Advantages of Activity Based Costing
In modern business environment, the use of traditional costing system is no longer relevance to the company to achieve competitive advantage. Nowadays, Activity Based Costing is considered as one of the effective tools to enhance the ability of the organisation to meet global competition. This had resulted in the change from traditional costing system to an increasingly popular costing system such Activity-Based Costing (ABC).
ABC system has emerged as an alternative to traditional costing system to meet the need for accurate cost information about the products, services, customer and processes.
ABC performs the arithmetic to provide accurate cost information while Activity Based Management (ABM) is focused on using this information obtained from ABC to manage activities in order to improving business (Gunasekaran et al. , 2000). Generally ABC systems enable indirect and support expenses onto each activity. Following by identify the cost drivers to measure the activity used by cost objects and allocate them to cost driver.
In order word, ABC helps the manager to understand about the cost and expense in each production by giving managers a clearer picture of the economics of their operations to managerial decision making at a strategic level (Kaplan and Copper, 1998). Apart from that, in twenty-first century market which is global consumer markets and rapidly changing product technologies have forced global manufacturers to make dramatic changes in their products, markets as well as production strategies.
In order to stay in the global market, organisations are advice to adopt ABC not only produces products at faster rates, but they produce with greater consistency and conformity to quality specifications. Also, ABC system allows the manufacturers to reduce the time between customer order and product delivery which can gives the manufacturer a competitive advantage in improving customer service (Gunasekaran et al. , 1999).
Therefore, it is necessary for organisation to adopt ABC system which can assist managers in identifying the value-added activities which they could further improve to meet customer’s demands and enhancing the product quality and process simplification and efficiency (Marx, 2009). For example, MelCo is the company that implements ABC and gets the benefits from it. MelCo is the only manufacturer of engineering components in Melbourne. Its previous costing system was a conventional costing system where overheads were allocated to products based on labour hour utilised (Sohal and Chung, 1998).
However, management found that implement ABC system in the organisation is seem to be useful because it can assist high level of flexibility and responsiveness that demanded by the marketplace. Besides, ABC system can generate true costing and pricing which automatically give performance measures and product profitability as well as provide a variety of information for management in strategic decision making. Even though it incur high cost, MelCo think that it is worthiness because it provides a tool for management for commercial decision making although it just implement for 12 months (Sohal and Chung, 1998).
Due to the changes of business environment, the company requires to manufacture very wide product range for a large customer base with high quality and innovative products in order to fulfil the demand of the consumer. By implementing ABC in organisation, ABM guides efforts to adapt business strategies to meet competitive pressures as well as to improve business operations. ABC information enables ABM to yield continuous improvement process. By continuous improvement, organisation can yield the maximum profitability as well as improved the customer’s satisfaction (Gunasekaran et al. 2000). Nowadays, customers want products and services that fit their specific needs; they want quality service at affordable price to be right now. However, since traditional costing system is volume-based, inaccurate information will be generated which lead to company make wrong decision (Gunasekaran et al. , 1999). Apart from that, stable product and mass production are no longer valid for today manufacturing system. Thus, manufacturing companies have reduced the implication of traditional cost accounting system by implementing ABC systems.
In contrast to standard costing, ABC can identify value-added and non-value-added activities. To clarify this, all activities should be compared with similar activities in another company or within the organisation in order to perform the best. Hence, benchmarking should be encourages to be carried out for both value-added and non-value added activities because it is a best practice which is mostly used in real-life situation (Gunasekaran et al. , 1999). For example, 100% on time delivery of customer orders is an essential activity.
Apart from that, non-value-added activities such as inspection and material handling can be reduced by using different quality assurance methods and techniques such as total quality management and just in time. With ABC, the company has a better access to decision which related to TQM and JIT (Gunasekaran et al. , 1999). To achieve cost reduction in a strategic way, activity-based costing presents to be more accurate in determining costly activities in order to help companies to better manage those activities.
Unlike the information available under traditional management accounting, ABC systems are capture the significant information among customer orders and provide strategic decision making with the indication of the changes in the customer’s specifications (Lere, 2000). By implementing ABC system, it also can reduce non-value activities as well as cost of their products to compete in today competitive market. Non-value added activities can be eliminated with the implementation of strategies such as total quality management, just in time and business process re-engineering.
Managers should pay more attention to those activities which will incur high cost but does not add any value to the product. Besides, managers prepared with the ABC systems were able to reduce overall costs, identify the opportunities for continuous improvement of the products. Nowadays, technology plays a dominant role of integrating various functional areas. Although the automation in advanced manufacturing environment has reduced the labour component, at the same time overheads have increased (Gunasekaran et al. , 1999).
Therefore, in manufacturing environment, it is necessary for organisation to minimize non-value adding activities to reduce the cost of their products to compete in the market. By implementing ABC system in organisation, it will help to reduce direct labour component, increase in overheads as well as productivity of knowledge workers. Apart from that, ABC also helps organisation in better communications and team working environment as well as reduce time required to perform an activities due to knowledge workers and re-engineering the suggestions by employees to reduce the non-value activities (Gunasekaran et al. 1999). In contrast, the traditional costing systems do not provide non-financial information such as defect rates, level of quality about the organisation. However, implementation of activity based costing is not an easy task as there are several difficulties in implementing ABC system. One of the first fundamentals for the success of an ABC implementation is top management support for the project (Zhang and Che, 2010). The failure of ABC projects can generally be attributed to lack of visible and active management.
If the organisation’s senior managers do not show the commitment and act passive in the program, it will negatively reduce the motivation of the employees. Apart from that, the productivity of the employees will also affect as well. Therefore, top management should be give full support with clear understanding of goals and objectives of the whole organisation to the employees. Besides, they should meet regularly in order to advise the management on the strategic and technology business problems (Gunasekaran et al. , 1999).
Commitment of employees is one of the important factors in implementing ABC system. For the successful implementation in ABC, the employees must have a clear understanding of its capabilities, goals and objectives (Zhang and Che, 2010). As a result, education and training are necessary for the employees to make sure that they understand the objective of ABC system. When the employees are well trained and educated, they can easily reduce the time and effort required to perform an activity, on-time delivery as well as reduce the cycle time of the product.
Also, employees should be provide with internal and external company training facilities to ensure them gain latest knowledge and trend in order to maintain company’s standard in today global market (Zhang and Che, 2010). For example, MelCo is a company that implementing ABC system and it found that the problems during implementation was lack of available skills in-house which means that they do not have considerable amount of education and training.
Therefore, MelCo are recommended that training of employees should be taking into consideration (Sohal and Chung, 1998). As a conclusion, the changes of global business environment had changes the way of the company doing the business and shift traditional management accounting to strategic management accounting for cost management in organisations. However, it does not means that traditional management accounting is usefulness and not applicable in today business environment.
Relevance of traditional cost accounting is very subjective in each view of the organisation. It may be suitable for some companies treated standard costing and variance analysis as a tool that enhances planning and control and improves performance evaluation rather than abolished it. To compete in today business environment, strategic management accounting is the most suitable accounting system for the organisation as ABC method can provides more accurate and better cost information which can helps manager to understand and make strategic decision making.
Furthermore, ABC system can eliminate the non-value added activities which added value to the product cost, by doing so, organisation can reduce those unnecessary costs. Thus, ABC system is most appropriate management accounting costing in today business environment. However, there are several problems and difficulties in implementing ABC system, company should take into consideration when implementing ABC in order to maximize the fully benefits for ABC systems.