Management Accounting Techniques: ABC Costing and Traditional Systems

This essay critically discusses the varying adoption of management accounting techniques, focusing on Activity-Based Costing (ABC) and traditional costing systems. It examines the reasons behind organizations' preferences, particularly in the context of manufacturing and financial institutions. The essay analyzes the benefits of ABC, such as accurate product costing and better decision-making, and compares it to traditional methods. It highlights the usage of these systems in Ireland and the United Kingdom, noting the prevalence of traditional costing in Ireland and the growing adoption of ABC in the UK, especially within financial institutions. The analysis considers factors like cost allocation, accuracy, and the suitability of each technique for different business environments. The essay concludes by emphasizing the importance of understanding why certain techniques are more widely used and the potential benefits of adopting ABC for improved management accounting practices.

ESSAY TOPIC: “Organisations need to understand why some
management accounting techniques may be more widely used than
others critically discuss”

Contents
INTRODUCTION...........................................................................................................................1
ANALYSIS......................................................................................................................................1
Activity based costing..................................................................................................................1
Activity based costing V/s traditional costing system.................................................................3
Usage of traditional costing system over ABC in Ireland and United Kingdom........................5
CONCLUSION................................................................................................................................7
REFERENCES................................................................................................................................8

INTRODUCTION
Management accounting is a method of developing of management accounting reports with
the help of MA systems which assist in analysing regular activities of an organisation by its
managers (Cooper, 2017). There are various management accounting techniques which assists a
company to analyse and interpret their operational costs. These techniques are used by
organisations according to their suitability and relevance. The aim of this essay is to develop an
understanding against the fact that why some organisations use specific management accounting
techniques over other (Van der Stede, 2017).
In this essay, activity based costing used in Ireland is considered as base which is then
compared to traditional costing system used in Ireland and United Kingdom in manufacturing
industry. These techniques are selected in order to fulfil the aim of understanding the fact why
traditional costing system is used over activity based costing in Ireland and UK after high
efficiency and benefits of ABC costing. In present essay all selected management accounting
techniques are discussed along with comparison between them. Reasons are also identified to
analyse why few management accounting techniques are widely used than others.
ANALYSIS
Activity based costing
As the name suggests, activity based costing is a managerial accounting technique which
traces overhead costs of specific activities and then assigns it to relevant account. This method
assists a manager to allocate the costs to the departments by which these costs have incurred.
ABC technique is based on the process in which management accountant first identifies all the
activities which are conducted by the organisation and then group those activities under certain
heads and departments. After classification, similar activities are assigned to a cost pool
regardless whether these costs are direct or indirect (Dale and Plunkett, 2017). Every cost pool is
known as a single activity cost driver. This method helps an organisation to allocate its expenses
to various jobs and products according to the suitability of the organisations. Unique aspect of
this technique is that it allows an organisation to allocate indirect expenses as well which helps
them in downsizing the resources which are outsourced which ultimately lead to maximum
utilisation of resources. Due to suitability of this method for all the organisations, this method is
more used than other methods. This essay is based on the fact that some management accounting
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techniques are more widely used than others. Organisations operating in business environment
needs to understand why some MA techniques such as ABC costing is more widely used than
other techniques. In order to support this statement, various benefits of ABC are discussed as
follows which will help in ascertaining why this technique is widely used (Zimmerman and
Yahya-Zadeh, 2011).
Accurate product cost is a benefit due to which this technique is widely used by
companies. ABC helps companies to get accuracy and reliability in product cost as it focusses on
cause and effect relationships in the cost occurrence. This costing system helps in ascertaining
accurate product and job costs as this method is based on the procedure of dividing all the costs
into classified cost pools due to which whether a cost is direct or indirect it will be allocated to
its cause product and job due to which accurate costs are determined (van Helden and Uddin,
2016).
There are various management accounting techniques which helps in ascertaining the costs
of product which are produced. But ABC also helps in ascertaining the behaviour of that costs.
