Comparative Study of Traditional and Activity-Based Costing in Forging Companies of Iran Tractor
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International Journal of Management Sciences and Business Research, Mar-2015 ISSN (2226-8235) Vol-4, Issue 3
http://www.ijmsbr.com Page 1
Comparative Study of Traditional and Activity-Based Costing in Forging
Companies of Iran Tractor.
Author’s Details:
(1)Dr. Mohammad Hassan Haddadi-Associated Professor, Department of Commercial
Management, Islamic Azad University, Julfa International Branch, Julfa, Azerbaijan
Sharqi, Iran.(2)Mir Javad Seyednezhad-Lecturer, Department of Accounting, Islamic
Azad University, Julfa International Branch, Julfa, Azerbaijan Sharqi, Iran.
Abstract:
The present study attempts to examine the impact/relationship between Activity Based Costing (ABC) adoption and
implementation versus Traditional Cost Accounting (TC) in Iranian forging companies of Iran tractor manufacturing.
Archival data were extracted from annual reports of 240 quoted companies in Iran for the year 2014. After conducting
an interviews with engineers and industrial accounting experts, all the products were classified according to weight
and by applying the sample method, only 10 kind of products were selected for the presented study. The results
showed that, (A) - there is no significant difference between cost of every unit according to TC and ABC system and
(B) - there is no significant difference between gross profit of every unit according to TC and ABC system. By
applying the statistical methods whit the help of Micro Soft Excel and SPSS software the results suggested that the
main hypothesis is confirmed and the sub-hypothesis Ha and Hb are rejected.
Keywords: Traditional Costing (TC), Activity Based Costing (ABC), Tractor Manufacturing, Forging Companies,
Management Accounting, Costing Systems.
Introduction
Activity Based Costing (ABC) adoption and
implementation versus traditional cost-accounting
have been widely researched in developed
countries. However, in developing countries like
I.R. of Iran, research regarding these issues in
general, and within the Iranian manufacturing of
forging company of Iran tractor in specific, is still
sadly limited. During the research we noticed that
at the end of 1960s and in early 1970s, some of
accounting researchers studied on the relationship
between activity and cost. But at the end of 1980s,
pursuant studies noticed that some factors like
profitability, competition at world level,
increasing customers’ satisfaction, emphasis on
products quality control and lowering costs were
taken as main Internal. The fact that costing
traditional systems not only cannot meet
managers’ needs but also using of the information
derived from these system in some cases causes
misleading and leads to making improper
decisions (Cooper and Slagmulder, 1997). By
following this trend, the increase of competitive
market that requires rational allocation of
production costs, a new system was introduced
under the title of activity based costing that was a
2-D system. Afterwards, it expressed costs
allocation from resources to activities and then
also from activities to cost objectives, that might
lead to presentation of useful information in order
to achieve corrected goals inside and outside the
organization. As a result, this technique may be
defined as follows (Szychta, 2010).
Kaplan and Johnson in a book titled Losses in
1987 introduced activity-based costing as an
alternative to traditional costing models. At that
time, traditional accounting models had failed to
provide information needed to calculate the cost
price of products and performance evaluation in
an environment with rapid technological changes,
intense competition, and information processing
revolution. Kaplan and Johnson's model was first
proposed in manufacturing companies to reduce
production costs. After the adoption of this model
by manufacturing companies, service industries
also took the model into account as an improved
method for calculating costs. The implementation of
the ABC and TC system has the following steps:
http://www.ijmsbr.com Page 1
Comparative Study of Traditional and Activity-Based Costing in Forging
Companies of Iran Tractor.
Author’s Details:
(1)Dr. Mohammad Hassan Haddadi-Associated Professor, Department of Commercial
Management, Islamic Azad University, Julfa International Branch, Julfa, Azerbaijan
Sharqi, Iran.(2)Mir Javad Seyednezhad-Lecturer, Department of Accounting, Islamic
Azad University, Julfa International Branch, Julfa, Azerbaijan Sharqi, Iran.
Abstract:
The present study attempts to examine the impact/relationship between Activity Based Costing (ABC) adoption and
implementation versus Traditional Cost Accounting (TC) in Iranian forging companies of Iran tractor manufacturing.
