Analysis of Activity Based Costing

MANAGEMENT ACCOUNTING
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Contents
Introduction................................................................................................................................3
Part A: Activity Based Costing..................................................................................................4
Part B: An explanation of how ABC model aligns with the current goals and strategies of the
company.....................................................................................................................................6
i) An identification of the company’s mission and objectives;..............................................6
ii) An identification of the company’s corporate strategies...................................................6
iii) An explanation of how ABC model assist in achieving the company’s strategies..........6
Part C: Recommendations..........................................................................................................8
Part D: Apart from ABC model, suggest one other management accounting tool suitable for
your company and justify it........................................................................................................9
Conclusion................................................................................................................................11
References................................................................................................................................12
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Introduction
This report is prepared for Nick Scali Pty that is operating their business operations in the
retail industry in Australia. Nick Scali Pty was founded in 1962 and is engaged in the
business of importing and retailing furniture in Australia. Nick Scali Pty has around 47 stores
across Australia and 7 distribution centres as well. In recent past few years, Nick Scali Pty
has able to increase their sales revenue to great extent. This report is based on analysis of
activity based costing that is used by many business organisations for costing purpose.
Activity based costing method for allocating cost on the most appropriate basis i.e. resource
utilisation basis. Nick Scali Pty’s goals, mission and vision have been included along with a
discussion of how ABC model is aligned with Nick Scali Pty. The recommendation has been
made for the implementation of ABC model and one more management technique has been
suggested for better cost management and allocation.
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Part A: Activity Based Costing
Activity based costing
Activity based costing is based on activities, resources and the consumption patterns
involved. A cycle of consumption where any activity would consume a resource and
customers, products consume activities. An accurate understanding of the flow of activities
and costs associated is needed. Activity-based costing is a refined multidisciplinary approach
in which costing of products and services are calculated via the following steps:
Step 1: Activity identification involved in the process of production.
Step 2: Activity classification as per the cost hierarchy (unit-level, batch-level, product level
and facility level);
Step 3: Total costs of each activity need to be identified and accumulated;
Step 4: Appropriate cost driver for each individual activity needs to be identified;
Step5: Total units of the cost driver as per relevance to each activity need to be calculated
(Askarany, Yazdifar & Askary, 2010)
The revolutionary edge
Earlier approaches didn’t have such sharp calculations on cost drivers. Cost drivers are very
important in understanding the central activity around which the cost incurred revolves. How
many hours a machine works is what determines the electricity it shall consume and how
much maintenance cost that shall be incurred. So the number of machine hours is a typical
cost driver which was used in traditional systems. The direct labour hours are another typical
cost driver. Over time complexities and dynamics have changed and the increasing need for
spontaneity and innovation have led to many more subtle cost drivers operating which are not
that easy to attribute and so forms the relevance for ABC (The Committee, 2007). The
traditional costing methods are simple and an over costing or under costing scenario is very
likely.
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The company clearly needs to build a strategy to communicate more with those customers
who in minimum time and energy generate more business for it. If the company can get
business from a certain segment of customers in minimum advertising or minimum calls then
more focus must be employed on that segment. The rate of the order of every customer is
different and certain segments may be more inclined to place repeat orders and so doing
business with them more fruitful (Horngren, 2009).
To serve customers better, this is the flow of activities
 Make calls for sales
 Due Processing of orders
 Packaging
 Shipping
 Making credit reminder calls
(Tsai, Leu & Lin, 2013)
The company via activity based costing finds that the costs to retrieve money are very high
and many customers decline product after it has been sent which leads to unnecessary
wastage in packaging and distribution. It also finds that huge bulk of calls for sales to certain
segments rarely work (Angels, Joan & Natalia, 2018). After the ABC costing the strategy
may be changed to:
 Make calls only to select customer
 Processing, packaging and shipping only when the payment is done
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Part B: An explanation of how ABC model aligns with the current goals and
strategies of the company.
i) An identification of the company’s mission and objectives;
Nick Scali has a mission to recruit the best talent in the industry and make constantly rising
quality furniture. Its key objective is to retain talent and ensure employee skillset growth by
continuing with a plethora of leadership and training programmes and continuous
performance assessment. It plans to get a sharp performance by rewarding its employees
timely and adequately commensurate with their hard work and skills and by what they have
chipped in towards the growth of the whole. Its objective is to constantly give long term and
short term incentives (Joshi, 2015). Equal opportunity is another objective along with rich
diversity in the workplace. The company has a mission to always provide a supportive culture
through objectives like rigorous occupational health and many other safety practices. It has a
mission to be an employer of the first choice in the retail sector and to constantly provide
aesthetically beautiful furniture at highly affordable prices.
ii) An identification of the company’s corporate strategies
The company maintains innovative strategies to maintain its competitive edge in the market.