Every costs which is incurred by organisations has its own behaviour such as direct, indirect,
fixed, variable etc. It is important to ascertain the behaviour of that costs so that they can
allocated properly to their products. Identifying the behaviour of costs also helps managers as
they can be able to control overheads according to its features. For instance, if a cost is fixed then
an understanding must be build that those costs cannot be eliminated at all. But if a cost is
variable then managers can make efforts to reduce that costs limited to few units. Other than this,
better decision making is also a benefit of ABC which helps managers to utilise reliable data of
product costs against which they make decisions regarding pricing of that product which
involves costs which incurred and relevant profit margin. For example: An Irish company
manufactures toys and in order to ascertain total costs of their toys they use ABC technique. this
technique will help them in determining accurate cost of their toys in which they will add their
profit margin and then sell on relevant prices by which all the parties involved such as company
and consumers will get benefitted (Kaplan and Atkinson, 2015).
Activity based costing technique has the major benefit of suitability by which it is not only
advantageous for manufacturing companies, but is also helpful for service organisations. ABC
technique has features which enables to identify cost for each process. This identification helps
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to determine which process incurs highest cost incursion and then that process can be targeted
for review.
From the above benefits of Activity based costing, it can be effectively proved why ABC
technique is widely used by organisation. This costing technique is suitable for all the
organisations. Companies which uses other management accounting techniques because they
belief they are appropriate for them, they should understand why ABC technique is more widely
used by their techniques as ABC is suitable for all type of organisations and this can bring a
uniformity in management accounting reports as well.
Activity based costing V/s traditional costing system
According to research article of Martin Quinn, Otman Elafi and Mark Mulgrew (2017), it
has been found that most organisations in Ireland uses traditional costing system and other
costing techniques and are not ready to change their techniques to a contemporary system which
is Activity based costing. This stubbornness is not due to the disadvantages of ABC technique
but because of the suitability of other techniques to their traditional businesses. This article
provides another aim due to which it is important for such organisations to understand why ABC
costing is more widely used in all over the world and they should also try to indulge ABC in
their management accounting operations. It is understandable that they do not want to change
their traditional costing system and adapt ABC but they must first evaluate both these systems
and then make a rationale decision. To provide evidence to the statement that ABC management
accounting technique is better than traditional costing system or other costing systems various
differences and benefits of ABC over traditional costing is mentioned below:
When it comes to accounting, the most important factor which is taken into consideration
is accuracy. Accuracy is the most essential characteristics of a good accounting system. ABC
management accounting techniques is considered to be more effective and accurate as it takes
important factors into account than traditional costing system (Rikhardsson and Yigitbasioglu,
2018). ABC technique considers non manufacturing expenses by which it is less complicated as
well. Traditional costing system only accounts for expenses which are incurred in production of
goods but ABC technique consider other expenses which are not directly connected to the
manufacturing but are highly related and these expenses are managerial and administrative costs.
Companies in Ireland still considers traditional costing system to be suitable as they have built an
understanding about this system and do not want to change their existing costing methods. These
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businesses are mostly small and medium scale organisations which do not have enough time and
money to train their accountants a new accounting technique (Shingo, 2019). But these
companies must understand that this is an one time investment. Once their accountants are
trained, they do not have to incur any time and money and this system can result in long term
benefits (Otley, 2016).
It is understandable, that in traditional costing system ascertaining the cost of a product is
much easier than ABC but that determination of cost only relies upon the average overhead costs
which means there are high chances of that costs to be not accurate. In this day and age, where
competition is so high, companies need to save every penny and ABC is the way to do it. ABC
technique will allow all the organisations, whether it is a manufacturing or service organisation
to use same kind of management accounting method and that is ABC method. Management
accounting is a system which assist managers of an organisation to take relevant decision for the
operations of the firm. In order to take relevant and suitable decisions, it is important that
manager is aware of all the situations of the company. If the cost incurred by the company is not
accurate then how manager will be able to take these decisions (DRURY, 2013).
Despite of all the differences, there is a similarity between ABC technique and traditional
costing system which is two stage allocation. In both the costing techniques, costs to products or
services are allocated into two stages. These two simple stages make the cost allocation easier.
