HI5017 - Managerial Accounting Assignment 1: ABC Costing Analysis

This report, submitted for HI5017 Managerial Accounting, analyzes Activity Based Costing (ABC) using two selected journal articles. It begins with an executive summary, table of contents, and introduction to ABC, contrasting it with traditional costing methods. The report details the advantages and disadvantages of ABC, followed by an explanation of the selected journals and their research questions. It explores similarities and differences between the journals, including specific outcomes and findings related to ABC's impact on pricing decisions, unused capacity measurement, and the importance of cost drivers. The analysis covers the application of ABC in various business scenarios, its role in decision-making, and the challenges associated with its implementation, such as the complexity of identifying cost drivers. The report also addresses the relevance of market factors and the importance of focusing on cost drivers for effective pricing strategies, concluding with a comprehensive reference list.

Managerial
Accounting
Assignment

1
By student name
Professor
University
Date: 20 the Sep 2018.
Executive Summary
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For this assignment two articles have been selected and analysed based on the concept of activity
based costing. There are various kinds of activity based methods that are there and companies
can follow whichever they want to find most suitable. These journal articles have been written by
approved sources and they have analysed and presented the various aspects of the different kind
of costing.
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Table of Contents
Introduction:...............................................................................................................................................4
Advantages Associated with ABC costing technique:..................................................................................5
Disadvantages associated with ABC method:..............................................................................................6
Selection of Relevant Journals:....................................................................................................................7
Brief explanation about the topics selected:...............................................................................................8
Purpose of the studies carried out in the journal and research Questions to be explored:........................8
Similarities between the two journals:......................................................................................................11
Differences between the two study papers:..............................................................................................12
Specific outcomes from the two study:.....................................................................................................13
References.................................................................................................................................................14
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Introduction:
There was always a look out to move ahead from the more conventional methods of indirect
costs and overhead allocation to a method that would provide more rational allocation based on
incidence of costs that are attributable to a function or activity. Hence, Activity based costing
emerged from that necessity. Under this technique overheads are allocating to specific items that
are incurring that cost because of using it. The general presumption used in conventional
methods of costing include allocating direct cost to specific activities and indirect costs are
allocated to the product. In ABC method there is a departure from this system of allocation. Each
type of work is treated as a cost driver and the entire costs related to that cost driver are
accumulated there. This is then allocated to specific cost centres depending on how much of the
usage of those cost drivers were done by the them. This ushers in a more transparent and logical
allocation of overhead costs and a true picture of the cost structure to the management aiding
them in better planning (Andiola, et al., 2018).
The cost drivers used in ABC system are simply a basis of allocating costs. Their frequency
determines the quantum of costs to be allocated. There are two main attributes related to cost
drivers that are considered in allocating costs. These are sub-divided into drivers called Duration
driver and Transaction driver (Appelbaum, et al., 2018). Duration driver records the time spent
on each driver and Transaction driver gives information on the number of transactions that occur.
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The frequency and quantum of both the drivers are directly proportional to the costs incurred on
them.
Advantages Associated with ABC costing technique:
Below are enlisted some of the advantages that Activity based costing possesses:
1) It becomes more logical to assign costs to a product or service in a more efficient and
reliable manner using ABC. Here it becomes necessary to understand that the costs are
driven by activities and not products. This becomes particularly helpful when the entity is
a conglomerate and has diversified operations, services and products.
2) For entities that operate in service industries such as healthcare, hotels and resorts,
entertainment industry, financial services, etc. have a better analysis of overhead
expenses the conventional methods of allocation in this sector fails to provide the correct
picture of the cost position (Bumgarner & Vasarhelyi, 2018).
3) When it comes to decision making on the to control or manage costs, ABC is of immense
help. The known drivers can be managed in a controlled manner and the avenues to plug
on or target areas can be easily identified and acted upon.
4) When one knows what are the nature of each type of cost driver, it is easier to decide if it
can be associated with a product or service associated with the given the nature of such
costs to the type of product or service.
5) A division or unit of a business which uses the driver can be tracked. Thus, the method
provides a tracking mechanism for identifying who is the ultimate user. Since the cost
centers get identified, the allocation becomes easier and more transparent (Fukukawa &
Mock, 2011).
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6) ABC ensures identification of areas that have spare capacity. This done as the
methodologies used result in pooling of cost to various activities. This in turn has a
positive impact on resource utilization which ultimately boosts the profitability of the
enterprise. . Redundant activities can be highlighted and their performance can be
tracked. The management can take a call on those sections whether to abandon them or
carry out some sort of restructuring to revamp them. Losses could be controlled by doing
so.
Disadvantages associated with ABC method:
ABC has a few downsides attached to it just like any other methods. Some of them are
enumerated as under:
1) ABC are not that beneficial for smaller companies as they for the larger ones. Initial
implementation of resources requires ample amount of investment, manpower and
commitment from the senior management which may not be always economically
feasible for them to undergo (Garon, 2018).
2) ABC is useful for companies that follow a pricing strategy of cost plus. For companies
whose are compelled to follow the market price approach due to conditions prevailing in
their industry will gain nothing out of ABC implementation.
