Activity-Based Costing (ABC) method

In the current phase of this environment, the ongoing demands on the part of the public has forced the banking institutions to offer them with fresher and beneficial products so that future requirements can be addressed. This is the reason why banking industries have initiated a decision to implement better policies and measures so that the resources can be obtained from the public. Moreover, the banks are concentrating on enhancing their efficacies to function effectively by means of implementing innovative technologies. In relation to activity-based costing (ABC), the present reason behind the cost is tracked prior to overhead allocation has been undertaken by relying on the affair instead of assigning the overheads based on machine hours (Ehlers, 2014). Further, it assists the overhead allocation to its source that can assist the management to track the costs related to a particular item. Nonetheless, it can be witnessed that activity-based costing (ABC) also plays a key role in allowing the management in recognizing the cause behind the increment in the expenses of products. Overall, activity-based costing is very crucial in overcoming the shortfalls of traditional method of costing so that better outcomes can be offered to the organization.

This method is regarded as the best method in the accounting era that can outperform the inefficacies prevalent in the traditional accounting model. Owing to the preciseness and simplicity of ABC in the corporate world, it is considered as the best method. Further, the expenses are assigned to its source based on machine hours. This is the reason why it is considered as a best costing method wherein the organizational activities are recognized and the expenses of every affair are allocated with their respective goods and services based on real consumption by each of them (Larry & Christopher, 2012). Moreover, activity-based costing depends on the principle that every goods and services can be valued and thus, every driver of cost is needed to be assigned to their respective goods and services. The prime purpose behind this approach is to track the ultimate expense related to specific items and services and the reason behind a deterioration and increment in such expenses (Phua et. al, 2011). Further, ABC is an approach wherein the consumption of resources and costing final outcomes are easily tracked. Nevertheless, in comparison to the conventional costing method, ABC allocates additional overheads to the direct expenses.

In relation to the ABC approach, resources are properly allocated to affairs and thereafter, affairs to cost objects relying on their expected consumption. While computing the expenses through the usage of ABC method, there are five relevant points that must be noted. Firstly, it is needed that every resource must be investigated that are consuming such affairs that are implemented to produce services or products by an organization to compute the expenses. The cost function of products and services must accommodate such quantified affairs performed by an organization’s employee (Shield, 2015). Secondly, it is needed that a cost pool must be established so that distinct overheads are easily assigned to their specific affairs. General material, capital, and energy are known to be one of significant resources that are consumed by the affairs. Thirdly, it is required that various cost drivers are recognized that is related to such specific item or service. Further, recognition of cost drivers is vital for corporates because it plays a key role in directly influencing the legitimate expense of the products and services (Horngren, 2011). Nevertheless, the absorption rate of overhead in relation to each pool of cost is computed and determined in the fourth step. Fifthly, the various costs are attributed to their specific items and services considering the absorbed resources during their production.

Characteristics of ABC method

Nonetheless, organizations that are involved in the business of manufacturing must choose such approach while the businesses who are not engaged in manufacturing segments must avoid such tool within their framework. This is because in non-manufacturing corporates, it is problematic to measure or record every single cost that has incurred because of intangibility. Therefore, such organizations must not choose or adopt such method within their framework. In contrast to this, manufacturing companies maintain significant data recording within their processes so that they can enhance and simplify the procedures of recognizing indirect expenses and allocating these to the respective goods and services. Further, traditional methods of accounting are framed when there was production of restricted kind of goods. Costs related to direct labour and direct material were the prime factors that played a benevolent role in such time. When compared to the current phase, the indirect expenses were very less in number. In addition, these costs were often treated in an inappropriate manner that facilitated in making distortion irrelevant in nature.

In the present phase, corporates have been indulging in the production or manufacture of various types of products and services. They incur indirect costs and the same carry primary value and hence, it is not appropriate to segregate such costs based on direct costs. Moreover, significant costing of products and services are extremely important because it assists in eradicating the issues in decision-making in such competitive environment. Besides, traditional approach can only track the costs related to volume and non-volume associated costs are discarded. Costs like set-up, material handling, etc are some costs that are non-volume in nature and are primarily required to track related costs because these cannot be segregated based on volume and can only be conducted by implementing the method of ABC.