But the process by which cost is allocated under these two methods are way different which
makes one costing technique which ABC, a much accurate and reliable technique and second
costing technique which is traditional system a lesser accurate method. In case of traditional
costing system, at the first stage, overhead costs are allocated to production departments and at
second stage these overheads are pooled department wise due to which few pools of cost are
created at the end of this process (Kertzer and Brutger, 2016). On the contrary, in case of ABC
technique, all the costs are first allocated to each major activity and then poll of costs are created
at the end of the process for each activity which makes sure all direct and indirect expenses are
taken into account. The major issue with traditional costing system is that it only bifurcates costs
according to few departments that exist in an organisation but organisations need to understand
that there are expenses as well which do not relate to any department due to which ABC is more
widely used than traditional costing system (Maskell, Baggaley and Grasso, 2017).
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Usage of traditional costing system over ABC in Ireland and United Kingdom
Ireland and United Kingdom are two progressive nations which has millions of businesses
running and growing. It is important for such organisations to understand that which
management accounting is to select or not. From the research article of Martin Quinn, Otman
Elafi and Mark Mulgrew (2017), it has been found that in Ireland major organisations are using
traditional costing system but in the case of United Kingdom, businesses are more progressive
which induces them to use ABC costing technique. To better understand this comparison and
relationship, a specific sector is selected which is financial institutions which provides financial
consultancy and other services to their customers. Financial institutions are non manufacturing
bodies, these organisations do not sell any physical property to their customers as they sell their
services which includes financial instruments, advices, consultancy etc. There are numerous
financial institutions in both Ireland and United Kingdom which includes Banks, consultancy
organisations.
Apart from above articles, various other articles are also use which helped in understanding
the scenario of United Kingdom. According to John Innes, Falconer Mitchell, Donald Sinclair
(2019), Most financial institutions of United Kingdom uses ABC costing technique as it helps to
allocate their costs which are incurred into different pools which helps them to ascertain cost
incurred against each customer and each service which is given to those customers. On the other
hand, it is also found that only 5.4% organisations of banking sector and only 8.9% of
consultancy organisations uses ABC costing technique in Ireland. From the research of Quinn
(2019), it was also ascertained that only 18.7% from the total businesses in Ireland uses ABC
technique and other organisations tend to use direct costing system traditional costing system and
other basic management accounting techniques.
It is a known fact, that in terms of business growth and sustainability, United Kingdom is
ahead than Ireland. Where Ireland only has few large companies; UK is a hub for large
organisation in every sector such as retail, financial consultancy etc. Organisations in Ireland
mainly organisations engaged in providing financial services are highly depended upon
traditional costing system due to their traditional outlook to grow their businesses. Majority of
the financial organisations in Ireland are family based businesses which continue to use their old
school methods sue to which their growth rate is low and sustainability is even lower. These
organisations need to understand why all big organisations use ABC costing technique and then
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implement it. From the above articles and by studying overview of UK businesses, it is
ascertained that the major reason behind adopting ABC technique over traditional costing system
was the aim to bring familiarity in management accounting report. There are various boards and
associations which determine specific rules and formats for the preparation of financial accounts
and reports. But certainly, there is no such rule or format to develop management accounting
report. In order to bring familiarity in management accounting reports as well, financial
institutions of UK decided to follow ABC costing technique which will help them to understand
profits and growth rate of their competitors which will ultimately enhance the sustainability.
Management accounting reports are prepared with the intention to assist manager in reliable
decision making but what if manager do not even understand every changing traditional costing
system. So, to assist manager ABC costing technique is important (Quinn, Elafi and Mulgrew,
2017).
From the findings of the research article of Martin Quinn, Otman Elafi and Mark Mulgrew
(2017), it has been found that there are various reasons due to which organisations do not want to
change their existing management accounting system and adopt Activity based costing
technique. The most frequent reason which is found from this article is that organisations are
satisfied with their current method and they do not want to change it as according to them
traditional costing system is suitable for them. 20.6% of the organisations has this reason to not
to adopt ABC, whereas, 15.3% organisations believe that ABC is a time consuming technique
and other organisations has reasons of high cost consumption, stubbornness of senior
management etc. Some of these reasons are genuine but others are just misconceptions of
organisations as ABC costing technique is not a time consuming technique, it is just a multiple
stage technique which consumes same time as any other costing system.
The research article also showcases findings related to financial accountants of organisations
of Ireland who always faces issues due to traditional costing system. These findings represent
that only 3.5% of financial accountants has never faced any issues in assessing accounts due to
traditional costing system. 46.1% has most of the time and 22.0% has always faced issues while
assessing financial and managerial reports due to traditional costing system. Financial
institutions of Ireland are heavily based on traditional costing system even after issues faced by
financial accountants and management accountants.