For example, just recently it benefited from a new warehouse management system. It has
made strategies to handle the likely housing sales market slowdown 2018. Its team of
research analysts and marketing team constantly interact with one another to foresee how the
dynamics are changing and constantly strategizing newer ways to gear up the company to
serve better. Its pricing strategies are to cater to all kinds of budget sizes. It incorporates
strategies for providing furniture of all kinds from that of formal settings to holiday homes. A
new high flying yet grounded strategy of 2018 is to open 10 new stores to get a better
foothold.
iii) An explanation of how ABC model assist in achieving the company’s strategies
ABC model will help achieve the company’s corporate strategies. The new warehouse
management system will have a series of intertwined activates with varying costs which
would be mapped incoherence. ABC shall help keep astute strategies intact to maintain strong
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balance sheets so that the cash flow is always optimal. The company wouldn’t have to lose
out on any growth opportunities and would be able to take advantage of any opportunity that
may arise inadvertently. Newer strategies to maintain its market-leading pioneer approach
and offering dynamic pushing edge services and products to its clients will be constantly
created as Activity Based Costing would provide the threshold and impetus by constantly
providing means to lower costs (Kuznetsov, 2014). ABC can determine the success of the
new warehouse system. The balance sheets and cost flow of the company are good but since
2018 is a challenging year in the housing sales market the company can surely benefit by the
reduction in the costs of individual activities brought about by implementing ABC. When all
budget sizes need to be encompassed the trajectory which needs to be traversed can be very
narrow at times and with the multidisciplinary and at times stringent measures in ABC, the
company can accomplish this goal more easily. Research has May intangible components and
ascertaining the right cost to the quality of data may improvise the company’s further
findings and prediction for markets and enable it to get a completive advantage by procuring
cheaper raw material earlier. The entry barriers in the market can be increased by Nick Scali
by constantly working on costs and the cost sensitivity of the furniture market is ample
reason to incorporate activity based costing (Lambert, 2012).
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Part C: Recommendations
The company must not leave the older methods of the cost it has been using as that has come
with years of trial and error. Along with other methods like target costing and budget costing,
activity costing mechanisms can be merged where deemed fit. Every costing method has its
own advantages and disadvantages, so whichever works best can be selected and
alternatively, different ones experimented to work out what works best for the organization at
large. A mix and match solution to cater to all recipes of the taste spectrum can be worked
out. If the in-house expertise of costing mechanisms isn’t very brilliant costing tools
implementing consultancy services can be outsourced. It is highly recommended that all
managers of the organization work in close coordination while implementing the ABC model
as any conflict in data can create huge costs and blunders (Dyas, et. al., 2015). Since sourcing
and retailing are the main activities undertake by Nick Scali it is recommended that the
managers are very careful in ascribing costs to activities here as the competitive edge of cost-
cutting is derived mainly from sourcing from right vendors and understanding vendor
dynamics and newer relation formation (Kazemi & Zadeh, 2015). While implementing the
model the company must ensure that the resistance to it is removed by providing accurate
training to its managers. The pressure which is created by keeping so many additional tabs
and tracks can only be moderated when the long term advantages both at the individual and
collective level are well understood (Krishnan, 2006).
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Part D: Apart from ABC model, suggest one other management accounting tool
suitable for your company and justify it.
The company can benefit attain benefit from budget costing method in alteration to the
activity based costing. Cost budgeting, in essence, is the estimation of costs over a period of
time and keeping in control the actual costs by constant comparison with the estimated costs.
A convenient time frame of monthly, quarterly or yearly can be chosen. To formulate a
precise cost budgeting plan the company must have a schedule and a resource plan intact.
Variations in costs in certain times and outfits can be managed when budgets are tight in
other zones. A budget is like a map. It enables the company to know where to traverse and
navigate in the financial territory in the broad spectrum of events and ever-changing business
landscapes. Borders and boundaries are defined well while leeways made to incorporate the
impermanence of change (Okpala, 2013).