3) Doubts may arise in the initial phase of the use of ABC as there are possibilities that the
results obtained from them would vary with the results the entity might already be having
out of the use of conventional methods. The management may find it hard to base their
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decision on the result obtained from ABC and these results are likely to create some sort
of confusion in evaluation of manager’s performances in relation to the division they
oversee.
4) There are complexities involved in ABC is ascertaining the cost drivers and the cost
pools involved. The decision making on their identification will involve substantial
amount of time as well as technical knowledge to correctly ascertain it. The entities might
not have their staff equipped to do it. This might create a logjam in the implementation in
the initial phase itself. Any negligence on this front could render the whole exercise
futile.
5) ABC requires complete implementation across all spectrums of the organization for it to
show good results. This might become logistically to put on ground as there strain the
resources of the organization and effect normal operations (Heminway, 2017).
6) ABC is computation extensive in nature. This means that there are a host of calculation to
be done for cost pools and drivers which require a certain degree of arithmetical accuracy
as well. Any deviation might lead to producing incorrect results.
Selection of Relevant Journals:
For the study we have shortlisted two journals. The first one is written by three authors
namely Warlop Luk, Eddy Cardinal and Filip Roodhooft. The article is titled “The Value of
Activity Based Costing in Competitive Pricing Decision”. The other article in this discussion
is written and presented by Hasan Ozyapici and Veyis Naci Tanis. The article goes by the
title “The measurement and management of unused capacity in a time driven Activity Based
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Costing System”. Both the articles touch upon various aspects of ABC system and carry
certain sets of similarities and differences in perception and opinion.
Brief explanation about the topics selected:
The journals give a sneak peak into the impact that ABC has on the business models
worldwide both good and bad. One of the article considers the pricing prevalent in the
manufacturing sector which it terms to be highly elastic to demand. The article compares
ABC system along with other methodologies which are also in practice (Kachelmeier, et al.,
2018). Both the articles enumerate more of positive sides of the method stating how the
method facilitates decision making by the management and saving of time and resources by
eliminating redundant or nonproductive issues. A more transparent and vibrant analysis is
portrayed which ensures a more effective decision making (Covaleski, et al., 2003).
Purpose of the studies carried out in the journal and research Questions
to be explored:
In the current business scenario, it has become increasing difficult to analyze only based on
financial information as there are a host of data available on from other sources such as
market review reports, customer feedbacks, etc. The significance of this method seems to be
more critical in aspects where relevant information to compare data is lacking or not
available. Due to large number of players involved in any given business segment at any
point in time becomes challenging to set product or service pricing as fixing of prices uses
conventional methods might give flawed results which will severely hamper the sale
potential of a product or service as the cost derived from those means may not give the true
picture and push the prices either too low or high and impact the sales and profitability
(Knechel & Salterio, 2016). A study was conducted in the year 1999 that revealed that
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market factors that influence pricing gave enterprises better choices in pricing. The data was
based on the data obtained from the markets and the benchmarks set by the entities.
However, it would be pertinent to note that there were very few players in the market to
complete. Later, when the number of market players increased the test was conducted again
using similar parameters (Hansen, et al., 2003). The tests results for the both the occasions
were then compared and it turned out that the results were drastically different. It was seen
that in the first case, the hypothesis obtained suggested that the prices and return on the
product were at its peak when the feedback received from the market was positive. It was
exactly the opposite when the feedback was negative. The second hypothesis stated that the
as the number of players in the market increase and there was a greater quantum of data
available in the market, ABC system of costing became more irrelevant. Thus, it can be said
that the methods seemed inappropriate in such circumstances. Some of this could be
attributed to the reason of bias in the opinion of the feedback. To form a constant and a more
conclusive pinion, a decision was taken to conduct one more tests. The involved a total of
131 participants and the whole population of those was divided into two groups. Care was
taken in the selection of those participants (Lessambo, 2018). They were either chartered
accountants or cost and management accounts. In the process, the participants were asked to
participate in the allocation of costs as per the ABC and traditional costing system. Certain
information related to the costs were provided to them. They were also provided details of
the cost drivers in that case which were necessary for ABC allocation. The drivers were
ordering, delivery and software handling. There were certain specific costs also that were
allocated on directly. The outcomes were analyzed for ten different scenarios involving
different time frames so that a direct relationship can be established with the costing and its
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corresponding effect on price. Herein the method revolved around finding out an average of
the initial five results and evaluate it correspondingly with its interface with the view of the
market and accounting view. The method did not yield the desired quality of result and hence
dubbed as unreliable. This meant that the hypothesis in the second test can no longer be
considered correct. The hypothesis suggested that its most likely that either all the
competitor’s operators in a single market or the information on which the evaluation is done
is unreliable or insufficient (Mock, et al., 2018). It concluded that instead of the market
forces, had the focus remained on the cost drivers involved, the pricing would have been
more logical and appropriate and that pricing will remain a competitive one and will yield
profits to the company as well.
The second study raises the issue of measurement of the optimum utilization to identify the
spare capacity whose potential is yet to be in clocked. ABC answers this question.
