Activity-Based Costing (ABC) Analysis: Use, Limitations, and Factors

This essay provides an in-depth analysis of Activity-Based Costing (ABC), a modern costing technique that allocates costs based on activity consumption. It examines the relationship between organizational size and ABC implementation, noting that larger firms often have the resources to manage complex costing systems, while smaller firms may find traditional methods sufficient. The essay also explores the competitive advantages ABC offers, such as improved cost effectiveness and innovation. Furthermore, it identifies the reasons why ABC is not widely used, including its complexity, the costs associated with design and implementation, lack of top management support, data availability issues, and the need for employee training and expertise. The analysis references several scholarly articles to support its arguments, providing a comprehensive overview of ABC's application and limitations.

Running head: ANALYSIS ON ABC COSTING
Analysis on ABC Costing
Name of the Student
Name of the University
Author Note

1ANALYSIS ON ABC COSTING
Table of Contents
Use of ABC by organisation and size..........................................................................................2
Reasons for not using ABC widely..............................................................................................3
References....................................................................................................................................5

2ANALYSIS ON ABC COSTING
Use of ABC by organisation and size
Activity Based Costing is a modern day costing technique that identifies all the costs
incurred by an organisation and allocates all the costs according to the consumption by each
product and service. It has been noted that a positive relation exists between the size of the firm
and its likeliness to implement ABC Costing. This is because large firms generally tend to have
the resources and expertise to maintain a complex system of costing like the ABC (John 2014).
However, along with size, willingness and ability of the firm to the costing system also play a
significant role in its implementation. It has also been noted that the level of innovations
occurring in small scale firms tend to be very limited in nature. Hence, they prefer sticking to the
traditional costing methods as their production processes do not tend to make a complex system
like ABC necessary for measuring the costs incurred by the entity (Charaf & Bescos, 2013).
Using ABC costing has also been found to provide competitive advantage by enabling an entity
to do cost effective business with its competitors. The results obtained from ABC are used as a
yardstick by most of the businesses in measuring their cost effectiveness over their rivals. It also
provides a distinct idea about where an entity stands with regards to the other firms operating in
the industry (Ismail & Reddy, 2017). Due to the increased pressure on entities after the global
economic crisis, innovation has become extremely important for firms to survive and thrive in
the long run. One of the most common aspects that every organisation looks forward to is to
innovate while maintaining the same level of quality in the products. Applying ABC analysis in
inventory management results in cost savings during an order cycle and thus prolongs the
production capabilities and costing life cycle of a firm. It also generates additional capital
amount for a firm which is very valuable in conducting the business in an effective manner. As

3ANALYSIS ON ABC COSTING
the competency levels of a business increase more than that of their competitors, they always
manage to stay relevant and profitable in the market.
Reasons for not using ABC widely
As stated above, ABC is a sophisticated tool which is very complex. Hence, the necessity
for using it does not arise in case of small scale firms and firms involved in the manufacture of a
single product. The inherent difficulties that exist with the design and implementation of the
ABC system along with the costs involved in it are some of the reasons for the ABC system not
being widely used. As the priority of the firms always tends to be towards making profits, they
are not interested in changing a system that produces their desired level of profits. Lack of
support from the top management is also a reason for the lack of wider implementation of the
system (Nassar et al., 2013). The data required for the correct implementation of the ABC
costing is not always readily available by using the regular accounting reports and hence, the
implementation becomes difficult. The usage of the ABC system also depends on the level of
overheads that are incurred by a firm. If the level of overheads incurred by a firm is negligible,
then implementing the ABC costing system is not advisable from a financial point of view for an
organisation. Most of the people accept that ABC costing properly aligns the manufacturing
objectives with that of the long term strategy of the entity. However, lack of sufficient training
and expertise to employees in this regard is one of the reasons why the implementation of the
system becomes increasingly complex. The lack of sufficient resources like software packages
and adequate training programs further aggravates this problem (Oseifuah, 2014). The cost
structure of an organisation also plays an important role in determining the suitability of the
implementation of the ABC system. If the indirectly costs can easily be identified, then
implementing the system becomes much easier. Otherwise, taking up the ABC system becomes a

4ANALYSIS ON ABC COSTING
more tedious process. The selection of cost drivers is also not easy in all situations. As selecting
the wrong cost drivers makes the entire system irrelevant and due to the costs involved in
implementing the system, it becomes difficult for organisations to accurately implement the cost
as a part of their organisational accounting system.

5ANALYSIS ON ABC COSTING
References
Charaf, K., & Bescos, P. L. (2013). The role of organizational and cultural factors in the
adoption of activity-based costing: the case of Moroccan firms. Accounting and
Management Information Systems, 12(1), 4.
Ismail, M. F. Z., & Reddy, B. K. (2017). Impact of Activity-based Costing (ABC) on
Competitive Advantage in the Jordanian Telecommunication. Research Journal of
Finance and Accounting, 8(20), 1-6.
John, AO. (2014). Effects of Firm Size on Activity-based Costing Implementation in Nigerian
Manufacturing Sector [Ebook]. Nigeria: International Journal of Innovation and
Scientific Research. Retrieved from
https://www.researchgate.net/publication/264912096_Effect_of_firm_size_on_activity-
based_costing_system_implementation_in_Nigerian_manufacturing_sector
Nassar, M., Aldeen Al-Khadash, H., Sangster, A., & Mah’d, O. (2013). Factors that catalyse,
facilitate and motivate the decision to implement activity-based costing in Jordanian
industrial companies. Journal of applied accounting research, 14(1), 18-36.
Oseifuah, E. K. (2014). Activity based costing (ABC) in the public sector: benefits and
challenges. Problems and Perspectives in Management, 12(4), 581-588.