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United Kingdom is the hub of successful financial institutions whereas Ireland has
successful organisations only in the field of manufacturing. This fact highly provides evidence
due to which organisations must need to understand that why few management accounting
techniques are widely used than other organisations (ABC costing technique in UK, 2015).
Organisations stubbornness has been developed due to their genuine statement that there is no
need to adopt a new management accounting technique when they already have a suitable
technique. But nothing can be concluded before it is tried. These organisations must try ABC
costing once before going through any judgment.
Traditional costing system or method identifies the costs which are indirect and then
estimate the period of their occurrence such as month, quarter or year. After which it selects a
suitable cost driver which usually developed against departments of the organisation. This cost
driver is then estimated for an appropriate period by which a per determined overhead rate is
ascertained. All these estimates can provide an average of costs but cannot provide an accurate
estimate of costs. On the other hand, in case of activity based costing all the costs are allocated to
different activity cost pools due to which each cost is assigned to the activity in which it is
incurred. Financial institutions do not provide services in bulk. Each service provided by these
organisations is different and hence each services is worth of different value. It is not viable for
these companies to allot the costs according to the departments as there are various services
which do not even have involvement of all the departments. Allocating the costs according to the
activities conducted helps financial institutions to ascertain valid costs which are occurred in
each of the service provided by them.
All the above evidences and arguments justifies why organisations need to understand that’s
some management accounting systems such as ABC costing technique are more widely used
than others.
CONCLUSION
From the above essay, it has been concluded that it is important for organisations to
understand that why activity based costing is widely used than traditional costing systems. This
essay summarises benefits and suitability of ABC over traditional costing system which can help
organisations to think over their current management accounting techniques. This essay also
concludes that companies uses traditional costing system as they are used to it now and do not
want to change their techniques just because ABC has more benefits.
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REFERENCES
Books and Journals
Cooper, R., 2017. Target costing and value engineering. Routledge.
Dale, B. G. and Plunkett, J. J., 2017. Quality costing. Routledge.
DRURY, C. M., 2013. Management and cost accounting. Springer.
John, I. and Falconer, M., 2017. The application of activity-based costing in the United
Kingdom's largest financial institutions. Service Industries Journal, 17(1), pp.190-203.
Kaplan, R. S. and Atkinson, A. A., 2015. Advanced management accounting. PHI Learning.
Kertzer, J. D. and Brutger, R., 2016. Decomposing audience costs: Bringing the audience back
into audience cost theory. American Journal of Political Science, 60(1), pp.234-249.
Maskell, B. H., Baggaley, B. and Grasso, L., 2017. Practical lean accounting: a proven system
for measuring and managing the lean enterprise. Productivity Press.
Otley, D., 2016. The contingency theory of management accounting and control: 1980–
2014. Management accounting research, 31, pp.45-62.
Quinn, M., Elafi, O. and Mulgrew, M., 2017. Reasons for not changing to activity-based costing:
a survey of Irish firms. PSU Research Review. 1(1). pp.63-70.
Rikhardsson, P. and Yigitbasioglu, O., 2018. Business intelligence & analytics in management
accounting research: Status and future focus. International Journal of Accounting
Information Systems. 29. pp.37-58.
Shingo, S., 2019. A revolution in manufacturing: the SMED system. Routledge.
Van der Stede, W. A., 2017. “Global” management accounting research: some
reflections. Journal of International Accounting Research. 16(2). pp.1-8.
van Helden, J. and Uddin, S., 2016. Public sector management accounting in emerging
economies: A literature review. Critical Perspectives on Accounting. 41. pp.34-62.
Zimmerman, J. L. and Yahya-Zadeh, M., 2011. Accounting for decision making and
control. Issues in Accounting Education, 26(1), pp.258-259.
Online
ABC costing technique in UK. 2015. [online]. Available through:
<http://eprints.glos.ac.uk/4260/1/Angela%20Lorenz%20s1012378%20PhD%20AL
%20FINAL%20to%20print%20colour%20headings_Redacted%20appendix%201%203rd
%20party%20copyright.pdf>
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