Identification of unused capacity becomes a challenge in circumstances where the entity’s
production line operates in double shifts. This case can be termed a complex and a help of
two less familiar concepts can be taken in this regard namely, compulsory unused capacity
and real unused capacity (Mubako & O'Donnell, 2018). The names of these two concepts are
self-explanatory in many ways. The primary objective of the research is focused towards is
pushing up the efficiency level of the Activity based costing system and Time driven Activity
based costing. There are clear definitions of the real unused capacity and compulsory unused
capacity in relation to each shift of the process. An allied objective of the activity of research
is to allocate surplus workforce to areas that are underutilized to maximize resource
optimization. Since the dynamics of the functions of businesses have changed it would be
rather prudent to say that conventional and orthodox methods of costing would fail to deliver
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in such scenarios since their applications have lost relevance. The competitive work
environment in which business thrive today made it improbable for conventional methods to
yield fruitful tangible benefits. The research underscores the limitations that ABC system
faces in terms of identification of cost drivers which at times becomes a cumbersome
exercise (Rimmer, 2017).
With time, the ABC method has evolved itself with a few versions that each have certain
special attributes. The latest version bears the addition of time factor. In this version, it is
necessary for the company to first clearly what resources it has at its disposal and then what
optimum mix of those resources would results in achieving the targets set in terms of
production achieved. The necessity for this advanced version came from creating a niche for
the company among its competitors in a tight battle for achieving greater consumer base in
cut throat market. The application of the Time-Based Activity costing revolves two main
factors which are the cost incurred per unit of material or article and the quantity used for the
production. The goal is to ascertain the time required and the resource needed for finishing a
set of actions. The method aims to minimize the impact of other constraints of ABC to boost
productivity (Segal, 2017). The costs are ascertained based on normal possible capacity
rather than an unrealistic full capacity. For any given resource for productions say a machine
there will always be some amount of downtime which could be attributed to several reasons
such as breakdown, scheduled maintenance etc. Hence, total capacity is ignored for the
purposes of computation and rather emphasis is laid down on effective capacity. More
information about this could be gathered from asking question to the right people that’ is the
staff equipped to do the job, seeing the work being performed, etc.
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Similarities between the two journals:
1) Bothe research articles aim to eliminate or at least minimize the inefficiencies associated
with the conventional methods of costing. The studies lay their attention to identification
of redundant or insignificant areas to remove them for becoming a bone of contention and
thereby bringing down cost, time and resources to a reasonable level. This not reduces the
cost burden of the entities but also provides relief to the workers and ensures that their
efficiency is not hot due reasons beyond their control (Sirois, et al., 2018).
2) Both the studies have laid enormous emphasis on the dual factors of time and inputs.
These two factors have been held as critical factors in maintaining a transparent and
reasonable cost structure and better pricing standards. Both them can boost production
and reduce costs of the products.
Differences between the two study papers:
1) Activity based costing aims at eliminating factors that lead to lower efficiency and less
utilization of resources not only in terms of money but also in terms of efforts and time
involved. Optimum price structures are achieved through appropriate allocation of costs
by assigning it to appropriately chosen cost drivers. What TDABC does is it focuses on
significantly reducing the time taken and makes the entire production cycle more smooth
and easy going. The modern companies have begun favoring TDABC over the ABC
system although both the system comes with their own share of advantages and
disadvantages.
2) The first study focuses more on the concepts related to the cost driver and issue ancillary
to it. However, the second study is more inclined towards the time aspect of the process.
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There was certain weakness pointed out in the activity based costing system but those
were undone by the introduction of the time-based version of activity based costing.
Though both the variants of activity based costing have their own share of drawbacks to
some extent, but when the methods are compared to the more conventional methods were
prevalent earlier, this seems more reasonable and appropriate from many aspects can be used
over time with certain modification warranted by time.
Specific outcomes from the two study:
Overall it can be said that the two methodologies discussed above are more beneficial than
not when compared to the previous tools being used. There are a few takeaways from the two
research papers.
Following are the learnings from the first paper:
1) A player who enters certain industry for the first time needs to follow the rules of the
trade set by the other existing players which are well established. This is kind of
disadvantageous for the company. Also, the profits as per the accounting treatment are
being shown at a level lower than the original one. This doesn’t have a good effect
(Axelsen, et al., 2017).
2) The markets are easily influenced by the pricing decisions set by the big players
internally in their respective organizations. This could prove to be detrimental to the
interest of small new players who might be able be able to bear the brunt of low pricing.
Following are the learnings from the second paper:
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1) The method helps in achieving the group’s goal congruence objective of reducing costs
incurred to thereby reducing pricing to boost demand and capture a larger market share.
2) The TDABC system focuses on the practical capacity rather than the real capacity. This
gives a more appropriate picture. However, there are challenges in determining the cost
centers (Bailey, et al., 2017).
References
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Appelbaum, D., Kogan, A. & Vasarhelyi, M., 2018. Analytical procedures in external auditing: A
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Axelsen, M., Green, P. & Ridley, G., 2017. Explaining the information systems auditor role in the public
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