This method accounts for every single activity as a major object of cost. Further, it is not cheaper than the conventional costing system as it assists in offering relevant information to the management for the purpose of effective costing. Further, it also assists the management in their decision-making process associated to cost control and other kinds of activities (Parrino et. al, 2012). It also assists in structuring a system of job costing in addition to a process costing approach. Moreover, it paves a path in creating a costing approach that can assist in reducing costs or mitigating unnecessary expenses so that better outcomes can be attained. Further, recognition of affairs wherein expenses are needed to be reduced and controlled is the primary step towards adopting an activity-based costing method (Lanen et. al, 2008). These affairs are thereafter classified into indirect and direct activities. Besides, direct labour and direct material frame or establish the direct affairs whereas indirect activities comprise of manual insertion of various parts, quality testing, legal costs, repairs, maintenance, depreciation of equipments, accounting expenses, utilities, indirect supplies, etc. The second most important step in relation to the same is that every activity is effectively burdened when the overheads are allocated to the activities based on selection of desired base of cost allocation (Marsh, 2009).

Currently in the scenario of immense and diversified competition throughout the world, there is an ongoing requirement for corporates to enhance their goods and services to maintain their firm position in the market and thereafter, address all future liabilities. This necessitates in the requirement of adopting an ABC approach for every corporate that intends to hold such firmness in such competitive environment (Petty et.al, 2012). It is also crucial for organizations to facilitate comparisons of value-added methods at every level with the related costs because it can assist the management in their decision-making process, thereby paving a path for eradicating such affairs that are not needed or considering the affairs that are primarily required or must be added. The method of activity-based costing primarily concentrates on activities and not on a specific department that in turn can assist the management of the organization in their process of decision-making. This signifies the fact that by concentrating on every activity, it has become simpler to segregate all non-value adding activities from the ones that pursue value (Broad & Crowther, 2011). Whenever the department becomes aware of such non-value adding affairs, they can easily facilitate a path for decision-making in relation to eradication or minimization of such activities that can ultimately enhance their overall effectiveness.

Insignificant information of costs can also be changed through the implementation of activity-based costing system. Moreover, in comparison to the traditional approach wherein direct expenses are allocated to the departments, such method can assist in focusing on alignment of indirect expenses to the individual activity (Porter & Norton, 2014). Besides, resources that are absorbed by activities are then determined based on apportioned expenses to such activities (Shim & Siegel, 2009). Nevertheless, activity-based costing approach can emphasize affairs instead of departments on a whole. Further, costs arising from affairs is the major basis by which activity-based costing can be undertaken. Overall, activity-based costing can be utilized to ascertain the interconnection betwixt activities and products by segregating the expenses associated with such activities to the goods.

In relation to this, it must be noted that long-term variable expenses must not be recognized to the products utilizing volume-related drivers of cost owing to their complexity and variety while the short-term variable expenses are needed to be recognized to the goods utilizing such related cost drivers like machine hours, direct material cost, direct labour hours, etc. Further, short-term variable expenses are primarily driven by volume and not variety and complications whereas long-term variable expenses are primarily driven not by volume and variety (Vanderbeck, 2013).

• Value of activity-based costing in competitive pricing decisions

This article has primarily highlighted the significance of activity-based costing in the current competitive environment. Furthermore, based on this article, the effectiveness of same in relation to price-setting primarily in the competitive environment has been focused. Moreover, this modern theory of accounting can play a key role in outperforming the ineffectiveness of traditional costing systems as these can filter irrelevant response on the part of competitors from the process of decision-making on a whole. In addition, this article has also highlighted the fact that activity-based costing can be regarded as an innovative and fresh tool in the enhancement of performance of corporates on a whole.

