Is ABC suitable for your company?
- Pages: 6
- Word count: 1430
- Category: Accounting
A limited time offer! Get a custom sample essay written according to your requirements urgent 3h delivery guaranteedOrder Now
Nowadays, we know that activity based costing system assigns overhead costs to products or services products that using a two-stage process, which focuses on activities. ABC is a relatively new and very important topic in managerial accounting. ABC allows us to find a way that we could determine the profitability of every product, profitability of every customer we serve, and the profitability of our process. Contents in brief, first that comparing potential advantages of ABC versus traditional costing methods. The second one that how does management use ABC information in decisions, which consists of weighting and combining the weights of the ten factors and to evaluate implementing ABC.
ABC analysis along two separate dimensions, and there are ten mediating factors can guide management in determining the answers. The first five factors based on the probability, the second dimension of the model seeks to establish decisions. Finally an impartial analysis of ABC operations can tell you yes or no that using contingency analysis model. Interpreting the results: Quadrant 1(both X and Y are positive): it is recommended to use ABC. Quadrant 2 (X-positive, Y-negative): ABC is not recommended.
Quadrant 3 (both X and Y are negative): ABC is not recommended. Quadrant 4 (X-negative, Y-positive) It is possible to implement ABC in long-term. The ten factors discussed above are based on the condition that ABC method is better than traditional method. So it is unfair to traditional one. The management should consider the reality to decide to use the ABC.
Is ABC suitable for your company?
–Using Estrin, Kantor and Albers’ contingency grid,
If an organization’s score puts it in Quadrant three,
Is ABC implementation recommended?
Explain. Is their method “foolproof?”
Many companies are switching to activity-based costing (ABC). ABC is just a new way of allocating overhead costs. ABC that it is not the making of products that directly affects costs. Activities directly affect costs. As activities are created or changed, costs are created or changed. So, Activity-based costing systems focus on activities rather than products, which helps to prevent the distorted product costs that can arise from the use of traditional cost systems based on volume. We know, ABC is a relatively new and very important topic in managerial accounting. It allows us to find a way that we could determine the profitability of every product, profitability of every customer we serve, and the profitability of our process. ABC information that results is more accurate and more useful for decision-making. Managers can see the strategic importance of having highly accurate product cost information.
Potential Advantages of ABC versus traditional costing methods Ttraditional costing methods often lack the degree of precision: 1. It is Not pure or say not objectivity allocates overhead to the cost objects. 2. Overhead is allocated to the products base on volume-based measure. (Eg: labor hrs, machine hrs.) 3. There is the relation between overhead and the volume-based measure. Otherwise ABC method: 1. More accurate cost management methodology 2. Focuses on indirect costs (overhead) 3. Trace rather than allocates each expense category t0particular cost object. 4. Makes indirect expenses direct. Traditional costing methods do not Know what the true cost of their product and service: To determine the true cost for a cost object (product, job, service, or customer), the true cost of product is so important because it can identify moneymakers and money losers, to finding an economic break-even point. In order to discover opportunities for cost improvement, business top need to prepare actualize business plan and improve strategic decision-making.
How does management use ABC information in decisions? This methodology is based on a company’s analysis of itself. It consists of weighting and combining the weights of the ten factors and to evaluate implementing ABC. The potential benefits of ABC can be analyzed in advance along two separate dimensions. And there are ten mediating factors (Pricing Diversity, Support Diversity, Common Processes, Cost Allocation, Growth of Indirect Costs, Pricing Freedom, Fixed Expense Ratio, Strategic Considerations, Cost Reduction Effort, Analysis Frequency) can guide management in determining the answers. The fist five factors (PD, SD, CP, CA, FG) based on the probability. The second dimension of the model seeks to establish decisions.
