HI5017 Managerial Accounting: Activity Based Costing Analysis

This report provides an analysis of activity-based costing (ABC) within the context of managerial accounting. It explores the application of ABC in both small and large organizations for channel selection, cost reduction, and value chain activity allocation. The report includes a discussion of two research articles focusing on ABC, examining their similarities, dissimilarities, and specific outcomes. It covers the advantages and disadvantages of ABC, including challenges related to performance measurement, implementation costs, and data accuracy. Furthermore, the report delves into time-driven activity-based costing as an advanced technique to address the limitations of traditional ABC. The analysis culminates in a conclusion and recommendations emphasizing the importance of ABC for businesses.

Managerial
Accounting
Assignment

1
By student name
Professor
University
Date: 30th Sep, 2018.
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Executive Summary
The report discusses about the use of activity based costing by small and big
organizations for selecting the right channel, reducing the costs and the allocation of the same to
the different activities of the value chain. Two research articles on the concept of ABC costing
has been selected and analyzed. Finally, conclusion and recommendations on the importance of
activity based costing for the business environment is given.
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Contents
Executive Summary.....................................................................................................................................2
Introduction.................................................................................................................................................4
Discussion on the selected journals.............................................................................................................6
Analysis and Explanation of the Journal articles..........................................................................................7
Purpose of the Selected Journals and the Proposed research questions....................................................7
Similarities between the two articles........................................................................................................10
Major dissimilarities between the two articles -.......................................................................................11
Specific Outcomes from the research articles...........................................................................................11
Conclusion.................................................................................................................................................13
References.................................................................................................................................................14
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Introduction
The report highlights the growth of activity based costing over the years. Analysis of 2
different research projects is done in the project based on similarities, differences and research
methodology of both the projects. There is high cost reduction pressure over the companies due
to the existing of perfectly competitive market and competitive pricing which can be resolved
through activity based costing. The advantages and disadvantages of activity based costing are
discussed thoroughly in this project along with solutions for the removal of the later. Activity
based costing is the process of allocation of indirect costs to different processes. The costs are
directly allocated to the processes in the ratio of sales of the company making the technique
relatively easy. This allocation is done based on a suitable cost driver. As per activity based
costing method, the total cost is allocated to different activities which are further assigned to
different cost centers based on nature of cost and finally distributed on cost driver’s basis which
helps in dividing the costs and calculate per unit cost of any activity (Awasthi, Omrani, &
Gerber, 2018). A relationship between activity and cost is always established under activity
based costing such as electricity can be distributed based on machine hours and rent based on
space occupied. It helps in allocating costs effectively and efficiently for optimum utilization of
scarce resources available. The costs are generally divided under 3 different categories- the fixed
costs, variable costs and semi variable costs.
Advantages and Disadvantages of Activity Based Costing
There are many advantages of activity based costing which can be listed in the following
manner:
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1. This technique helps in detecting the nonproductive and inefficient repetitive activities
which the company can remove by properly evaluating the same. This in turn will enable the
company to perform its operations more efficiently and reduce the total costs involved in such
operations (Boghossian, 2017). If the company finds outsourcing of these activities cheap, it can
be an alternative option for achievement of the specified goals.
2. In case of manufacturing and service industry this technique helps in accurate pricing of
the products by allocating the costs to the activities to which it belongs thus preventing allocation
of lower costs to some products and higher costs for other products. This makes product wise
profitability analysis of the company difficult for the management.
3. The company can estimate the manufacturing overheads that the company can reduce to
increase the profitability by calculating the correct profit margins through activity based costing.
4. For different products of the company this method provides the standard key for correct
costing along with time driven costing. Both these methods were formulated to provide correct
and accurate cost allocation and the logic for each allocation.
Activity based costing techniques has many demerits involved in it which are very harmful for
the organization. These demerits are as follows:
1. Under activity based costing the performance of the managers cannot be linked to its
results because it may result in something which is drastically different from that which can be
determined under traditional based costing. This difference or irregularity may lead to conflict
between both the parties (Dan, 1995).
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2. This type of costing will lead to additional investment of funds and requires extra time
since it is not a standardized process and not in line with the Generally Accepted Accounting
Principles (GAAP). So there arises a need to prepare a separate cost report by the company
which are prepared as per the guidelines of the Generally Accepted Accounting Principles
(GAAP).
3. Due to the involvement of huge costs and expert knowledge required for the process of
activity based costing this method is not very popular among the small companies as
implementation of this process is very difficult for them. In these small companies the number of
products is much less. So, the cost heads and cost base is also very low. Due to this the
difference between the results as per traditional costing and ABC costing is not very high. So,
implementation of ABC costing will not make any impact on the profitability of the company
(Eddy, Filip,R, & Warlop, 2004).