• Innovation action research

It can be seen from this article that the research of innovation action is the primary reason behind the adoption of activity-based costing in this competitive environment. In other words, this is regarded as a fresh system to help corporates in the adoption of a new viewpoint. In addition, this article also sheds light on the relevance of action research that has played a key role in the establishment of fresh management accounting theories such as activity-based costing, etc. Moreover, based on such article, it can also be noted that action research primarily involves a researcher to establish fresh solutions in an explicit way that can play a key role in transforming the present practice and thereafter, examine the possibilities and properties of the innovation (Vanderbeck, 2013). Further, innovative action research has also concentrated on eradicating the restrictions of traditional cost accounting systems so that a newer concept like activity-based costing can be adopted in such competitive era and thereafter, this method can further be implemented to modify or enhance the newer theories of accounting.

• Value of activity-based costing in competitive pricing decisions

This article has concentrated on the matters associated with the impacts of the design of price-setting and cost system in the competitive markets with the adoption of an activity-based costing. Furthermore, this article has also highlighted the significant benefits of alternative costing approaches for setting of prices in competitive markets. Moreover, in relation to activity-based costing, the same has been considered as a more effective costing approach that pursues a value-enhancing impact on the pricing decisions and profit performance on a whole (Broad & Crowther, 2011). In addition, prior research has been undertaken through this article that plays a benevolent part in suggesting that the cost refinement system can facilitate in setting of prices even in the presence of an informative response on the part of markets. In other words, it has been assessed whether activity-based costing can modify the prices when response from competitors is not very informative. Although the performance has decline because of huge dependence on an uninformative response from markets through the participants, activity-based costing played a major role in reporting a strong efficacy over the biased-information of conventional or traditional costing (Kim, 2008). The primary reason behind this fact can be that activity-based costing has allowed decision-makers to filter out less relevant competitive prices.

• Innovative action research

This article has highlighted a newer innovation theory that has resulted in the introduction of modern accounting theories like activity-based costing.  In addition, the article has highlighted whether such newer and modern accounting theories can be accessed to a widespread target audience of scholars and practitioners with the adoption of innovation action research (Broad & Crowther, 2011). Overall, with the help of innovative action research, the negligence and restrictions of individuals to the theories and practices of activity-based costing has been effectively highlighted. This can pave a path for the termination of loopholes that has prevailed in the current requirements of managers (Kim, 2008). Therefore, with the implementation of an innovation action research, scholars and researchers can enhance and modify the underlying theories and become a professional or experienced implementer of ABC in the current scenario.

Activity-based costing can assist in recognizing and allocating the overheads together with recognizing the labour expenses to every particular activity so that maximum usefulness can be attained. The primary part is to allocate various costs to different activities and thereafter, compute the profitability of customers based on products and services. Further, the outcomes attained through these methods can assist the organization in making a procreate decision so that overall goals can be attained (Kim, 2008). This is the reason why the banks of Australia have adopted the activity-based costing tools within their framework so that maximum effectiveness can be attained through gathering of necessary information.

As per Kim (2008), the method of activity-based costing is primarily not an accounting tool that can facilitate in assisting bankers to understand the various kinds of courses involved in undertaking banking segments but it can also assist in exploring various aspects of the new banking segments too. Moreover, since activity-based costing can assist in assigning various costs to the goods and services, it can help various organizations in such competitive market as well. Besides, in relation to banking industry, they are overburdened with tremendous amount of pressure from the players in the market and costing methods is highly required to be improved so that their market shares can be improved, thereby resulting in the maximization of wealth of shareholders. With such new method in place, banks can not only enhance their overall efficiency but also retain their interest of shareholders, thereby paving a path for generation of huge profits (Broad & Crowther  , 2001). Further, activity-based costing can also assist banks in seeking what products maybe attractive for the customers. It can assist the managers in determining the demand from customers and therefore, enhance the entire decision-making process that can improve the overall organizational profits.

Overall, the new accounting tool of activity-based costing can assist the banking industry and all the small-scale industries in undertaking effective operations. The software is also called as the Fresh Books and the same has been utilized by more than five million people around the world (Broad & Crowther ,2001). Nevertheless, with the help of such software, invoicing and tracking of transactions have become a lot easier than it was.