Archival data were extracted from annual reports of 240 quoted companies in Iran for the year 2014. After conducting
an interviews with engineers and industrial accounting experts, all the products were classified according to weight
and by applying the sample method, only 10 kind of products were selected for the presented study. The results
showed that, (A) - there is no significant difference between cost of every unit according to TC and ABC system and
(B) - there is no significant difference between gross profit of every unit according to TC and ABC system. By
applying the statistical methods whit the help of Micro Soft Excel and SPSS software the results suggested that the
main hypothesis is confirmed and the sub-hypothesis Ha and Hb are rejected.
Keywords: Traditional Costing (TC), Activity Based Costing (ABC), Tractor Manufacturing, Forging Companies,
Management Accounting, Costing Systems.
Introduction
Activity Based Costing (ABC) adoption and
implementation versus traditional cost-accounting
have been widely researched in developed
countries. However, in developing countries like
I.R. of Iran, research regarding these issues in
general, and within the Iranian manufacturing of
forging company of Iran tractor in specific, is still
sadly limited. During the research we noticed that
at the end of 1960s and in early 1970s, some of
accounting researchers studied on the relationship
between activity and cost. But at the end of 1980s,
pursuant studies noticed that some factors like
profitability, competition at world level,
increasing customers’ satisfaction, emphasis on
products quality control and lowering costs were
taken as main Internal. The fact that costing
traditional systems not only cannot meet
managers’ needs but also using of the information
derived from these system in some cases causes
misleading and leads to making improper
decisions (Cooper and Slagmulder, 1997). By
following this trend, the increase of competitive
market that requires rational allocation of
production costs, a new system was introduced
under the title of activity based costing that was a
2-D system. Afterwards, it expressed costs
allocation from resources to activities and then
also from activities to cost objectives, that might
lead to presentation of useful information in order
to achieve corrected goals inside and outside the
organization. As a result, this technique may be
defined as follows (Szychta, 2010).
Kaplan and Johnson in a book titled Losses in
1987 introduced activity-based costing as an
alternative to traditional costing models. At that
time, traditional accounting models had failed to
provide information needed to calculate the cost
price of products and performance evaluation in
an environment with rapid technological changes,
intense competition, and information processing
revolution. Kaplan and Johnson's model was first
proposed in manufacturing companies to reduce
production costs. After the adoption of this model
by manufacturing companies, service industries
also took the model into account as an improved
method for calculating costs. The implementation of
the ABC and TC system has the following steps:
International Journal of Management Sciences and Business Research, Mar-2015 ISSN (2226-8235) Vol-4, Issue 3
http://www.ijmsbr.com Page 2
ACTIVITY BASED COSTING
METHOD
TRADITIONAL BASED
COSTING
1 Identify & Classify activities 1 Identification of indirect cost
2 Estimate cost for whole activity 2 Estimation of indirect cost
3 Compute a cost driver rate 3 Choose cost drivers
4 Apply activity costs using cost
drivers
4 Estimation of value for cost
drivers
5 Computation of overhead rate
6 Application of overhead rate
Source: Anderson (1995), Shields (1995), Innes and Mitchell (1995), Gosselin (1997),
Foster and Swenson (1997), Malmi (1997), McGowan and Klammer (1997),
Krumweide (1998); Chenhall and Langfield-Smith (1998), Anderson and Young
(1999).
Activity based costing is based on actual
performance, consumption and expense data taken
out from the organization‘s existing information
system and combined with the knowledge of those
directly involved in the distribution of goods and
services. Here the cost is designated to activities
based on the resources they use for processing.
The ABC also provides insights into the starting
place of costs and also the probable outcome of
different decisions by the process managers. Apart
from providing the information required for this
process, it also realizes performances
breakthrough.
In Traditional costing, there is a certain amount of
estimation in cost allocation. The cost systems do
not focus on why or where cost occurred.
Generally, there is little insight into the causes of
variances. The reporting methodology is
accounting –oriented, inaccurate, not flexible and
often not timely. The operational managers often
cannot understand since it is very analytical and
does not relate to the cost of a product or services
applied.
Advantages of Activity based costing and
Traditional based costing.
Kingcott (1991) advised that if the costs of
Activity-based costing (ABC) exceeded the
benefits, company should not apply Activity-
based costing (ABC) systems. If so, the capital
expenditure on the activity based system and its
subsequent running costs can be a road block for
firms.
Johns, Evans and Ashworth (1995), indicated that
the question that lingers in our minds is why those
companies even now implement traditional
costing instead of Activity-based Costing (ABC)?
It is because the Activity-based Costing (ABC)
has it pros and cons.
Gunasekaran, (1999) in Malaysia some
organizations that have changed to the Activity-
based Costing (ABC) system since as far back as
1980 as the system had proven its usability in the
appropriate product mix decision and overheads
management.
