
are processes under the ABC method.
Outcomes
• From the very starting, the report can be seen to focus on the facts related to the efficiency
of activity-based costing and the positiveness in the decision making process of the company
which will help the company to thrive in this type of competitive market. Cases in which a
false or threat output generation was made has also been stated because in that case, the
activity-based costing was unavailable to reach its limit.
• All the procedures and the expenditure involved with the same is disclosed by the
activity-based costing technique which will effectively help the management to gain
knowledge about the same and to eliminate all the extra and bogus costs incurred by the
company regularly (Needles, 2011).
• The outputs produced and delivered by the company along with the processes are the
pillar that determines the success and the efficiency of the activity-based costing. This
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Activity-based costing
particular technique and the plans inscribed in the same has been very positive with respect to
the practitioners and scholars in the costing field (Vanderbeck, 2013).
• From the above discussions and explanations, it can be said that this development of latest
techniques has supported the scholars to comply more with the undertaken projects and to
work according to the specifications of the client and to benefit themselves as well as the
respective company so as to increase the company’s financial equation (Venanci, 2012).
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Activity-based costing
Conclusion
From the above report and its explanations, it can be clearly understood that the technique of
activity-based costing has been proved to be much more efficient and beneficial from the
traditional methods in numerous ways which were not working out in today’s current
situation. Attention should also be paid towards the fact that this technique works well for
only for manufacturing industries and may cause misstatements when used in any other field.
This method has been necessary to adopt by the management to reach the goals and bring the
company up to a whole new height. Many new ideas and techniques related to the payment
gateway in the industrial sectioned have been seen over quite a long time now. Many
methods have now been created which leads to successful payments even when the gateway
system fails or the payment is due.
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Activity-based costing
References
Drury, C. (2011). Cost and management accounting. Andover, Hampshire, UK: South-
Western Cengage Learning.
Drury, C. M. (2013). Management and cost accounting. Springer.
Horngren, C T & Foster, G. (2008). Cost Accounting: A Managerial Emphasis. United
States Edition
Horngren, C. (2011). Cost accounting. Frenchs Forest, N.S.W.: Pearson Australia.
Kaplan, R. S. (1998). Innovation action research: Creating new management theory and
practice. Journal of Management Accounting Research, 10, 89-118. Retrieved from
https://search.proquest.com/docview/210236279?accountid=30552
Kennedy, T., & Affleck-Graves, J. (2001). The impact of activity-based costing techniques
on firm performance. Journal of Management Accounting Research, 13, 19-45.
Retrieved from https://search.proquest.com/docview/210238789?accountid=30552
Lanen, W. N., Anderson, S & Maher, M. W. (2008). Fundamentals of cost accounting. NY:
Hang Loose press.
Larry M. W & Christopher J. S. (2012). Managerial and Cost Accounting. Pearson Press
Needles, B. E.& Powers, M. (2013). Principles of Financial Accounting. New York Press
Needles, S. C. (2011). Managerial Accounting, USA: South-Western Cengage Learning .
Robinson, M., & Last, D. (2009). Budgetary Control Model: The Process of Translation.
Accounting, Organization, and Society. NY Press
Shim, J. K & Siegel, J G. (2009). Modern Cost Management and Analysis. Barron's
Education Series
Vaitilingam, R. (2010). The Financial Times Guide to Using the Financial Pages, London:
FT Prentice Hall.
Vanderbeck, E J. (2013). Principles of Cost Accounting. Oxford university press
Venanci, D. (2012). Financial Performance Measures and Value Creation. State of art .
New York: Springer.
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