Nick Scali should adopt a budget costing model which is flexible and vigilant enough to be in
sync with its constant expansion and diversification. Since furniture manufacturing and
shipping requires huge inventory management production budgets make this process more
seamless. The demand in the market can constantly fluctuate as in recession, buying furniture
is a low priority choice and the budget costing method thrives in managing uncertainty by
finding predictability within. To furniture manufacture Nick Scali may need to procure
materials from multiple vendors and having a clear budget policy would surely help to
eliminate purchase from vendors whose quality is not commensurate to the price (Frow,
Marginson & Ogden, 2010). Since Nick Scali has grown in quantum leaps over the past few
years it can also put aside funds in advance for areas where budget overshooting can’t be
controlled thereby untangling undue complexes of tight budget restrictions.
The employees would also have an expectation of how much they can spend on a process and
won’t have a careless spending attitude considering the company they are working for is too
big to care. This is possible only when an employee is aware of the allocated budget for the
particular process and how they need optimally they need to spend (Dunk, 2011).
The cost of quality which is the liquidity required for doing a project properly and the
resource cost rate for labour and material is an important part of the budget costs. Nick Scali
has the expertise to get bottom-up estimating of costs incurred by finding price prevalent at
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lower levels and summing it up to arrive at the upper layers. Bottom-up estimation goes in
tandem with a good budget costing plan. Nick Scali has maintained a good track record in
profitability and payment history. Thereby the contingency reserves which need to be
maintained in a neat budget costing model would ensure the legacy (Wallis, 2009). With
around 47 showrooms in the country, Nick Scali cannot afford expenses not justified and one
protocol change in any showroom can be emulated across many and profitability enhanced
considerably.
There is constant crunch amongst various departments of a company in releasing funds
internally and to vendors externally as each project manager wants to keep a financial safety
net by having ample liquidity. Budget costing must not be so rigid or tight that the tension
leads to undue conflicts and business suffering. For this reserve, the analysis is must ensure
cash advances in case of overruns (Potts & Ankrah, 2014). Going by the company’s fresh
vision and flexibility it can employ the best of budget costing like flexible budgeting which
changes the level of activity attained. The constant flux of new activities in Nick Scali calls
for the same.
The budget costing method also breaks budget into multiple mini-budgets basis areas of
spends like plant utilization budget, production cost budget which encompasses material and
labour. Performance budgets which are based on program functionality. Cash budgets are
also made for cash which may be needed within a certain period.
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Conclusion
From the above report, it can be concluded that there are many cost management or costing
techniques which can be used by the business organisation for costing purpose. ABC method
is comparatively different and most appropriate method of cost allocation. In this method,
cost of different products or process are divided or charged on the basis of resources utilised,
therefore, this makes it effective. It can be concluded that Nick Scali need to use ABC
method for the cost allocation because their manufacturing unit has different cost for many
processes. At last, is recommended to use one more management accounting technique i.e.
budgetary control as it provides a base for cost management and cost control in the business
organisation.
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References
Askarany, Yazdifar, & Askary. (2010). Supply chain management, activity-based costing and
organisational factors. International Journal of Production Economics, 127(2), 238-248.
Dunk, A. (2011). Product innovation, budgetary control, and the financial performance of
firms. The British Accounting Review, 43(2), 102-111.
Dyas, S. R., Greenfield, E., Messimer, S., Thotakura, S., Gholston, S., Doughty, T., ... &
Phillips, R. (2015). Process‐Improvement Cost Model for the Emergency
Department. Journal of Healthcare Management, 60(6), 442-457.
Frow, Marginson & Ogden, 2010. "Continuous" budgeting: Reconciling budget flexibility
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Joshi, K. (2015). Continuity planning: the importance of including digital property. Strategic
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Kazemi, Z., & Zadeh, H. A. (2015). Activity based Costing: A Practical Model for Cost Price
Calculation in Hospitals. Indian Journal of Science and Technology, 8(27).
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Kuznetsov, N. (2014). Management Innovation Companies Based Business Cost
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M. Angels Fito, Joan Llobet, & Natalia Cuguero. (2018). The activity-based costing model
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Okpala, K., 2013. Budgetary Control and Service Charge Management Performance in Real
Estate Sector: An Empirical Study of the Motivational Aspect. Asian Economic and
Financial Review, 3(6), p.749.
Potts, K., & Ankrah, N. (2014). Construction Cost Management. Hoboken: Taylor and
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Tsai, Chen, Leu, Chang, & Lin. (2013). A product-mix decision model using green
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Wallis, L. (2009). Budgetary Control. Nursing Standard (through 2013), 23(25), 64.
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