Gering (1999), mentioned that Activity-based
costing (ABC) will work best with a minimum
amount of detail and estimated cost figures. This
means that companies in Malaysia wanting to
change to Activity-based costing (ABC) needed to
the appointment of a designer to come out with
more precise measurement tools if more accurate
costs are needed.
Stapleton et.al (2004), indicated that the costs of
finding true costs overshadowed the benefits of
finding true costs.
These findings were later confirmed by Charles
and Hansen (2008). Even though Activity-based
costing (ABC) often provided better product cost
than traditional volume-based systems, it still had
some limitations (Evans and Ashworth, 1995).
First and foremost, Activity-based costing (ABC)
systems were found to be expensive to use. In
Malaysia the increased cost of identifying
multiple activities and applying large amounts of
cost drivers deterred many organizations from
using Activity-based costing (ABC).
According to Qian and Ben-Arieh (2008) is
Activity-based costing (ABC) is more accurate
cost-estimation method. They argued that
Activity-based costing (ABC) helped managers to
become aware of original parameters that created
demands on indirect and keep up resources which
can identify and remove non-value adding
activities. Also illustrated that Activity-based
costing (ABC) approach had demonstrated to be
more accurate than the traditional cost estimation.
Singer and Donoso (2008) conducted several test
on the validity of Activity-based costing (ABC)
cost estimation and they concluded that the
accuracy of estimation of costs made by Activity-
based costing (ABC) was valid. Activity-based
costing (ABC) was a more accurate product-
http://www.ijmsbr.com Page 2
ACTIVITY BASED COSTING
METHOD
TRADITIONAL BASED
COSTING
1 Identify & Classify activities 1 Identification of indirect cost
2 Estimate cost for whole activity 2 Estimation of indirect cost
3 Compute a cost driver rate 3 Choose cost drivers
4 Apply activity costs using cost
drivers
4 Estimation of value for cost
drivers
5 Computation of overhead rate
6 Application of overhead rate
Source: Anderson (1995), Shields (1995), Innes and Mitchell (1995), Gosselin (1997),
Foster and Swenson (1997), Malmi (1997), McGowan and Klammer (1997),
Krumweide (1998); Chenhall and Langfield-Smith (1998), Anderson and Young
(1999).
Activity based costing is based on actual
performance, consumption and expense data taken
out from the organization‘s existing information
system and combined with the knowledge of those
directly involved in the distribution of goods and
services. Here the cost is designated to activities
based on the resources they use for processing.
The ABC also provides insights into the starting
place of costs and also the probable outcome of
different decisions by the process managers. Apart
from providing the information required for this
process, it also realizes performances
breakthrough.
In Traditional costing, there is a certain amount of
estimation in cost allocation. The cost systems do
not focus on why or where cost occurred.
Generally, there is little insight into the causes of
variances. The reporting methodology is
accounting –oriented, inaccurate, not flexible and
often not timely. The operational managers often
cannot understand since it is very analytical and
does not relate to the cost of a product or services
applied.
Advantages of Activity based costing and
Traditional based costing.
Kingcott (1991) advised that if the costs of
Activity-based costing (ABC) exceeded the
benefits, company should not apply Activity-
based costing (ABC) systems. If so, the capital
expenditure on the activity based system and its
subsequent running costs can be a road block for
firms.
Johns, Evans and Ashworth (1995), indicated that
the question that lingers in our minds is why those
companies even now implement traditional
costing instead of Activity-based Costing (ABC)?
It is because the Activity-based Costing (ABC)
has it pros and cons.
Gunasekaran, (1999) in Malaysia some
organizations that have changed to the Activity-
based Costing (ABC) system since as far back as
1980 as the system had proven its usability in the
appropriate product mix decision and overheads
management.
Gering (1999), mentioned that Activity-based
costing (ABC) will work best with a minimum
amount of detail and estimated cost figures. This
means that companies in Malaysia wanting to
change to Activity-based costing (ABC) needed to
the appointment of a designer to come out with
more precise measurement tools if more accurate
costs are needed.
Stapleton et.al (2004), indicated that the costs of
finding true costs overshadowed the benefits of
finding true costs.
These findings were later confirmed by Charles
and Hansen (2008). Even though Activity-based
costing (ABC) often provided better product cost
than traditional volume-based systems, it still had
some limitations (Evans and Ashworth, 1995).