The first article has primarily highlighted the significance of activity-based costing in relation to pricing of decisions in the competitive markets. It has also reflected the inefficacies that prevail in contemporary costing systems that is more biased when it comes to presence of informative response in the markets (Kim, 2008). Further, the article has disclosed that in situations wherein activity-based costing has generated accounting losses, the contemporary or conventional systems have always portrayed a negative outcome that is biased on a whole (Kim, 2008). Nevertheless, adoption of activity-based costing can result in poor performance but it also assists in providing a diagnostic solution on specific activities where managers can determine the reason for losses in their enterprise (Needles & Powers, 2013).

In contrast to this, innovative action research sheds light on the fact that activity-based costing has been introduced as a newer theory in the accounting world that has outperformed the drawbacks of traditional accounting methods. In addition, such research has allowed practitioners and scholars to indulge in allowing companies to implement a new ideology. Moreover, through such engagement, they can not only advocate themselves about the idea but also the scenarios for efficient adoption of activity-based costing in organizations (Broad & Crowther ,2001). Overall, innovative action research has allowed scholars to function with client organizations to enhance and supervise emerging tools like activity-based costing in maximization of financial performance of companies.

Conclusion

Activity-based costing has emerged as an effective tool in the competitive era that can outperform the inefficacies of traditional costing. It can not only facilitate in allocation of overheads with the various goods and services but also allow corporates in attainment of organizational goals. Moreover, when it comes to non-manufacturing organizations, this method cannot be useful for them because proper information cannot be reflected through this tool. Therefore, only manufacturing companies can attain maximum usefulness from the adoption of such measure. Furthermore, there are various issues that have been asserted by critics in relation to implementation of activity-based costing in the organizational world but researchers and studies have highlighted the fact that such method can assist in outperforming other tools because the outcomes granted by it are more beneficial and accurate. Therefore, activity-based costing must be duly considered by companies in the modern scenario so that maximum usefulness can be attained.

References

Broad, M., & Crowther, D. (2001). Activity based costing in universities – an inappropriate technique? Journal of Applied Accounting Research, 6(2), 55-89. Available from:  https://search.proquest.com/docview/1031187247?accountid=30552 [Accessed 22 September 2018]

Ehlers, T. (2014) Understanding the Challenges for Infrastructure Finance.  BIS Working Papers, No 454, BIS, Basel.

Horngren, C. (2011). Cost accounting. Frenchs Forest, N.S.W.: Pearson Australia.

Kim, L.S. (2008) Activity based costing in universities – An inappropriate technique?. Accounting, Auditing & Accountability Journal. 21(2), 204-228.DOI:10.1108/09513570810854400

Lanen, W. N., Anderson, S & Maher, M. W (2008) Fundamentals of cost accounting. NY: Hang Loose press.

Larry M. W & Christopher J. S. (2012) Managerial and Cost Accounting. Pearson Press

Marsh, C. (2009) Mastering financial management. Harlow: Financial Times Prentice Hall.

Needles, B.E. &  Powers, M. (2013) Principles of Financial Accounting. Financial Accounting Series: Cengage Learning.

Parrino, R, Kidwell, D. and Bates, T. (2012) Fundamentals of corporate finance. Hoboken, NJ: Wiley

Petty, J. W, Titman, S., Keown, A. J., Martin, J. D., Burrow, M. and Nguyen, H. (2012) Financial Management: Principles and Applications, 6th ed. Australia: Pearson Education Australia.

Phua, Y. S., M. A. Abernethy, and A. M. Lillis. (2011) Controls as exit barriers in multiperiod outsourcing arrangements. The Accounting Review. [online].  86, p. 1795–1834. [22 September 2018]

Porter, G. and  Norton, C. (2014) Financial Accounting: The Impact on Decision Maker. Texas: Cengage Learning

Shield, M.D. (2015). Established Management Accounting Knowledge.  Journal of Management Accounting research. 27(1), 123-132. DOI: 10.2308/jmar-51057

Shim, J. K & Siegel, J G. (2009) Modern Cost Management and Analysis. Barron’s Education Series

Vanderbeck, E J. (2013)  Principles of Cost Accounting. Oxford university press

In Week 9 (Friday, 11.30 pm) submit through the Assessment Dropbox on VU Collaborate the following documents in separate files:

• Assignment cover sheet (signed Declaration);

• Questionnaire

• Brief report.