General question: “…To the extent that costs of activities are not, after all, direct costs, there is no reason to suppose that the allocation procedure by which they are determined is more accurate than any other “. (Armstrong, 2002:107)
Critically discuss the idea that ABC is a more accurate costing approach than traditional full (absorption) costing. Present in detail the differences between ABC and traditional full (absorption) costing, and the main advantages and limitations of ABC implementation. Also, explain how the organizational context influences the implementation of ABC as well as its consequences.
Burchell et al. (1980), p.5) discussed the importance of accounting. He mentioned that accounting has become increasingly important in the modern world. What is accounted for shapes the participant’s views of what is actually important? As per Hoskin and Macve, (1988, p.68) this field has been seen as the response of men who are facing any organization and entrepreneurial challenges. The image of accounting is that it is a neutral combination of techniques which objectively and passively represents and records the organizational activity and its results. It justifies the public image of the accounting as the one serving legitimacy to the accountant, and it’s reported accounting information as the neutral arbiter of the company’s truth. The critique of this self-image of accounting compares it with the actual accounting practice and its consequences. One of the attempts was made to analyze it regarding the utilization of accounting knowledge in the production and the reproduction of the system of accountability (Roberts, 1991, p.355).
The system of reporting can be varied for each type of business. While some use process costing for reporting others use activity-based costing. The difference in these costing systems affects the reported costs as well. In a manufacturing plant, defining of units produced and the costs associated with it are fairly easy to identify, in some cases, it is not. It is where Activity-based costing helps. Traditional costing uses few cost pools as compared to activity-based approach. Traditional costing uses financial variables as indirect allocation basis, whereas activity-based costing uses non-financial variables for indirect allocation bases. While the Activity-based costing provides an accurate decision for pricing, it can be very difficult and time-consuming to implement it. Moreover, not all costs are identifiable through activity-based costing as well. Other than this, any wrong allocation can lead to misleading reporting. It also uses certain assumptions like costs are separable and have linear behavior. However, it provides a better reflection of the costs of complex products and enables the company to develop processes which are more efficient. It also enables the managers with the ability to evaluate the costliness of the new products and designs better.
Accounting and costing have historically remained busy in the finding of ways to eliminate waste and efficiency in the resource employment (Miller & O’Leary, 1987, p.240). The analysis of this use of accounting for the accountability systems provides alternative solutions for conceiving the transformation of accounting. The influence of accounting knowledge arises in business from the means it has been institutionalized as trustworthy and makes activity visible. The two systems of a cost that are used by firms for the reporting of activity are the traditional costing and the activity-based costing. These two are different ways for allocating the overhead costs to products. Managers can simultaneously increase profitability by increasing their revenues and decreasing the spending (Green & Welsh, 1991, p.293). Both costing methods estimate the cost of overhead which is related to production and assign it to products as dependent on the driver rate. The main difference is in the accurateness and the difficulty of these techniques. Dyson (2012, p.27) showed that ABC solves the problems of traditional costing.
The absorption or traditional costing is simpler, however less accurate than ABC. The absorption costing allocates the overhead costs relied on the arbitrary mean rate the ABC is more precise and complex as compared to the conventional costing. Taylor (2016, p.18) found that the ABC model is difficult to put into practice because of high costs utilized on survey and interview people for an initial model of ABC. Firms have been experiencing problems in their implementation (Shields, 1995, p.148). In this method, the indirect costs are allocated to the activities and then consequently to the products as relied on the utilization of the activities by-products. It is more accurate because it provides the more precise breakdown of the overhead costs. It is more costly as well. The transition from the traditional costing to the ABC costing is therefore very difficult. On the other hand, the traditional costing system is easier and simpler regarding its implementation as compared to ABC costing. Moreover, the traditional systems result in under or over cost by a considerable amount. Armstrong (2002, p.100) mentioned that the traditional costing considered the indirect costs as a homogenous lump.
The advantages of the ABC costing show that it makes scientific pricing and equitable possible by the reduction in the product prices which consumes fewer resources. Any system needs control. The task of the control system is to maintain activity within the feasible region (Otley & Berry, 1980, p.238). Consequently, the increment in the product prices, which consume more resources, enables it. It also gives the company information about the top-up of the existing product lines as based on the actual cost incurred. It also helps elimination of the unprofitable items from a product portfolio, thereby appreciating profitability without increasing the prices. Moreover, the removal of the cost of maintaining the non-remunerative activities boosts profits as well.
Study by Innes et al. (2000, p.349) conducted on finding out the causes for their lack of obligation to the ABC model has shown some limitations. The limitations of the ABC costing is the method of its implementation is complex, costly, and time-consuming, the data collection and data entry process need resources and offers cost. The too much detail to the big picture makes the firm lose sight of the firm’s biggest picture and strategic objectives in pursuit of the small savings. Furthermore, as Fei and Isa (2010, p.2302) mentioned it is also a disadvantage of the firm that there are some costs which cannot be traced back to the activities like the chief executive salary cannot be divided on a per-product basis. It also fails to account for the hour’s employee spent on first aid awareness programs which can lead to cost leaks.
The currently advanced environments need an increment in better and more accurate costing systems. The volume-based costing leads to distortions in costing information. ABC was launched to deal with the limitations of conventional accounting. It was found that in western areas the main influences on the achievement of the ABC costing included organizational reasons like adequate resources, management support, and training. Chinese firms were found to be affected by the competitive environment. It was found in the study that the process of implementation influences the outcomes of the ABC implementation. Both the outcomes and the process of implementation are influenced by the contextual settlement of the firms. It can be explained by the example that those managers are more likely to support the ABC process when better performance is rewarded (Byrne et al., 2009, p.38).
Therefore, it can be said that on the whole, the process of costing depends on the nature of the business as well. As dependent on the nature of the business, the more beneficial or challenging a costing system becomes (Argyris and Kaplan, 1994, p.83). For example, Anderson and Young (1999, p.525) showed that for a manufacturing business where costs can be traced back to individual activity, the ABC costing is more appropriate to be used. On the other hand, services businesses or businesses which cannot be traced back to individual activity can use the traditional costing system more appropriately.
References:
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Argyris, C. & Kaplan, R., 1994. Implementing new knowledge: The case of activity-based costing. Accounting Horizons, 8(3), pp.83-105.
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Dyson, J.R., 2012. Accounting for non-accounting students. 8th ed. Essex: Pearson Education Limited.
Fei, Z.Y. & Isa, C.R., 2010. Behavioral and organizational variables affecting the success of ABC success in China. African Journal of Business Management, 4(11), pp.2302-2308.
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Innes, J., Mitchell, F. & Sinclair, D., 2000. Activity-based costing in the U.K.’s largest companies: a comparison of 1994 and 1999 survey results. Management Accounting Research, 11(3), pp.349-362.
Miller, P. & O’Leary, T., 1987. Accounting And the Construction of the Governable Person. Accounting, Organizations and Soceity, 12(3), pp.235-265.
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Roberts, J., 1991. The Possibilities of Accountability. Accounting OrganizationsandSociety, 16(4), pp.355-368.
Shields, M.D., 1995. An empirical analysis of firms’ implementation experiences with activity-based costing. Journal of Management Accounting Research, 7(1), pp.148-166.
Taylor, F.W., 2016. The Principles of Scientific Management. Cosimo Classics
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