First and foremost, Activity-based costing (ABC)
systems were found to be expensive to use. In
Malaysia the increased cost of identifying
multiple activities and applying large amounts of
cost drivers deterred many organizations from
using Activity-based costing (ABC).
According to Qian and Ben-Arieh (2008) is
Activity-based costing (ABC) is more accurate
cost-estimation method. They argued that
Activity-based costing (ABC) helped managers to
become aware of original parameters that created
demands on indirect and keep up resources which
can identify and remove non-value adding
activities. Also illustrated that Activity-based
costing (ABC) approach had demonstrated to be
more accurate than the traditional cost estimation.
Singer and Donoso (2008) conducted several test
on the validity of Activity-based costing (ABC)
cost estimation and they concluded that the
accuracy of estimation of costs made by Activity-
based costing (ABC) was valid. Activity-based
costing (ABC) was a more accurate product-
Shubham Mishra_JPR
12/11/2018, 11:34:48 AM
International Journal of Management Sciences and Business Research, Mar-2015 ISSN (2226-8235) Vol-4, Issue 3
http://www.ijmsbr.com Page 3
costing system than traditional volume-based
costing systems especially when organizations
were facing higher product diversity.
Disadvantage of Activity Based costing and
Traditional Costing method
The disadvantage of traditional costing systems is
that they do not present nonfinancial information
about Small and Medium Enterprises (SMEs). The
traditional costing systems provided trivial
information regarding the factors that was
significant to the customers like quality and
service. A traditional based costing system
typically uses a single overhead pool that is a
single collection of costs that are not directly
peculiar as product part costs or as labor. This
would comprise of supply and maintenance
expenses, allotment of management salaries,
Depreciation, etc.
However, Cooper and Kaplan, (1991) Activity-
based costing (ABC) had emerged as a
tremendously useful guide to management action
that translated directly into higher profits.
Another disadvantage mentioned by Noreen
(1991) is that Activity based costing (ABC)
implementation provided beneficial results only
under specific conditions.
Datar and Gupta, (1994), indicated that the
disadvantage of Activity-based costing (ABC)
was that it increased the frequency of errors in
product cost measurement through increasing in
number of cost pools and improvement in
specification of cost bases.
Evan and Ashworth (1995) claimed that although
more overhead costs can be allocated straight to
products via ABC’s multiple activity cost pools,
but, some overhead cost remained to be dispensed
with the help of some arbitrary volume based cost
driver like machine or labor hours.
Carolfi (1996) claimed that Activity-based costing
(ABC) allowed managers to get rid of costs
related to non-value added activities and develop
the efficiencies of present development since
Activity-based costing (ABC) offered better
visibility into business development and their cost
drivers.
Another study conducted by McGowan and
Klammer (1997) suggested that many Activity-
based costing (ABC) adopters had abandoned
their implementations and this raised concerns on
the potential impact of Activity-based costing
(ABC) on performance.
Furthermore, Gunasekaran, Marri and Grieve,
(1999) traditional costing systems show that only
financial information while non-financial
information like defect rates and throughput rates
in each activity was beyond the capacity of
traditional costing systems. At first, managers
viewed Activity-based costing (ABC) approach as
a more accurate way of calculating product costs.
According to Dickinson and Lere (2003), one of
the most significant weaknesses of the traditional
costing method is that the cost of a sales
representative’s engaging in non-standard selling
activities is frequently excluded from his/her. Also
has mentioned that in order to comprehend the
potential power of Activity-based costing (ABC)
cost data in pricing, it is important to comprehend
how Activity-based costing (ABC) cost data is
different in contrast to the traditional method. The
attribute of Activity-based costing (ABC) is that it
does not vary with volume; however it may differ
with some other measure of activity. Activity-
based costing (ABC) recognizes that activities
cause cost.
Review of Literature
There are many studies that demonstrate the
benefits of ABC/TC implementation in different
manufacturing/service industries.
Keegan and Eiler, (1994) they stated that, the
increased knowledge of cost drivers has prompted
many companies to reengineer their business
processes by monitoring each of their processes
and then, eliminating (or improving) the processes
which are non-value added.
Evans and Ashworth, (1995), there are many
advantages and disadvantages of Activity-based
costing (ABC) as pointed out in the literature
review. The main disadvantages or limitations of
Activity-based costing (ABC) is that it is
expensive to use.
Andrade, Filho, Maia and Qassim (1997), found
that Activity-based costing (ABC) is being
extensively implemented as an alternative to
traditional costing.