4. If the data entered ABC costing is incorrect or inaccurate and proper time is not allotted
for this method, ABC costing will remain useless for the company. Therefore, execution of this
method involves correct data base, proper results and a lot of time.
5. A person must have in-depth knowledge of the nature of the company along with its
methods of operations. He should be expert in costing terms such as the cost pools, cost drivers,
allocation logic etc. for the execution of activity based costing in the organization. So, we can
say that it is one of the most necessary conditions for implementation of the same.
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Discussion on the selected journals.
In this assignment two journals have been selected that highlights the different aspects
that are related to ABC costing. In this assignment few similarities and dissimilarities between
the two journals and their specific outcomes has been discussed. The two journals that have been
selected are The Measurement and Management of Unused Capacity in a Time Driven Activity
Based Costing System” by Veii’s Naci Tanis and Hasan Özyapici (Naci & Hasan, 2012) and
“The Value of Activity-Based Costing in Competitive Pricing Decisions” by Eddy Cardinals;
Filip Roodhooft, and Warlop Luk. All the analysis conclusion and recommendations are based
on the given journals for the company (Eddy, Filip,R, & Warlop, 2004).
Analysis and Explanation of the Journal articles
The first journals highlight the importance of activity based costing for allocation of the cost
especially in manufacturing industries and that is driven by various factors. But when activity
based costing cannot be applied or it fails than the companies opt for more advanced technique
of costing that is known as the Time driven activity based costing which is said to be the best
ways for the allocation of the given cost for the companies. This has been discussed in the
second journal article that has been selected.
Purpose of the Selected Journals and the Proposed research questions
The first case study aims to determine the importance of ABC Costing techniques in
manufacturing industries. It states how ABC Costing can be used to determine the prices when
there is no proper information available to the companies. There is a lot of competition in the
market also it can be seen that the pricing of the products become difficult because no proper
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information is available in the market (mejia, Tosi, & Hinkin, 2017). In cases where traditional
method of costing is used the prices that are calculated based on that are almost wrong and not
accurate and hence companies need such techniques which can overcomes these challenges. The
pricing methods and the base data when coupled with the market feedback gave the correct
information only when there was no direct competition between the two. During this period the
ABC costing was analyzed and it was found there were two assumptions that were considered
which included that the ABC Costing gave more accurate results when the information from the
market was more informative and less uninformative and the second assumption was that the
outcomes from ABC costing was more better than traditional costing methods when the data was
more informative (Werner, 2017).
To test this a test was conducted where 131 management graduates and costing students where
asked to allocate cost based on the techniques of ABC Costing and traditional costing. From the
results that were accumulated it was found that there was minimum relationship between the
market conditions and the pricing decisions and it was found that in competitive market
conditions the companies have limited information about their competitors and hence it was not a
driving force that entities need to recon with and thus the second assumption was not correct.
The following research questions can be stated?
 How is ABC Costing method better than the traditional system of costing and what are
the areas in which they need to improve based on that?
 How are the market information plays an important role in pricing decisions of company
and if they hold significance in the advanced form of costing?
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The second journal article states how companies can overcome the limitations that are there in
case of activity based costing and where they can make effective use of their unutilized
capacities so that there is better efficiency and effectiveness in operations. The answer to such
kind of scenario is time driven activity based costing (Sithole, Chandler, Abeysekera, & Paas,
2017). Most of the companies are working 24hrs in day and thus it gets very difficult to judge the
unused capacities for the companies so to solve this problem there are two types of capacities
that are known as compulsory and real unused capacities. In this paper the author aims to show
how the inefficiency in ABC costing can be reduced if it is adopted based on the time driven
capacity technique. In this case the employees are allocated to the productive areas based on shift
rather than on unused capacities. Also, there are other drawbacks in case of ABC costing like the
selection of the cost drivers for every department and that was very difficult as not all companies
were having same drivers and this process was different for different companies and so we see
that there was no level of uniformity that should have been there (Meroño-Cerdán, Lopez-
Nicolas, & Molina-Castillo, 2017).
Time driven activity based costing can be descried as a better version of the ABC Costing where
the management need to aware of the total resources they might need to complete a given
activity for the company. There are two parameters in this type of costing which are the cost per
unit of the resources and the number of resources that might be required by each activity. It helps
in giving better results that are based more on logic and are somewhat accurate (Covaleski,
Evans, Luft, & Shields, 2003). The companies can conduct surveys within the organizations to
understand what are the specific requirements of the units are for each activity and this can be
done by asking the employees who work on such activity.
The research questions that can be proposed from this kind of study are-
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1. How is time driven activity based costing better than the activity based costing and what
are the parameters based on which the companies should judge the effectiveness of the
both?