lY axis potential for ABC due to cost distortion—PD.SD.CP.CA.FG lX axis proclivity to use cost information in decision—PF.FE.SC.CR.AF To start management must analyze and responses to two key questions: 1. For a given organization, is it likely that ABC will produce costs that are significantly different from those that are generated with conventional accounting, and does it seem likely that those costs will be “better”? 2. If information that is considered “better” is generated by the system, will the new information change the dependent decisions made by the management? After finish these questions managers of company can discuses the ten factors that support or reject implementation. Finally, the combined weighted scores are plotted as a point on one of the four quadrants of a graph.Plotting the Answers— Use Contingency Grid Method The steps in the contingency approach to implementing ABC: ABC approach to cost allocation are: score range between -5 —- +5 Contingency Grid: Quadrant 1(both X and Y are positive):
It is recommended to use ABC Quadrant 2 (X-positive, Y-negative): Management is free to utilize product cost information, No direct benefit to implementing ABC, ABC is not recommended. Quadrant 3 (both X and Y are negative): Management has limited ability to utilize or react to modified costs, No direct benefit to implementing ABC, ABC is not recommended. Quadrant 4 (X-negative, Y-positive): Management has little ability to modify cost Implementing ABC has potential benefit, Management should re-examine its use of product cost information and its freedom to react to changes, It is possible to implement ABC in long-term. When we using Estrin,Kantor and Albers’ contingency grid, if an organization’s score puts it in Quadrant three: ABC implementation does not recommend. Because: Reasons of why Y value is negative:1. Lack of product variety2. Indirect costs are assigned little3. Different products have less common process 4. Assigned overhead to period cost allocation5. Rate of growth of period costs is lower Reasons of why X value is negative:
1. Less control of pricing freedom2. Fixed expense ratio is lower3. Lack of strategic considerations4. Short of ability of cost reduction 5. Analysis infrequencyWhile the scoring system is subjective, it is grounded on factors cited in the ABC as being causal in determining the superiority of ABC over traditional costing. ABC method presents a structure for managers to use in their decisions to arrive at some consensus with regard to the degree to which the factors are present in their company and ultimately to convince themselves as to desirability for implementation of ABC. Although ABC method is not powerfully foolproof method, it should help managers by matching the characteristics of their company, its products, and the costing system used with the factors that make ABC most effective. In a word, ABC is more accurate cost management system over traditional cost accounting. Traditional cost accounting is unable to calculate the true cost of a product.
1. Atwater, Brian; Gagne, Margaret L; “The theory of constraints versus contribution margin analysis for product mix decisions “, Journal of Cost Management; Boston; Jan/Feb 1997
2. Umble, M Michael; Umble, Elizabeth J; “How to apply the Theory of Constraints’ five-step process of continuous improvement “, Journal of Cost Management; Boston; Sep/Oct 1998
3. Ruhl, Jack M; “The theory of constraints within a cost management framework “, Journal of Cost Management; Boston; Nov/Dec 1997
4. Robin Cooper; Regine Slagmulder; “Integrating activity-based costing and
the theory of constraints” Management Accounting; New York; Feb 1999
5. Steve Demmy; John Talbott; “Improve internal reporting with ABC and TOC ” Management Accounting; New York; Nov 1998
6. Charles J Coate; Karen J Frey; “Theory of constraints: It doesn’t mean good-bye to variances ” Management Accounting; London; Nov 1998
7. Karen M Kroll; “The theory of constraints revisited” Industry Week; Cleveland; Apr 20, 1998
8. Fawcett, Stanley E.; Pearson, John N.; “Understanding and Applying Constraint Management in Today’s Environment”, Production and Inventory Management Journal; Falls Church; Third Quarter 1991
9. Jan Mouritsen, “Driving growth: Economic Value Added versus Intellectual Capital” Management Accounting Research, 1998,9, 461-482
10. John O’Hanlon & Ken Peansnell, “Wall Street’s contribution to management accounting: the Stern Stewart EVA financial management system” Management Accounting Research, 1998,9,421-444
11. Ronald W. Hilton (fifth Edition) Managerial Accounting, McGraw-Hill Higher Education