Gunasekaran and Sarhadi (1998) discussed
different issues associated with the
implementation of ABC in manufacturing. They
explained that new productivity and quality
improvement strategies could increase in the
awareness of ABC in present day manufacturing
organizations and an appropriate framework for
the management of productivity and quality.
According to Ray H. Garrison and Eric W.
Noreen, (1999) there are six basic steps required
to implement an ABC system: (A). Identify and
define activities and activity pools, (B). Directly
trace costs to activities (to the extent feasible),
(C). Assign costs to activity cost pools, (D).
http://www.ijmsbr.com Page 3
costing system than traditional volume-based
costing systems especially when organizations
were facing higher product diversity.
Disadvantage of Activity Based costing and
Traditional Costing method
The disadvantage of traditional costing systems is
that they do not present nonfinancial information
about Small and Medium Enterprises (SMEs). The
traditional costing systems provided trivial
information regarding the factors that was
significant to the customers like quality and
service. A traditional based costing system
typically uses a single overhead pool that is a
single collection of costs that are not directly
peculiar as product part costs or as labor. This
would comprise of supply and maintenance
expenses, allotment of management salaries,
Depreciation, etc.
However, Cooper and Kaplan, (1991) Activity-
based costing (ABC) had emerged as a
tremendously useful guide to management action
that translated directly into higher profits.
Another disadvantage mentioned by Noreen
(1991) is that Activity based costing (ABC)
implementation provided beneficial results only
under specific conditions.
Datar and Gupta, (1994), indicated that the
disadvantage of Activity-based costing (ABC)
was that it increased the frequency of errors in
product cost measurement through increasing in
number of cost pools and improvement in
specification of cost bases.
Evan and Ashworth (1995) claimed that although
more overhead costs can be allocated straight to
products via ABC’s multiple activity cost pools,
but, some overhead cost remained to be dispensed
with the help of some arbitrary volume based cost
driver like machine or labor hours.
Carolfi (1996) claimed that Activity-based costing
(ABC) allowed managers to get rid of costs
related to non-value added activities and develop
the efficiencies of present development since
Activity-based costing (ABC) offered better
visibility into business development and their cost
drivers.
Another study conducted by McGowan and
Klammer (1997) suggested that many Activity-
based costing (ABC) adopters had abandoned
their implementations and this raised concerns on
the potential impact of Activity-based costing
(ABC) on performance.
Furthermore, Gunasekaran, Marri and Grieve,
(1999) traditional costing systems show that only
financial information while non-financial
information like defect rates and throughput rates
in each activity was beyond the capacity of
traditional costing systems. At first, managers
viewed Activity-based costing (ABC) approach as
a more accurate way of calculating product costs.
According to Dickinson and Lere (2003), one of
the most significant weaknesses of the traditional
costing method is that the cost of a sales
representative’s engaging in non-standard selling
activities is frequently excluded from his/her. Also
has mentioned that in order to comprehend the
potential power of Activity-based costing (ABC)
cost data in pricing, it is important to comprehend
how Activity-based costing (ABC) cost data is
different in contrast to the traditional method. The
attribute of Activity-based costing (ABC) is that it
does not vary with volume; however it may differ
with some other measure of activity. Activity-
based costing (ABC) recognizes that activities
cause cost.
Review of Literature
There are many studies that demonstrate the
benefits of ABC/TC implementation in different
manufacturing/service industries.
Keegan and Eiler, (1994) they stated that, the
increased knowledge of cost drivers has prompted
many companies to reengineer their business
processes by monitoring each of their processes
and then, eliminating (or improving) the processes
which are non-value added.
Evans and Ashworth, (1995), there are many
advantages and disadvantages of Activity-based
costing (ABC) as pointed out in the literature
review. The main disadvantages or limitations of
Activity-based costing (ABC) is that it is
expensive to use.
Andrade, Filho, Maia and Qassim (1997), found
that Activity-based costing (ABC) is being
extensively implemented as an alternative to
traditional costing.
Gunasekaran and Sarhadi (1998) discussed
different issues associated with the
implementation of ABC in manufacturing. They
explained that new productivity and quality
improvement strategies could increase in the
awareness of ABC in present day manufacturing
organizations and an appropriate framework for
the management of productivity and quality.
According to Ray H. Garrison and Eric W.
Noreen, (1999) there are six basic steps required
to implement an ABC system: (A). Identify and
define activities and activity pools, (B). Directly
trace costs to activities (to the extent feasible),
(C). Assign costs to activity cost pools, (D).
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