2. How can companies adopt time driven activity based costing in their operations and what
are the factors that they need to keep in mind?
Thus, we see that both the articles are based on the different aspects of activity based costing and
speaks about ways companies can improve the drawbacks from the traditional costing and get the
most accurate results when it comes to cost allocation and pricing decisions. A few similarities
and dissimilarities between the two articles have been stated below for analysis (Grundy, Held,
& Bero, 2017).
Similarities between the two articles
There were many similarities between the two case studies out of which some are stated below:
 Both the articles highlight the need for better costing techniques so that companies can
make better allocation of the cost and the overall pricing decision of the company is also
accurate. They tend to sort the various problems that companies might have with respect
to allocation of cost and how they can find the correct cost drivers and that can help them
in better allocation of the bases. Both the theories helped in making the overall pricing
more accurate and reduced the stress over the competitive market in general.
 Both the articles are highlighting the needs for better time management and cost
management for the companies. In case of traditional system of costing there were lot of
issues present in the ways the management used to allocate the cost and thus better
techniques like ABC was developed and now it can be seen that ABC is having its share
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of disadvantages and to overcome that the TDABC was developed by the company so we
see that change and updating is happening every now and then and companies need to be
sure on how they are allocating and adapting it (Jefferson, 2017).
Major dissimilarities between the two articles -
 The first article talks about the importance and the parameters that can be associated with
activity based costing and the drawbacks of the traditional system of costing is
highlighted. It reflects lights on the important parameters that important for better
allocation of cost as per the ABC Costing method. The second article highlights the
drawback of the ABC costing and state ways on how companies can improve their
position and adopt better costing techniques like the Tome Driven Activity based costing
that has all the important elements that ABC lacks and that which can help in better
allocation of cost in all ways (Kusolpalalert, 2018).
 The first article is based on the concept of selection of appropriate measures that can help
in better cost allocation, it aims to highlights the issues that are associated with selection
of a proper cost driver. On the other hand, in case of the second article it highlights the
need of better time management rather than better resource allocation so that the
unutilized capacities cannot be left vacant and are used and thus help in improving the
overall efficiency of the process.
Both the studies have their share of advantages and disadvantages and it depends on the
management of the company on how they utilize the same for their benefit.
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Specific Outcomes from the research articles.
1. The first research article highlights the importance of activity based costing and the
importance of proper resource allocation and cost base without which there might be
chances that the results of pricing decisions are not accurate. It also highlights how
activity based costing can be better than traditional system of costing and it also
encourages managers to follow such type of costing technique which is far more efficient.
2. The second outcomes from the first article can be stated as that it establishes the fact that
market information is very limited and thus in perfectly competitive scenarios it won’t be
possible for the companies to get correct information about their competitors, hence in
that case we see that cost allocation based on cost drivers is a better way. It can also be
seen that when traditional system of pricing is used it is often possible that the prices are
not correct or optimal and hence the need arises that optimal pricing techniques should be
used so that the revenue is not hampered and that is possible only in the case of ABC
method (Egelund-Mu¨ller, Elsman, Henglein, & Ross, 2017).
The analysis of the second research paper lead to the following outcomes and learnings
1. The shifting of manpower to different productive areas and effective utilisation of
minimum resources was the main focus of this second research paper. It focuses on the need of
effective utilisation of capacity by better allocation of resources by making the employees work
on shift basis.The defects of the traditional based costing and the volume based cost allocation
methods is removed through the concept of activity based costing which helps the companies to
identify the possible output by determining the practical and effective capacity of the machines.
3. The inefficient processes and activities of the company is also highlighted through this
research paper along with the methods by use of which the company will be able to remove them
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resulting in the increase in overall efficiency of the operations of the company.With respect to
the allocation keys, activity based costing leads to a standardisation of the companies by the
refinement of the traditional costing system. Through this the comparability of data increases.
Thus through this technique estimation and forecast of the future becomes very easy for the
company.
Conclusion
Based on the overall analysis it can be said that both the articles have highlighted the
need for good costing technique very properly, along with major focus on areas like better
resource allocation, cost budgeting, allocation based on other factors like the capacity available,
the market information that is available. In all cases the primary aim of the management is to
make sure that their pricing policy is correct in par with the market trends and their overall profit
is not affected because of that. So we see that there are many costing techniques and methods
and it entirely depends on the companies which method they want to apply but proper analysis
should be done and based on the overall requirement of the company, the process should be
selected and proper disclosure also should be given.
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References
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Dan, S. (1995). The benefits of activity-based cost management to the manufacturing industry. Journal
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Kusolpalalert, A. (2018). The relationships of financial assets in financial markets during recovery period
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mejia, L., Tosi, H., & Hinkin, T. (2017). Managerial Control, Performance, and Executive Compensation.
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